"Now is a good time for directors to pause and look at how they're going with the new standard."
November Edition, Many Hats: Audit & Risk Insights
The new financial instruments standard is already being applied, with December year-end companies now 6 months into applying the new rules and June year-ends having begun on 1 July 2018. Now is a good time for directors to pause and look at how they're going with the new standard: what are the governance arrangements around the assumptions they've made, what transition disclosures have been made, and what are the policies and procedures that have been adopted for the new standard? ASIC will be looking at these disclosures on transition and questioning companies about their new policies and new disclosures.
The financial instruments standard brings three key areas of change regarding:
classification and measurement of financial assets (including receivables and investments)
credit impairment, and
With the new financial instruments standard, it is the unusual situations that companies need to keep an eye out for. People are finding more assets that need to be recognised at fair value rather than amortised cost under the new rules. A few examples of assets that may now need to be fair valued through profit and loss are:
All companies should have reassessed their receivables under the standard's new credit impairment rules. For every receivable portfolio, be it a book of retail customers in the utilities space or a book of large corporate customers in the property industry, there will be some customers who pay late or who don’t pay. The impact of this needs to be recognised up front and an estimate of impairment built into the receivables the day they are recognised, whereas previously companies waited until the impairment actually occurred to recognise it. So where in the past companies might have seen zero provision in the first 30 days of aged receivables, now there needs to be a provision and it should reflect a company's experience and expectations on the future. Large corporate customers might look to credit ratings to get an idea of what the provision needs to be. This is also often helpful for intercompany loans within a group when considering the parent entity disclosures.
There will be many assumptions made in estimating future impairment. Directors might want to understand the sensitivity of those assumptions, the governance around changing them, and how linked they are they to external information, such as credit ratings, unemployment rates or GDP.
The new hedging rules make it much easier for companies to apply hedge accounting and better align with companies' risk management strategies. Much of the volatility caused by the time value of hedging instruments, such as options, is moved to reserves under the new standard and many previous economic relationships now also work for hedge accounting. There is still a requirement to be clear what derivative is hedging what underlying transaction - it's a fundamental premise which clarifies when derivatives need to be put through profit and loss.
Directors should be asking whether management have reassessed their hedging strategy and considered the benefits under the new rules. If the company has, for example, debt in USD and is using cross currency interest rate swaps (CCIRS) or interest rate swaps (IRS) to move it back to AUD, then it would be unusual not to apply hedge accounting. Have they also reconsidered their use of options, particularly in the commodities space? If management change their hedge accounting, they may also want to consider changing how underlying earnings is reported so the two align in a meaningful way for investors.
ASIC will be looking at these disclosures on transition and questioning companies about their new policies and new disclosures.
There are a number of questions directors should ask to satisfy themselves that their organisation is ready for the new standard:
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