IAS 39, “Financial Instruments: Recognition and Measurement,” was a crucial standard in international accounting. Though superseded by IFRS 9, understanding IAS 39 remains important for interpreting older financial statements and appreciating the evolution of accounting practices.
The primary objective of IAS 39 was to establish principles for recognizing, measuring, and disclosing information about financial assets and financial liabilities. It aimed to improve transparency and comparability in financial reporting across different entities and jurisdictions.
Key aspects of IAS 39 included:
Classification and Measurement: IAS 39 categorized financial instruments into several groups, each treated differently. These included:
- Financial assets at fair value through profit or loss (FVTPL): Assets held for trading, or designated as such, were measured at fair value, with changes recognized directly in profit or loss. This category was used for speculative holdings.
- Held-to-maturity investments: Debt instruments with fixed or determinable payments and fixed maturity, which the entity had the positive intention and ability to hold to maturity, were measured at amortized cost.
- Loans and receivables: Non-derivative financial assets with fixed or determinable payments that are not quoted in an active market were also measured at amortized cost.
- Available-for-sale financial assets: Assets not classified in any of the previous categories were classified as available-for-sale. They were measured at fair value, with changes recognized in other comprehensive income (OCI), until the asset was sold or impaired.
Impairment: IAS 39 required entities to assess at each reporting date whether there was objective evidence that a financial asset or group of financial assets was impaired. If impairment existed, an impairment loss was recognized in profit or loss. The process for determining impairment was complex, particularly for debt instruments. The incurred loss model required evidence of a loss event before recognizing an impairment. This backward-looking approach was a significant point of criticism.
Hedge Accounting: IAS 39 provided rules for hedge accounting, which allowed companies to match gains and losses on hedging instruments (e.g., derivatives) with the changes in fair value or cash flows of the hedged items (e.g., assets, liabilities, or future transactions). Strict criteria had to be met to qualify for hedge accounting, including documentation of the hedging relationship and demonstration of effectiveness.
Derecognition: The standard also specified when a financial asset or financial liability should be removed from the balance sheet. For example, a financial asset was derecognized when the entity had transferred substantially all the risks and rewards of ownership.
Criticisms and Replacement by IFRS 9: IAS 39 faced considerable criticism, especially during the 2008 financial crisis. The incurred loss model for impairment was seen as too little, too late, as it delayed the recognition of losses until a loss event had already occurred. This contributed to a lack of transparency and timely recognition of credit risk. The complexity of the classification and measurement rules, and the restrictive rules for hedge accounting, were also criticized.
These criticisms led to the development of IFRS 9, “Financial Instruments,” which replaces IAS 39. IFRS 9 introduces a more forward-looking expected credit loss model for impairment, simplifies classification and measurement, and revises the hedge accounting requirements. While IAS 39 is no longer in effect, its legacy continues to influence accounting practice and the understanding of financial statements prepared under older standards.