CFM16055 - Accounting for financial instruments: IAS 32 and IAS 39: subjects covered by IAS 39

What IAS 39 covers

Scope

IAS 39 applies to all types of financial instruments, with certain exceptions – see CFM16065.

Definitions

The standard categorises financial instruments into four types. The category determines the presentation and measurement of the instruments in the accounts. These categories are defined:

• A financial asset or financial liability at fair value through profit or loss ("FVTPL"). This is exactly what the term implies – the asset or liability is measured at fair value, with changes going through profit and loss. An item may fall into this category because it is held for trading ("HFT"): all derivatives, except hedges, fall into the HFT category. However, a company may also designate a financial asset or financial liability as FVTPL, with some restrictions.
• Held-to-maturity investments ("HTM"). This is a restricted category for financial assets with fixed maturity and determined or determinable payments, which the company intends to hold, and is able to hold, until maturity.
• Loans and receivables ("L&R"). This comprises most unquoted non-derivative financial assets, other than those held for trading – trade debts, for example, would fall into this category.
• Available-for-sale financial assets ("AFS"). Financial assets that do not fall into any of the three categories above are classified as AFS. A company may also designate a particular non-derivative financial asset as AFS.

CFM16115 onwards explains the classification of financial assets in more detail.

Embedded derivatives

IAS 39 requires derivatives embedded in a host contract (see CFM16035) to be accounted for separately in many cases – this is covered at CFM16100 onwards.

Recognition and derecognition

A company is required to recognise all financial assets and liabilities, including derivatives, on its balance sheet at the time when it becomes a party to the contract concerned. IAS 39 also sets out in considerable detail when a financial asset is derecognised. In broad terms, this depends on whether or not

• it has transferred the contractual right to receive the cash flows from the asset
• it has transferred substantially all the risks and rewards of ownership, and
• it has relinquished control of the asset.

Derecognition of liabilities is also covered. See CFM16245 onwards.

Measurement

Financial assets and financial liabilities are initially measured at cost – which will normally be fair value, and should include transaction costs.

Subsequently, the measurement depends on the category.

Financial instruments at fair value through the profit or loss (FVTPL) are remeasured at fair value and the changes in value recognised in the Income Statement. As all derivatives are within this category, all derivatives are remeasured at fair value, unless they are used for hedging.

Available for Sale (AFS) assets are valued at fair value. The changes are recognised directly in equity. Where there is objective evidence that the asset is impaired, cumulative losses equivalent to the impairment are "recycled" i.e. brought back into the income statement.

Held to Maturity (HTM) instruments are measured at amortised cost. Where the recoverable amount of such an investment is less than the carrying amount, there is an impairment loss that must be recognised in the income statement. If a company sells more than an insignificant proportion of its portfolio of held to maturity assets, other than because of a non-recurring and unpredictable circumstance, it must reclassify the remainder of its HTM assets as AFS. This "tainting" expires at the end of the second year following the premature sales.

Loans and receivables (L&R), except those held for trading or designated as FVTPL, are measured at original recorded amount less repayments of principal and amortisation.

Where a company holds unquoted equity instruments, whose fair value cannot be reliably determined, it must measure the equity instrument at cost.

The measurement provisions of IAS 39 are covered in more detail at CFM16205 onwards.

Hedging

Hedge accounting is only permitted under IAS 39 in certain tightly defined circumstances, provided that the hedging relationship is clearly defined, measurable and actually effective. Hedge ineffectiveness, however, is immediately recognised in the income statement, along with all other fair value changes in derivatives that do not function as hedges. An outline of this complex subject is at CFM16265 onwards.

Effective date and transition

IAS 39 is effective for accounting periods beginning on or after 1 January 2005. Earlier application is permitted, but if a company does so, it must also apply IAS 32, though under UK law this is not possible. On initial adoption of IAS 39, adjustments to bring derivatives and other financial assets and liabilities on to the balance sheet, and adjustments to remeasure certain financial assets and liabilities from cost to fair value, are made by adjusting retained earnings brought forward – see CFM16345.