reclassification of financial assets (old standard)

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Issue 34 / March 2009

Reclassication ofnancial assets

Supplement to IFRS outlook

This publication summarises all the recent amendments to IAS 39

Financial Instruments: Recognition and Measurement and IFRS 7

Financial Instruments: Disclosure and IFRIC 9 Reassessment ofEmbedded Derivatives. It also includes decision trees for applying

the amendments, answers to some frequently asked questions,

and updated examples of their application.

On 13 October 2008, the International

Accounting Standards Board (the IASB

or the Board) approved and published

amendments to IAS 39 and IFRS 7 to allow

reclassications of certain nancial assets

held for trading to either held to maturity,

loans and receivables or available for sale

categories. The amendment also allowsthe transfer of certain nancial assets from

available for sale to loans and receivables.

The IASB temporarily suspended normal

due process, with agreement of the

trustees of the International Accounting

Standards Committee Foundation.

Consequently, there was no exposure or

comment period. The effective date is

1 July 2008.

The amendments were made in response

to requests by regulators to enable banks

to record nancial assets which are no

longer traded in an active market at

amortised cost, thereby reducing reported

prot or loss volatility. They will also apply

to non-banks that have nancial assets

recorded as held for trading or availablefor sale.

The amendments introduce concepts

already present in US GAAP, which allow

loans to be transferred from held for

trading to held for investment if there is a

change in holding intent, and the transfer

of securities from held for trading to

available for sale or held to maturity, in

“rare” circumstances.

As a result of the accelerated amendment

process, it was stated at the 13 October

2008 Board meeting that corrections would

be made to the amendments, if found to

be necessary. This publication includes

amendments issued through to the end of

March 2009.



Reclassication of nancial assets March 20092

Summary of theamendments

The amendments allow entities to reclassify

certain nancial assets out of held for

trading if they are no longer held for the

purpose of being sold or repurchased in the

near term (paragraph 50(c)). Entities still

cannot reclassify instruments that were

designated at fair value through prot or

loss using the fair value option (although

the IASB has been requested by the

European Commission1

to permit this),nor derivatives.

The amendments distinguish between

those nancial assets that are eligible for

classication as loans and receivables and

those that are not. The former are those

instruments which, apart from not being

held with the intent of sale in the near

term, have xed or determinable

payments, are not quoted in an active

market and contain no features which could

cause the holder not to recover

substantially all of its initial investmentexcept through credit deterioration.

Financial assets that now meet the criteria

to be classied as loans and receivables

may be transferred from held for trading to

loans and receivables, if the entity has the

intention and the ability to hold them for

the foreseeable future (paragraph 50D).

Neither “foreseeable future” nor “near

term” are dened.

Financial assets that are not eligible for

classication as loans and receivables, may

be transferred from held for trading toavailable for sale or to held to maturity,

only in “rare” circumstances (paragraph

50B). “Rare” is not dened, although it is

claried in the Basis for Conclusions that

“rare circumstances arise from a single

event that is unusual and highly unlikely

to recur in the near term”. Also, in 2008

the IASB stated on its website: “The

deterioration of the world’s markets that

has occurred during the third quarter of

this year is a possible example of rarecircumstances cited in the IFRS

amendments and therefore justies their

immediate publication.”

Financial assets may only be transferred

into the held to maturity category if the

entity has the positive intent and ability to

hold them to maturity. Also, entities must

not forget that, from an accounting

perspective, if they sell the asset before

maturity, this will taint the remaining

portfolio (with only a few exceptions),

resulting in reclassication of the entireportfolio as available for sale.

The amendments also allow reclassication

of nancial assets out of available for

sale to loans and receivables if the entity

has the intent and the ability to hold them

for the foreseeable future and the assets

meet the denition of loans and receivables

at the date of reclassication (paragraph

50E).

The ow charts on the following page

provide a roadmap to illustrate the

amendments.

Embedded derivatives

For nancial instruments classied as held

for trading, there is no need to consider the

separation of any embedded derivatives,

because the entire instrument is recorded

at fair value through prot or loss.

However, when an instrument is not

recorded at fair value through prot or

loss, it is necessary to assess when

becoming a party to the contract whetherto separate, and report at fair value

through prot or loss, any embedded

derivative (if its economic characteristics

and risks are not closely related to those of

the host instrument). The original version

of IFRIC 9 Reassessment of Embedded

Derivatives prohibited the subsequent

reassessment of whether to separate

embedded derivatives unless there was a

change in the terms of the contract

signicantly modifying its cash ows.

Financial assets that wouldnow meet the criteriato be classied as loans

and receivables, may betransferred from heldfor trading to loans andreceivables, if the entityhas the intention and theability to hold them for the

foreseeable future.

1 The Commission wrote to the Board on 27 October 2008 requesting this as well as, amongst others, a clarication that a

credit derivative in a synthetic CDO does not require separation (see later in this publication).




2 The amendments, as worded, allow nancial assets to be reclassied to loans and receivables if they meet the relevant criteria as of the reclassication date, even if on original

recognition, they were quoted in an active market and so would not have been eligible to be recorded in this category. However, to reclassify such assets, it would also be necessaryfor there to be an intention to hold them for the foreseeable future or to maturity. The question has been asked as to whether, if an asset would now qualify to be regarded as a loanand receivable but the entity cannot assert that it will hold it for the foreseeable future, the asset can, alternatively be reclassied to available for sale, if the circumstances are rare.

