Hedge Accounting under IAS 39 and IFRS 9- a Critical Comparison - Research Proposal Example

? Hedge Accounting Under IAS 39 and IFRS 9- A Critical Comparison Hedge Accounting Under IAS 39 and IFRS 9- A Critical Comparison Abstract This study aims to provide a comprehensive comparison of two main financial instruments used in hedge accounting. The first section of the study is aimed to recognize the differences between IAS 39 and IFRS 9, implications of changes, current issues and regulation and future development for IFRS 9. This section demonstrates the relevance of the study identifies specific research questions and describes aims and objectives for this investigation. The second section reviews the literature related to IAS 39 and IFRS 9 as financial instruments used in hedge accounting. The next section outlines the methodology used in this study, including a conceptual framework of research variables, data sources, data collection and data analysis methods. The last section of this study discusses the ethical issues ethical issues arising from the proposed research and techniques to address these issues. Introduction Hedge accounting is a technique utilized in accounting where entries for the rights of a security and the opposing hedge are treated simultaneously. Hedge accounting endeavors to ease the volatility generated by the repetitive adjustment of the value of a financial instrument. This reduced volatility is done by combining the hedge and the instrument as one entry, which balances the opposing movements (GUPTA, 2008). IAS 39 Financial Instruments: Recognition and Measurement are a global accounting standard for financial instruments released by the International Accounting Standards Board (IASB) which summarizes the requirements for the recognition and measurement of financial liabilities, financial assets, and some contracts to buy or sell non-financial items. International Financial Reporting Standards (IFRS) is a complete, internationally recognized set of accounting standards using an approach based on principles with a bigger emphasis on elucidation and relevance of those principles, intending at best replicating the economic substance of transactions. IFRS 9 Financial Instruments outlines the recognition and measurement requirements for fiscal instruments and contracts to buy or sell non-financial items set to eventually form a comprehensive substitution for IAS 39 Financial Instruments: Recognition and Measurement. It was initially published in November 2009, reissued in October 2010 with requirements for financial liabilities, and pertains to annual periods commencing on or after 1st January 2015 (MIRZA & NANDAKUMAR, 2013). What makes IFRS 9 to be the most preferred than IAS 39 is its top preference of financial information which is a prerequisite for the evolution of capital markets as it has been argued that the structure informational environment plays a principal role in helping investors come up with decisions. Regulators will also have a lot of power with them to order a financial body to act whenever an instance is deemed to not be adequate (DICK & MISSIONIER-PIERA, 2010). In conclusion therefore, this is a complex issue that will need to be tackled carefully by experts in this field. In as much as the IAS 39 was greatly deemed unreliable and IASB went to great lengths to come up with a better standard that they thought would be suitable, these efforts may have not paid as it is not yet clear if most companies are going to readily adopt this new standard (IFRS 9). Although it has been termed as better than the previous one, still concerns have been raised that more amendments should be done on the yet not completed IFRS 9. The major complaint launched being that financial reporting be carried out in a specific context before any standard is imposed. This is actually hard to achieve and may continue to delay the completion of the IFRS 9 which is in fact still underway and has already suffered great delays. IFRS 9 is a 'work in progress' and will eventually replace IAS 39 in its entirety and is subject to several modifications till the prescribed effective date and even after (DICK & MISSIONIER-PIERA, 2010). However, this is the limited area worked out for the sake of awareness about the emerging changes in reporting. It is intended to continue to cover complex areas of Derivatives and Hybrid Financial Instruments anon. it is also important to note that insurance companies, banks, and mutual funds would largely be affected by the recommended shift from IAS39 to IFRS9. The recommended changes would not have a remarkable effect on profitability but will considerably alter the manner of presentation. Fair value by profit and loss category would still be the same as the recognition procedure for both standards are similar because the objective is to make profits from fair value changes (2011). Nonetheless, re-measurement to fair value will be done on each date of reporting with any gain in fair value directly taken into profit and loss. Additionally, decrease in interest rates would be converted into gain in present value of security for financial assets categorized as Fair Value through Profit And Loss (FVTPL). However, assets categorized at Amortized Cost would remain the same as long as there is an evidence of probable impairment. Therefore, the financial sector would not be greatly affected by constant interest rate cut as they can simply change their dependence from advances to short term investments The contents of both standards are alike with only some amendments were done to the fair value option for financial liabilities in IFRS 9 Financial Instruments in order to address the subject of own credit risk. In the future, IAS 39 will be replaced