IAS 39: Subhash Abhayawansa and Dr Indra Abeysekera explain the complexities and challenges of the international accounting standard on financial instruments.
| Author | Abhayawansa, Subhash |
| Position | Casestudy |
IAS 39 Financial Instruments: Recognition and Measurement revolutionised the way in which public listed companies present their financial instruments, such as derivatives and other contracts. Prior to IAS 39 and FAS 133, the literature covering financial derivatives was inconsistent and inadequate. FRS 13, issued in the UK in September 1998, moved the disclosure of financial instruments forward there, but it was widely accepted that more needed to be done over recognition and measurement. The US has no Generally Accepted Accounting Principle (GAAP) for commodity hedging. Financial derivatives were traditionally accounted for using historical cost accounting. Since many financial derivatives did not attract an initial cost, the presentation was limited to a note in the financial statements that did not reveal companies' real exposure.
IAS 39 brings derivatives that used to be oil-balance sheet on to corporate financial statements and so increases transparency. It abolishes the common synthetic instrument accounting practice which netted hedges in the balance sheet and presented the hedge item and hedge instrument together as a single instrument.
The standard prescribes principles for recognising and measuring financial assets, financial liabilities and contracts for non-financial items, including financial derivatives and derivatives embedded in non-derivative contracts, except for certain specifically excluded items (IAS 39.2). Accordingly, all derivative instruments need to be carried at fair value on the balance sheet (eg through marking to market) with any changes in the fair values being recognised in the income statement on a periodic basis. Unless a derivative qualifies for hedge accounting, gains and losses in the hedging instrument cannot be offset against gains and losses in the value of the hedged item. Stringent criteria must be met for a derivative to benefit from hedge accounting. This is why most derivatives used for hedging are classified as held for trading and do not qualify for the preferred accounting treatment. The requirement to mark a derivative to market value without doing the same for the corresponding hedged item creates artificial volatility in reported earnings. So the standard brings treasury performance to the forefront of financial reporting.
IAS 39 further incorporates substance over form for classifying debt and equity. Importantly, the standard requires a review of quasi capital financial instruments in...
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