This question is likely to be relevant only if the entity regards the intent to hold the asset for the foreseeable future as more onerous than no longer having the intent to hold theasset for sale in the near term, which will turn on the interpretation of both these terms, and the circumstances are, indeed, rare. In our view, the amendments can be read both toprohibit such an alternative assessment for such assets or to allow it. Therefore, until the IASB claries this issue, we believe that entities can interpret the amendments to permit

this alternative assessment if they so wish. We would expect them to disclose this interpretation in their accounting policies, if the effect is material.

Reclassication as loans and

receivables permitted

Are the circumstances “rare”?(paragraph 50B)

Reclassication as

available for sale permittedReclassication as held to maturity and

available for sale permitted

Does the entity intend and have theability to hold the nancial asset for the

foreseeable future or until maturity?(paragraph 50D)

Does the nancial asset meet the

denition of loans and receivables at

the date of reclassication?(paragraph 50D and denition of “Loans and

Receivables” paragraph 9)

Is the nancial asset no longer held for

the purpose of selling in the near term?(paragraph 50(c))

Does the entity intend and have the abilityto hold the nancial asset until maturity?(Denition of held to maturity in paragraph 9)

Is the nancial instrument a derivative?

Is it a nancial asset designated at

FVTPL on initial recognition?No reclassication permitted

Unclear (2)

NO

NO

NO

NO

NO

YES

YES

YES

YES

YES

Reclassication out of fair value through prot or loss

NO YES

YES

NO

With “Look back option” to 1 July 2008 if consistent with the date of change of intent

Reclassication as loans and

receivables permittedNo reclassication permitted

Reclassication as held to

maturity permitted

Does the entity intend and have theability to hold the nancial asset in the

foreseeable future or until maturity?(paragraph 50E)

Does the nancial asset meet the

denition of loans and receivables at

the date of reclassication?(paragraph 50D and denition of “Loans and

Receivables” paragraph 9)

Does the entity intend and have the abilityto hold the nancial asset until maturity?(Denition of held to maturity in paragraph 9)

NO

NO

YES

YES

Reclassication out of available for sale

NO YES

With “Look back option” to July 1, 2008 ifconsistent with the date of change of intent

No “Look back option” to July 1, 2008(reclassication was already permitted by

IAS 39 paragraph 54)

3




The amended IFRIC 9 requires:(a) An entity to assess whether an

embedded derivative is required to be

separated from a host contract when

the entity reclassies a hybrid

nancial asset out of the fair value

through prot or loss category; and

(b) The assessment to be made on the

basis of the circumstances that

existed on the later of:

the date when the entity rst•

became a party to the contract,and

the date at which a change occurs•

in the terms of the contract that

signicantly modies the cash

ows that otherwise would have

been required under the contract.

IAS 39 is also amended to state that if

the fair value of an embedded derivative

that would have to be separated on

reclassication cannot be reliably

measured, the entire hybrid nancial

instrument must remain classied as atfair value through prot or loss and

cannot be reclassied.

Effective date

The effective date of the amendments is

1 July 2008. Reclassications before

1 July 2008 are not permitted but, prior to

1 November 2008, entities were able to go

back to 1 July 2008 and make transfers as

of that date, as long as the assets met the

criteria for reclassication at that time.

Any reclassication of a nancial asset

made on or after 1 November 2008 will

take effect only from the date when the

reclassication is made. An amendment

issued by the Board on 27 November 2008

made clear that the look back option to

1 July 2008 was no longer available after

1 November 2008.

Reclassications out of available for saleinto held to maturity were already

permitted for debt instruments before the

amendment, whenever there was a change

in intent or ability. The 1 July 2008

effective date applies only to the newly

permitted reclassications. Therefore, an

entity may not reclassify from available for

sale into held to maturity as of 1 July

2008, unless it had changed its intention

and decided to reclassify as at that date.

The amendments to IFRIC 9 and IAS 39,

as they relate to separation of embeddedderivatives upon reclassication, are

applicable for annual periods ending on or

after 30 June 2009. IAS 8 Accounting

Policies, Changes in Accounting Estimates

and Errors is to be applied upon transition,

accordingly, retrospective application will

be required. Any entities that have not

reassessed their embedded derivatives will

need to restate their nancial statements

when implementing the amendments.

Accounting for reclassied

assets

Any reclassication should take place at

the fair value at the date of reclassication.

For example, an instrument that was

acquired at its par value of 100, had

declined in fair value to 60 and is now

reclassied to held to maturity, will have

a new amortised cost of 60. The new

cost would be amortised back to the

instrument’s expected recoverable amount

over its expected remaining life through

the effective interest method. Therefore,the loss of 40 recognised in prior periods

will not be reversed through prot or loss

on reclassication, but will be amortised

through interest income over the remaining

life of the contract.

“In response to requestsfor clarication, the Board

made it clear that anyreclassication made on

or after 1 November 2008takes effect from the dateof reclassication.”

4




Any subsequent increase in expectedrecoveries will also be recognised through

interest income, by increasing the effective

interest rate. This is achieved by an

amendment of paragraph AG 8 of IAS 39.

