Accounting for Financial Instruments Set 3

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• Originiated or aquired loans and receivables
• Limitation to financial instruments with fixed or determinable maturity not quoted on an active market
• Active markets are ones where
  • items traded within the market are homogeneous
  • willing buyers and sellers can normally be found at any time
  • prices are available to the public
• Active markets if prices are regulary available from an exchange, dealer, broker, industy group, pricing service, or regulatory agency
• Loans and receivables from which a lender cannot materially recover his entire initial net investment (other than impaired loans) are considered financial assets "available for sale"
• Holdings in investment funds not containing loans or receivables also classified as financial assets "available for sale"
• Exceptions - loans and receivables
  • voluntary designated under fair value option or
  • voluntary designated as available for sale

• Non-derivative financial assets
• Fixed or determinable maturities
• Positive intention and ability to hold the asset to maturity
• Exceptions - investments
  • voluntary designated under fair value option or
  • voluntary designated as available for sale or
  • financial assets that meet the criteria of loans and receivables

• More than a marginal part of investments has been sold within the current year or within the preceding two years (tainting rule) unless
  • such sales were so close to maturity (within three months or less) that this did not materially impact thei fair values
  • payments received up to the sale of the asset substantially correspond to the repayment amount (at least 90%)
  • sales result from an event beyond holder's control

• Two subcategories
  • financial assets or financial liabilities held for trading
  • financial assets or financial liabilities voluntarily designated to fair value option

• Assets or liabilities acquired or incurred principally for purpose of short-term sale or repurchase
• Parts of portfolio of identified financial instruments that are managed together and for which there is evidence of a recent actual pattern of short-term profit-taking
• Derivatives (except that is a financial guarantee contract or a designated and effective hedging instrument)

• Excludes equity instruments without an active market if their fair value cannot be measured reliably
• Allowable if relevant information is made
  • providing recognition inconsistencies (accounting mismatches) are eliminated or significantly reduced
    • inconsistent measurement of assets or liabilites
    • inconsistent recognition of gains and losses
  • or managed and its performance is evaluated on a fair value basis
• Allowable for contracts which include one or more mebedded derivatives unless
  • the embedded derivative has no significant effects on the cash flow of the host contract or
  • separation is prohibited (i.e. embedded termination rights in certain loan agreements)
• Mandatory for entire contract if derivative cannot be valued separately (IAS 39.12)

• Non-derivative financial assets
• Voluntary designation, except for assets held for trading (designation category)
• Obligatory if instrument cannot be included in any other category (residual category)

• Subsequent measurement of financial liabilities
  • after initial recognition, all financial liabilities to be measured ar amortised cost
  • exception - financial liability measured at fair value through profit or loss

• Non-derivative financial assets which are classified as
  • held for trading
  • available-for-sale (just under certain circumstances)
• No reclassification of a
  • derivatives
  • financial assets of the fair value option
  • financial liabilities
• Reclassification into held for trading not allowed

• 1st requirement "no longer held for the purpose of being sold or repurchased in the near term" and (cumulatively)
• 2nd requirement "if the requirements in parahraph 50B or 50D are met
  • 50B - only in rare circumstances (or alternatively)
  • 50 D - in case that the finacial asset "would habe met the definition of loans and receivables" and (cumulatively) "if the entity has the intention and ability to hold the financial asset for the foreseeable future or until maturity"

• 1st requirement "no longer held for the purpose of being sold or repurchased in the near term"
  • reversion of notion "principally purchased or assumed with the intention to sell or resell the financial instruments in short terms"
  • broad interpretation allowed
• 2nd requirement 50B - rare circumstances
• single event that
  • is unusual and
  • no repetition is highly probable in a foreseeable future
• deterioration of the global finance market in third quarter 2008 as an example
• unnecessary requirements are
  • disappearance of market activity
  • high-graded illiquidity of a market
  • disappearance of a market

• 2nd requirement 50D - second option
  • "if the entity has the intention and ability to hold the financial asset for the foreseeable future or until maturity" and (cumulatively)
  • "a financial asset ... that would have met the definition of loans and receivables"
  • logical connections with loans and receivables
  • equity instruments do never meet case 50D (reclassification only in accordance with case 50B in rare circumstances)
  • critertion of intention and ability to hold the financial asset for the foreseeable future
    • no definition in the standard
    • basis of period probably more than one year
    • sale shortly after the market recovery endanger criteria of intention to hold
    • intern rules and documentation necessary
• Criterian "that would have met the definition of loans and receivables" in case 50 D
  • timing - immediately before or at date of reclassification (not necessary at date of purchase)
  • objective - meeting the defintion of loans and receivables
    • no derivative
    • fixed or determinable payments
    • not quoted in an active market
    • no intention of trading (than held for trading)
    • not categorised at fair value option
    • not categorised as available-for-sale
    • not financial assets, for whcih the holder may not recover substantially all of its initial investments other than because of credit deterioration, which shall be classified as available-for-sale
    • pruchasing a pool of assets the assets shall be loans or receivables

