Following on the Financial Instruments Disclosures Part 1—where we have discussed about disclosures of financial instruments by categories, reclassifications disclosures, derecognition of financial assets disclosures, and collateral disclosure, I am going to complete the series through this post.
Before going to the part 2, please note that IFRS 7 (“Financial Instruments: Disclosures”) applies to those financial instruments to which IAS 32 applies, with the additional exclusion of equity instruments (including puttable instruments classified as equity).
As promised, Part 2—the final series, is going to discuss about: disclosures for impairment allowance disclosures, disclosures in the statement of comprehensive income, hedge accounting disclosures, fair value disclosures, disclosures in lieu of fair value disclosures, necessary notes to the fair value hierarchy-based disclosures, and three types of risks that must be shown in financial instruments—credit risk, market risk, and liquidity risk.
An entity maintains a separate allowance account to recognize individual and/or collective credit loss arising out of impairment of financial assets. Such impairment loss is not directly deducted from the carrying amount of the financial asset. An entity shall disclose a reconciliation showing movements in such allowance account.
- Compound Financial Instruments with Multiple Embedded Derivatives.
- Descriptive disclosure is required to explain the existence of such features in the financial instruments.
Defaults and Breaches – For loans payable, the following disclosures are required:
- Details of any defaults during the period of principal, interest, sinking fund, or redemption terms of those loans payable;
- Carrying amount of the loans payable in default at the end of the reporting period; and
- Description whether the default was remedied, or the terms of the loans payable were renegotiated, before the financial statements were authorized for issue.
Disclosures In The Statement Of Comprehensive Income
An entity has to disclose gains or losses, total interest income and expense, fee income and expense covering:
(1) net gain or loss classified by categories of financial assets and liabilities;
(2) total interest income and expense calculated using effective rate interest method;
(3) fees, income and expenses other than those included in determining the effective rate of interest;
(4) interest income on impaired financial assets accrued; and
(5) impairment losses for each class of financial asset.
Hedge Accounting Disclosures
Paragraphs 22–24 of IFRS 7 require the following disclosures:
(a) Hedging in general – The entity must provide:
1. A description of each type of hedge;
2. A description of the financial instruments designated as hedging instruments and their fair values at the end of the reporting period; and
3. Nature of the risks being hedged.
(b) For cash flow hedge – The entity must provide:
1. The periods when the cash flows are expected to occur and to affect profit or loss;
2. A description of previously applied hedge accounting to a forecast transaction that is no longer expected to occur;
3. The amount that was recognized in other comprehensive income during the period under cash flow hedge reserve;
4. Reclassification adjustment carried out of the cash flow hedge reserve during the period, showing the amount included in each line item in the statement of comprehensive income;
5. Amount of reclassification adjustment that is included in the initial cost or other carrying amount of a nonfinancial asset or nonfinancial liability whose acquisition or incurrence was a hedge; and
6. The ineffectiveness recognized in profit or loss that arises from cash flow hedges.
(c) For fair value hedge – Disclose gains or losses:
1. On the hedging instrument; or
2. On the hedged item attributable to the hedged risk.
For hedging net investments in foreign operations – Discloses the ineffectiveness recognized in profit or loss that arises from hedges of net investments in foreign operations.
Fair Value Disclosures
The fair value of each class of assets and liabilities should be presented in a way that permits it to be compared with its carrying amount. An entity has to classify the fair value measurements of all items of financial assets/liabilities using a fair value hierarchy. The fair value hierarchy reflects the significance of the inputs used in making the measurements. It has three levels:
- Level-1: Quoted prices (unadjusted) in active markets for identical assets or liabilities
- Level-2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (i.e., as prices) or indirectly (i.e., derived from prices)
- Level-3: Inputs for the asset or liability that are not based on observable market data (unobservable inputs)
Note that fair value of financial assets and liabilities are not offset against each other unless they are offset in accordance with IAS 1, “Presentation of Financial Statements.”
Disclosures when using the valuation model (as it is believed that the best evidence of fair value at initial recognition is the transaction price) include:
- Valuation technique and assumptions used including assumptions relating to prepayment rates, rates of estimated credit losses, and interest rates or discount rates wherever applicable;
- Accounting policy for recognizing that difference in profit or loss to reflect a change in factors (including time) that market participants would consider in setting a price; and
- The aggregate difference yet to be recognized in profit or loss at the beginning and end of the period and a reconciliation of changes in the balance of this difference.
Fair value disclosures are not required when:
- The carrying amount is a reasonable approximation of fair value, for example, for financial instruments such as short-term trade receivables and payables;
- An investment in equity instruments does not have a quoted market price in an active market, or a derivative linked to such equity instruments, that is measured at cost; or
- A contract contains a discretionary participation feature.
Disclosures In Lieu Of Fair Value Disclosures
In relation to investment in equity instrument discussed earlier and for a contract containing a discretionary participation feature, an entity shall make the following additional disclosures:
- The fact of nondisclosure of fair value information because their fair value cannot be measured reliably;
- A description of the financial instruments, their carrying amount, and an explanation of why fair value cannot be measured reliably;
- Information about the market for the instruments;
- Information about whether and how the entity intends to dispose of the financial instruments; and
- Information explaining that a financial instrument whose fair value previously could not be reliably measured is derecognized, if applicable, its carrying amount at the time of derecognition and the amount of gain or loss recognized.