An issue that was discussed at some

length at the board meeting to approve

the amendments was how, in practice, to

determine the new effective interest rate

once the asset has been reclassied. The

effective interest rate will depend on the

level of cash ows expected, so higher

expected cash ows will result in a higher

effective rate. This calculation willnecessarily be judgmental, but the

amendment to paragraph AG 8 will

reduce the effect on reported prot of

changes in estimates, while the

requirement to disclose the expected cash

ows will provide information to users of

the nancial information as to how the

judgment has been applied.

If the instrument is reclassied as available

for sale, any subsequent change in fair

value (other than amortisation of interest

at the new effective interest rate) from

the fair value at the date of reclassication

will be recorded in the available for sale

revaluation reserve in equity (other

comprehensive income) until the asset is

derecognised or impaired.

For any asset reclassied out of available

for sale to held to maturity or loans and

receivables, any gain or loss recorded in the

revaluation reserve in equity will be

amortised to prot through interest income

over the asset’s remaining life, until the

asset is derecognised or impaired.

ImpairmentThere is no need to assess for impairment

for a nancial asset if classied as held

for trading. However, once an asset is

reclassied to loans and receivables,

held to maturity or available for sale, it

will subsequently need to be reviewed

for impairment using the IAS 39

impairment rules for the category

into which it is reclassied.

If an asset that is reclassied as available

for sale is deemed impaired, then any

decline in fair value subsequent to

reclassication will need to be recorded as

an impairment loss. If an asset is

reclassied from available for sale to held

to maturity or loans and receivables, and it

is subsequently considered impaired, then

the cumulative gain or loss that was

previously recorded in equity will need to

be recognised immediately in prot or loss.

Going forward, any asset reclassied to

loans and receivables or held to maturity

will need to be assessed for impairment not

only individually, but also collectively.

Embedded credit

derivatives

In February 2009, the IASB staff issued a

Q&A on the IASB website providing

guidance on another matter relating to

credit derivatives: whether embedded

credit derivatives in collateralised debt

obligations (CDOs) not classied as at fair

value through prot or loss need to be

separated and accounted for separatelyunder IFRS. The Q&A notes that

subordination (‘waterfall’) features

generally do not result in the separation of

an embedded credit derivative from the

CDO. However, AG 30(h) of IAS 39,

requires separation of embedded credit

derivatives within CDO structures which do

not hold the reference assets but, instead,

create credit exposure to these assets using

credit derivatives (such as credit default

swaps). Accordingly, entities that reclassifyCDO investments out of the fair value

through prot or loss category must

determine whether any related credit

derivatives need to be separated.

The IASB acknowledges that IFRS and US

GAAP may treat these instruments

differently due to different approaches to

the assessment of embedded derivatives.

However, it did not nd cause to amend

IFRS to harmonise with US GAAP as these

inconsistencies will be addressed in the

planned joint project on recognition andmeasurement of nancial instruments.

Hedge accounting

It is probable that nancial assets which are

now being reclassied were, while recorded

as held for trading, economically hedged

for some of their risks, such as movements

in LIBOR, by derivatives that were also

recorded at fair value through prot or loss.

Hedge accounting was not previously

necessary to obtain consistency of

measurement. While the assets could bereclassied as loans and receivables as of

1 July 2008, the hedging derivatives could

not. Gains or losses on the derivatives will

continue to be recorded in prot or loss

subsequent to 1 July 2008 and these will

not be offset by similar recorded gains or

losses on the transferred assets.

Hedge accounting cannot be applied

retrospectively, so the derivatives can only

be treated as hedges of the transferred

assets for accounting purposes once the

hedges have been documented and thehedge effectiveness demonstrated. Also,

as the derivatives will no longer have a fair

value of zero, it is probable that there will

at least be some hedge ineffectiveness,

especially for cash ow hedges, or they

may fail the effectiveness test altogether.

If an instrument is reclassied into held

to maturity it is not eligible for hedge

accounting for interest rate risk.

5




DisclosuresIf the reclassication amendments are

applied, the disclosure requirements are

substantial. They are intended to permit a

user of the nancial statements to

determine what would have been the

accounting result had the reclassication

not been made. The collection of this data

will require the maintenance of parallel

information, giving rise to additional effort

for the entity.

The disclosure requirements include:1. The amount reclassied into and out of

each category.

2. For each reporting period until

derecognition, the carrying amounts and

fair values of all nancial assets that

have been reclassied in the current

reporting period and in previous

reporting periods.

3. For nancial assets reclassied in “rare”

circumstances, the rare situation and the

facts and circumstances indicating that

it was “rare”.

4. In the reporting period when nancial

assets are reclassied, the fair value

gains or losses on those assets

recognised either in prot or loss or in

other comprehensive income in that

reporting period and in the previous

reporting period.

5. Over the remainder of the instruments’

lives, the gains or losses that would have

been recognised in prot or loss or other

comprehensive income had they notbeen reclassied, together with the

gains, losses, income and expenses

now recognised.

6. As at the date of reclassication, the

new effective interest rates and

estimated amounts of cash ows the

entity expects to recover.

Implementation questionsThe following are some questions and

answers on implementation which have

arisen with respect to the amendments:

Scope of the amendment

Q1: Is it possible to apply the

amendments to reclassify a nancial

asset which was originally classied as

held for trading because “it was part of a

portfolio of identied instruments that

are managed together and for which thereis evidence of a recent actual pattern of

short term prot-taking” (paragraph (a)

(ii) of the denition of held for trading)?

