Financial Instruments
IAS 39, IAS 32, SFAS 133
Firms must classify, measure, recognise and de-recognise financial instruments in reporting. A financial instrument is a contract that creates a financial asset of one entity and a financial liability or equity instrument of another. Selected examples included in the scope of IAS 39 are debt and equity investments, loans, trade receivables and payables, qualifying provisions, net cash-settled commodity contracts, financial guarantee contracts, derivatives and convertible debt and other contracts that include embedded derivatives.
Measurement of these assets arises in the context of business combinations (IFRS 3, SFAS 141), hedge accounting, or in the normal course of financial reporting. Options may be found in a growing variety of contracts. Companies outside of the financial services market are sometimes surprised to find that they hold derivatives.
More and more firms find themselves with sophisticated financial instruments with properties of both debt and equity such as convertible debt from early stage investment, leases with options and other contracts with embedded derivatives. Classification of these contracts requires detailed economic analysis because the economic effects of the conditions on the reporting firm must be considered. Measurement often requires the use of valuation models. All financial assets (liabilities) within the scope of IAS 39 are initially measured at fair value or fair value plus transaction costs (less transaction costs).
After initial recognition, fair value measurement is required for financial assets that are available-for-sale investments and for financial assets and liabilities initially recognised as at fair-value-through-profit-or-loss (the “fair value option”). Financial instruments measured at fair value other than those designated via the fair value option will require impairment testing.
The application of IAS 39 in hedge accounting presents challenges for firms that adopt the standard, because it requires effectiveness testing at inception and each subsequent reporting date, but does not specify a particular test to be used. In order to maintain a cash flow or fair value hedge, high effectiveness must be demonstrated, essentially requiring a valuation regime.
Auditors cannot provide valuation services for the purposes of financial reporting. American Appraisal has experience providing independent valuation opinions of financial instruments at all levels of complexity in accordance with the requirements of IAS 39.
American Appraisal offers its clients independence, deep technical insight and a level of commitment to client satisfaction not commonly found in valuation consulting. For more information please contact us.