A Practical Guide to IFRS for Derivatives and Structured Finance

Graeme Tosen, the manager for technical accounting at HBOS Treasury Services in London, has written a step-by-step guide to understanding and implementing the highly technical accounting rules of the International Financial Reporting Standards (IFRS) that apply to derivatives and structure finance.This is an essential reference for every practitioner needing to interpret and apply the rules to derivatives, structured finance and securitisations.

Table of Contents:
Contents: Foreword by Phil Hodkinson, Finance Director, HBOS plc About the author 1. Introduction (including how to use the book) The background to this book Who should read this book? The structure of this book How to use this book 2. Fair value and amortised cost accounting Introduction Background to the accounting rules Day 1 profit of loss Definitions Additional points Main issues Assets at amortised cost or fair value? Held-for-trading assets Designated at fair value through profit or loss The fair value option Loans and receivables Held-to-maturity investments Available-for-sale Financial liabilities Determining the fair value Step 1: First determine if the instrument price can be obtained from an active market Bid, mid or ask Recent transaction price Components and whole Step 2: What if there is no active market? Equity instruments with no active market Frequently asked questions * What is the 'near term'? * What is 'a pattern of profit taking'? * What about new non-derivative products where they are not acquired or incurred for selling or repurchasing in the near term but the entity still wants to classify them as held-for-trading? * Are all legal derivatives also derivatives for accounting? * Are any derivatives not accounted for at fair value? * How are synthetic derivatives (offsetting loans) treated? * What is the EU carve-out? * Can a proportion of a liability/asset be designated as at fair value through profit or loss? * How will assets where the holder may not recover all of its initial investment be classified? * What happens when there is no definite maturity date with regards to effective interest rate? * What do you include in effective interest rate calculations? * What would form part of initial measurement at fair value? * Is fair value and original cost/transaction price always the same and if not, how is the difference accounted for? * Is there a difference between 'more than insignificant' and 'significant'? * Are there any exceptions to the tainting rules? * Do you consider all scenarios when determining intent and ability? * How are the foreign exchange profits/losses treated? * Can assets be transferred into the AFS category? * Are there circumstances where liabilities would not be at amortised cost? * Which rate should be used in discount cash flow analysis? Summary comparison with US GAAP Practical implementation 3. Embedded derivatives Introduction Background to the accounting rules Definition Purpose of the rules Main issues When do you have to separate an embedded derivative? Measurement issues Non-options derivatives Embedded options When embedded must and may not be separated from the host Frequently asked questions * Is there a choice to separate the derivative and treat it as trading if you wanted to? * How are synthetic positions treated where the derivative is legally a separate contract? * Did the EU carve-out create problems for European entities? * Do you only assess for separation at the initial recognition date or throughout? Summary comparison with US GAAP 4. Hedge accounting Introduction Background to the accounting rules Definitions Main issues What can be hedged? What can not be hedged? What hedging instruments can and cannot be used? The hedging criteria What types of accounting hedges are there? Accounting for fair value hedges Fair value hedge accounting for a portfolio of interest rate risk What happens if you cease hedge accounting? Accounting for net investments in foreign operations The hedge effectiveness issue Frequently asked questions * Can an entity designate a hedge relationship retrospectively? * What does 'highly effective' mean? * When will exposures not affect profit or loss and therefore not be allowed for cash flow hedging? * When is something 'highly probable'? * How should an entity assess hedge effectiveness and when should an entity do this assessment? * What is the 'roll-over rule'? * Can you hedge equity issued in a currency that is not your functional currency? * Can you hedge future profits? Summary comparison with US GAAP Practical implementation 5. Derecognition of financial instruments Introduction Background to the accounting rules Main issues The derognition decision tree for assets Derecognition of a part of an asset What happens if an asset qualifies for derecognition? Issues surrounding continuing involvement Issues surrounding collateral Rules regarding financial liabilities Frequently asked questions * What happens first - consolidation rules or derecognition rules? * Are computations required