AASB 139 Financial instruments: recognition and measurement

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Overview

AASB 139 Financial Instruments: Recognition and Measurement is equivalent to IAS 39 of the same name as issued by the International Accounting Standards Board. The objective of AASB 139 is to provide the principles for recognising and measuring financial assets and financial liabilities. It is applicable for annual reporting periods beginning on or after 1 January 2005. AASB 9 Financial Instruments will supersede AASB 139 from 1 January 2015.

Main requirements

Scope (paragraphs 2-7)

Applies to all types of entities to all types of financial instruments. Exceptions include:

  • Interests in subsidiaries, associates and joint ventures that are accounted for under other standards
  • Receivables and payables under AASB 117 Leases and AASB 119 Employee benefits
  • Insurance contracts under AASB 4 Insurance Contracts, other than certain financial guarantee contracts
  • Business combinations settled at a future date
  • Loan commitments, other than those:
    • Designated at fair value through profit or loss
    • That can be settled net in cash or by delivering/issuing another financial instrument
    • Provided at a below market interest rate
  • Share-based payment transaction accounted for under AASB 2 Share-based Payment

Definitions (paragraphs 8-9)

AASB 139 definitions include:

  • Four categories of financial instruments:
    1. Financial assets or financial liabilities at fair value through profit or loss. Classification only permitted if the instrument is held for trading (i.e. will be sold/repurchased in short term) or is designated as such upon initial recognition, subject to certain conditions
    2. Held to maturity investments, which are non-derivative financial assets with determinable payment and maturity and which is intended and can be held to maturity
    3. Loans and receivables, which are non-derivative financial assets with determinable payments that are not quoted in an active market
    4. Available for sale financial assets, which are non-derivative financial assets that are designated as such or that are not classified under the other three categories
  • Derivative
  • Financial guarantee contract
  • Amortised cost of a financial asset or financial liability
  • Effective interest method
  • Fair value
  • Hedging instrument
  • Hedged item
  • Hedge effectiveness

Embedded derivatives (paragraphs 10-13)

  • An embedded derivative is an item within a non-derivative host contract that modifies the cash flows of the contract due to changes in a variable (e.g. interest rate)
  • Embedded derivatives must be separated from the contract and accounted for as a derivative if all 3 criteria are met:
    1. The economic characteristics and risks of the embedded derivative are not closely related to the contract
    2. The embedded derivative would be considered a derivative if it was a separate instrument
    3. The contract is not measured at fair value through profit or loss
  • If an embedded derivative that must be separated cannot be measured, the entire contract must be designated at fair value through profit or loss

Recognition and derecognition (paragraphs 14-42)

Initial recognition (paragraph 14)

A financial asset or liability is recognised on balance sheet when an entity becomes a party to the contractual terms of the instrument.

Derecognition of a financial asset (paragraphs 15-37)

  • Derecognise a financial asset when:
    • The contractual rights to the cash flows of the financial asset expire; or
    • An entity transfers the financial asset such that either:
      • The contractual rights to receive the cash flows have been transferred
      • The contractual rights to receive the cash flows is retained but a contractual obligation is assumed to pay the cash flows to other parties, provided certain conditions are met; and
    • Substantially all the risks and rewards of ownership have been transferred. Any rights or obligations created or retained as a result of the transfer must be recognised.
  • If substantially all the risks and rewards of ownership have been retained, the financial asset is not derecognised.
  • If the risks and rewards have neither been retained nor transferred, the entity determines if it retains control of the financial asset. If control has been retained, the financial asset is recognised to the extent of the entity’s continuing involvement, which is the extent to which it is exposed to changes in the value of the asset

Regular way purchase or sale of a financial asset (paragraph 38)

Regular way purchases and sales of financial assets (e.g. listed securities) can be accounted for using either trade date or settlement date accounting.

Derecognition of a financial liability (paragraphs 39-42)

  • A financial liability is derecognised when the obligation is extinguished either due to the obligation being discharged, expired or cancelled
  • When an existing financial liability is modified substantially or renegotiated with substantially different terms, this is to be accounted for as an extinguishment of the original financial liability and recognition of a new financial liability
  • The difference between the carrying amount of the financial liability extinguished and the consideration paid is recognised in profit or loss

Measurement (paragraphs 43-70)

Initial measurement (paragraphs 43-44)

  • Measurement of a financial asset or financial liability upon initial recognition must be at fair value
  • For financial assets or liabilities that are not subsequently measured at fair value through profit or loss, the initial measurement of fair value must include any direct transaction costs

Subsequent measurement (paragraphs 45-47)

Subsequent to initial recognition, financial assets can be measured as follows:

  • Fair value through profit or loss –this includes all asset derivatives
  • Amortised cost using the effective interest method applicable to loans and receivables and held-to-maturity investments
  • For available-for-sale assets, fair value movements are recognised in equity and recycled to profit or loss when the asset is derecognised
  • Cost for investments in equity instruments that are not publicly traded and whose fair value cannot be measured reliably

All financial assets except those measured at fair value through profit or loss are subject to the impairment rules below.

