IASB issues revised standards 32 and 39 focussing on Financial Instruments

The International Accounting Standards Board (IASB) has issued revised versions of its two Standards dealing with financial instruments. IAS 32 deals with the disclosure of financial instruments and their classification as debt or equity. IAS 39 deals with recognition, derecognition, measurement and hedge accounting.

The release of these revised Standards is part of the IASB’s initiative to improve fifteen of the Standards that it inherited from its predecessor body (the International Accounting Standards Committee—IASC), in time for them to be used by companies adopting International Accounting Standards for the first time in 2005.

These two accounting standards provide comprehensive guidance on the accounting for financial instruments. The need for such guidance is crucial. Financial instruments are a large part of the assets and liabilities of virtually every company, in particular financial institutions. They also play a central role in the efficient operation of financial markets. As an illustration of the importance of financial instruments, at the end of June 2003, the Bank for International Settlements estimated that the total estimated notional amount of over-the-counter (OTC) derivatives contracts stood at US$169.7 trillion with a gross market value of $7.9 trillion.

Financial instruments, including derivatives, can be useful tools for managing risk. But they can also be very risky themselves. In recent years there have been many “disasters” associated with derivatives and other financial instruments, including Barings, (in part) Enron, and others.

The Standards require companies to disclose their exposure to financial instruments and to account for their effects—in most cases as they happen, rather than allowing problems to be hidden away. In particular, IAS 39 requires derivatives to be reported at their ‘fair’ or market value, rather than at cost. This overcomes the problem that the cost of a derivative is often nil or immaterial and hence if, derivatives are measured at cost, they are often not included in the balance sheet at all and their success (or otherwise) in reducing risk is not visible. In contrast, measuring derivatives at fair value ensures that their leveraged nature and their success (or otherwise) in reducing risk are reported.

The former IASC began work on the original Standards fifteen years ago and issued IAS 32 in 1995 and IAS 39 in 1999. Both Standards were in existence in 2000 when the European Union unanimously agreed to require European listed companies to adopt International Financial Reporting Standards (IFRSs), including International Accounting Standards. The revised Standards improve the previous versions by reducing complexity, clarifying and adding guidance, eliminating internal inconsistencies and incorporating elements of Standing Interpretations Committee (SIC) Interpretations and IAS 39 implementation guidance published by the former Implementation Guidance Committee (IGC) set up by IASC. In revising IAS 32 and 39, the IASB did not reconsider the fundamental approaches contained in them. To do so would have resulted in a delay of several years in the production of a new Standard. The requirements in IAS 32 and IAS 39 are very similar to those in equivalent US Standards. The improvements further converge with US GAAP by eliminating ten differences between the two sets of standards.

The IASB has conducted extensive due process in developing the improvements issued today. This includes:

– publishing an Exposure Draft in June 2002 on which the IASB received over 170 comment letters
– conducting nine roundtable discussions in March 2003, in which over a hundred organisations and individuals took part
– discussions with the Standards Advisory Council and the IASB’s partner standard-setters
many meetings with constituents
– discussions about the issues raised on the exposure draft in every Board meeting from March to October 2003. In total, the IASB considered 61 agenda papers about issues raised on the exposure draft, amounting to over 1200 pages.

There was one issue that emerged from the consultation process for which the IASB decided that a further exposure draft was required. The issue was the use of fair value hedge accounting for a portfolio hedge of interest rate risk (sometimes referred to as ‘macro hedging’). The IASB published a further exposure draft on this one aspect of IAS 39 in August 2003, with a comment deadline of 14 November. The IASB has received over 120 comment letters and is in the process of finalising its proposals. However, in order to help those companies preparing to adopt the revised IAS 32 and IAS 39 in 2005, the IASB decided not to delay the completion of the rest of the Standards for this one issue to be resolved. Accordingly, the IASB is publishing the revised Standards now, subject to any changes that it might make for macro hedging. Any such amendments to IAS 39 for macro hedging will be issued early next year.

Introducing the Standards, Sir David Tweedie, IASB Chairman, commented,

“With thousands of companies being required to implement international standards it is essential that implementation is made easier. The improvements to the existing IASs 32 and 39 facilitate this for financial instruments and also introduce additional guidance based on extensive discussions with constituents. In a world in which financial instruments are being used ever more extensively, are becoming exceedingly complex and are often a source of confusion for investors, it is essential to have working standards in place, with appropriate guidance.”

Those wishing to subscribe to the standards should contact:

IASCF Publications Department, 30 Cannon Street, London EC4M 6XH,
United Kingdom. Tel: +44 (0)20 7332 2730, Fax: +44 (0)20 7332 2749,
email: [email protected] Web:

Printed copies of IAS 32 Financial Instruments: Disclosure and Presentation and IAS 39 Financial Instruments: Recognition and Measurement (ISBN 1-904230-33-4) will be obtainable, priced together as a set at £20.00 (€32/US$31) including postage, from IASCF Publications Department when stocks become available in January.

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