UK: IFRS Preparers Be Warned - IFRS 7 Introduces Further Demanding Requirements

IFRS 7, which replaces IAS 30 and IAS 32, has a number of new disclosure requirements that companies need to take into account.

IFRS 7, ‘Financial Instruments: Disclosures’ combines the disclosure requirements arising from IAS 30 and IAS 32 in a new standard. As a result, IAS 30 and paragraphs 51 to 95 of IAS 32 have been superseded. The remaining paragraphs of IAS 32 are still effective as ‘Financial Instruments: Presentation’ (IFRS 25).

IFRS 7, issued on 18 August 2005 and adopted for use in the European Union on 27 January 2006, is now in force, effective for periods beginning on or after 1 January 2007. The standard has been available for early application in the UK for some time, and though take-up was encouraged (but not required), only a few companies chose to adopt it early. For many IFRS preparers, the new standard will result in more onerous disclosure requirements.

There is no exemption from presenting comparative information unless the standard is adopted for a period beginning before 1 January 2006.

Scope
IFRS 7 applies to all IFRS-compliant financial statements that include financial instruments not specifically excluded from the scope of the standard. IFRS 7 has also been incorporated into UK GAAP as FRS 29 and needs to be applied by UK companies implementing FRS 26.

Management approach
For each type of risk arising from financial instruments, entities must disclose summary quantitative data about exposure to these risks at the reporting date. This disclosure should be based on information provided internally to key management personnel (as defined in IAS 24 Related Party Disclosures).

Disclosing information on this basis should save companies time and money, provided that the information they supply internally surpasses the minimum required by IFRS 7.

New information to capture
IFRS 7 necessitates disclosure of information not previously required. Unfortunately, some companies may find that their existing financial reporting systems do not capture all the information they now need to disclose.

For example, entities now have to disclose an aged analysis of financial assets that are past due, but not impaired at the reporting date. Thus, they will have to prepare an aged analysis of any outstanding trade debtors who have not settled their debts within the stated credit terms. So, if an entity issued a sales invoice (with credit terms of 30 days) 40 days before the year-end, and it hadn’t been paid as at the year-end, that debtor would be disclosed as past due.

Sensitivity analysis
Entities need to produce a quantitative analysis of how profit or loss and equity would have been affected by ‘reasonably possible’ changes in market movements.

The standard does not stipulate how such an analysis should be performed or presented, but an illustrative example is provided in paragraph IG36.

Maturity analysis
Companies are required to show a maturity analysis based around future undiscounted gross contractual cashflows arising from financial liabilities, i.e. what will actually be paid in the future, and not the amounts at which the liabilities are stated in the financial statements.

For example, a bank loan of £100,000 is initially recognised in a company’s financial statements at fair value (normally the amount received) and subsequently measured at amortised cost. If the interest is paid at 9% per annum over five years, with the principal repaid at the end of that period, then, if the loan was entered into at the balance sheet date, the total amount to be disclosed in the balance sheet would be £100,000. However, £145,000 would be disclosed in the maturity analysis, as this is the total of the future payments to be made under the loan.

In some cases, entities may have to do extra work to identify these amounts, as they may not be captured by their accounting systems.

• Entities need to disclose the carrying amounts of financial assets and liabilities by category, either on the face of the balance sheet or in the notes. (The word ‘category’ refers to the categories of financial instruments defined in IAS 39, i.e. financial assets or liabilities at fair value through profit or loss, held-to-maturity investments, loans and receivables, available-for-sale financial assets, and financial liabilities held at amortised cost.)

• There are extra disclosure requirements relating to items designated at fair value through profit or loss. Some of these are potentially onerous as they require the component of fair value movement relating to fluctuations in credit risk to be calculated.

• There are new disclosure requirements relating to any difference between the fair value of a financial instrument at initial recognition and the amount at that date using a valuation technique.

• When entities record an impairment on an individual or group of financial assets through an allowance account (e.g. a bad debt provision), as opposed to recording a direct reduction in the carrying amount of the asset, they need to disclose, for each class of financial asset, a reconciliation of changes in carrying amounts in that account during the period.

• Companies need to make new disclosures for hedge ineffectiveness, and gains and losses in fair value hedges.

• Entities now have to disclose separately the net gain or loss for the following categories of financial assets and liabilities: held-to-maturity investments, loans and receivables, and financial liabilities measured at amortised cost.

As IFRS 7 introduces so many ‘extra’ disclosure requirements, companies that didn’t opt for early adoption should not delay in starting the process.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.