A: A reclassication out of held for trading

can only be made if the entity no longer

has any trading intent with respect to that

instrument. Therefore, despite the transition

rules, reclassication is only possible from

the date of cessation of trading intent.

While this situation is not specically

referred to, we believe, in practice, that

the amendments will be applied to suchnancial assets if they are no longer held

with trading intent.

Q2: Do the amendments apply to

recognised loan commitments?

A: Loan commitments that can be settled

net in cash or by delivering or issuing

another nancial instrument are derivatives.

The amendments only apply to non-

derivative nancial assets and so cannot

be applied to a loan commitment. This

means that any commitments to lend can

only be reclassied as of the date the loans

were drawn down, at the fair values of the

loans on those dates.

Effective date

Q3: Was 31 October 2008 the last

possible date on which it was possible to

choose to reclassify a nancial asset as

of 1 July 2008?

If the reclassication

amendments areapplied the disclosurerequirements aresubstantial.

6




A: Yes, all decisions to use the ‘look backoption’ to 1 July 2008 must have been

made prior to 1 November 2008, as

claried in the October IASB Update.

Q4: If nancial assets were reclassied

before 1 November 2008 on the basis of

paragraph 50C of the amendments,

because the entity no longer intended to

sell the asset in the short term and there

were “rare” circumstances, what were

these circumstances and at what date

should the reclassication be made?

A: The answer to this question hasseveral components:

a) In many cases, it will be reasonably clear

that the market was sufciently

disrupted for the trading circumstances

to be considered “rare” before 1 July

2008, in which case the effective date

of reclassication would be the later of

1 July 2008 and the date of change in

intent to sell.

b) It is possible that some markets only

became seriously disrupted after 1 July,

in which case it would not be possible tosay that there were rare circumstances

at that time. If this is the case, it may not

be possible to determine exactly when

the requirements of paragraph 50C were

met, as the circumstances will have

emerged over a period of time. Selecting

the effective date for reclassication will

require judgment and it is possible that

different entities could form a different

assessment. It would be expected that

participants in particular markets will

have similar views and that there will belocal consensus on this issue. Entities

will need to gather and document

evidence to support their selected date.

c) While it is possible that “rare”

circumstances arose by different dates

for different markets, it is unlikely that

entities will be able to demonstrate

evidence for different reclassication

dates for different assets within the

same market (unless there is a clear

difference in intent).

d) The amendments allow reclassicationif there has been a change in intent

and the circumstances are rare, but

do not require the decision to be

made immediately when these two

criteria are met. Therefore, entities

would be permitted to select a later

reclassication date in order to reclassify

all assets as at the same date, in order

to reduce the practical cost of applying

the amendment, provided that at the

selected date of reclassication both

criteria were still being met.

In addition:

i) It should be noted that there are two

parts of the test: not only must there be

“rare” circumstances (paragraph 50C)

but also there must be no intent to sell

the asset in the short term (paragraph

50(c)). It is possible that the entity was

still seeking to sell assets even after the

start of the rare circumstances and so

reclassication would only be possible

once this intent had changed. The date

of change of intent might vary from one

group of assets to another, but entities

will need to have evidence of the

change in intent, which may not be

easy to obtain.

ii) As claried by the IASB, this will be an

issue primarily where the decision to

reclassify was made before 1 November

2008. On or after 1 November 2008,

the assessment of rare circumstances

must be made at the decision date.

Q5: On 1 July 2008, an entity still

intended to sell, in the near term, anancial instrument which was no longer

quoted in an active market and so would

otherwise have met the criteria to be

reclassied as a loan and receivable in

accordance with the new paragraph 50D.

If the entity, subsequent to that date,

changed its intention and decided to

hold the asset for the foreseeable

future, what is the appropriate date

of reclassication?

A: The date of change of intent. If thatdate was before 1 July 2008, the earliest

reclassication date would be 1 July 2008.

If the change of intent was later, then the

date of reclassication would be that

later date.

Q6: Can an entity apply the ‘look back

option’ to reclassify a nancial asset

from held for trading as at 1 July 2008

if there have been active efforts to sell

that asset since 1 July 2008 or sales

since that date of similar assets?

A: In order to reclassify as of 1 July 2008,the entity must demonstrate that the asset

was no longer held with the intent to sell in

the short term. In addition, if the asset is to

be reclassied into loans and receivables,

the entity must have no intention to sell the

asset in the foreseeable future. Efforts to

sell the asset or actual sales of similar

assets are difcult to reconcile with the

intent not to sell in the short term or in

the foreseeable future. In any event,

management should, in accordance with

IAS 1, disclose any signicant judgments

made in this regard.

Q7: If the entity had disclosed that a

nancial asset recorded as held for

trading as at 30 June 2008 was fair

valued by reference to quoted market

prices (i.e., ‘level 1’ of the fair value

hierarchy), can it subsequently be

reclassied as of 1 July 2008?

A: Yes, provided the conditions to reclassify

are met. The reclassication amendmends

do not require, as a prerequisite, the

absence of an active market. Rather, they

only require, for reclassications to loans

and receivables, a change in intent to sell

and both the intent and ability to hold

the instruments for the foreseeable future.

