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ISDA Workshop – The practical implications of the new accounting rules

ISDA. International Swaps and Derivatives Association, Inc. ISDA Workshop – The practical implications of the new accounting rules. 8 November 2004. Overview of current position of IFRS. Significant differences between current UK GAAP and IFRS

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ISDA Workshop – The practical implications of the new accounting rules

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  1. ISDA International Swaps and Derivatives Association, Inc. ISDA Workshop – The practical implications of the new accounting rules 8 November 2004

  2. Overview of current position of IFRS • Significant differences between current UK GAAP and IFRS • Accounting for financial instruments under IFRS is rules based, UK GAAP is principles based • Adopted IFRS mandatory for all listed EU companies in their consolidated accounts after 1 January 2005 • Extension of IFRS to non-consolidated accounts varies by country • EU adopted IAS 39 will differ from that issued by the IASB. Certain “carve outs” have been proposed by the ARC • Changes still being proposed to IAS 39 with four Exposure Drafts issued since January 2004

  3. IFRS – Key standards for financial instruments accounting IAS 39: - Recognition and measurement of financial assets and liabilities; - Treatment of certain other non-financial items eg, commodity contracts; - Derecognition of financial assets and liabilities IAS 32: - Presentation of financial instruments from the perspective of the issuer; - Provides detailed rules covering netting; - Requires disclosures to enable a user to understand significance of financial instruments to an entity’s financial position SIC 12: -Consolidation of Special Purpose Entities IFRS 4: - Insurance contracts IAS 37: - Provisions, contingent liabilities and contingent assets

  4. The measurement categories • IAS 39 includes an option to designate ANY financial instrument at fair value at inception • Detailed guidance also provided on separating embedded derivatives from host contracts

  5. Hedge Accounting - Key steps to achieving a qualifying hedge • Identify the type of hedge – fair value or cash flow or net investment • Identify the hedged item or transaction • Identify the nature of the risk being hedged • Identify the hedging instrument • Demonstrate that the hedge has and will continue to be highly effective • Document the hedging relationship above, including the risk management objectives and strategy for undertaking the hedge • Monitor effectiveness

  6. Fair Value measurement • Defined as: “The amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arms length transaction” • It is not the amount that an entity would receive or pay in a forced transaction or distressed sale • Active markets – defined as those where quoted prices are readily available and representative of actual, regular market transactions. Financial Instrument valued using quoted price • No active market – models that are commonly used by the market are considered appropriate for valuing financial instruments

  7. Presentation – Netting & debt v equity • Financial liability – a contractual obligation to deliver cash or another financial asset to an entity • Equity instrument – a contract that evidences a residual interest in the assets of an entity • Some instruments have both a liability and equity component – eg convertible bonds. The fair value of the liability should be classified in the liability section of the balance sheet and the “plug” in equity • Ownership by an entity of its own shares is never an asset of that entity • Complex rules for derivatives on own shares • Financial assets and liabilities may only be offset in the balance sheet when there is both: - a legal, enforceable right of set-off; and- an intention to exercise the right or settle simultaneously

  8. Consolidation and Derecognition Consolidation Principles (SIC 12) • An enterprise should consolidate enterprises it controls • Control of SPEs is determined by considering factors outlined in SIC 12 Derecognition Principles (IAS 39) • Applied to transferor’s consolidated group, including SPEs if consolidated • Mixed model, based on both risks and rewards and control. Revised standard based on a decision tree: • Has there been a transfer or pass-through of cash flows? • Has there been a substantial change in the exposure to the risks and rewards? • Has there been a transfer of control (as evidenced by transferee’s ability to sell assets)?

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