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.
ü Financial assets at fair value through P&L (held for trading)
ü Held to maturity investments
ü Loans and receivables
ü 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.
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 corporate and financial institutions especially in the context of greater integration of our markets with international markets.