Alternatively, instruments can be reclassied

from held for trading to available for sale

or held to maturity provided it can be

demonstrated that: there has been a change

in intent to sell the instrument; and that

there are rare circumstances as described in

paragraph 50B.

7




Near term and foreseeable future

Q8: Are “near term” and “foreseeable

future” the same?

A: Neither term is dened. “Near term” is

a period of time, whose length might be

interpreted differently by different entities

but is likely to remain xed. We have seen

cases where it has been interpreted for

individual entities to be a period as short as

three months or as long as a whole year.

“Foreseeable future” is even more difcult

to interpret and will vary in duration

depending on circumstances. Normally it

will be longer than the near term but the

two periods are not necessarily contiguous.

This will be a matter of judgment. Each

entity needs to determine how it will

interpret these terms and it will usually be

necessary to disclose how they are

interpreted as part of the judgments made,

in accordance with IAS 1.

Q9: Can an entity assert that it

intends to hold a nancial asset for

the foreseeable future if it is prepared

to sell the asset on receipt of a

reasonable offer?

A: In general, no. To have the intent not to

sell the asset in the foreseeable future, the

entity should normally have an expectation

that it will not consider any offers. While

circumstances may change in future, the

intent not to sell in the foreseeable future

implies that there is no expectation that

there will be a change in circumstances over

this period of time.

Transfers from available for sale

Q10: If a nancial instrument is

reclassied from available for sale to

loans and receivables should the amount

recorded in equity also be reclassied

out of equity?

A: No, the negative revaluation reserve willremain in equity, to be amortised to prot

or loss over the asset’s life in accordance

with paragraph 54 unless the asset is

subsequently sold or deemed to be

impaired, in which case, the balance is

transferred to prot or loss.

Effective interest rate

Q11: How should the new effective

interest rate (EIR) be determined

on a nancial instrument reclassied

from available for sale to loans

and receivables?

A: Upon reclassication, a new EIR must be

calculated so as to accrete the asset’s fair

value as at the date of reclassication to the

expected level of cash ows to be received.

If the asset is not considered to be impaired,

the cash ows should not include future

credit losses and the EIR will be equivalent

to the market yield as of the date of

reclassication. This is also the EIR that is

required to be disclosed by paragraph

12A(f) of the amendments. If the asset isregarded as impaired when reclassied,

then the expected cash ows will reect the

expected recoveries and so the EIR will be

lower than the yield determined by the

market. If, subsequent to reclassication,

the asset is deemed to be impaired, then

the new EIR calculated as of the date of

reclassication will be used to discount

the expected cash ows in order to

calculate impairment losses.

As mentioned in the response to question

11, the amount previously recorded inequity for the revaluation of the asset will

also be amortised to prot or loss over the

remaining life of the asset. While this

amortisation will normally be recorded in

interest income, it will not form part of the

EIR. If in the future the asset is deemed to

be impaired and any decit in equity

“Foreseeable future”is a more complexconcept and will vary induration, depending oncircumstances. Normallyit will be longer than thenear term.




relating to the asset is transferred directlyto prot or loss, this will be in addition to

any impairment loss as calculated in the

previous paragraph.

Transfers to loans and receivables

Q12: What happens if the market for a

nancial asset reclassied to loans and

receivables in accordance with paragraph

50D or 50E becomes active again

subsequent to reclassication? In

particular, if the asset is again quoted in

an active market, or the entity resumes

its intent to sell the asset in the

foreseeable future (and so it no longer

meets the criteria contained in the

denition of loans and receivables), is it

necessary or permitted to reclassify the

asset to another category, such as held

for trading, available for sale or held

to maturity?

A: It is clear that it is not permitted to

transfer any asset into the held for trading

or designated at fair value categories

subsequent to initial recognition. It is notclear whether the amended IAS 39 either

requires or permits reclassication out of

loans and receivables to available for sale

or held to maturity, if the asset once again

becomes quoted or is held with an intent to

sell in the foreseeable future. It is our view

that until this issue is addressed by the

IASB, entities have a choice whether or not

to reclassify assets previously transferred

to loans and receivables when they no

longer meet the criteria set out for that

category. This choice of policy should be

applied consistently for all assets and

should be disclosed. This issue is equally

applicable to nancial assets that were

originally classied as loans and receivables

and is not restricted solely to those that

have been reclassied.

Q13: Upon reclassication of a nancialasset to loans and receivables, should it

be tested for impairment?

A: The fair value of the asset as at the date

of reclassication will become its new cost

and no further impairment losses will

normally need to be provided as of that

date. However, subsequent to the date of

reclassication, the entity will need to

assess whether there is objective evidence

of impairment as required by IAS 39. It

should be noted that any asset recorded

at amortised cost must be assessed for

impairment individually (unless it isindividually insignicant) and, if not

individually impaired, also on a collective

basis.

It is possible that, for a portfolio of assets

transferred from available for sale to loans

and receivables, an allowance may be

needed for impairment based on a

collective assessment, even if none of the

assets is individually deemed to be

impaired. It is unclear whether it is

necessary to make such an assessment on

reclassication – if so, there could be a

need to transfer some of the loss previously

recorded in equity to prot or loss. This is

not a new problem: it would have also been

applicable for transfers from available for

sale to held to maturity in the past. Until

this issue is claried by the IASB, it is our

current view that the assets once

reclassied are treated as if newly

originated, in which case no immediate

impairment should be recorded.

