Ifrs Accounting Of Financial Liabilities

Financial liabilities below IFRS 9 IASB Worldwide Accounting Standard Board has recently concluded on the 2nd phase regarding the ongoing project regarding the proposed IFRS 9 financial instruments that is to replace the existing IAS 39 Financial instruments Recognition and measurement. First component of IFRS 9, regarding financial assets - classification is already published and this one, the 2nd part, is proposed to close the accounting aspects of financial liabilities and de-recognition of financial assets. Highlights regarding the 2nd component of IFRS 9, are as follows. In the case of Financial liabilities that are designated on initial recognition at fair cost through profit and loss, their reporting date measurement is proposed to be changed, so as not to recognize fair cost changes attributed to variation in own credit risk, within the profit and loss account. However, no changes are proposed to general principles of recognition and measurement of financial liabilities.

In other words, principles as they stand in IAS 39 in vogue should continue to apply generally. As regards the de-recognition principles within the case of financial assets, the revised IFRS does not propose any changes except for sure more disclosure requirements. Although IASB has not suggested any change to existing principles in IAS 39, on recognition and measurement of financial liabilities, the principles in vogue as per IAS 39 are different from GAAP followed in many components regarding the world. This story takes a look at challenges within the accounting of financial liability below IFRS 9. Challenges on Initial measurement of financial liabilities.

Initial measurement of all financial liabilities shall be at fair cost below IFRS. Subsequently the guidance within the Standard clarifies that in an arm's length transaction the transaction cost is the fair value. In situations where transactions involve other considerations than that are involved in arms length transactions that affect the pricing or contractual terms of a liability, the fair cost is likely to be different from transaction value. Subsequently application guidance provided with the Standard prescribes that on initial measurement, while recognizing a liability at its fair cost no profit or gain shall be recognized in its income statement. The inference is that, where the fair cost of a financial liability is fewer than its transaction value, the latter itself becomes the basis of measurement on initial recognition.

Subsequently practices followed by entities to comply with this requirement of initial measurement at fair cost are different. Loan liabilities within the accounts of a subsidiary company, payable to a parent company, taken at concessional rate of interest should be a typical example in this context. Since such transactions are not priced at market rates, fair cost of financial liability is fewer than its transaction value. The IFRS standard is not specific as how the difference between the fair cost and transaction cost has to be accounted for. Appropriate application guidance should be compulsory in this context,, to make sure that uniform practices, throughout the globe.

Another region of challenge is related to accounting of costs incurred in connection with origination of a financial liability. Transactions costs related to financial liabilities other than those measured at fair cost through profit and loss are to be charged to liability itself. For instance, cost of issue of debentures or bonds has to be reduced from the proceeds of those debts and accordingly the liability shall be reflected at its net of cost of issue, on initial measurement. There exists a good many economies where such cost of raising debt is a direct charge to profit and loss account. Below IFRS, accounting for interest has to be below effective interest method.

Most regarding the third world countries follow contractual interest method in its location and that in effect want them to charge upfront fees paid on raising loans processing fees etc. to profit and loss account on day one. On the contrary below effective interest method, such initial charges are in substance the component regarding the effective interest and hence should grow to component regarding the periodical charge of interest rather than a onetime charge as expense at the time of incurrence. During the intervening time of amortization those charges are offset from liabilities rather than shown as separate unamortized asset. This also changes the method financial liabilities shall be presented below IFRS.

Balances carried within the account of financial liabilities shall not represent contractual obligation. That necessitates maintenance of 3 sets of account; one from contractual spot of view and the other from accounting point. In the cases of trade liabilities, where extended credit period is allowed, the consideration includes interest for the credit period also. The requirement of measuring a financial liability at fair cost for initial measurement can pose challenges in such cases as the total consideration has to be broken into fair cost of goods or services and interest. Below IFRS principles, the interest cost shall not grow to the liability until it accrues and hence a reduced liability is measured initially.

There are cases where liabilities are proposed to be settled through equity shares. Within the case of convertible bonds, the holders have choice to obtain shares at a prefixed price. At the time of issue of such bonds, the management of a business should be unsure regarding the likelihood regarding the bond holders exercising the choice of getting shares. Subsequently the pricing of bond is affected due to the fact that regarding the convertible option. In other words, without a convertible option, the cost interest rate of bond should have been different.

