financial instruments masb islamic finance master class

Financial Instruments

MASB Islamic Finance Master Class

21 November 2013

MASB Islamic Finance Master Class – 21 November 2013

COMPETITION LAW CAUTION

The participants in this event and the MASB shall not enter into any discussion,

activity or conduct that may infringe, on the part of the participants or the MASB, the

provisions of the Malaysian Competition Law 2010. By way of example, participants

shall not discuss, communicate or exchange, any commercially sensitive information.

Disclaimer

The views and opinions expressed during the MASB event do not represent the

official views of the MASB or necessarily represent the organisations that the

participants belong to. Official positions of the MASB on accounting matters are

determined only after extensive deliberations and due process. The materials

presented during this event are intended to convey the general information only and

they should not be taken as the official MASB view.

Neither the MASB nor any member of the MASB Secretariat accepts responsibility or

legal liability arising from or connected to the accuracy, completeness or reliability of

the materials and information contained in this event. Participants are hereby advised

that entity specific matters concerning the application of the MFRSs and the

appropriate treatment should be addressed by the preparers with their respective

auditors and/or their independent accounting advisors.

4 STANDARDS ON FINANCIAL INSTRUMENTS

Presentation

Recognition & Measurement

Disclosures

• IAS 32

• IAS 39

• IFRS 9

• IFRS 7

• 1 Jan 2010

• FRS 139

• FRS 7

Pre

Convergence MFRS = IFRS

1 Jan 2012

• MFRS 132

• MFRS 139

• MFRS 7

• MFRS 9 *

Post

• 1 Jan 2006

• FRS 132

* Effective date has been deferred

MFRS 139 – Classification and measurement

5

At Fair Value Through Profit & Loss (FVTPL) [eg quoted shares, bonds]

• -2 categories, ie (i) Held for Trading; (ii) Designated on Initial

Recognition

Available for Sale Held (AFS) [eg quoted shares not for trading, unquoted shares, bonds]

- asset not classified as FVTPL, HTM or LAR

Held-to Maturity (HTM) [eg government & corporate bonds]

-Fixed determinable payment, fixed maturity, ability to hold till

maturity

Loans & Receivable (LAR) [trade & other receivables, intercompany loans/advances]

- Fixed, determinable payment & not quoted in active market

Financial

Assets

MFRS 139 – Financial Asset (FA) Measurement

6

Initial measurement : all FA shall be measured at FV

Subsequent

measurement

Fair Value Amortised cost using EIR

method

EXCEPT

Cost

FA @ FVTPL AFS FA (a) Loans &

receivables

(b) HTM

Investments

(c) Equity

Instruments that

do not have

quoted market

price Gain/loss-

PL

Gain/Loss

(1) FV changes-

OCI

(2) FA

impairment&FX

gain/loss - PL

Gain/Loss - PL (when a FA is

derecognised, impaired or

amortised)

7

MFRS 139 – Financial Liability (FL)

Classification & Measurement

At Fair Value Through Profit & Loss (FVTPL)

(i) Held for Trading

(ii) Designated on Initial Recognition

Liabilities not classified as FVTPL, measured at amortised cost

Trade & other payables, bank borrowings, debentures

Financial

Liabilities

Subsequent measurement of FL – at amortised cost using EIR

method, except for FL at FVTPL which shall be measured at fair

value.

WHY IS IASB REPLACING IAS 39?

• Reduce complexity in accounting for financial instruments – Too many classification and measurement categories

– Different impairment models that apply to different financial assets

– Bifurcation of complex instruments using rules which are unclear and inconsistent

• Too little too late impairment provisions

• Strict hedge accounting rules and not aligned to risk management activities

8

ROADMAP FOR IAS 39 REPLACEMENT

IAS 39 IFRS 9

Classification and measurement • IFRS 9 (2009) • Limited amendment (Dec 2011) • IFRS 9 (2010) • ED (Nov 2012)

Impairment ED (Nov 2009) SD (Jan 2011) (ED Mar 2013)

General hedge accounting ED (Dec 2010) Final draft (Sept 2012) IFRS (19 Nov 2013)

Macro Hedging DP (Q1 2014)

9

2

1

3

HIGHLIGHTS OF IFRS 9 IMPROVEMENTS

Financial Assets (FA)

• Logical structure and rationale for FA classification

• TWO measurement categories for FA to reflect how they are managed and nature of cash flows

• A single classification approach, eliminating requirements for bifurcation of hybrid FA

• Reclassification between measurement categories when business model changes

10

HIGHLIGHTS OF IFRS 9 IMPROVEMENTS

• Effects of changes in own credit are presented in OCI if a non-derivative FL is measured at fair value; while other changes in fair value is recognised in profit or loss.

