| IAS progresses but many issues still to resolve |
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| The EU has concluded the endorsement process for IAS 39 but there are still a number of questions left regarding its application. Brendan Sheridan examines these issues, among which is the stance to be taken by Ireland's standard setter, the Accounting Standard Board. |
On November 19th, the European Commission adopted a regulation endorsing International Accounting Standard (IAS) 39 on Financial Instruments: Recognition and Measurement, with the exception of certain provisions on the use of the fair value option and on hedge accounting.
Endorsement of IAS 39
This concludes the long drawn-out process of endorsing IAS 39 for adoption in Europe, a process which many consider was perhaps unduly influenced by political and other interests. It is hoped that the endorsement of other standards will not be subject to such delays and influences. This is particularly relevant at present, with the other new and revised international standards issued in the past year due to be reviewed at the meeting of the Accounting Regulatory Committee (ARC) on November 30th. The ARC is the body that makes the final recommendations to the European Commission regarding the endorsement process. It is of concern that modification of international standards may undermine global convergence of financial reporting.
While the EU endorsement process has been concluded for now, there are still open questions regarding the application of IAS39. These concern such matters as the position being taken by Ireland's current standard-setter, the Accounting Standards Board (ASB), the implications for first-time adopters and the approval of the full standard in due course.
Carve-out
The sections carved out of IAS 39 – hedge accounting and the fair value option – were in response to observations and concerns expressed by the European Central Bank and the banking community in Europe.
The application of fair value accounting to financial liabilities was considered inappropriate by the regulators and was seen to contravene Article 42A of the Fourth Company Law Directive on valuation of financial liabilities. European banks were concerned that IAS 39 restricts the use of hedge accounting, posing a major problem for risk management, which could lead to disproportionate and costly changes both to their asset/liability management and to their accounting systems.
The European Commission has made these carve-outs in the expectation that the International Accounting Standards Board (IASB) will adopt improvements in both areas by Autumn 2005 and that, all other things being equal, it will move to endorse these improvements as soon as possible thereafter. Accordingly, IAS 39 should be endorsed in full at that stage.
IAS 39 continues to be an evolving standard with many different aspects subject to review by the IASB, some of which have already been the subject of exposure drafts already issued with revisions to the standard expected to be released in early 2005 for application in 2006.
Position in UK and Ireland
The regulation adopted by the European Commission gives member states the option to permit or require companies to apply the full version of IAS 39 in respect of the hedge accounting carve-out. However, this option is not granted to member states in respect of the fair value option because Article 42A of the Fourth Company Law Directive restricts the type of liabilities that may be subject to valuation at fair value. The 'Fair Value' regulations were issued in draft form in Ireland some weeks ago for comment and will in due course be included in Irish companies legislation.
The ASB is critical of the position taken by the EU regarding the adoption of IAS 39. It comments that it has seriously weakened hedge accounting requirements and may give rise to artificial volatility in reported profits and difficulties in application as a result of limiting the fair value option.
Accordingly, the ASB plans to issue its own accounting standard which it is expected will be in line with the unamended version of IAS 39. It intends to issue guidance on the use of the fair value option and the interaction with legal requirements.
Of significance to certain sectors, notably the funds industry, is the apparent expediting of the convergence process. The EU IAS regulation requires that listed entities prepare their consolidated financial statements in accordance with IFRS from January 1st 2005. Standards being issued by the ASB implement the equivalent requirements for all listed entities from January 1st 2005. Many of Ireland's investment funds are single entities listed on the Irish Stock Exchange which will not be subject to the mandatory requirements of the IAS regulation but it appears may now be required by ASB standards to implement equivalent requirements in 2005.
First-time adoption
The ability of first-time adopters of IFRS to take advantage of the exemptions laid down in IFRS 1 is critical to efficient transition from current standards to IFRS. Ability to use IFRS 1 requires a non-explicit and unreserved statement of compliance with IFRS and the European Commission has indicated that companies which use the European modified version of IAS 39 will be entitled to avail of IFRS 1 exemptions. The ASB has expressed concern regarding how this will work in practice and it may well require the issue of additional guidance. At a broader level, the US has indicated its willingness to consider relaxing the requirements for first-time adopters of IFRS to provide only one year's comparative financial information with their SEC Returns, where companies are dual-listed. What may be seen as incomplete adoption of IFRS may mean that this concession is not available to such companies.
Impact for all entities
All companies, not just listed entities, will have new considerations to take into account in 2005 in relation to the presentation of financial instruments in line with IAS 32 with the impending release of an equivalent standard by the ASB. Matters of particular significance include classification of certain instruments as liability or equity, for example, preference shares, and the treatment of compound financial instruments. This will require change in many cases. The new measures correspond with the EU Accounts Modernisation Directive that requires classification of items on the balance sheet to have regard to their substance.
The disclosure requirements of the new standards will apply in 2005 for those entities applying the measurement and hedge accounting principles of IAS 39, and from 2007 for all other entities. It is helpful that the European Commission has concluded on its position regarding the adoption of IAS 39. However, there are many uncertainties remaining |
Brendan Sheridan is director of financial reporting services with Deloitte.
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| Article appeared in the December 2004 issue.
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