The Hindu Business Line : The road to AS 32

The ICAI has issued AS 32, “Financial Instruments: Disclosures”, which would be applicable to all entities including non-financial entities, except small medium enterprises. It would come into effect in respect of accounting periods commencing on or after April 1, 2009, and will be recommendatory in nature for an initial period of two years and mandatory for accounting periods commencing on or after April 1, 2011. The standard is modelled on IFRS 7 and there ar e no significant differences between the two standards.

The objective of IFRS 7 is (a) to provide information that will enhance the understanding of the significance of financial instruments to a company’s financial position, performance, and cash flows and (b) to assist in evaluating the risks associated with these instruments, including how the company manages those risks.

Disclosure requirements

IFRS 7 disclosure requirements include both ‘qualitative’ narrative descriptions and specific ‘quantitative’ data. The level of detail of such disclosures should not overburden users with excessive detail, but equally should not obscure significant information as a result of excessive aggregation. Further, it repeatedly requires disclosure by ‘class’ of financial instrument, a group that is appropriate to the nature of the information disclosed and the characteristics of the instruments. A class of financial instrument is a lower level of aggregation than a category, such as ‘available-for-sale’ or ‘loans and receivables’. For example, government debt securities, equity securities, or asset-backed securities could all be considered classes of financial instruments.

IFRS 7 requires extensive disclosures concerning the entities’ exposure to financial risks and how these are managed. These disclosures will be achieved through a mixture of qualitative and quantitative requirements, of which the former will be most challenging for preparers. IFRS 7 is generally more suited to financial institutions than non-financial institutions. Certain disclosure requirements such as risk exposures, maturity pattern of assets and liabilities, etc. which are typically bank-only requirements, will be required to be furnished by non-financial entities also. As a result, some of the requirements, such as the market risk sensitivity disclosures discussed below, will entail significant implementation costs for non-financial entities as it will entail collecting data that were hitherto not relevant.

Entities will be required to provide a quantitative analysis of their group-wide sensitivity to each type of market risk (interest rates, foreign exchange rates, equity prices, etc.), showing how profit or loss and equity would be affected by a reasonably possible range of increases and decreases in each of the market rates (the impact of a +/-5 percentage in the GBP/euro exchange rate).

The new market risk disclosures

Large entities, particularly financial institutions, which already have market risk measures in place such as value at risk, will be able to use these as a basis for the requirements. However, for all other entities, this analysis will have to be built up by collecting the relevant risk exposures globally.

This analysis applies to all instruments an entity has — for example, loans, equity instruments, derivative instruments, swaps, futures, forward contracts and any options held. For many of these instruments, identifying what is a ‘reasonably possible’ change in market risk variables and calculating the effect of these movements, requires additional expertise and knowledge to which many non-financial institutions do not have access. This will, therefore, require additional investment in internal models or a need for greater reliance on external providers.

The new credit risk disclosures

Within the new credit risk disclosures, IFRS 7 specifically requires an analysis of the age of all financial assets that are past due but not impaired. Since this disclosure in theory includes any debtor that is one day or more overdue, the collection of such data across multiple locations may present an operational issue for many entities. Overdue information may not be readily available or it may not be captured by an entity’s credit systems until such time as it becomes past due by a critical period, for example, 90 days.

Challenge of explaining IFRS 7

Two themes are emerging from the disclosure requirements discussed. First, most entities will show a significant volume of disclosure regarding financial risks in their financial statements. Second, certain disclosures are likely to be difficult to compare between entities, at least in the first few years before standard benchmarks become accepted.

For many non-financial entities, this level of disclosure on financial risks, which will be out of proportion with the required level of disclosure on non-financial risks, may give an unbalanced perception regarding the true risks of the business. Because of this, entities may find themselves spending a significant amount of time explaining the information contained in these disclosures to the users of the financial statements. The challenge for CFOs will be to explain these risks to users of the financial statements.

How should you approach the implementation of IFRS 7 or AS 32? One of the biggest practical challenges will be the collection of the information requiring disclosure.

One of the best ways to start is to take each IFRS 7 requirement in turn so as to determine whether it is already being disclosed or is at least already internally available.

The difficulties of gathering the information for disclosure should not be underestimated, particularly as such information is often not held directly in the accounting records but instead must be sourced from other areas.

Senior management should therefore begin a process now to assess the potential impact of IFRS 7 (or AS 32) on their financial statements and determine the appropriate level of project support that is required.

(The author is Partner, Ernst & Young Pvt. Ltd. )

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