Finance & Accounting

Significant disclosure under IFRS 7 for Financial Instruments

IFRS 7 is one of three IFRSs that apply to financial instruments: IAS 32, IAS 39, and IFRS 7. IAS 39 is being revised in stages; a portion of the rewritten IAS 39 may be found in IFRS 9. IFRS 7 is primarily concerned with the qualitative and quantitative disclosures required for financial instruments. IAS 30 is superseded by IFRS 7. Specifically, whereas IAS 30 exclusively applied to banks and financial intermediaries, IFRS 7 applies to all companies, even if financial instruments represent a little portion of the entity’s entire operations.

IFRS 7 is primarily intended for disclosures regarding the risks inherent in financial instruments held or issued by a business. This article categorizes and discusses the different disclosures required by IFRS 7 for financial instruments.

Disclosures relating to the significance of financial instruments

In terms of the impact of financial instruments on the entity’s financial situation and the entity’s statement of financial position (i.e., balance sheet), the entity must provide a number of critical disclosures. Paragraph 7 of IFRS 7 necessitates disclosure of the importance of financial instruments to the entity’s financial state and performance.

The carrying values of each of the following kinds of financial instruments must be reported, either in the body of the statement of financial position or in notes:

• The financial assets that are taken at fair value through profit or loss (i.e., FVTPL), differentiating those FVTPL that are held on initial recognition from those categorized as trading assets under IAS 39. It should be noted that, according to IAS 39, trading assets must be fairly evaluated using a profit and loss account.
• Available for sale financial assets, Held to Maturity (HTM) investments, loans, and receivables
• Financial liabilities that are taken at FVTPL, and differentiated in the same manner as in the case of financial assets
• Financial liabilities that are being measured at amortized cost
• Additional disclosures in regard to credit risk^[1], etc. in the case of any loans treated through FVTPL
• Details on any financial assets or liabilities that have been reclassified in accordance with Paragraphs 12 and 12A.

When financial assets are transferred, such as when they are sold or securitized, de-recognition normally occurs. The following information must be given for all such de-recognized assets:

• the nature and type of the assets
• the characteristics of risks and rewards of ownership that the company remains exposed to
• when the entity continues to recognize all of the assets, the carrying values of the assets, and the corresponding liabilities (it should be noted that if major risks/rewards are maintained, the sale/securitization transaction does not qualify for de-recognition)
• the total carrying value of the underlying assets, the value of the assets that the business continues to recognize, and the carrying value of the related liabilities: all of this needs to be disclosed when the entity continues to recognize the assets to the extent of its continued engagement/involvement

There are provisions that impose disclosure requirements for both collateral given and collateral kept. The organization must declare the carrying value of financial assets used as collateral for liabilities or contingent obligations. The company must declare the fair value and other information concerning financial and non-financial collateral held by it that it is authorized to sell in the absence of default by the collateral’s owner. It is important to note that in the case of secured lending, most security interests possessed by a lender may not be subject to this provision since the right to sell the collateral often arises only in the event of obligor failure.

Another requirement under IFRS 7 is disclosures concerning credit losses where the firm does not make impairment provisions against individual assets but instead debits impairment losses to a credit losses allowance.

The entity is required under the standard to give information about defaults. It should be noted that these are information about defaults committed by the entity, not defaults committed against it. Some of the defaults are as follows:

• Information on any defaults that may have occurred within the timeline of principal, interest, sinking fund, or redemption conditions of the loans that are payable
• At the conclusion of the reporting period, the carrying value of the ‘loans payable’ in default
• Whether the default was corrected or the conditions of the loans’ payable were renegotiated prior to the financial statements being authorized for release
• Defaults on any other loan terms or covenants

Disclosures relating to Comprehensive Income

In terms of the incomes, costs, gains, and losses relating to financial instruments, the following disclosures are needed in either the statement of comprehensive income (profit and loss statement) or in notes:

