The Accounting Standards Board of the Institute of Chartered
Accountant of India, which sets the standard for the country, has
formulated two new Standards on Financial Instruments — AS 30
(Financial Instruments: Recognition and Measurement) and AS 31
(Financial Instruments: Presentation). These standards were placed
in public domain as exposure drafts for comments up to March 31,
2007 and are now being finalised. While AS 30 is the equivalent of
International Accounting Standard IAS 39, AS 31 corresponds to IAS
32.
Features of AS 30
The AS 30 is a complex standard and its main objective is to
establish principles for recognising and measuring financial
instruments whose definition encompass most items of financial
assets, financial liabilities in an entity's balance sheet. The
introduction of this Standard is likely to affect almost all items
in a corporate/bank balance sheet. It deals with recognition/de-
recognition and measurement of financial instruments as also
derivatives and hedge accounting.
AS 30 uses a mixed measurement model. Some assets and liabilities
are valued at Fair Value and others on cost basis. The concept of
fair value is central to the standard as also the concept of
symmetry. Fair value is the amount for which an asset could be
exchanged or a liability settled between knowledgeable willing
parties in an arm's length transaction. The standard stipulates
measurement of assets and liabilities at fair value unless otherwise
stated. Rationale for fair value stems from the fact that for
financial instruments the most relevant information is the amount
that could be realised from disposal. Subsequent measurement of
financial assets depends upon their classification at initial
recognition into any of the four categories.
Financial assets at fair value through P&L (held for trading)
Held to maturity investments
Loans and receivables
Available for sale financial assets
Subsequent measurement of financial liabilities classified under
fair value through P&L is at fair value and the resulting
gains/losses are recognised in the statement of profit and loss. All
other financial liabilities are to be measured at amortised cost
using the effective interest method.
The standard also stipulates restrictions on reclassification
between categories. No reclassification of a financial instrument
into or out of the category fair value through profit and loss is
permitted. The standard however prescribes certain exceptional
circumstances under which reclassification between `held to
maturity' and `available for sale' categories are permitted.
The requirements regarding impairment and uncollectability of
financial assets constitute an important and significant part of AS
30. Conceptually at each balance sheet date, an entity should assess
whether there is any objective evidence that a financial asset or
group of financial assets is impaired and if so it should determine
the amount of impairment loss and provide for the same.
Asset is defined as a resource controlled by an entity having future
economic benefit. Two key ingredients in this definition are
resource controlled by an entity and future economic benefit
associated with it. If the entity loses control or future economic
benefit ceases, there is impairment and it has to be provided. These
areas will have significant impact on the financial statements of
banks, since they are currently following 90-day delinquency norms
for recognition of NPAs and provisioning.
The standard also stipulates the criteria to qualify for hedge
accounting and the recognition and measurement of gains and losses
for different types of hedging relationships such as fair value
hedges, cash flow hedges and hedge of a net investment in a non-
integral foreign operation. Derivatives will be recorded on the
balance sheet at fair values and changes in their fair values will
be reflected in the profit & loss account unless stringent hedge
accounting criteria are satisfied.
Challenges
Change in accounting ushered in by the standard can substantially
affect the operation of entities. The implementation of AS 30 has
the potential to accentuate earnings volatility especially since
hedge accounting has been defined very rigorously under the
framework and derivatives that do not qualify as hedges will have to
be marked to market and resultant gains or losses will have to be
routed through the profit & loss account.
Resorting to fair value measurement would pose a serious challenge
in the valuation of financial instruments underpinning the need to
develop skills for valuation among accountants, finance
professionals and prepare for greater level of transparency through
enhanced disclosure requirements and documentation needs prescribed
by the standard.
Appropriate Board oversight and involvement of senior management
would be a pre-requisite for the smooth adoption. Further, there is
a need to revamp the MIS and technology capabilities of the entities
that have to comply with AS 30 for which significant initial
investment would have to be earmarked. Migration to fair value
accounting has its own challenges but at the same time it brings in
enormous amount of opportunities for Indian corporates and financial
institutions especially in the context of greater integration of our
markets with international markets.
The author is general manager with RBI. Views expressed in the
article are personal
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