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Financial instruments made focus for 2019

Financial instruments made focus for 2019

(ESMA; German Financial Reporting Enforcement Panel)

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Understanding and implementing the rules of IFRS 9 have led to some intense adjustment activities for industrial and trading entities, and this isn't quite over yet. The challenges concern the development of technical concepts, the calculation of specific values for financial reporting and the notes disclosures according to IFRS.

As regards the technical concepts, the main issue has been the development of approaches for the relevant sets of rules. And for this task, the biggest difficulties have concerned the rules for classifying financial assets and the new credit risk model. On top of this, individual entities have had to resolve other highly complex issues that significantly impact the statement of financial position and statement of profit or loss and OCI (for example if immaterial contractual changes have arisen concerning an entity's own debt that was in the portfolio for transition). For specific financial reporting purposes according to the new standard and to prepare the SOFP and the consolidated statement of profit or loss and other comprehensive income, the calculations must be made twice: once for transition to the new standard and once for the financial year's statements themselves. However, anyone closely involved with IFRS accounting knows that the real challenge lies in how to prepare the notes disclosures. The IASB's simplification initiative for the notes has not made this challenge much easier. And yet many entities had hoped this would provide a grace period for precise implementation in the notes. 

Since 26 October 2018, it can be confidently assumed that there will be no grace period for public interest entities! On this day, the ESMA (European Securities and Markets Authority) published its priorities for 2019.

These priorities were carried over in identical form to the priorities of the FREP (German Financial Reporting Enforcement Panel) and thus form the basis for the questions in the FREP's investigations for 2019.

In its explanations on the priority, ESMA then mentions exactly those challenges noted above. It can thus be assumed that the audit will incorporate content-related questions as well as a review of completeness regarding the notes disclosures. Although the ESMA recognises that banks and insurers will be affected more acutely by the changes brought about by IFRS 9, it explicitly maintains a broad scope for those affected ('this standard is applicable to all issuers'). As always, if something obvious is explicitly repeated, it is advisable to pay particular attention. If the individual points are regarded individually, it becomes clear that the explanations on the priority also include a change to IAS 1.82, which is currently (often on grounds of materiality) the subject of a certain amount of implementation fatigue. At the very least, the explicit disclosure of impairments in the income statement is relevant for most entities. It should be noted at this point that the FREP does not know the materiality assessment of an audit firm and is generally not bound by concepts of materiality. So, if you consider the income statement item to be immaterial, you should be able to substantiate the amount and be absolutely certain about the marginality of the amount. Under the circumstances as noted, it can only be advised to state the amount in the income statement in all cases. 

Of course, the further explanations on the enforcement priority include the disclosures on the transition from IAS 39 to IFRS 9, which concentrate on the changes due to the principles of classification and measurement and the impairment model. These changes must me made individually for at least each class of financial instrument or measurement category, and the value drivers must be explained. 

Furthermore, there are changes in the notes both in the general part (accounting and valuation options) and in the disclosures on individual items of the SOFP and statement of profit or loss and OCI. As regards the changes in the general part, ESMA would like the options that have been exercised under IFRS 9 to be described explicitly. This again underlines the FREP's expectation that the notes disclosures, including the general part, are always to be entity-specific. However, it is expected that using purely standard text in the general part will raise queries from the FREP. The section in which no changes in measurement have been caused by the change from IAS 39 to IFRS 9 should also be re-read in the context of IFRS 9. One specific point often identified is the initial measurement of all financial instruments at fair value. Different to IAS 39, trade receivables are initially measured under IFRS 9 at the transaction price as defined by IFRS 15. This is put into operation in the IASB's typically British style under IFRS 15.46f. as 'consideration promised' (IFRS 15.47), or the amount to which the entity contractually 'expects to be entitled'. For the general part, it will surely be sufficient to base initial measurement of trade receivables on the transaction price and other financial instruments on the fair value.

In the notes to the individual items, the new disclosures on impairment are likely to be a focus area. Nevertheless, IFRS 7.35 has been extended by sub-items A to N (which themselves include a number of sub-items). 

However, in the notes on the individual items, there is a further point, which particularly affects corporates. To buy time, many entities have exercised the option to continue presenting their hedge accounting under IAS 39. Incidentally, it should first be noted that the IASB has made big steps towards the Macro Hedge Accounting Standard, and that this option may soon disappear in that regard. In formulating its priorities, moreover, the ESMA notes specifically that the option does not relate to the new notes disclosures on hedge accounting according to IFRS 7. The respective new disclosure requirements described must be implemented fully even if hedge accounting under IAS 39 is continued.

For all these reasons, in advance of the preparation of the financial statements, there should already be something of a final spurt for implementation of the standards, and this should involve a focus on the completeness and accuracy of the changed disclosures in the notes.

Source: KPMG Corporate Treasury News, Edition 86, November 2018

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