Riyadh, 16 October Agenda

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1 Investment Securities Accounting IFRS and SOCPA ICAP KSA Chapter Riyadh, 16 October 2012 Mansoor Chaudhry Agenda 1. Introduction 2. Initial Recognition & Measurement 3. Trade date vs. Settlement date accounting 4. Categories of financial assets and transfers between categories 5. Subsequent measurement 6. Fair value guidance 7. Derecognition 8. Key differences between SOCPA vs. IFRS bind any member firm. All rights reserved. 1

2 Definition of financial instruments A financial instrument is a contract that gives rise to: a financial asset of one entity and a financial liability or equity instrument of another entity Financial asset Cash Equity instrument of another entity Contractual right to receive cash or another financial asset or to exchange financial assets or liabilities under potentially favourable conditions Certain contracts settled in the entity s own equity Financial liability Contractual obligation to deliver cash or another financial asset or to exchange financial asset or liabilities under potentially unfavourable conditions Certain contracts settled in the entity s own equity Equity instrument t Contract evidencing a residual interest in the assets of an entity after deducting all of its liabilities Definition of Securities A financial instrument that represents: an ownership position in a publicly-traded corporation (stock), a creditor relationship with governmental body or a corporation (bond), or rights to ownership of certain assets (ABS). A security is a fungible, negotiable financial instrument that represents some type of financial value. The official definition, from the Securities Exchange Act of 1934, is: "Any note, stock, treasury stock, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit, for a security, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or in general, any instrument commonly known as a 'security'; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker's acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited." bind any member firm. All rights reserved. 2

3 Scope exclusions Extract IAS 32 IAS 39 IFRS 7 Applicable Standard Interests in subsidiaries X X X IAS 27 Interests in associates X X X IAS 28 Interests in joint ventures X X X IAS 31 Employers' right and obligations under employee benefit plans X X X IAS 19 Financial instruments, contracts and obligations under share-based payment transactions X X X IFRS 2 Rights and obligations under insurance contracts (except embedded derivatives and certain financial guarantees) X X X IFRS 4 Rights and obligations under leases (except embedded derivatives) - X - IAS 17 Contracts for contingent consideration in a business combination (for the acquirer) X X X IFRS 3 Loan commitments that are not settled net in cash or another financial instrument - X - IAS 37 Initial recognition and measurement Recap All financial assets and financial liabilities, including derivatives, are recognised in the statement of financial position when the entity becomes party to the contractual provisions of the instrument Upon initial recognition, an entity measures a financial instrument at fair value. Transaction costs are included in the initial measurement except for instruments classified as FVTPL Transaction price is presumed to be the best evidence of fair value at initial recognition, unless another amount is determined by reference to observable current market transactions or by using valuation techniques that use only data from observable markets bind any member firm. All rights reserved. 3

4 Trade date vs. Settlement date An enterprise should recognize a financial asset or financial liability on its balance sheet when, and only when, it becomes a party to the contractual provisions of the instrument. Generally, trade date is the date on which an entity commits itself to purchasing or selling an asset and settlement date is the date on which an asset is delivered to or by an entity. One can infer from the above that IAS 39 requires Trade Date Accounting but that is not the case. In a contract for purchase or sale of Financial Assets requiring delivery of the assets within a time frame generally established by the regulation or convention in the market place concerned called a regular way contract. Entities have flexibility to use either trade date or settlement date accounting for initial recognition of regular way purchases of financial assets. The method used should be applied consistently for all purchases and sales of F.As that belongs to the same category Trade date vs. Settlement date Illustration to show Trade date / Settlement accounting 29/12 Commits to purchase F.A. 1,000 (including transaction costs) 31/12 Fair value 1,002 (financial year end) 04/01 Fair value 1,003 (settlement date) bind any member firm. All rights reserved. 4

5 Trade date accounting Date Amortised cost Fair value 29/12 FA 1,000 Payable 1,000 FA 1,000 Payable 1,000 31/12 FA 2 Equity 2 or P&L 2 04/01 Payable 1,000 Cash 1,000 Payable 1,000 Cash 1,000 04/01 F.A. 1 Equity 1 or P/L a/c 1 Settlement date accounting Date Amortised cost Fair value 29/12 31/12 3/ Receivable 2 Equity 2 or P&L 2 04/01 FA 1,000 Cash 1,000 F.A. 1,003 Receivable 2 Cash 1,000 Equity 1 or P/L a/c 1 bind any member firm. All rights reserved. 5