• Any net gains or losses on the financial assets that are taken at fair value through profit or loss (i.e., FVTPL), differentiating those FVTPL that are held on initial recognition from those categorized as trading assets under IAS 39.
• Any net gains or losses on financial liabilities that are taken at FVTPL, differentiated in the same manner as in the case of financial assets
• Any net gains or losses on available for sale financial assets, Held to Maturity (HTM) investments, loans, and receivables
• Any net gains or losses on financial liabilities that are being measured at amortized cost
• For financial assets or financial obligations that are not at fair value via profit or loss, the total interest income & total interest expense (computed using the effective interest method) are determined.
• Fee incomes and expenditures (other than the amounts considered in determining the effective rate of interest)
• Any interest income on impaired financial assets that are accrued in accordance with IAS 39
• The amount of impairment loss in respect of each class of financial asset

Other disclosures

Significant accounting policies relating to financial instruments must be disclosed. In addition, hedging derivatives are accounted for in accordance with IAS 39. Cash flow hedges, fair value hedges, and net investment hedges in non-integral international operations are the three forms of hedges. Each type of hedge, the risk hedged, and the hedging instruments will be shown in the financial statements. Furthermore, the following information is necessary for each type of hedge:

• In the case of cash flow hedges, when are the cash flows likely to affect revenue and when are they expected to occur?
• In the case of cash flow hedges, a description of any predicted transaction that was previously accounted for using hedge accounting but is no longer expected to happen
• In the case of cash flow hedges, the amount recognized in other comprehensive income during the period (any gain or loss on cash flow hedge valuations is lodged in “other comprehensive income” and released whenever cash flow volatility hits the firm)
• In the case of cash flow hedges, the amount reclassified from equity to profit/loss for the period, displaying the amount contained in each line item in the statement of comprehensive income 
• In the case of cash flow hedges, the amount taken out of equity and included in the initial cost or other carrying value of a non-financial asset or non-financial obligation whose purchase or incurrence was a hedged highly probable forecast transaction during the period.
• In the case of fair value hedges, gains or losses on the hedging instrument & the hedged item that are due to the hedged risk
• The inefficiency recorded in profit or loss as a result of cash flow hedges
• The inefficiency recorded in profit or loss as a result of net investment hedges in non-integral international operations

Another important disclosure required by the Standard (IFRS 7) is the fair value disclosure. It requires the company to disclose the fair value of all financial assets it holds. It should be noted that some asset classifications – available-for-sale assets and trading assets – are carried in books at fair value. The Standard, however, mandates disclosure of fair values even for classes such as loans and receivables and held-to-maturity securities. Short-term receivables, equity instruments where fair value cannot be consistently evaluated, and discretionary participation contracts (such as insurance contracts with profit participation characteristics or equity-linked instruments) are the exclusions where fair valuation is not necessary.

Following fair value disclosures are required:

• The methodologies and assumptions that are utilized in establishing the fair values of each type of financial asset or financial liabilities when a valuation approach is used. Default rates, credit spreads, and interest rates employed in valuation are some examples.
• Whether fair values are derived entirely or partially by reference to public price quotations in an active market, or whether they are calculated using a valuation method.
• Whether or not the fair values are derived entirely or partially utilizing a valuation approach based on assumptions that are not substantiated by prices from observable current market transactions in the same instrument and are not based on accessible observable market data.
• If altering one or more of those assumptions to reasonably credible alternative assumptions shall materially alter the fair value, the business must acknowledge this fact and disclose the consequences of those changes.

Moreover, the standard (IFRS 7) requires extensive disclosures on financial instrument risks. Credit risk, liquidity risk, and market risk are the three major risk categories where disclosures are necessary. For each of them, both qualitative and quantitative disclosures are required. For example, the entity should report the maturity analysis of assets/liabilities and outline how it manages liquidity risk.

A sensitivity analysis for every form of market risk to which the enterprise is exposed, demonstrating how variations in the relevant risk variable would have affected profit or loss and equity, as well as the methodologies and presumptions used in trying to prepare the sensitivity analysis and changes from the prior period in the methodologies and presumptions used, will be disclosed. Entities must disclose interest rate risk, currency risk, and other pricing risks as part of their market risk disclosures.

Conclusion

IFRS 7 mandates qualitative and quantitative disclosure of information on the relevance of financial instruments to a company, as well as the type and degree of risks emerging from such financial instruments. Specific disclosures are necessary for transferred financial assets and a variety of other issues. IFRS 7 was first announced in August 2005 and applies to fiscal years starting on or after January 1, 2007.

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