AASB Amends AASB 139 and AASB 7 - Reclassification of Financial Assets

On 13 October 2008, the International Accounting Standards Board (IASB) published amendments to IAS 39 'Financial Instruments: Recognition and Measurement' and IFRS 7 'Financial Instruments: Disclosures'.

On 22 October 2008, the Australian Accounting Standards Board (AASB) released AASB 2008-10 'Amendments to Australian Accounting Standards - Reclassification of Financial Assets' which contained amendments to the equivalent Australian Accounting Standards, being AASB 139 'Financial Instruments: Recognition and Measurement' and AASB 7 'Financial Instruments: Disclosures'.

The amendments are a response to calls from the IASB's constituents, particularly within the European Union, to create a 'level playing field' with the United States' generally accepted accounting principles (US GAAP) regarding the ability to reclassify financial assets. The changes to IAS 39/AASB 139 permit an entity to reclassify non-derivative financial assets out of the 'fair value through profit or loss' (FVTPL) and 'available-for-sale' (AFS) categories in limited circumstances. Such reclassifications will trigger additional disclosure requirements.

The effective date of the amendments is 1 July 2008 (i.e. before the date of issue).

Scope of the amendments

The amendments will only permit the reclassification of certain non-derivative financial assets recognised in accordance with IAS 39/AASB 139. Financial liabilities, derivatives and financial assets that are designated as FVTPL on initial recognition under the 'fair value option' cannot be reclassified. The amendments therefore only permit reclassification of debt and equity financial assets subject to meeting specified criteria.

The amendments do not permit the subsequent reclassification into FVTPL.

Reclassification out of FVTPL and AFS

A financial asset within the scope of these amendments can only be reclassified out of FVTPL or AFS if specified criteria are met. The criteria vary depending on whether the asset would have met the definition of 'loans and receivables' (L&R) had it not been classified as FVTPL or AFS at initial recognition.

A debt instrument that would have met the definition of L&R if it had not been required to be classified as held for trading at initial recognition may be reclassified to L&R if the entity has the intention and ability to hold the asset for the foreseeable future or until maturity.

A debt instrument classified as AFS that would have met the definition of L&R had it not been designated as AFS may be reclassified to the L&R category if the entity has the intention and ability to hold the financial asset for the foreseeable future or until maturity.

Any other debt instrument, or any equity instrument, may be reclassified from FVTPL to AFS, or from FVTPL to "held to maturity" (HTM) (in the case of debt instruments only), if the financial asset is no longer held for the purpose of selling in the near-term - but only in 'rare' circumstances. In its press release the IASB acknowledged that market conditions in the third quarter of 2008 are a possible example of a 'rare' circumstance.

It should be noted that the amendments do not refer to the reclassification of AFS debt instruments to HTM because IAS 39 already permitted such reclassification (see IAS 39.54). These reclassifications are not within the scope of the current amendments, and therefore they do not trigger the additional disclosures required by IFRS 7.12A, referred to below.

Measurement at the reclassification date

All reclassifications must be made at the fair value of the financial asset at the date of reclassification. Any previously recognised gains or losses cannot be reversed. The fair value at the date of reclassification becomes the new cost of amortised cost or the financial asset, as applicable.

Measurement after the reclassification date

The existing requirements in IAS 39 for measuring financial assets at cost or amortised cost apply after the reclassification date (with one exception, which is outlined below). Therefore, for financial assets measured at amortised cost, a new effective interest rate will be determined at the date of reclassification. In the case of reclassifications of a fixed-rate debt instrument to L&R and HTM, this effective interest rate will be used as the discount rate for future impairment calculations.

For reclassifications out of AFS, IAS 39.54 requires the amounts previously recognised in other comprehensive income (OCI) to be reclassified to profit or loss either through the effective interest rate (if the instrument has a maturity) or at disposal (if the instrument has no maturity, i.e. it is perpetual). Amounts deferred in equity may also need to be reclassified to profit or loss if there is an impairment.

The one exception to the existing measurement requirements is for reclassified debt instruments. If, after reclassification, an entity increases its estimate of recoverability of future cash flows, the carrying amount is not adjusted upwards as is currently required by IAS 39.AG8 for changes in estimates of cash flows. Instead, a new effective interest rate is determined and is applied from that date forward. Hence, the increase in the recoverability of cash flows is recognised over the expected life of the financial asset.

Disclosures

To make any reclassifications under the new requirements transparent to users, IFRS 7/AASB 7 is also amended, although the requirements for reclassifications in accordance with IAS 39.51-54 remain unchanged (IFRS 7.12). The following additional disclosures are required for reclassifications within the scope of the current amendments (new paragraph IFRS 7.12A):

• the amount reclassified into and out of each category;

• for each reporting period until derecognition, the carrying amounts and fair values of all financial assets reclassified in the current or previous reporting periods;

• if the financial asset has been reclassified based on the 'rare circumstances' exception, details of those circumstances - including the factors that indicated that the situation was rare;

• the fair value gain or loss recognised in profit or loss or OCI for the reporting period in which  reclassification occurs and in the previous period;

• in the period of reclassification and in subsequent periods until the financial asset is derecognised, the gain or loss that would have been recognised in profit or loss or OCI had the financial asset not been reclassified, and the actual gain, loss, income and expense recognised in profit or loss; and

• the effective interest rate and estimated cash flows the entity expects to recover as at the date of reclassification of the financial asset.

Effective date and transition

These amendments are effective from 1 July 2008. Entities are not permitted to reclassify financial assets in accordance with the amendments before 1 July 2008. Any reclassification of a financial asset made in periods beginning on or after 1 November 2008 will take effect only from the date when the reclassification is made. Any reclassification of a financial asset in accordance with the amendments should not be applied retrospectively to reporting periods ended before the effective date.