A glimpse of International Financial Reporting Standards 9
May 20, 2018 | 2:53 PM
A.V. Manohar. - Supplied picture

Muscat: Financial reporting is geared to touch a new milestone with the implementation of IFRS 9 (International Financial Reporting Standards) from Jan 1, 2018. It is a welcome and wholesome document, carrying enhanced features in reporting financial assets such as equity, bonds, receivables and hedges. The global financial fiasco in 2008 pointed out certain weaknesses in reporting per International Accounting Standards (IAS) 39, calling for a drastic change and hence IFRS 9 is set out as a corrective tool.

Business entity’s objectives of investing, duly guided by prudence and pro-active assessment of the future, has become the dashboard in this new effort. It’s time to reformat the reporting style in alignment with the new classification, measurement and de-recognition rules. A quick glance of IFRS 9 rules, applicable for equity and bonds(receivables and hedges are not covered in this article) shall be helpful to unravel the intricacies in investment reporting.

Business model

Foremost, the reporting format needs to be expressive of the business model of the investing entity. Prudent investment strategy is (a) to have a mix of regular stream of income by way of fixed interest and varying dividends (linked to profitability)from equity shares (b) to decide the exit parameters for encashing the accumulated gains (c) to have ownership control (d) for parking short term funds. Basically, IFRS 9 wants the classification of investments, valuation methodology and its reporting to align with the chosen investment strategy.

Amortised cost

This option of valuation and reporting is exercised when an investment is made simply for getting regular and contractual cash flows, comprising solely payment of principal and interest (SPPI) on specified dates, as in fixed deposits and bonds. Here the investment is preserved and shielded away from market volatility. If the returns are cumulative in nature, as in Cumulative Deposits, then such returns are amortised every year,based on the time value of money. These investments, comprising of principal and amortised interest are stated in Balance Sheet at Amortised Cost and the effective interest gets reflected in Profit & Loss Statement (P&L).

Fair Value

Equity investments (equity) are tradable and dividends from equity are not guaranteed of a constant contractual cash flow on specified dates i.e. non-SPPI cases. Here the valuation is determined on Fair Value (FV) i.e. market value, which is based on quoted price at the stock market, if the equity is listed. Quoted bonds, satisfying the SPPI Test but intended for sale, without waiting for redemption, is also reported at FV basis.

For unquoted equity, computation of FV is to be done as per IFRS 13, although it is complex and judgmental, requiring expertise in valuation, that will make an estimation of future cash flows and bringing it to the present value, applying an appropriate discounting rate. This exercise is not simple as in Quoted equity, but cumbersome and susceptible to wrong valuations, arising from errors in judgement.

Having chosen the FV option, the next step is decide where to reflect the periodical increase /decrease in value and also the final gain / loss arising while selling such investments. The options available are Fair Value through P&L (FVTPL) if such investment income is decided to be reported in P&L itself or Fair Value through Other Comprehensive Income (FVTOCI) if such income reporting is through OCI and Fair Value Reserve in Balance Sheet.

These two options i.e. FVTPL or FVTOCI have different levels of impact on the final profit/loss of the entity and hence calls for extreme care and caution in choosing, keeping in mind that the financial ratios such as EPS, P/E and P/BV and also dividend declarations and directors remuneration are determined based on the final profit, as per P&L and not as per OCI.

There’s a caution at this stage. If the chosen option is FVTOCI and if it’s going to create or enlarge an accounting mismatch of final results in comparison with that of FVTPL i.e. impact of FVTOCI is vastly different from that of FVTPL, then the classification needs to be done under FVTPL only and not FVTOCI, vide IFRS 9, paragraph 5.7.8.

Under both the above FV options, dividend earnings are routed through P&L and there is no separate charge by way of impairment of investments in P&L, as the FV, denoting the saleable value is net of deterioration in value, if any.

Investments falling under Associates, Joint arrangements and Subsidiaries are out of the purview of IFRS 9.

Overall, IFRS 9 has brought in Fair Value oriented reporting, based on future, not merely on the past and while doing so, it has made the past investment strategies to get streamlined with upgraded business orientations.

* The writer is the Chief Financial Officer of Oman & Emirates Investment Holding Co.

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