Accounting News. AASB 7 More Financial Instrument Disclosures. In this issue. What About Comparatives? What About Parent Entity Disclosures?

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1 Accounting News A National Assurance Publication AASB 7 More Financial Instrument Disclosures AASB 7 Financial Instruments: Disclosures will require more disclosures about financial instruments for reporting entities or entities preparing general- purpose financial reports for financial years commencing on or after 1 January All reporting entities, not just banks and financial institutions, will be required to apply this standard. This newsletter provides example disclosures to assist with understanding the new requirements of AASB 7. The financial instrument disclosures previously contained in AASB 132 Financial Instruments: Disclosure and Presentation and AASB 130 Disclosure in the Financial Statements of Banks and Similar Financial Institutions have been effectively moved to AASB 7, the major new disclosures required by AASB 7 relate to: Market risk sensitivity analyses Credit risk Allowance account for credit losses Hedging Reclassification of financial instruments Investments in equity instruments measured at cost. When Does AASB 7 Apply? AASB 7 applies for financial years commencing on or after 1 January This means that it will apply to In this issue Market Risk - Sensitivity Analyses Credit Risk Allowance Account For Credit Losses Hedging Reclassification of Financial Instruments Investments in Equity Instruments AASB 101 Amendments December balancing entities for the year ended 31 December 2007 and to June balancing entities for the year ended 30 June Early adoption is permitted under section 334(5) of the Corporations Act but this fact must be disclosed in the financial statements. What About Comparatives? Comparative information will need to be disclosed for all information required by AASB 7, even if such disclosures were not required in the previous year. This means that entities will need to start thinking about what information will need to be disclosed, particularly where the information was not previously required by AASB 132 or AASB 130. What About Parent Entity Disclosures? Under the previous version of AASB 132, parent entity disclosures were not required where the parent entity financial statements were presented together with the consolidated financial statements in the annual financial report (which is common practice in Australia). AASB 7 however includes no such exemption. Therefore financial instrument disclosures will need to be compiled for the parent entity, including comparatives, for the first financial year commencing on or after 1 January

2 Market Risk Sensitivity Analyses For market risk disclosures, AASB 7 now requires a sensitivity analysis for each type of market risk. Entities need to show how changes in each type of identified market risk would impact on profit or loss and equity in the period. Types of market risks include: foreign exchange currency risk interest rate risk other price risk. Examples of all three types of market risks are illustrated below. Foreign currency sensitivity analysis The entity is mainly exposed to the Japanese Yen and the Euro. The following table shows the entity s sensitivity to a 5% increase and decrease in the Australian Dollar against the Yen and the Euro. 5% is the sensitivity rate used for internal reporting to key management personnel and represents management s assessment of the possible change in foreign exchange rates. The impacts highlighted below on profit or loss are based on outstanding foreign currency receivables at reporting date, adjusted for a 5% change in foreign exchange rate. Impact of EURO Impact of Yen Profit or loss 25,185 22,173(a) 32,761 29,143(b) (a) (b) This is mainly due to the exposure outstanding on the Euro receivables and payables at the end of the year. This is mainly due to the exposure to outstanding Japanese Yen receivables at year-end. The entity s foreign currency sensitivity has increased during the current period. This is mainly due to the increase in sale of goods in both currencies in the last quarter of the financial year due to significant nonrecurring transactions, which has led to higher receivables balances in both currencies at year-end. In management s opinion, the sensitivity analysis disclosed is unrepresentative of the entity s exposure to risk during the period because of the significantly higher foreign currency receivables at year-end from the non-recurring sales transactions. If the sensitivity to foreign exchange rates is based on average foreign currency receivables balances during the year, the impact on profit or loss using a 5% sensitivity rate would be as follows: Impact of EURO Impact of Yen Profit or loss 5,687 3,985 7,634 6,254 Interest rate sensitivity analysis The interest rate sensitivity analysis below has been calculated based on the interest rate risk exposure on floating rate instruments and fixed rate investments at 31 December 2007 (2006). If interest rates increased/decreased by 50 basis points and all other variables were held constant, the entity s: Profit for the period ending 31 December 2007 would increase/decrease by 3,154 (2006: increase/ decrease by 2,351). This is mainly due to the entity s variable rate borrowings. Other equity reserves would increase/decrease by 5,214 (2006: increase/decrease by 4,165). This is mainly due to the changes in the fair value of available-for-sale fixed rate instruments. 2

