Ias 39

What Is IAS 39?

IAS 39, or International Accounting Standard 39, was an International Accounting Standard that prescribed the requirements for the recognition and measurement of Financial Instruments, including Financial Assets and Financial Liabilities, as well as certain contracts to buy or sell non-financial items. This standard fell under the broader category of financial accounting standards, specifically governing the way companies report their financial holdings and obligations. IAS 39 addressed when a financial instrument should be recorded on a company's Balance Sheet, how it should be valued, and when it should be removed.

History and Origin

IAS 39 was originally issued by the International Accounting Standards Committee (IASC) in December 1998, replacing parts of IAS 25 Accounting for Investments. The International Accounting Standards Board (IASB) adopted a revised IAS 39 in April 2001, and further reissued it in December 2003 as part of its agenda to improve existing standards. It became effective for annual periods beginning on or after January 1, 2005.²¹, ²²

The standard's introduction was a significant step in harmonizing global accounting practices for financial instruments. The European Union formally adopted a revised version of IAS 39 in 2004, with its application generally beginning on January 1, 2005.²⁰ However, certain provisions, particularly those related to the "fair value option" and certain aspects of Hedge Accounting, were initially excluded or modified due to concerns from European banks and regulators regarding potential volatility.¹⁸, ¹⁹ This regulatory engagement highlights the critical role IAS 39 played in defining how financial institutions and other entities accounted for their complex financial exposures.

Key Takeaways

• IAS 39 established principles for recognizing and measuring financial instruments on a company's financial statements.¹⁷
• It categorized financial assets and liabilities, dictating how each category should be measured, whether at Fair Value or Amortized Cost.¹⁵, ¹⁶
• The standard included detailed rules for hedge accounting, allowing entities to offset changes in the fair value or cash flows of hedged items.¹⁴
• IAS 39 was largely superseded by IFRS 9 Financial Instruments, which became effective for annual periods beginning on or after January 1, 2018.¹³

Interpreting IAS 39

Interpreting IAS 39 involved understanding its detailed classification and measurement requirements for various financial instruments. The standard required initial recognition of a financial instrument at fair value when an entity became a party to its contractual provisions.¹² Subsequent measurement depended on the instrument's classification. For example, Loans and Receivables and Held-to-Maturity Investments were generally measured at amortized cost using the effective interest method. Conversely, financial assets designated at fair value through Profit or Loss were measured at fair value, with changes recognized directly in profit or loss.¹¹ Available-for-sale financial assets were also measured at fair value, but unrealized gains and losses were recognized in Other Comprehensive Income until realized.¹⁰

The principles within IAS 39 dictated how an entity's financial position and performance were reported, directly impacting financial metrics and analysts' interpretations. Understanding these classifications was crucial for assessing a company's true economic exposure and the volatility reflected in its financial statements.

Hypothetical Example

Consider "Alpha Corp," a manufacturing company that holds a significant amount of short-term government bonds. Under IAS 39, Alpha Corp would need to classify these bonds. If Alpha Corp intends to hold these bonds to collect contractual cash flows and has the ability to do so, they might be classified as "held-to-maturity investments" and measured at amortized cost.

However, if Alpha Corp holds these bonds primarily for short-term trading purposes with the intent to profit from fair value fluctuations, they would be classified as "financial assets at fair value through profit or loss." In this case, any changes in the fair value of the bonds would be recognized directly in Alpha Corp's income statement.

For instance, if Alpha Corp purchased $1,000,000 of these bonds and their fair value increased to $1,010,000 by the end of the reporting period, a $10,000 unrealized gain would be recognized in profit or loss. This classification decision under IAS 39 directly influenced how the bonds impacted the company's reported earnings and overall financial performance.

Practical Applications

IAS 39 had significant practical applications across various sectors, particularly in banking and finance, due to the prevalence of financial instruments in these industries. It influenced how banks recognized and measured derivatives, loans, and other financial assets and liabilities. The standard's requirements for hedge accounting allowed entities to manage and reflect their risk management activities in their financial statements. For example, a company might use Derivatives to hedge against foreign currency fluctuations on a future transaction. IAS 39 provided specific criteria for such hedging relationships to qualify for hedge accounting treatment, ensuring that the gains and losses on the hedging instrument and the hedged item were recognized symmetrically.⁹

However, the application of IAS 39, particularly its fair value provisions, faced scrutiny during periods of financial instability. During the 2008 global financial crisis, there were debates and criticisms regarding how the fair value measurement requirements of IAS 39 might have exacerbated market volatility, leading to calls for amendments. In response, regulators, including the European Union, introduced changes to the standard to provide more flexibility in reclassifying financial assets out of the fair value through profit or loss category under certain distressed market conditions.⁸ This illustrates the dynamic interplay between accounting standards and real-world economic events.

Limitations and Criticisms

While IAS 39 aimed to enhance transparency and comparability in financial reporting, it faced several criticisms, primarily concerning its complexity and its treatment of financial instruments during economic downturns. One major point of contention was the application of fair value accounting, especially for illiquid assets, during market crises. Critics argued that requiring financial instruments to be marked to market could lead to a downward spiral, where falling market prices force further write-downs, which then feed back into lower market prices. The European Central Bank (ECB) expressed concerns about potential artificial volatility arising from the mixed accounting model and the complexities of hedge accounting rules within IAS 39.⁷

The standard's rules for Impairment of financial assets were also a subject of debate. The "incurred loss" model, which required an impairment loss to be recognized only when there was objective evidence of an incurred loss event, was criticized for leading to delayed recognition of credit losses, particularly during the build-up to the 2008 financial crisis.⁶ This delay meant that financial statements might not fully reflect deteriorating asset quality in a timely manner, potentially misleading investors and regulators. This shortcoming eventually contributed to the development of IFRS 9, which introduced an "expected credit loss" model.

Furthermore, the complexity of its hedge accounting rules, including strict effectiveness tests for Cash Flow Hedges, often made it challenging for entities to apply hedge accounting, leading to volatility in reported earnings.⁵ These limitations ultimately prompted the IASB to undertake a comprehensive project to replace IAS 39 with IFRS 9, aiming for a simpler, more principles-based approach to financial instrument accounting.

IAS 39 vs. IFRS 9

IAS 39 and IFRS 9 are both International Financial Reporting Standards (IFRS) dealing with the accounting for financial instruments, but IFRS 9 largely superseded IAS 39 with significant changes, particularly in classification and measurement, impairment, and hedge accounting.

The primary intent behind replacing IAS 39 with IFRS 9 was to simplify the classification and measurement of financial instruments, introduce a more forward-looking impairment model, and make hedge accounting more reflective of an entity's risk management strategies. While IFRS 9 now governs most aspects of financial instruments, entities were given the option to continue applying the hedge accounting requirements of IAS 39 instead of those in IFRS 9 for a transitional period, acknowledging the complexities involved.⁴

FAQs

What is the main purpose of IAS 39?

The main purpose of IAS 39 was to establish principles for how companies should recognize, measure, and derecognize Financial Instruments, including financial assets and liabilities. It provided guidance on when these items should appear on a company's books and at what value.³

When was IAS 39 replaced, and by what standard?

IAS 39 was largely superseded by IFRS 9 Financial Instruments. IFRS 9 became mandatorily effective for annual periods beginning on or after January 1, 2018.²

What were the main criticisms of IAS 39?

Key criticisms of IAS 39 included its complexity, particularly regarding Hedge Accounting, and its "incurred loss" model for Impairment, which was seen as delaying the recognition of credit losses during economic downturns. The fair value option also drew scrutiny.¹