Introduction
Financial instrument can be defined as any form of contract leading to a financial asset rise on one entity and a subsequent financial liability on another entity or an equity instrument. Financial assets means things like cash, other entities equity instruments, contractual rights to obtain cash or other form of financial asset of other entities, and rights for exchanging financial assets or liabilities with favorable conditions for the entity. On the other hand, financial liabilities involve things like contractual obligation to send cash or other financial assets to other entities, and under the obligation for exchanging financial assets under unfavorable terms for the entity (ANZ annual report, 2010).
The IFRSAASB 9 provides guidelines on recognition and measurement of financial assets within the guidelines of the financial instruments as outlined by IAS/AASB 139. The changes in the accounting standards on financial instruments present significant changes in the way the financial instruments are dealt with (Chattered accountants and business advisors, 2005).The significant changes from the requirements of IAS/AASB 139 include, firstly, the requirement to classify all financial assets under two categories; Amortized or fair value via the income statement, except only for some equity instruments. Moreover, under amortized cost they should include that generate interests and payment of principal and the model of the business replicates collection of contractual cash flows representing interest and principal. Secondly, it requires that some non-trading equity statements be recognized and classified at fair value under income statement. In addition dividends should be recognized in net income through fair value. Thirdly, to minimize accounting mismatch financial assets, financial assets meeting the criterion for classification as amortized cost are allowed to be measured at fair value (Chattered accountants and business advisors, 2005).
According Group of 100 (2009) IASA/ASB 139 provides that only debt instruments that meet the business model test and cash flow characteristics test criteria to be measured under amortized cost. In addition, all other debt instruments should be measured at FVTPL (fair value through profit and loss). However, IFRSAABS 9 provides guidelines to measure the debt instruments that meet the amortized cost test at FVTPL, but, with some restrictions.
Under the scope of the IFRSAABS 9 , Group of 100 (2009) states that “ all equity instruments are measured at fair value in the balance sheet and value changes recognized in profit and loss”. However, unquoted equities are not exempted. IFRSAABS 9 provides guidelines on when cost remains a better estimate of fair value or not. Moreover, the treatment of equity instruments not held for trade require to recognize it and measure at FVTOCI (fair value through other comprehensive income) recognizing dividends in the profit and loss (Group of 100, 2009).
IFRSAABS 9 includes the concept of embedded derivatives in its guidelines; this would be considered separately under IAS/AABS 139. Therefore, would be accounted for at FVTPL separately. The new standard IFRSAABS 9 demands that to measure all derivatives at fair value (Group of 100, 2009).
The introduction of IAS/AASB 139 in Australia and its implementation has been a thorny issue to many financial and non financial institutions. The issues faced by the non financial institutions were a bit different from those faced by banks. This is due to difference in business structure as well as what had gone been considered before the introduction of IAS/AASB I39. Two companies listed in the Australian securities exchange have been considered for discussion of this paper. This includes the Australia and New Zealand banking group limited. The following are the main areas which raised the greatest problem include fair value estimation, hedging, loans and are receivables held to maturity, Embedded Derivatives and impairments.
Fair value
According to IAS/AASB 39 the market value (the previous price paid for a financial instrument) gives the fair value of a financial instrument. However, alteration is permitted if the `instrument can be valued in light of other observable market transactions and its value be seen to differ from the previous purchase price. A firm is allowed to alter the existing fair market price of an instrument (represented in its books of account) if it successfully demonstrates that such price is only payable in distress sale. Therefore, determination of fair price relies on the market free forces of demand and supply in stock exchange (Delloitte, 2003).
The IAS/AASB139 is only simple to apply in cases where there is bond holding or equity in another listed company. Determining the fair value of financial instrument in this case pose no problem especially when the older accounting rules does not vary with IAS/AASB139 The main problem however, would be dealing with bond held in another unlisted company. Such bond prices cannot be easily attributed to given fair value because unlisted companies do not engage in national stock exchange where the value of the shares can be determined by the forces of demand and supply. The complication comes in when dealing with a subsidiary company of unlisted company. In this case has to put into consideration many variables before determining the fair value of bonds and shares (Robinson, 2008). Financial guarantees of Endeavor international limited fair value is estimated by making the following assumptions probability of default, loss given default, and the maximum loss that is exposed to company in case guarantee party was to default. This is usually considered in the begging and at the end of each financial year something which is very cumbersome for the company. Interest bearing loan and borrowings are recognized in endeavor limited company at the fair price of the consideration less any attributed transaction costs. The company interest bearing loans thereafter are usually represented at amortized costs.
Hedging
This was the area with the greatest short comings where, many companies had not put in place the required documentation when IAS/AASB 139 took effect. The requirements of IASAASB 139 were that some of the prior transactions classified as hedges could no longer be regarded for hedge accounting (Robinson, 2008).
The issues regarding documentation which rose when IAS/AASB139 was introduced were: adequate documentation where necessary before any transaction could qualified for hedge accounting otherwise such transaction was seen to increase the volatility of earnings, the documentation were supposed to be in line with companies strategies and objectives. These two issues made maintaining of information across flat forms as well as different business areas very challenging.
On the other hand, there were the following issues surfaced in regard to this accounting standard effectiveness: the requirement for all hedge effectiveness to be scrutinized at the start and end of the accounting period was quite cumbersome and tedious finally, the recognition of ineffective derivative portion used in the hedging relationship could easily increase the volatility of earnings.
Endeavor international limited in its books of account recognizes cash flow edges. The group tests all designated cash flow hedge effectiveness using regression analyzing in start and end of every month. The company uses at least 30 data points in the regression analysis the test is only regarded as highly effective if it falls within the range of 80:125. The Austria and New Zealand bank provides $162m hedging reserve in accordance with IAS/AASB139. This reserve is deemed to change when IFRSAASB9 is introduced.
