The long-awaited standard on financial instruments will not only affect financial institutions, but companies from all sectors including the retail, ICT, manufacturing and the automotive sectors. While these changes only become effective for annual financial periods beginning on or after 1 January 2018, SAICA recommends companies should start now to consider the system changes required and upskilling the relevant staff to ensure effective implementation of the standard.
The need to reform the financial instruments standard arose amid the global financial crisis in 2008, when various interested parties including the G20 highlighted the urgent need to address bad debts and recoverability of financial assets. During the financial crisis, the delayed recognition of credit losses on loans, debtors and other financial instruments was identified as a weakness in existing International Financial Reporting Standards (IFRSs), and the new financial instruments standard will require a more timely recognition of expected losses, says Bongeka Nodada, the project director of financial reporting standards at SAICA.
“The new requirements will now call for companies to account for expected credit losses on financial assets such as debtors, mortgage bonds or vehicle loans from day one, and require continuous assessment over the life of the financial asset. This new impairment model is forward-looking and eliminates the threshold for the recognition of expected credit losses, so that it is no longer necessary for a trigger event to have occurred before credit losses are recognised.
“For instance, a bank that grants a 20-year mortgage bond will be required to recognise a portion of the expected credit losses on the bond from day one, and not wait until a customer defaults before it starts raising an impairment loss. This is a significant change, as companies currently recognise credit losses on financial assets only when a trigger event occurs, for example a customer default, thereby affecting the timing of recognition,” says Nodada, adding that the changes may also introduce volatility in the financial statements.
The current financial reporting standard on financial instruments is rule-based, requiring multiple-impairment models. Own-credit gains and losses are recognised in profit or loss for fair value option financial liabilities, and the rules around reclassifying financial instruments are quite complex. The new financial instruments standard is principle-based and has only one impairment model.
Companies may also be required to reclassify some of its financial instruments under the new requirements. Classification will be driven by a company’s cash flow characteristics and business model in which an instrument is held.
The hedge accounting requirements have also substantially changed, and more enhanced disclosures about risk management activity will be required. The new model therefore represents a significant overhaul of hedge accounting that aligns the accounting treatment with risk management activities, enabling entities better to reflect these activities in their financial statements.
“Preparers of financial statements, users and auditors of financial statements find the current financial instruments standard complex and this new standard eliminates this complexity. The new financial instrument standard is intended to simplify and improve the requirements for reporting financial instruments - thus enhancing the relevance and understandability of information about financial instruments for investors and other users of financial statements,” states Nodada.
This topic will be debated at the SAICA and IFRS Foundation IFRS Conference on 13-14 August 2014. Participants will include leading South African CFOs, financial analysts, the Registrar of Banks, IFRS advisors and the International Accounting Standard Board members who have issued IFRS 9.
