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FROM: JUL-AUG 2008 ISSUE | BY STEPHEN SPECTOR
In March 2008, the International Accounting Standards Board released a discussion paper entitled Reducing Complexity in Reporting Financial Instruments. The goal of the IASB is to eventually replace IAS 39, Financial Instruments: Recognition and Measurement. For Canadians, this is important for two reasons: Handbook sections 3855 and 3865 are based on IAS 39, and Canada is adopting IASB-based standards for public entities effective January 1, 2011.
Current GAAP requirements can be traced back to 1986, when the Financial Accounting Standards Board undertook a broad project on financial instruments. The FASB was attempting to deal with four main issues:
- how to measure financial instruments, including how to report gains and losses;
- when financial assets should be considered sold and when financial liabilities should be considered settled;
- how to account for instruments designed to transfer risks; and
- how to distinguish between liability instruments and equity instruments.
Financial instruments are complex and the term encompasses a wide variety of instruments. While GAAP has matured over the past 20 years, as soon as accountants develop rules to account for financial instruments, financial engineers develop new instruments requiring new or modified GAAP. So round and round it goes. Consider that in 1986, most derivative instruments were not recognized, and those that were recognized were reported at nominal amounts. Yet GAAP now requires most derivative instruments to be measured at fair value.
The discussion paper acknowledges that a long-term solution will not be possible until there is agreement on the underlying issue; namely, the many ways of measuring financial instruments and the associated rules. Today’s standards contain many alternatives, bright lines, and exceptions that often obscure the underlying principles. Until these issues are resolved, accounting for financial instruments will remain a complex exercise.
The paper argues that fair value is the only measure appropriate for all types of financial instruments; it also recognizes there are issues to be addressed before GAAP could be amended to require fair value measurement for all financial instruments. Instead, the IASB hopes to arrive at an acceptable “fix” for the immediate future, leaving time for a resolution of this and other key issues related to the recognition and measurement of financial instruments.
Towards that goal, the paper sets out a possible intermediate approach that might improve and simplify measurement and hedge accounting requirements for financial instruments more quickly than the introduction of a general fair value measurement requirement. Specifically, the paper proposes that the IASB:
- amend measurement requirements by reducing the number of categories of financial instruments;
- replace the existing requirements with a fair value measurement principle and some optional exceptions to fair value measurement; and
- simplify hedge accounting.
The IASB will review responses before deciding how to proceed, and has stated that the key to changes is the need for users of financial statements to receive reliable information at a reasonable cost as a basis for economic decisions. Comments are due by September 19, 2008. Go to www.iasb.org for a copy of the paper.
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