to prove transfer of risks and rewards? * What is the effect on transfer of an option to buy the asset back at fair value? * Does the standard provide any examples of a transfer of risks and rewards of ownership? Summary comparison with US GAAP Practical implementation 6. Offsetting financial assets and liabilities Introduction Background to the accounting rules Main issues Frequently asked questions * Would synthetic instruments qualify for offsetting? * Could more than one party be involved in a legal arrangement that would allow for offsetting? Summary comparison with US GAAP Practical implementation 7. Impairment and uncollectibility of financial assets Introduction Background to the accounting rules Main issues Impairment Events and indicators of impairment Future events Individual versus collective impairment Calculating the impairment loss and accounting for it (and reversals) Financial assets carried at amoritised cost Financial instruments at cost Available-for-sale assets Frequently asked questions * What if there are no relevant observable data to support the impairment calculation? * What constitutes a prolonged decline in fair value below cost for an equity instrument? * What does 'similar risk characteristics' mean? * What if you do not have groups of assets with similar characteristics? * What rate should be used if the effective interest rate was modified during a previous period? * What if assets have a variable interest rate? * If fair value of an amortised cost accounted for asset is observable in the market, can this value be used to determine the impairment loss? Summary comparison with US GAAP Practical implementation 8. Consolidation Introduction Background to the accounting rules Main issues When do you have control? Where an entity has voting power Where an entity has no voting power Special purpose entity Control under Paragraph 10 of SIC 12 Control and the appendix to the interpretation How should the accounting be done in the separate (non-consolidated) financial statements? What accounting processes will be followed on consolidation? Frequently asked questions * How are potential voting rights taken into account? * Can SIC 12 override IAS 27 when assessing an SPE for consolidation purposes? Summary comparison with US GAAP Practical implementation 9. The effects of foreign exchange Introduction Background to the accounting rules Definitions Main issues Establishing your functional currency How to translate to functional currency Translation of foreign operations for consolidation purposes Summary comparison with US GAAP Practical implementation 10. Provisions, contingent liabilities and contingent assets Introduction Background to the accounting rules Definitions Provisions Main issues Criteria The present obligation Legal or constructive A present obligation from a past event Determining the amount to recognise Risks and uncertainties Discounting Future events influencing cash flows Sale or disposal of related assets Contingent liabilities and contingent assets Contingent liabilities Contingent assets Summary of proposed IASB changes Frequently asked questions * What about a published dividend policy? * Must the expectation be on the part of the same parties to whom the statement was addressed in the case of a specific current statement? * Can the timing between a past event and the recognition of an obligation be different? * Do you provide for the possibility of changes in the law? * When would decisions by the board of a company give rise to an obligation? Summary comparison with US GAAP Practical implementation 11. Debt or equity classification Introduction Background to the accounting rules Definition Main issues Ordinary shares Preference shares Own equity transactions Contingent settlement and settlement options Compound instruments Frequently asked questions * How do you account for convertible bonds issued in a foreign currency? * What if an entity reacquires its own equity instruments? * What are the effects on the consolidated financial statements? * What happens when a compound instrument is settled early? Summary comparison with US GAAP Practical implementation 12. Financial guarantee contracts Introduction Background to the accounting rules Definition Main issues Initial measurement Subsequent measurement Designated at fair value through profit or loss Benchmark rules for subsequent measurement of financial guarantee contracts The difference between financial guarantee contracts and credit derivatives Summary comparison with US GAAP Practical implementation 13. Writing a technical accounting opinion and accounting checklist Introduction Steps to consider Practical implementation Accounting checklist 14. Understanding the administration Different standard names Different sections of the standards and their authority SIC and IFRIC The Accounting Framework IFRS standards currently in issue Interpretations Definitions Appendix - Disclosure of financial instruments Introduction How to use the disclosure table Disclosure requirements in IAS 32 but not in IFRS 7