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REGULATIONS
High profile business failures and fraud have time and again tested the overall banking and financial services industry. All these events have pushed the regulators to take necessary actions to bring transparency and efficacy in financial statement reporting. International Accounting Standard 39 (IAS 39) is the pioneering standard issued by the International Accounting Standard Board. IAS 39 is a standard to establish principles for recognising, measuring, and disclosing information about financial instruments in the financial statements of business enterprises. It also requires hedge effectiveness to be assessed by prospective and retrospective testing. IAS 39 brings visibility for financial statements users. Asia's IAS 39 Implementation: Where Are We?In the Asia-Pacific region Singapore and Australia have, since the 1 January 2005, already complied with IAS 39. In Singapore the Council on Corporate Disclosure and Governance (CCDG) issued FRS 39 (Financial Reporting Standards 39) - the Singaporean equivalent to IAS 39. Meanwhile in Australia the standard is published by the Australian Accounting Standard Board. Elsewhere in the Asia-Pacific region, Malaysia, Taiwan, New Zealand and Japan are in the process of adopting IAS 39 and have issued timetables for adoption. The bodies responsible for implementing these standards are the Malaysian Accounting Standard Board, the New Zealand International Financial Reporting Standards (NZ FRS) body and the Accounting Standard Board of Japan. Key Points for Implementation of IAS 39 Standards-Recognition & Derecognition: Recognition means identifying the financial instruments (financial assets and liabilities) and recognizing them in financial statements. Derecognition means removing financial assets and liabilities from financial statements. Financial asset is derecognized from the IAS 39 calculations when the asset expires, or ownership is transferred etc. Fair Value Calculation: Fair value is the value at which the asset is exchanged and liabilities are settled. Changes in fair value are recognized in the profit and loss account. Fair values can be calculated daily, monthly or on a quarterly basis. Exchange traded instruments are fair valued using market quoted prices, OTC derivatives can be calculated using the Black & Scholes model, and interest rate instruments are fair valued using NPV or zero curve methodology. Impairment of Assets: Impairment loss is recognised only when it is incurred. If there is evidence of impairment then it should be accounted for in that period. Effectiveness of the Hedge Transactions (Prospective/Retrospective Testing): Effectiveness testing is required whenever financial statements are generated and released for internal or external purposes. Effectiveness of the hedge transactions mean the ability to offset the hedge item's fair value.
If the value is equal to one then the hedge is called perfectly effective, if the value is between 0.8-1.25 it is called highly effective and if the value is not in the range of 0.8-1.25 then it is an ineffective hedge. Hedge Accounting: Hedge accounting recognises and discloses the effects on profit or loss of fluctuations in hedge items (corporate bonds, government bonds, government loans, housing loans, subordinate debt, etc.) to hedge instruments (interest rate swap, currency rate swap, etc). Profit or loss arising through these transactions is posted in the general ledger. Issues in Implementing the Standard:
A hedging relationship qualifies for hedge accounting if, at inception of the hedge, there is formal documentation of the hedging relationship and the entity's risk management objective and strategy for undertaking the hedge. Accounting of embedded derivatives is difficult because most of these are recorded as composite derivatives in the system. Most of the existing applications do not support recording of embedded derivatives so the challenge here is to identify and account for them. Fair value is the value where the asset can be exchanged and liabilities can be settled. Some instruments are not active and their price information is not readily available, so there are concerns about the reliability of measurement of the market value of these financial instruments. At the time of implementation we need to decide the method of calculating those instruments. To calculate hedge effectiveness of the transactions, and to post accounting entries, the banks need to have connectivity with their front-office and back-office systems for seamless processing. Unfortunately, most of the banks have discrete systems but their compliance teams calculate and post accounting entries in the financial statements manually. Hence there is a need for internal straight through processing (STP) to reduce cost and risk. Banks and financial institutions face major challenges in interfacing with the legacy systems to get the required & clean data (hedge items, instruments, yield curves, pricing details) to calculate fair value, hedge effectiveness. Accounting systems in most organizations are complex and are difficult to change. This must be taken into consideration when implementing the IAS 39 standards. There are few software products in the market that address effectiveness, so many companies are still using traditional methods of calculation, i.e. Excel spreadsheets. Excel calculation is tedious and chances of manual errors are very high. Traditionally, derivative transactions were regarded as off-balance sheet items. However, thanks to IAS 39 it is now mandatory to measure and include these transactions in company's financial statements. All these measures will definitely lead to true and fair accounting practices. Copyright © ChinaForum 2008 |
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