Embedded derivatives
The standard made that for any derivative to be classified as a financial should bear the following characteristics: its value should always change with respect to the underlying index or price, it does not require any initial investment or if initial net investment is required it would be smaller than it could have be required for other types of investments contracts which could have same response to alteration of market factors and that the derivative would be settled at a probable future date
According IAS/AASB 139 derivative which is not effective or designated hedging instrument should be carried at a fair value in all accounting periods in profits and loss account. It is possible for derivates to be embedded in other instruments even in non –derivative host contracts e.g. lease insurance contracts and sale contracts. All embedded derivatives cause all or a proportion of the entire cash flows of a contract to be modified in accordance with a determined variable e.g. foreign exchange contract, interest rate or commodity price. Sometimes a derivative embedded in host contract may separately be recognized. The IAS/AASB139 clearly lays down the following requirements to be met for separate recognition: the risk of the embedded derivative as well as its economic characteristics are not in any way related to those of the host contract, a separate instrument with similar terms to those of the embedded derivative would meet the definition stated by IAS/AASB139 and the contract fair value is not estimated in profit and loss (Delloitte, 2003).
IASAASB139 has laid down the criteria to be followed in derecognizing financial assets. It states that any asset should be derecognized when all the contractual rights pertaining cash flows from the assets have expired and in situations when a firm transferred the assets. Assets are transferred from one entity to another when: contractual rights of receiving cash flows are transferred or when contractual rights are retained but the cash inflows received are forwarded to another recipient under special arrangement. In situations where the firm has neither substantially retained all rewards and risks of ownership nor transferred them, then it is up to an entity to determine whether it has transferred the rights. Then it will either recognize or derecognize the asset. The following issues therefore arise: lack of effective guidance on when to recognize or derecognize an asset, the non clarity leads to different interpretation of de-recognition criteria and in the application of AASB 139 also requiring SIC 12 to be complied with (ANZ annual report, 2010).
To evade this contentious issue the AASB39 required that the embedded derivatives recognized under IAS/IASB 139 to be separately recognized and accounted for at FVTPL because of they were regarded distant from financial host assets. All cash flows from the assets would be measured in their entirely while the asset would be measured at FVTPL. This is however the case in situations where any cash flow does not represent payment of interest or principle amount of the asset (Delloitte, 2003).
Endeavor limited recognizes an asset immediately an asset is purchased and derecognizes the asset when its rights to receive cash flow from the asset expires or in situations when the entity transfers substantial amount of rewards and risks associated with holding the asset. On the other hand Australia New Zealand bank limited makes derecognizes an asset when it loses substantial amount of risk and cash flow associated with the asset.
Impairments
AASB139 calls for provisions to be made for any impairment to be recognized, but objective evidence of impairment should be provided. Therefore provision for impairment on loans is mandatory but restricts any provision for expected losses which are yet to be incurred. The Australia and New Zealand bank adequately provides for this impairment (ANZ annual report, 2010). The endeavor limited recognizes impairments in its books of account. It has strictly followed AASB 139 where it provides evidence for any impairment recognized in the books of account.
Conclusion
The introduction of AASB 139 in Australia and its implementation has brows to many companies. The following are the main areas which raised the greatest problem: fair value estimation, hedging, loans and receivables held to maturity, Embedded Derivatives and impairments.
The issue of estimating fair value of assets is not clearly defined. Where by firm are required to estimate the fair value of asset using last transaction or the current market price.
Pertaining hedging the main area of contention was that AASB39 required accounting standard effectiveness to be enhanced by the requirement for all hedge effectiveness to be scrutinized at the start and end of the accounting period something which was quite cumbersome. On part of embedded derivatives the standard is not clear on when there is full transfer of property rights and risks. These make it quite difficult to determine the best way of treating inflows from such assets. All this issues gave the need to put in place IFRS9.
References
Australia accounting standard board (2009). Financial instrument: IFRSAASB 9. Retrieved from
http://www.aasb.com.au/admin accessed (29th April 2011)
Adrew j. (2010). AASB 139(IAS 39) in Australia –the main challenges for banks. Retrieved
from http://ozrisk.net/ accessed (29th April 2011)
ANZ financial report (2006). The rewards of being different: Financial report. Retrieved from
www.anz.com accessed (29th April 2011).
ANZ annual report (2010). Notes to financial instruments
Australian prudential regulation authority (2005). Adoption of international financial reporting
Standards prudential approach
Chattered accountants and business advisors (2005).a summary of recent changes to financial
reporting requirements
Delloitte (2003). Accounting alert:analysis of the latest accounting developments delivered to
you via email, financial instruments. Retrieved from http://www.iasplus.com/au/2004-03.pdf. Accessed (29th April 2011).
Ernst and Young (2011). Endeavor (International) limited: Financial report 31 December 2010,
an illustration of an Australian company’s annual financial report. Retrieved from http://www.ey.com/Publication Accessed (29th April 2011).
Group of 100 (2009). G100 members update 2009. Group of 100 Inc
Kemp Stephanie (2009). A look at IFRS for SMEs . retrieved from
http://www.charteredaccountants.com.au accessed (29th April 2011)
New Zealand institute of chartered accountant (2010). Submission by the financial reporting
standards boards of the New Zealand institute of chartered accountants to the accounting review board for approval: New Zealand equivalent to international financial reporting standards 9. Accessed from http://www.nzica.com/ accessed (29th April 2011)
Paladin energy limited (2010). Summary of significant accounting policies. Retrieved from
ttp://www.paladinenergy.com.au/ accessed (29th April 2011)
Price water house coopers (2010). Digging into IFRS http://www.pwc.com accessed
(29th April 2011)
Robinson D. (2008). Fair value issues and the subprime crisis