Impairment

Q14: Upon reclassication of an available

for sale debt instrument into loans and

receivables does an entity need to

individually assess the instrument for

impairment if the entity has previously

done so before reclassication, or can

just a collective assessment be made?

A: The fact that an entity assessesimpairment on a collective basis, on the

grounds that the reclassied nancial

assets are now deemed not to be

individually signicant, does not allow it to

avoid recycling its revaluation reserve to

prot or loss. Paragraph 64 of IAS 39

states that an entity rst assesses whether

objective evidence of impairment exists

individually for nancial assets that are

individually signicant, and individually or

collectively for nancial assets that are not

individually signicant. The amount

transferred to prot or loss must be similar

whatever the method that is used to

calculate impairment. As a result,

impairment is normally assessed on an

individual basis, as before.

Hedge accounting

Q15: Is an entity able to start to hedge

account for risks of an asset at the date

of reclassication even though the

reclassication was made with

retroactive effect?A: Hedge accounting is only allowed from

the date that the hedge relationship meets

the criteria set out in IAS 39. Applying

hedge accounting with retroactive effect is

not allowed because the hedge relationship

would not have been adequately

documented and the effectiveness of the

hedge would not have been tested before

hedge accounting was applied.

Q16: Should an entity re-document a

hedge relationship if the hedged asset is

reclassied from available for sale toloans and receivables?

A: Not necessarily, but this will depend on

how specic the hedge documentation was

at the date of reclassication.

9



Example 1: Reclassicationfrom trading into

loans and receivables

(with no impairment)

On 30 September 2007, Bank A originates

a 6%, 5 year loan for €100 million with the

intention to syndicate 80% after origination.

At the date of origination it therefore

classies 80% of the loan as held for trading

and the other part (20%) as loans and

receivables (the loan is not quoted in anactive market).

Due to the current market situation,

the syndication fails and the loan is retained

by the bank, with the intention to hold it for

the long term.

By 30 June 2008, the part of the loan that

was classied as held for trading (80%)

decreased in fair value to €65 million.

On 25 October 2008, using the

amendment, the bank reclassies the part

of the loan recorded as held for trading toloans and receivables in its third quarter

nancial statements, as of 1 July 2008.

Its amortised cost is recorded at €65 million.

At that date, the bank estimates thatit will recover all the contractual cash ows

on the loan (i.e., with no impairment).

The contractual cash ows are as follows:

The EIR that exactly discounts these future

cash ows to the fair value of the loan at

the date of reclassication is 13.5%. This

new EIR is then used to amortise the

difference between the amortised cost of

the loan at the date of reclassication and

the redemption value until the maturity

date. Accordingly, the amortised cost will

accrete as follows:


Coupon

(€m)

Principal

(€m)

30 September 2008 4.83




30 September 2012 4.8 80

Period end* Amortised

cost

brought

forward

(€m)

Interest

income at

13.5%

(€m)

Coupon

(€m)

Difference

recorded in

amortised

cost

(€m)

Amortised

cost

carried

forward

(€m)

30 September 2008 65 2.14 4.8 -2.7 62.3

30 September 2009 62.3 8.45 4.8 3.6 65.9

30 September 2010 65.9 8.96 4.8 4.1 70

30 September 2011 70 9.57 4.8 4.7 74.7

30 September 2012 74.7 10.18 4.8 5.3 80

Examples of applyingthe reclassication

amendments

3 4.8 = 80 x 6% 4 2.1 = 65 x 13.5% x 3/12 (from 1 July to 30 September) 5 8.4 = 62.3 x 13.5%

6 8.9 = 65.9 x 13.5% 7 9.5 = 70 x 13.5% 8 10.1 = 74.7 x 13.5%

* The period ending 30 September 2008 represents three months. All other periods in this table are 12 months.

10




Period end* Amortisedcost

brought

forward

(€m)

Interestincome at

19.6%

(€m)

Coupon(€m)

Differencerecorded in

amortised

cost

(€m)

Amortisedcost

carried

forward

(€m)

30 September 2008 35 1.69 0 1.6 36.6

30 September 2009 36.6 7.210 0 7.2 43.8

30 September 2010 43.8 8.611 0 8.6 52.4

30 September 2011 52.4 10.312 0 10.3 62.7

30 September 2012 62.7 12.313 0 12.3 75

Period end Amortised

cost

brought

forward

(€m)

Interest

income at

23.6%

(€m)

Coupon

(€m)

Difference

recorded in

amortised

cost

(€m)

Amortised

cost

carried

forward

(€m)

30 September 2011 52.4 12.314 0 12.3 64.7

30 September 2012 64.7 15.315 0 15.3 80

Example 2: Reclassicationfrom trading into


(with impairment)

On 30 September 2007, Bank A acquired a

6%, 5-year bond that was originally quoted

in an active market. The bond was acquired

at its par value of €80 million and its

maturity date is 30 September 2012. The

bond was held for trading purposes and was

classied accordingly as held for trading.