After initial recognition, financial liabilities are measured at amortised cost using the effective interest method, except for:

  • Financial liabilities at fair value through profit or loss
  • Financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition
  • Financial guarantee contracts and loan commitments provided at a below market rate. The issuer must measure these at the higher of the amount determined under AASB 137 and fair value, less any cumulative amortisation determined under AASB 118

Fair value measurement considerations (paragraphs 48-49)

  • Quoted prices in an active market provide the best evidence of fair value of a financial asset or liability
  • If the market for a financial instrument is not active, a valuation technique is used to determine fair value

Reclassifications and gains and losses (paragraphs 50-57)

  • A financial instrument cannot be transferred into or out of the fair value through profit or loss category while it is held or issued
  • If it is no longer appropriate to classify a financial asset as a held-to-maturity investment, then it must be reclassified as available-for-sale and remeasured at fair value, with the difference recognised in equity until the financial asset is derecognised, at which point the cumulative gain or loss will be recognised in the profit or loss
  • Gains or losses on financial assets or financial liabilities classified as fair value through profit or loss are recognised in profit or loss
  • Gains and losses on available-for-sale financial assets are recognised in equity, except for impairment losses and foreign exchange movements. When the financial asset is derecognised, the cumulative gain or loss is transferred from equity to profit or loss
  • When financial assets or liabilities measured at amortised cost are derecognised, gains or losses are recognised in profit or loss
  • Where settlement date accounting is used, any change in fair value between trade date and settlement date is not recognised for financial assets carried at cost or amortised cost

Impairment and uncollectibility of financial assets (paragraphs 58-70)

  • At each reporting date, an entity must assess whether there is objective evidence that a financial asset or group of financial assets is impaired.
  • If such evidence exists for a:
    • Financial asset at amortised cost, the loss is measured as the difference between the carrying amount and present value of future cash flows discounted at the financial asset’s original effective interest rate. A reversal of the loss is permitted, but cannot exceed the carrying amount of the asset had the loss not been recognised
    • Financial asset carried at cost, the loss is measured as the difference between the carrying amount and present value of estimated future cash flows discounted at the current market rate of return for a similar financial asset. Such impairment losses cannot be reversed
    • For available-for-sale assets, the cumulative loss recognised in equity is transferred to the profit or loss. The amount transferred is the difference between the acquisition cost and current fair value. Impairment losses recognised for an equity instrument cannot be reversed. For debt instruments, an impairment loss can be reversed through profit or loss

Hedging (paragraphs 71-102)

Hedging instruments (paragraphs 72-77)

  • All derivatives (except written options) may be designated as the hedging instrument, provided the criteria for hedge accounting below are met
  • Non-derivative financial asset or liability may be designated as the hedging instrument for a hedge of foreign currency risk
  • Only instruments with parties external to the reporting entity can be designated as hedging instruments
  • A proportion of the amount of a financial instrument may be designated as a hedging instrument, but a portion of time the financial instrument is outstanding cannot be designated as a hedging instrument
  • A single hedging instrument can be designated as a hedge of more than one type of risk, provided certain criteria are met
  • There are some circumstances permitted where two or more derivatives (or proportions of) can be jointly designated as the hedging instrument

Hedged items (paragraphs 78-88)

  • A hedged item can be a recognised asset or liability, an unrecognised firm commitment, a highly probable forecast transaction or a net investment in a foreign operation. All except the last item must involve an external party
  • Non-financial assets or liabilities can be designated as the hedged item, provided that it is for foreign currency risks or for all risks
  • Similar assets or liabilities can be aggregated and hedged as a group, provided that each shares the risk that is being hedged

Hedge accounting (paragraphs 89-102)

The criteria for hedge accounting are:

  • There is formal designation and documentation of the hedging relationship at inception
  • The hedge is expected to be highly effective (ie changes in fair value or cash flows of hedged risk are offset by changes in fair value or cash flows of hedging instrument)
  • For cash flow hedges, a forecast transaction must be highly probable and be exposed to cash flows movements that affect profit or loss
  • The effectiveness of the hedge can be reliably measured
  • The hedge is continually assessed and is highly effective (i.e. 80-125%) throughout the period the hedge is designated for

In a fair value hedge:

  • the entity hedges a change in fair value of a recognised asset or liability or firm commitment, or a portion thereof
  • the change in fair values of both the hedging instrument and the hedged item are recognised in profit or loss when they occur

In a cash flow hedge:

  • The entity hedges changes in the future cash flows relating to a recognised asset or liability or a probable forecast transaction
  • The change in fair value of the hedging instrument that results in an effective hedge, is recognised directly in equity until such time as those future cash flows occur
  • The ineffective portion of the hedging instrument is recognised directly in profit or loss

In a hedge of a net investment of a foreign operation, the accounting is similar to cash flow hedges:

  • The change in fair value of the hedging instrument that results in an effective hedge, is recognised directly in equity until the foreign operation is disposed
  • The ineffective portion is recognised directly in profit or loss

Appendix A (Application Guidance)

Provides guidance on:

  • Scope
  • Definitions
  • Embedded derivatives
  • Recognition and derecognition
  • Measurement (including fair value and impairment)
  • Hedging

Illustrative Example

Provides an example of hedging interest rate risk.

Implementation Guidance

Provides guidance and examples on:

  • Scope
  • Definitions
  • Embedded derivatives
  • Recognition and derecognition
  • Measurement
  • Hedging
  • Other

The information provided is a brief summary of the requirements of this standard and is not intended to be used as a substitute for reading the standard itself nor does it attempt to provide any interpretative advice. To apply the standard to their particular circumstances readers are encouraged to read the text of the standard and, if necessary, seek professional advice from a Chartered Accountant or other suitably qualified professional. The Institute expressly disclaims all liability for any loss or damage arising from reliance upon any information or inaccurate statement made in this summary.

Article last updated 13 May 2014

The information provided is a brief summary of the requirements of this standard and is not intended to be used as a substitute for reading the standard itself nor does it attempt to provide any interpretative advice.

To apply the standard to their particular circumstances readers are encouraged to read the text of the standard and, if necessary, seek professional advice from a Chartered Accountant or other suitably qualified professional.

The Institute expressly disclaims all liability for any loss or damage arising from reliance upon any information or inaccurate statement made in this summary.