– Rationale:“entity cannot profit from its own downgrade”

11

NEW

Financial Liabilities (FL)

• Carried forward almost all of the accounting requirements in IAS 39 for financial liabilities; but with one exception

IFRS 9: Classification & Measurement of Financial Assets

Debt instrument

Cash flow characteristics test?

“Business model” test?

Fair value (FV) option elected ?

Amortised cost

Pass

Pass

No

Derivative Equity instrument

FV through PL FV through OCI (no recycling)

Fail

Fail

Yes

Held for trading?

FV through OCI option elected?

No

Yes

No

Yes

Subsequent measurement of Financial Assets

12

LIMITED AMENDMENTS TO IFRS 9 IN DEC 2011

• To take into account the interaction between the classification and measurement of FA and the accounting for insurance contract liabilities

• To clarify a narrow range of application questions

• To reduce key differences between IFRS 9 and the proposed FASB model

13

PROPOSED AMENDMENT TO IFRS 9

The December 2011 proposals:

• New category of FA FVOCI measurement category for qualifying debt instruments

• Eliminate phased approach to the early application of IFRS 9 except for the requirements related to own credit on FL

• Clarify application questions e.g.. amount/frequency of sales that would be consistent with ‘hold to collect’ business model and how to assess contractual cash flows

14

PROPOSED AMENDMENT TO IFRS 9 (NOV 2012 ED)

Debt instrument

Cash flow characteristics test?

“Business model” test?

FV option elected ?

Pass

No

Derivative Equity instrument

FV through PL FV through OCI (no recycling)

Fail

Yes

Held for trading?

FV through OCI option elected?

No

Yes

No

Yes

Amortised

cost

FVOCI (with

recycling)

No

[1]

Hold to collect

contractual

cash flows

[2]

Hold to collect

cash flows

& to sell FA

[3]

Neither [1]

nor [2]

Pass

Fail

IAS 39

FVTPL

Available-for-sale (~FVOCI)

Held-to-maturity

Loans and receivables

IFRS 9 (Current)

Amortised cost

FVOCI – Equity

FVTPL

IFRS 9 (Proposal)

Amortised cost

FVTPL

FVOCI – Debt & Equity

16

PROPOSED AMENDMENT TO IFRS 9 – CLASSIFICATION & MEASUREMENT AT A SNAPSHOT


IAS 39 IFRS 9



General hedge accounting


IFR

17

2

1

3

PROPOSED AMENDMENT TO IFRS 9 – EXPECTED CREDIT LOSSES

Discussion Paper

(March 2008)

Request for Info

(June 2009)

Exposure Draft

(November 2009)

Supplementary Document

(January 2011)

Revised Exposure Draft

(March 2013)

18

A long process undertaken by the IASB…


What’s the challenge?

19


Scope

• Debt instruments measured at:

• amortized cost

• fair value through other comprehensive income (FVOCI) (new measurement category proposed in the Nov 2012 ED)

• Trade receivables & lease receivables

• Irrevocable loan commitments & financial guarantee contracts not accounted for at fair value through profit or loss

Expected credit losses will be recognized for all of these

financial instruments at each reporting date.

20

• The yield on financial instruments reflects initial credit loss expectations

• When expected credit losses exceed those initially expected an economic loss is suffered

• Proposals reflects this in a more cost effective way by: • Recognizing a portion of expected credit losses initially • Recognizing lifetime expected credit losses when

significant deterioration in credit risk occurs

21


Change in credit quality since initial recognition

Stage 1 Stage 2 Stage 3

12-month expected

credit losses

Recognition of expected credit losses

Lifetime expected

credit losses

Lifetime expected credit

losses

Interest revenue

Effective interest on gross carrying

amount

Effective interest on gross carrying

amount

Effective interest on amortised cost carrying amount (same as IAS 39)

22

AN OVERVIEW OF THE PROPOSED EXPECTED CREDIT LOSSES MODEL

THE 3 STAGES OF THE PROPOSED EXPECTED CREDIT LOSSES MODEL

• Stage 1 – No significant deterioration in credit quality – ‘Investment grade’