Fair Value Hierarchy-Based Disclosures
For each class of financial instruments, disclosures shall be based on the fair value hierarchy. An entity shall disclose, for each category of financial instruments, the level in the fair value hierarchy into which the fair value measurements are categorized in their entirety.
1. Classify fair value measurements into appropriate category
2. Tell significant transfers between Level 1 and Level 2.: (a) Show transfer to and transfer from separately; not to be disclosed net; (b) Judge level of significance with reference to profit or loss, and total assets or total liabilities.
3. Fair value disclosures to be included for Level 3 are: (a) Opening balance – total gains/losses recognized during the period in the statement of comprehensive Income (or separate statement of income, refer to IAS 1); (b) Describe where they are presented – (1) total gains/losses recognized during the period; and (2) Purchases, sales, issues, and settlements; (c) Disclose each type of movement separately – transfers into and out of Level 3; (d) Disclose significant transfers in and out separately.
4. Provide disclosure about inclusion of gains/losses of financial instruments out of Level 3 measurement, which are included in the profit and loss. For the items of financial assets/financial liabilities that are held at the end of the reporting period, include: (a). A description of where those gains or losses are presented in the statement of comprehensive income or the separate income statement (if presented).
5. Include sensitivity analysis of inputs at Level 3: (a) Significant changes in fair value as a result of changed inputs resulting from alternative assumptions; (b) Describe the effect of change; (c) Significance level is to be arrived at with reference to profit or loss, and total assets or total liabilities.
The entity shall disclose the fair value hierarchy based on quantitative information as stated here. An entity shall also disclose the methods and, when a valuation technique is used, the assumptions applied in determining fair values of each class of financial assets or financial liabilities, as well as any changes in valuation techniques and the reasons for making such changes.
There are three types of risks that must be shown in financial instruments: credit risk, market risk, and liquidity risk. Interest rate risk and currency risks are variants of market risk only. The entity shall make qualitative and quantitative disclosures showing risk, including the following:
1. Qualitative disclosures:
- Exposure to risks and how such risks came about.
- Objectives, policies, and processes for managing the risk and the methods used to measure the risk.
- Any changes of risks and risk management policies from previous period.
2. Quantitative disclosures:
- Summary of quantitative data about the exposure to that risk at the end of the reporting period. This disclosure shall be based on the information provided internally to key management personnel of the entity.
- Provide disclosures in accordance with materiality.
- Further information should be included such as concentrations of risk, if quantitative data provided is not sufficient.
3. Liquidity-risk disclosures
An entity discloses summary quantitative data about its exposure to liquidity risk on the basis of the information provided internally to key management personnel in accordance with IFRS 7.34(a):
- Non-derivative financial, that is: (a) Not later than one month; (b) Later than one month but not later than three months; (c) Later than three months but not later than one year; and (d) Later than one year but not later than five years.
- Derivatives, that is: (a) Not later than one month; (b) Later than one month but not later than three months; (c) Later than three months but not later than one year; and (d) Later than one year but not later than five years.
Also notes that:
1. The entity will decide the appropriate time frame. Embedded derivatives are not segregated from hybrid financial instruments for the purpose of liquidity risk disclosure.
2. The entity is required to explain how those data are determined.
3. The entity shall disclose the fact if the cash flows indicated could arise earlier than indicated in the data or if they could be significantly different than presented.
4. When an entity is committed to make amounts available in installments, each installment is allocated to the earliest period in which the entity can be required to pay.
5. The amounts disclosed in the maturity analysis are the contractual undiscounted cash flows.
6. An entity shall analyze conditions existing at the end of the reporting period for determining the amount payable under a financial instrument that is not fixed For example, when the amount payable varies with changes in an index, the amount disclosed may be based on the level of the index at the end of the reporting period.
Other factors that can be disclosed in the liquidity risk management explanation required under paragraph 39(c) of IFRS 7 and:
- Committed borrowing facilities;
- Deposits at central banks to meet liquidity needs; and
- Diverse funding sources.
The entity might consider disclosing:
- Significant concentrations of liquidity risk in either its assets or its funding sources;
- Internal control processes and contingency plans for managing liquidity risk;
- Instruments that could require the posting of collateral (e.g., margin calls for derivatives);
- Instruments that allows the entity to choose whether it settles its financial liabilities by delivering cash (or another financial asset) or by delivering its own shares; or
- Instruments that are subject to master netting agreements.
Disclosure of Market Risk Sensitivity Analysis
An entity must disclose: (1) sensitivity analysis in regard to changes in risk variables, (2) methods and assumptions adopted for sensitivity analysis, and (3) changes in methods and assumptions from previous period, if any, explaining reasons thereof.
When an entity prepares sensitivity analysis that reflects interdependencies between risk variables such as value-at-risk, it shall disclose (1) an explanation of the method used, parameters and assumptions of the underlying data provided; and (2) an explanation of the objective of the method used and of limitations that may result in the information not fully reflecting the fair value of the assets and liabilities involved.
In case the sensitivity analyses applied are unrepresentative of a risk inherent in a financial instrument (if the year-end exposure does not reflect the exposure during the year for example), disclose that fact and the reason thereof.
In term with insurance contract, information about credit risk, liquidity risk, and market risk that paragraphs 31–42 of IFRS 7 require are to be disclosed for insurance contracts as if the insurance contracts were within the scope of IFRS 7. However, an insurer need not disclose the maturity analysis discussed in this chapter if it discloses information about the estimated timing of the net cash outflows resulting from recognized insurance liabilities instead.