Principles of IFRS standards
The international accounting standards were created to ensure the transparency of listed companies’ accounts and meet three major criteria:
- Completeness: the financial statements must record the activity of the company and prevent off-balance sheet transactions.
- Comparibility: the financial statements are standardised and identical for all businesses.
- Neutrality: the standards should regulate account management for all busineeses.
IFRS evaluation methods of financial items
IFRS standards permit different evaluation methods. Two approaches are commonly used:
- The historical cost model
- The fair value model.
Financing accounting: Amortisation cost & Fair value [IAS 32/39]
The accounting of financial liabilities under IFRS standards depends on how the company writes them off from the balance sheet. IFRS standards favour the historical cost evaluation method for the liabilities held until maturity.
For the liabilities that are likely to be written off before the contractual maturity [Available for sale], the IASB recommends accounting at fair value. This fair value should reflect the interest rate change between the transaction date and the settlement date. Over the same period, it is also necessary to monitor the development of credit risk. In reality, this approach leads to greater volatility of liabilities in the balance sheet.
Accounting of interest rate derivatives and currency [IAS 39]
IFRS and IAS 39 standards require accounting hedging derivative instruments at their fair value. To mitigate earnings volatility due to changes in the fair value of derivatives, IAS 39 allows for an accounting exception: hedge accounting.
Hedge accounting is an accounting exception, it can only be applied provided that the following three conditions are met:
- Existence of documentation
- Eligibility criteria of the hedged item and the hedging instrument
- Demonstration of the effectiveness of the hedging relationship
Sensitivity of financial expenses and valuation [IFRS 7]
Companies subject to IFRS standards are required to assess the nature and magnitude of risks stemming from financial instruments in the portfolio on the balance sheet date.
Valuation of the fair value of interest rate and currency derivatives in accordance with IFRS 13
IFRS 13 standard introduces a new definition of fair value for interest rate and currency hedges. It defines the concept of fair value as the price that would be paid to transfer a liability or for the sale of an asset during a transaction between financial market participants at the valuation date.
Companies applying IFRS standards will therefore communicate at each closing, an exit price of their derivative instruments including counterparties’ credit risk.
IFRS 9 – expected developments
Starting Jan. 1, 2018, replacing IAS 39 with IFRS 9 will be mandatory in Europe (subject to its approval by the European Union).
As it relates to financial liabilities, this new standard will provide a lot more flexibility in terms of hedging strategy. It aims to integrate current business practices in regard to managing interest rate and currency risks. In return, it will be necessary to provide more documentation.
Finance Active’s approach
For over 10 years, Finance Active has guided the corporate sector finance departments on IFRS issues related to accounting for financial liabilities. Our IFRS offers are focused on two areas of expertise:
- Technology expertise. Our interest rate and currency solutions allow you to develop, simulate and automate the accounting treatment of your financial instruments.
- Consulting expertise. At each stage, our consultants assist you in the implementation and production of your IFRS statements.
Custom support during the implementation, production of regulatory statements, monitoring and discussion with statutory auditors … Throughout the value chain, Finance Active enables you to focus on the essentials: getting the job done.