• Stage 2

– Significant deterioration in credit quality – Not ‘investment grade’ – Rebuttable presumption met if more than 30 days past due

• Stage 3

– Credit-impaired or incurred loss has occurred (incurred under the current MFRS 139)

Expected credit losses are updated at each reporting date for new information irrespective of whether a financial instrument stays at

the same stage

23

EXPECTED CREDIT LOSSES – Illustrative example

24

Entity A originates a loan for CU 1,000,000. Taking into consideration the expectations for instruments with similar credit quality (using the most relevant information available), the credit quality of the borrower, economic outlook for the next 12 months, Entity A assumes that the instrument has a 0.5% probability of default (PD) in the next 12 months. Entity A also assumes that 25% of the gross carrying amount will be lost if the loan defaults (LGD).

The loss allowance for the 12 month expected credit losses is CU 1,250 [ 1,000,000 * 0.25 * 0.005]

Dr Impairment provision (P/L) 1,250

Cr Impairment allowance (B/S) 1,250

In the following year, due to the economic downturn, the credit quality of the loan significantly deteriorates. PD within the next 12 months is 0.5%, lifetime PD is 15%. LGD remains at 25%.

What is the expected credit loss provision ?


IAS 39 IFRS 9



General hedge accounting


25

2

1

3

AMENDMENT TO IFRS 9 - HEDGE ACCOUNTING

Discussion Paper

(March 2008)

Exposure Draft 2010/10/13 Hedge

Accounting

(December 2010)

Decided to decouple macro hedging from IFRS

9 project

(May 2012)

Draft Paper on Hedge Accounting (Chapter 6) as an inclusion to IFRS 9

(November 2012)

IFRS

(19 Nov 2013)

WE ARE HERE

Target discussion paper on Macro Hedging

(Q1 2014)

26

Hedge accounting project milestone…

AMENDMENT TO IFRS 9 - HEDGE ACCOUNTING (cont’d)

Proposal : more closely-aligned with risk management activities

27

Closer

alignment

with risk

management

Enhanced

presentation

and

disclosures

ED proposes a model that aims to align accounting with risk

management activities

ED proposes comprehensive disclosures focusing on the risks and how they

manage, as well as the outcome

Investors obtain more useful information

Hedged items would include certain risk components of non-financial items – for example the oil price component in a jet fuel price exposure.

Fair value mechanics will be aligned closer to cash flow hegde mechanics. Proposed requirement is more aligned to cash flow hedge.

Gain/loss from remeasuring hedging instrument – OCI

Gain/loss from hedged items – presented separately in SOFP and correspondingly in OCI (hedged item basis is not adjusted)

Ineffective portion of the gain/loss – transferred from OCI to PL

28


Quantitative threshold and retrospective review on hedge will be eliminated - Hedge effectiveness is met if the hedging relationship, when tested prospectively, produces an unbiased result and is expected to achieve other than accidental offsetting.

Removal of the arbitrary bright line test of 80% -125% for hedge effectiveness

Rebalancing the hedging relationship but voluntary discontinuation is prohibited. If a hedging relationship subsequently fails to meet the objective of the hedge effectiveness assessment but the entity’s risk management objective has not changed, then an entity would rebalance the relationship by adjusting the hedge ratio.

Any hedge ineffectiveness determined – recognise in PL

29

PROPOSED AMENDMENT TO IFRS 9 - HEDGE ACCOUNTING (cont’d)

• Enhanced disclosures – in addition to IFRS 7 disclosure requirements, entities would need to disclose:

– an entity’s risk management strategy and how it is applied to manage risk;

– how the entity’s hedging activities may affect the amounts, timing and uncertainty of its future cash flows; and

– the effect that hedge accounting has had on the entity’s statement of financial position, statement of comprehensive income and statement of changes in equity.

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EFFECTIVE DATE OF IFRS 9 HAS BEEN PUSHED BACK

IASB’S work plan @ 19 November 2013

2013 Q4 2014 Q1 2014 Q2

Classification & Measurement

Target IFRS

Impairment Target IFRS

Hedge Accounting IFRS issued 19 Nov

Accounting for macro hedging

Target DP

31

* IFRS 9 was originally effective for annual periods beginning on or after 1 January 2015

financial instruments masb islamic finance master class

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