6 Categories of financial assets Category Financial assets at fair value through profit or loss Definition Financial assets held for trading Derivatives, unless accounted for as a hedging instrument Financial asset designated to this category under the fair value option (must meet certain criteria) Loans and receivables Held-to-maturity investments Available-for-sale financial assets Non-derivative financial assets with fixed or determinable payments that are not quoted in an active market Non-derivative financial assets with fixed or determinable payments and fixed maturity that the entity has the positive intent and ability to hold to maturity All financial assets that are not classified in another category are classified as available-for-sale Any financial asset designated to this category on initial recognition Subsequent measurement of financial instruments Instrument Measurement Value changes Financial assets at fair value through profit or loss Fair value P&L Held-to-maturity investments Loans and receivables Available-for-sale Amortised cost (effective interest rate) Amortised cost (effective interest rate) Fair value Not relevant (unless impaired) Not relevant (unless impaired) Other comprehensive income (OCI) (unless impaired) Derivatives Fair value P&L bind any member firm. All rights reserved. 6

7 Reclassification of financial assets An entity may wish to or need to transfer a financial asset from one category to another. However, for certain categories transfers should be very rare or may not be allowed at all without tainting implications. Such limitations are imposed due to the concept in IAS 39 that asset classification should generally be clear as of the moment the asset is acquired or originated. Transfer t0: Trading L&R HTM AFS Transfer from: Trading N/A 50D 50C/B 50D /50C/B L&R N/A N/A N/A N/A HTM N/A N/A N/ A Results in tainting AFS N/A 50E In case of change intent and if all criteria are met N/A 13 Reclassification of financial assets Reclassifications out of FVTPL Derivatives Designated Other Loans and receivables 50B 50D HTM AFS Paragraphs: 50B = only in rare circumstances FVTPL L&R 50D = intention ti and ability to hold for foreseeable future or until maturity 14 bind any member firm. All rights reserved. 7

8 Reclassification of financial assets Reclassifications out of AFS AFS L&R 50E Loans and receivables Other Paragraph 50E = intention and ability to hold for foreseeable future or until maturity 15 Guidance on fair values Active market: published price quotations No active market: valuation techniques using as many market inputs as possible Fair values of equity instruments: in the absence of market quotes, the fair value should be estimated bind any member firm. All rights reserved. 8

9 Fair value hierarchy Level 1 Fair values measured using quoted prices (unadjusted) in active markets for identical assets or liabilities Level 2 Fair values measured using inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices) Level 3 Fair values measured using inputs for the asset or liability that are not based on observable market data (i.e. unobservable inputs) Derecognition A financial asset (or part of a financial asset) is derecognised when: the rights to the cash flows from the asset expire the rights to the cash flows from the asset and substantially all risks and rewards of ownership of the asset are transferred an obligation to transfer the cash flows from the asset is assumed and substantially all risks and rewards are transferred substantially all the risks and rewards are neither transferred nor retained but control of the asset is transferred. If the entity retains control of the asset but does not retain or transfer substantially all the risks and rewards, the asset is recognised to the extent of the entity s continuing involvement. A transaction is accounted for as a collateralised borrowing if the transfer does not satisfy the conditions for derecognition. bind any member firm. All rights reserved. 9

10 Derecognition Derecognition bind any member firm. All rights reserved. 10

11 IFRS vs. SOCPA Financial instruments Classification SOCPA Accounting Standards Financial instruments can be classified as Trade securities Available for sale Held to Maturity Loans and receivables is specifically not mentioned as the SOCPA standard deals with Investment in securities only Transfers between classes is ordinarily permissible. IFRS Financial instruments can be classified as At fair value through profit or loss (which includes trading and designated instruments) Available for sale Held to Maturity Loans and receivables Transfer between classes is permissible if certain conditions are met. IFRS vs. SOCPA Financial instruments Measurement SOCPA Accounting Standards On acquisition, Securities shall be measured and recorded at cost. The cost includes the purchase price and all the expenses incurred by the enterprise for the purpose of acquiring the securities. Determination of FV: Securities which have no active market and there are no sufficient indicators to allow determination of market value objectively (e.g. Equity securities) then the cost is considered as most appropriate objective and reliable measurement of the fair value of securities. IFRS Initially, financial assets and liabilities should be measured at fair value (including transaction costs, for assets and liabilities not measured at fair value through profit or loss). Determination of FV: IAS 39 provides a hierarchy to be used in determining the fair value for a financial instrument and assumes that fair value of the instrument cannot be determined only in rare cases. bind any member firm. All rights reserved. 11

12 IFRS vs. SOCPA Financial instruments Impairment SOCPA Accounting Standards Decline in fair value is considered other than temporary if there are certain indicators proving its continuity or these indicators could indicate the nature of the decline Significance of the decline and period has to be considered while determining whether the decline in fair value is to be considered as impairment. IFRS Decline in fair value is considered permanent and the security is considered impaired if the decline in its fair value below cost is significant or prolonged. Other qualitative factors are also to be considered. Questions? bind any member firm. All rights reserved. 12

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