IASB* recently published an exposure draft on the classification and measurement of financial instruments. This is the first of three planned phases to replace the controversial International Accounting Standard 39 (IAS 39), which determines how financial assets and liabilities are accounted for. It is a complicated area, and has been the target of much debate in the international arena, with governments and companies around the world getting into the fray.
The review of IAS 39 is a direct response to, among other things, the G20 leaders’ call in April for standard-setters ‘to reduce the complexity of accounting standards for financial instruments’ and to address issues arising from the financial crisis, such as loan-loss provisioning. While we at the ICAEW believe that a review is important, we are concerned about the implications of moving too fast with changes, and its potential effect on banks and investors.
The proposed changes to the IAS 39 aim to reduce the complexity of accounting by reducing the number of classification categories – to two measurement categories: fair value or amortised costs.
Currently, the IAS 39 establishes the principles for recognising and measuring financial assets and liabilities, requiring items to be measured at fair value – market prices or estimates of market prices. This has led to critics arguing that it has amplified the financial crisis because fair value forces banks to cut the book value of assets in bad times, when asset prices are falling and capital is tight. They argue that this has led to a show of lower profits or increased losses.
Others however argue that fair value accounting works not to devalue healthy assets, but to bring problems to light earlier than other accounting methods would do.
Local banking players and investors are watching these proposed changes closely, particularly as Singapore and Malaysia are set to join over a hundred countries in reporting to IFRS by 2012. Keep in mind that because this is one of the most complex and controversial areas of accounting, the implications could be far-reaching.
The impact of IAS 39 changes on banks is multi-fold.
Firstly, some instruments will have to be classified and measured differently – impacting profits and balance sheets. New systems will have to be set up to collect the new kinds of information required – from details about basic loan features to whether measurements at fair value will eliminate or significantly reduce measurement or recognition inconsistency – and this will involve substantial investments of time and money.
There have been many initial comments from across the industry. One pertinent school of thought is that the proposed changes will allow banks to easily re-categorise assets, thus allowing them to gloss over problems and present a less transparent picture to investors. ICAEW’s technical experts are currently reviewing the proposals in detail, and we look forward to sharing our views with the IASB before the consultation period closes in mid September.
Because this is one of the most complex and controversial area of account, there is no right answer on how to account for financial instruments. We are likely to see many differing views from policy makers, politicians and industry leaders, compounded by the fact that because the proposed changes are published in stages, their interactions with each other is unclear.
With a shorter than usual consultation period, it is difficult for ICAEW along with the myriad organisations to examine these suggested changes – and conduct extensive internal tests to clearly evaluate how it will impact systems and results.
While we do agree that fair value accounting may not be perfect, we do believe that for certain items at least, it is the best option available. Further, we are concerned that the short timeframe for the proposed changes – full replacement by 2010 and mandatory by 2012 – will prove a challenge for banks and companies both in South East Asia, and across global markets.
We believe that changes to global accounting standards should happen only after thorough consultation and due process. A piecemeal approach as we currently are seeing will only lead to uncertainty, both among preparers and users of financial report. This may damage business confidence; a commodity is short supply these days.
Though the global economy seems to be stabilising, we should remain aware that this is a fragile peace. We should take a cautious and considered approach in changing the frameworks that provide investors the confidence to make business decisions.
One thing is for sure, accounting is a very exciting field to be in at the moment!
*International Accounting Standards Board
The views expressed in this column are the author's own and do not necessarily reflect this publication's view, and this article is not edited by Asian Banking & Finance. The author was not remunerated for this article.
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Mark Billington is Regional Director at ICAEW South East Asia. He is a UK qualified Chartered Accountant with 15 years experience in various business units.