3 Equity price sensitivity analysis The equity price sensitivity analysis has been calculated based on the equity price risk exposures at 31 December 2007 (2006) on listed investments that are classified as held for trading and available-for-sale. If the equity index increased/decreased by 10% while all other variables were held constant, Net profit for the year ended 31 December 2007 would increase by 5,298 (2006: increase by 6,360). Other equity reserves would increase by 3,215 (2006: increase by 2,399). VAR Analysis If the entity manages its market risk using a sensitivity analysis such as value-at-risk that reflects the interdependence between different risk variables, it can use this analysis to replace the sensitivity analysis for each individual risk variable, as illustrated above. In such cases, the financial statements must include an explanation of the: method used to prepare the value-at-risk sensitivity analysis; main parameters and assumptions underlying the data provided; objective of the method used; and limitations that may result in the information not fully reflecting the fair value of the assets and liabilities involved. Credit Risk The amount of the entity s maximum exposure to credit risk at reporting date, not taking into account the value of any collateral held or other netting arrangements that do not qualify for offsetting under AASB 132, is still required. There are also some new requirements, for example: a description of the collateral held as security information about the credit quality of financial assets that are neither past due nor impaired the carrying amount of financial assets that would otherwise be past due or impaired whose terms have been renegotiated financial assets that are either past due date or impaired: (a) analysis of the age of financial assets that are past due at reporting date that are not impaired; (b) analysis of financial assets that are individually determined to be impaired at reporting date, including the factors the entity considered in determining that they are impaired; and (c) for items in (a) and (b), a description of collateral held as security (and unless impracticable, an estimate of fair value). This introduces extensive additional disclosures for most reporting entities. An example of credit risk disclosure is illustrated below. Extract of Trade Receivables Note Trade receivables Payment terms for trade receivables is 45 from invoice date. Interest is charged at 2.5% on amounts outstanding that exceed 45. An allowance has been made for all trade receivables outstanding for more than 90 because past experience shows that such balances are generally not recoverable. Further allowances have been made for remaining past due balances, i.e. between 45 and 90 based on historical default experience. Before accepting new customers, the entity utilises an external credit scoring facility to assess the prospective customer s credit quality. Credit limits are defined for each prospective customer. Customers credit limits and credit scores are reviewed semi annually. No customer represents more than 3% of the total balance of trade receivables. Carrying amount of past due/impaired trade receivables with renegotiated terms Trade receivables 5,678 4,950 Total renegotiated trade receivables 5,678 4,950 3

4 Ageing analysis of trade receivables that are past due but not impaired (by class) Total Trade receivables 9,125 8,326 1,000 18,451 Total 9,125 8,326 1,000 18, Total Trade receivables 9,500 7,854 1,654 19,008 Total 9,500 7,854 1,654 19,008 The above amounts which are past due at 31 December 2007 (2006) are included in the entity s trade receivables balance. The entity has not provided for the carrying amount as there are reasonable grounds for the entity to believe that the amounts are still recoverable as there has not been a significant change in credit quality. The entity holds no collateral over the balances. Allowance Account For Credit Losses When an entity chooses to adjust the impairment of a financial asset using an allowance account instead of directly reducing the carrying amount of the financial asset, the entity needs to disclose a reconciliation of changes in the carrying amounts for the year for each class of financial assets as follows: Extract of Trade Receiveables Note Trades receivables Reconciliation of allowance for doubtful debts Year ended 31/12/07 Year ended 31/12/06 Balance at beginning of the year 1,287 2,252 Amounts written off during the year (952) (1,529) Amounts recovered during the year (1,180) (885) Net change in allowance recognised in profit or loss 1,552 1,449 Balance at end of the year 707 1,287 4

5 Hedging Whilst some entities may already have disclosed this information, for fair value hedges, gains or losses on the hedging instrument and the hedged item must also be disclosed. Where these relate to adjustments to finance costs, this disclosure can be included within the finance costs note. Otherwise it can be included within other income/expenses. Reclassification of Financial Instruments When a financial instrument that used to be measured at fair value is now being measured at amortised cost instead (or vice versa), AASB 7 requires the entity to disclose the reason for the reclassification. Investments in Equity Instruments Measured at Cost be reliably measured, besides disclosing this fact, the entity must also disclose information about: the market for such instruments; and whether and how the entity intends to dispose of the financial instruments. AASB 101 Amendments Along with the release of AASB 7, the Australian Accounting Standards Board has also amended AASB 101 (in line with the amendments to IAS 1) to include additional capital management disclosures that also apply for financial years commencing on or after 1 January Conclusion AASB 7 requires significant additional disclosures to the financial statements, including comparatives. Entities need to start preparing now to ensure that all information is available on time, particularly with respect to sensitivity analyses and also parent entity disclosures which have not been done in the past. Where investments in equity instruments do not have a quoted market price in an active market and have been measured at cost because the fair value cannot For more information Phone or visit New South Wales* Sean Osborn Telephone sosborn@bdosyd.com.au Western Australia Brad McVeigh Telephone mcveigh@bdowa.com.au Northern Territory Casmel Taziwa Telephone casmel.taziwa@bdont.com.au Queensland Tim Kendall Telephone tkendall@bdokendalls.com.au South Australia Greg Wiese Telephone gregory.wiese@bdosa.com.au Victoria Ian Fergusson Telephone ifergusson@bdosyd.com.au BDO is a national association of separate partnerships and entities. Disclaimer: This publication is issued exclusively for the general information of clients and staff of BDO. The contents are not a substitute for specific advice and should not be relied upon as such Accordingly, whilst every care has been taken in the presentation of the publication, no responsibility is accepted for persons acting on this information. *Liability limited by a scheme approved under Professional Standards Legislation.