That is why the combination of bond bundled with an equity choice is a combination, the cost issue cost of which has 3 components, the bond and the choice to obtain equity shares. They want to be split such that the correct fair cost of liability should be captured on initial measurement. This is a marked departure from practices followed below regional GAAPs in many countries where the whole of bond cost is a liability. The process of splitting pre-requires the testing whether the combination is of a liability and equity or not by virtue regarding the definitions as in IAS 32. Reporting date measurement.

In addition to challenges at the time of initial measurement, the subsequent measurement of financial liabilities below IFRS also is at variance from IGAAP. Unlike in IGAAP, most regarding the financial liabilities below IFRS are measured at amortized cost as on reporting date. With the initial measure of financial liability at fair value, when interest calculated regarding to effective rate of interest method is applied and adjustments for the cash flows related to liabilities are done, till the date of reporting, the resultant is the amortized cost. Effective rate of interest in a variable interest contract has to be on estimated basis. Such estimations involve subjectivity.

It is likely that a lender and a borrower shall have different estimates about future interest scenario and hence different rates of effective rate of interest for similar to contract. This points to a scenario where a financial liability account as per contract shall be receiving note of different from a financial liability account as per the IFRS accounts. Entities should want to maintain multiple ledgers in that context and IT processes need appropriate modifications. Apart from measuring financial liabilities at amortised cost, there exists sure financial liabilities that are measured at fair cost even for reporting date. They can be neither those financial liabilities that are within the category of held for trading or designated by businesses initially as products at fair cost through profit or loss.

In most these categories their fair cost variations affect the Income Statement. Financial liabilities fall below held for trading category when they can be the result of a business model of brief term profit booking within derivatives, but not designated effective hedging instruments. Financial liabilities are designated at fair cost through profit and loss below 3 situations. a when the liability is a combination of debt and a derivative where from the cash flow from derivative is significantly at variance from the host liability, as per the general requirement of IFRS such combination embedded derivatives want to be split and the derivative wants to be measured at fair cost and the host wants to be measured at amortised cost. Alternatively the whole regarding the combination should be designated at fair cost through profit or loss as permitted by this IFRS.

be When the designation at fair cost through profit or loss eliminates an accounting mismatch. For instance a bank manages a portfolio of asset below held for trading category and measures at fair cost through profit or loss. There is a corresponding liability against it speak payable to port folio investors. It is necessary to measure those liabilities also at fair value. The bank can designate them so.

c When the internal monitoring of a portfolio liability, for management objective is at fair value, its measurement for reporting should possibly be at fair value. Change proposed in IFRS 9. The proposed change through IFRS 9 is regarding the measurement regarding the financial liabilities designated at fair cost through profit or loss covered by points a to c. Regarding to proposed change, fair cost change on reporting date on such financial liabilities should be attributable to different reasons? one amongst them being change in own credit rating. When the credit rating of a business decreases, recoverability of debt from that business also decreases.

That means cost of liability shall hold a lesser fair value. That should result in profit, that is undesirable. That is why the proposed IFRS 9 prescribes bifurcating fair cost changes for such liabilities as attributable to a own credit rating and be others. Fair cost change attributable to former is not recognized in profit or loss, instead in equity through the Other Comprehensive Income Statement OCI. While this proposed change is a prudent step, a couple of questions are relevant here.

Why is that the proposed change is applicable only within the case of products designated at fair cost through profit and loss and not the liabilities below Held for Trading Category. Suppose, a business had written choices and defaulted on payments when the buyers have exercised the option. This is a case where the credit worthiness regarding the business should be impaired significantly. Market cost regarding similar written choices should decrease like a result of credit risk increase. These written choices fall below HFT category and hence are to be measured at fair cost through profit and loss account.

Subsequently the fair cost change here is attributed to own credit risk at fewest partly if not fully, which if separated and kept out of profit and loss account should hold a higher loss recognized within the profit and loss account. The proposed provisions in IFRS 9 ignore these situations. When accounting is a means and not an end in itself, the process of separation of fair cost change as attributable to a own credit risk and be others is an exercise likely to invite more cost than benefit. The greatest course should have been to follow a conservative method below which net losses are taken to profit and loss account and net gains are to equity, with suitable to provisions for reversal of such losses and gains to be place along side the location of origins. In conclusion, IFRS accounting of financial liabilities is cumbersome and in an analysis of cost versus benefits, it is advantage professionals and not to entities C V SAJAN.