By 30 June 2008, the market is no longer

active and the fair value of the security

has declined to €35 million. This is

because principal and interest are no

longer expected to be fully recovered, and

the market rate for an instrument with

similar risk characteristics is signicantly

higher than the security’s coupon. The

bank now intends to hold the bond in

the foreseeable future.


amendment, the bank reclassies the

bond to loans and receivables in its third

quarter nancial statements, as of

1 July 2008. Its amortised cost is

recorded at €35 million.

At that date, the bank estimates that it will

receive no interest and just €75 million of

principal repayment at maturity date.

The EIR that exactly discounts these

expected future cash ows to the fair value

of the bond at the date of reclassication is

19.6%. This new EIR is then used toamortise the difference between the

amortised cost of the bond at the date of

reclassication and its expected redemption

value until the maturity date. Accordingly,

the amortised cost will accrete as follows:

On 30 September 2010, the bank still

expects not to receive the interest

payments, but now expects to recover

100% of principal (i.e., €80 million).

According to revised IAS 39 paragraph

AG8, the bank should not write up the

recorded value of the bond but, instead,

should revise the EIR.

The revised EIR that exactly discounts the

revised expected future cash ows to the

current amortised cost of the bond

(€52.4 million) is 23.6%. This new EIR

is then used to amortise the residual

difference between the amortised cost of

the bond and its expected redemption value

until the maturity date. Accordingly, the

amortised cost will accrete as follows:

9 1.6 = 35 x 19.6% x 3/12 (from 1 July to 30 September) 10 7.2 = 36.6 x 19.6% 11 8.6 = 43.8 x 19.6%

12 10.3 = 52.4 x 19.6% 13 12.3 = 62.7 x 19.6% 14 12.3 = 52.4 x 23.6% 15 15.3 = 64.7 x 23.6%

* The period ending 30 September 2008 represents three months. All other periods in this table are 12 months.

11




Example 3: Reclassicationfrom trading into available

for sale

In June 2006, Bank A purchased a cash CDO

(i.e., a collateralised debt obligation in which

the SPE which issues the security is required

to hold the underlying reference assets,

rather than derivatives referenced to those

assets) with a 2020 maturity date at its par

value of Euro 100 million. The CDO was held

for trading purposes and was classied

accordingly as held for trading.

By June 2008, the CDO had declined in fair

value to €75 million and was no longer

traded in an active market. Consequently,

the bank determines that it no longer has the

intent to trade the CDO.

On 25 October 2008, using the amendment,

the bank reclassied the CDO to available for

sale as of 1 July 2008. The CDO is

reclassied at its fair value at that date

(€75 million) and will be subsequently

remeasured at fair value with any change infair value recorded in the available for sale

revaluation reserve (except for amortisation

through the effective interest rate) until the

CDO is impaired or derecognised.

The EIR is determined using the method

described in examples 1 and 2. The EIR is the

rate that exactly discounts the expected

future cash ows (with the expected

maturity date) to the fair value of the CDO at

the date of reclassication. This EIR is used

to amortise the difference between the fair

value of the CDO at the date ofreclassication and the expected redemption

value at the expected maturity date.

Although the legal maturity of the CDO is

2020, the CDO could mature earlier if the

underlying assets prepay earlier. It is

currently unclear whether the prepayment

option would need to be separated and

recorded at fair value through prot or loss.

Example 4: Reclassicationfrom available for sale into


In June 2006, Bank A purchased a cash

CDO with a 2020 maturity date at its par

value of €100 million. The CDO is classied

as available for sale.

By June 2008, the CDO has declined in fair

value to €75 million and is no longer traded

in an active market. The bank has

determined that it intends to hold theCDO for the foreseeable future.


amendments, the bank reclassied the

CDO into loans and receivables as of

1 July 2008. Its amortised cost was

recorded at €75 million (the fair value of

the CDO at the date of reclassication).

At that date, the bank estimated that it

would recover all the contractual cash ows

on the CDO (i.e., with no impairment) with

an expected maturity in June 2014.

The contractual cash ows are as follows:

The EIR that exactly discounted these

future cash ows to the fair value of the

CDO at the date of reclassication was

12.10%. This new EIR was then used to

amortise the difference between the

amortised cost of the CDO at the date

of reclassication and the redemption

value until the expected maturity date.

Accordingly, the amortised cost will

accrete as follows:

Coupon

(€m)

Principal

(€m)

30 June 2009 616

30 June 2009 6

30 June 2010 6

(...) 6

30 June 2014 6 100

It is currently unclearwhether the prepaymentoption would need to beseparated and recordedat fair value throughprot or loss.

12

16 6 = 100 x 6%



13Reclassication of nancial assets March 2009

Period end Amortisedcost

brought

forward

(€m)

Interestincome at

12.10%

(€m)

Coupon(€m)


amortised

cost

(€m)

Amortisedcost carried

forward

(€m)

30 June 2009 75 9.117 6 3.1 78.1

30 June 2010 78.1 9.418 6 3.4 81.5

30 June 2011 81.5 9.919 6 3.9 85.4

30 June 2012 85.4 10.320 6 4.3 89.7

30 June 2013 89.7 10.921 6 4.9 94.6

30 June 2014 94.6 11.422 6 5.4 100

17 9.1 = 75 X 12.10% 18 9.4 = 78.1 x 12.10% 19 9.9 = 81.5 x 12.10% 20 10.3 = 85.4 x 12.10%

21 10.9 = 89.7 x 12.10% 22 11.4 = 94.6 x 12.10%

23 The amortisation of the AFS reserve equals the difference between the interest income calculated

using the effective interest method and the coupon received on the CDO.

