2011: Rabbits and financial instruments accounting

The Year of the Rabbit will be a year with quite a lot of attention on accounting standards, particularly financial instruments accounting.

Over the next 12 months, several important decisions will be taken about the rules to which publicly listed companies report on their financial health. These decisions will have an impact on domestic companies and global businesses alike – but the greatest impact may be on banks.

Towards one global set of standards

Several Asian countries are in the process of converging their domestic financial reporting rules to the International Financial Reporting Rules (IFRS), which are set by the International Accounting Standards Board (IASB) and used by more than 100 countries around the world. Singapore and Malaysia are this year finalising their preparations to fully converge domestic standards with IFRS by the 1 January 2012 deadline. India is working towards IFRS implementation by April this year (though there have been some reports about a potential delay), and Japan plans to harmonise the country’s accounting rules with the international standards by June, with adoption becoming mandatory from 2015.

June is also an important deadline for the convergence project between the IASB and the US Financial Accounting Standards Board (FASB), which determines US financial reporting rules; US GAAP. The two boards have been working on converging their rule books since 2002.

The challenge of financial instruments

Aligning different sets of accounting standards is no small feat. This has been quite clearly illustrated by the challenges faced by the US and international standard setters. Despite their agreement to converge standards and the G20 leaders’ call for one high-quality global financial reporting language, the two boards have, since the financial crisis, seemingly been moving further apart. The most debated area where the two boards have been in disagreement about approach is financial instruments accounting, standards of high relevance to banks and other businesses with financial assets and liabilities.

The IASB split its project to replace the old, defunct financial instruments standard into three phases, while the FASB decided to do it all in one go. The product of the IASB’s first phase is IFRS 9: Financial Instruments - ‘classification and measurement’. The IASB finalised this phase in time to allow, but not require, early application for 2009 year-end financial statements. However, both Singapore and the European Union, for example, have deferred adoption.

As a result of the IASB and the FASB’s divergent approach, the two boards have been operating with different timelines and have also proposed very different solutions. This, in turn, has resulted in questions being asked about whether the two boards could ever agree on one final standard. However, in recent weeks there have been some positive signals, suggesting the boards are again moving closer. The FASB has suggested it will align its classification and measurement proposals with the IASB’s ‘mixed’ approach, where both fair value and amortised cost are used to determine the value of financial instruments. The boards have also recently published a joint proposal for how impairments should be accounted for.

The financial instruments standard is only one of several complex standards due for completion by June. Others include standards for insurance and lease accounting. The outcome of these joint projects will play a major role in the US’ decision later this year on whether to adopt IFRS. A positive decision in the US is, in turn, likely to be a catalyst on other countries’ plans for converging to or adopting IFRS.

The question of how and when

There will be lots of changes over the coming years for companies reporting to IFRS, as well as for those auditing these reports and users of them such as the investor and analyst community. The IASB has recently asked for stakeholder views on how and when these standards should become implemented. To limit the amount of disruption and costs to businesses, the preferred approach is probably to make all the new and amended standards effective from a single and certain date, rather than let them trickle through under a phased approach. However, it is also important that businesses are given plenty of time to implement these new standards.

Such big adjustments require years of preparations and the learning curve for many businesses will be fairly steep. Reporting to the new standards may require a substantial amount of work and potentially investment both in training and systems. An early start on assessing the impacts can help limit disruption and costs considerably. Support will be at hand both from the standard setters and professional accountancy bodies. There will be hurdles to jump but we can jump them together.