• Critical aspects of defintion of category loans and receivables
  • general separation obligation for embedded derivatives (like ABS notes)
    • intern rule and documentation are necessary
    • standardised for all derivatives exercising selection right
      • separation of derivatives and continuance in trading
      • adopting of IFRIC 9 and treatment as one entire financial asset (in accordance with IASB - meanwhile - not longer possible)
  • no recovery substantially all of inital investments
    • other reasons than credit deterioration
      • reference to credit deterioration of the financial instrument
      • credit deterioration after purchase is accommodated by impairment
      • other reasons can be based on the derivative itself (no financial guarantee)
      • other reasons can be based on the structure of the asset (look through principle)
• no active market
  • there is usually an active market for government and corporate bonds

• Reclassifcation in accordance with IAS 39.50B due to rare circumstances
  • equity instruments (like shares) in available-for-sale
  • financial liabilities that do not meet the criteria of loans and receivables, because of
    • an existing active market
    • (imaginable for government and coprorate bonds)
    • no recovery substantially all of initial investments (imaginable for CDO/ ABS structures)
    • potentially receiving category
      • available-for-sale - unimportant in case of an impairment, because whole fair value decrease through profit or loss
      • held to maturity - but holding until maturity is important

• Requirements in accordance with IAS 39.50E
  • "a financial asset ... that would have met the defiition of loans and receivables" and (cumulatively)
  • "if the entity has the intention and ability to hold the financial asset for the foreseeable future or until maturity"
• No possibility for reclassification of equity instruments out of available-for-sale (only out of held for trading in rare circumstances in accordance with IAS 39.50B)
• Criterion of intention and ability to hold for a foreseeable future to be interpreted like IAS 39.50D
• Criterion of meeting the defintion of loans and receivables to be interpreted like IAS 39.50D
• Embedded derivative that would normally to be separated
  • no technical problem (in contrast to held for trading) because separation obligation to be verifying at pruchase
  • application of IFRIC 9 (no reassessment of separation requirement)
  • no recovery substantially all of initial investemtns
    • other reasons than credit deterioration
      • interpretation like IAS 39.50D
      • no possibility for reclassification out of available-for-sale if there is a credit deterioration
    • no active market
      • interpretation like IAS 39.50D
      • no possibility for reclassification out of available-for-sale if there is an acitve market

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• Entity to assess at each balance sheet date whether there is any objective evidence that a financial asset or a group of financial assets are impaired
• Impairment only if there is objective evidence
• Only objective evidences as a result of one or more events occured after inital recogntion of the assets are relevant

• Significant financial difficulty of the issuer
• Actual breach of contract such as default or delinquency in interest or principal payments
• Any concessions to debtor due to financial problems
• High probability of bankruptcy or other need for financial reorganisation
• Disappearance of an active market for that financial asset due to difficulties

• Information about
  • significant changes with an adverse effect that have taken place in the technological market and economic or legal environment in which the issuer operates and
  • indicates that the cost of the investment may not be recovered
• Significant (approx. 20%) or prolonged (approx. 9 months) decline in fair value of that financial instrument below its cost

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• Determine the impairment loss as the differecne between amount carried and discounted value of the estimated future cash flow using the original effective interest rate

• Financial assets are grouped on the basis of similar credit risk characteristics providing there is no objective evidence of impairment
  • characteristics include asset type, sector, region, collateral type, etc.
• Impairments are assessed separately on each portfolio
• Estimated future cash flow are calculated from historical default risk adjusted for current market conditions
• Use peer gorup analysis when insufficient historical data available
• Formula-based or statistical methods may be used to calculate impairment
  • models used are not allowed to give rise to impairment loss on initial recogntion of a financial asset (provided model excludes inpairment occuring from an event at or prior to issuance)
• Approaches and their underlying assumptions to be reviewed regularly

• Calculate interest income from impaired finanial assets or financial portfolios at original effective interest rate

• Cumulative loss that had been recognised directly in equity to be removed from equity and recognised in profit or loss