The negative available for sale revaluation reserve of €25 million was frozen at the date of

reclassication and will be amortised to prot or loss over the remaining life of the CDO. As

a result, it will be debited to prot or loss as follows:

Period end AFS

revaluation

reserve

brought

forward

(€m)

Amortisation

of AFS

revaluation

reserve in

prot or loss23

(€m)

AFS

revaluation

reserve

carried

forward

(€m)

Interest

income at

12.10%

(€m)

Net interest

income

(€m)

30 June 2009 (25) (3.1) (21.9) 9.1 630 June 2010 (21.9) (3.4) (18.5) 9.4 6

30 June 2011 (18.5) (3.9) (14.6) 9.9 6

30 June 2012 (14.6) (4.3) (10.3) 10.3 6

30 June 2013 (10.3) (4.9) (5.4) 10.9 6

30 June 2014 (5.4) (5.4) 0 11.4 6

On 30 June 2011, the bank estimates that the CDO is now impaired. It expects that it will

no longer receive any coupon and that only 80% of principal amount will be recovered (i.e.,

€80 million).

According to paragraphs 54(a) and 67 of IAS 39, Bank A recycles all of the residual AFS

revaluation reserve to prot or loss. Additionally, it records an impairment loss measured as

the difference between the CDO’s carrying amount and the present value of estimated

future cash ows discounted at the CDO’s revised EIR (i.e., the EIR determined at the date

of reclassication).



14 Reclassication of nancial assets March 2009

Amortisation of AFS

revaluation reserve in

prot or loss

(€m)

Impairment loss on

the CDO

(€m)

Total impact on prot

or loss

(€m)

30 June 2011 (14.6) (28.6)24 (43.2)

Period end Amortisedcost

brought

forward

(€m)

Interestincome at

12.10%

(€m)

Coupon(€m)


amortised

cost

(€m)

Amortisedcost carried

forward

(€m)

30 June 2012 56.8 6.925 0 6.9 63.7

30 June 2013 63.7 7.726 0 7.7 71.4

30 June 2014 71.4 8.627 0 8.6 80

The amortised cost of the CDO will then accrete as follows:

Following the impairment, the net amount recorded in prot or loss is only the interest

income recorded using the EIR of 12.10% since the entire AFS revaluation reserve has

already been recycled to prot or loss.

Example 5: Reclassicationfrom available for sale into

held to maturity

The assumptions used are the same as

in example 4 except that, on 25 October

2008, the bank decides to reclassify the

CDO as held to maturity based on its intent

and ability to hold the CDO until maturity

and there is still an active market for CDOs.

On 25 October 2008, the fair value of the

CDO was €60 million.

According to paragraph 54 of IAS 39, the

reclassication is only effective

prospectively, starting on 25 October 2008.

Accordingly, the decrease in fair value

between 1 July 2008 and 25 October 2008

(€15 million) must be recognised as an

unrealised loss in the AFS revaluation

reserve (assuming, as before, that the

asset is not considered to be impaired) and

the amortised cost of the CDO at the date

of reclassication is €60 million.

Following the reclassication on 25 October

2008, the CDO should be accounted for in a

similar manner to that shown in example 4.

The bank appreciates that it may not sell

the CDO without tainting the entire

held to maturity portfolio.

24 (28.6) = 56.8 — 85.4 (Present value of expected future cash ows discounted at 12.10% less amortised cost carried forward on 30 June 2011 (before impairment))

25 6.9 = 56.8 x 12,10% 26 7.7 = 63.7 x 12.10% 27 8.6 = 71.4 x 12.10%

The present value of the expected future cash ows discounted using the EIR determinedat the date of reclassication (12.10%) is €56.8 million. The total impact on prot or loss

is as follows:



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About Ernst & Young’s International

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The move to International Financial

Reporting Standards (IFRS) is the single

most important initiative in the financial

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support our client teams. And we work to

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Limited nor any other member of the global Ernst & Young

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occasioned to any person acting or refraining from actionas a result of any material in this publication. On any

specific matter, reference should be made to the

appropriate advisor.

About Ernst & Young

Ernst & Young is a global leader in

assurance, tax, transaction and advisory

services. Worldwide, our 135,000 people

are united by our shared values and an

unwavering commitment to quality.We make a difference by helping our

people, our clients and our wider

communities achieve their potential.

For more information, please visit

www.ey.com

Ernst & Young refers to the global

organization of member firms of

Ernst & Young Global Limited, each

of which is a separate legal entity.

Ernst & Young Global Limited, a UK

company limited by guarantee,

does not provide services to clients.

About Ernst & Young’s International

Financial Reporting Standards Group

The move to International Financial

Reporting Standards (IFRS) is the single

most important initiative in the financial

reporting world, the impact of which

stretches far beyond accounting to affect

every key decision you make, not just how

you report it. We have developed the global

resources — people and knowledge — to

support our client teams. And we work to

give you the benefit of our broad sector

experience, our deep subject matter

knowledge and the latest insights from ourwork worldwide. It’s how Ernst & Young

makes a difference.

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