by IFRS 9 which will make simpler the categorizations of financial assets into those to be carried at fair value and those to be carried at amortized cost. This study aims to critically the hedge accounting practices under IAS 39 and IFRS 9 by identifying the key similarities between the two standards. Research questions The conduct of this proposal based on the subject under study will be done while taking into consideration the following questions: RQ1: How does hedge accounting vary under IAS 39 and IFRS 9? RQ2: What impacts do the amendments in IFRS 9 have on firms? Literature review The topic of financial reporting continues to be faced with several issues regarding measurements. This consequently has continued to be a principal debate, and there have been calls for adjustments in the manner in which financial reporting is carried out. The most important purpose for introducing IAS 39 was to generate cohesive guidelines for reporting of financial instruments. This was in an attempt to guarantee that companies presented them in the most consistent and transparent manner (COLLINGS, 2011). Since IAS 39 handles financial instruments such as derivatives, it was going to be the first time that these companies would explain derivative business deals on their balance sheets. This was going to clearly have an effect on companies which had not formerly made use of the IAS 39. There exists incongruity in the manner in which standards of measurement are set and what the accounting theory calls for of the information economics strategy (ANAGNOSTOPOLOUS & BUCKLAND, 2011). This could have prompted the International Accounting Standards Board (IASB) decision to develop a replacement for IAS 39 when it came to their attention that most companies protested its incompetence as it was much more complex and also cost them high fees to effect. Although the IASB has embarked on the responsibility of increasing people’s understanding of the IFRS 9 with the aim of ensuring that as many companies as possible conform come 2015, the number of members who have so far agreed to implement the first chapter of IFRS 9 is still very low. These include Hong Kong and Australia who have agreed to the early implementation of IFRS 9. A large number of the members are still hesitant when it comes to adopting this new standard. The amendments that have been undertaken lately in financial reporting have resulted in the relevance of measurement issues today. This has been largely attributed to the introduction of International Financial Reporting Standards (IFRS 9) (ANAGNOSTOPOLOUS & BUCKLAND, 2011). However, replacing IAS 39 has not proved to be a simple task as it was a complicated standard that is also intricate to apply. The replacement procedure therefore had to be partitioned into three major phases. The first phase of this process has been effectively completed. The IASB is still building up the replacement of the remaining phases while the IAS 39 is still in place. Sections of the completed phases which will have fresh requirements will then be added to IFRS 9 (WALTON, 2011). IFRS 9 is to go into operation from January 2015 and will be compulsory for all companies. Nonetheless, interested companies have been allocated a provision of taking on the IFRS 9 before this date on condition that they stick to set conditions whereby such should be affirmed in their financial statements. These companies will still apply IAS 39 to hedge accounting and impairment, but it is more often than not firms with small amounts of financial instruments that will undergo minimal effects when changing (COLLINGS, 2011). The critics of IAS 39 primarily base on the huge differences in the manner in which the two standards are organized and how they operate. For instance, the IAS 39 has been carped for not valuing equity investments such as shares in other companies at fair value via other inclusive income. In this manner, the volatility in a company’s profits is raised. Also, there is an inequality experienced in the method equity and debt instruments are categorized and calculated in the two standards (RAMIREZ, 2011). The lack of transparency in financial stability is attributed to be one of the many reasons for the collapse of the US thrift industry. This could also account for the financial crisis of the US Savings & Loans in the late 1980s. Normally, when losses are not recognized, or take a long duration to be noticed, this always exposes the bank to vast problems as they unknowingly continue to take more risks in their financial transactions. This strategy makes a company’s losses not to be reflected in its financial report. This is a strategy that was acceptable in the IAS 39 meant to make companies delay their loss recognition in anticipation that they will pick up in the near future. The current financial crisis in the US is similar to that of Japan in that there is a great comparison in their financial environments and the systems employed in their financial reporting. The failure to transparently report losses prevents the detection of potential future economic problems that could be experienced in the future. By not recognizing losses, the investors and regulators are not kept in the light of the issues and so this becomes hard for the fall of such companies to be prevented. However, the IFRS 9 is more suitable especially to those firms that normally uphold good presentation of income to their shareholders. On the other hand, the IFRS 9 may appear to some firms as it puts strict measures on asset revaluation. According to Devi & Hooper (2011), in order to prevent future collapses of financial bodies, full fair value reporting should be availed to investors and regulators. This is important as they will be in the know on the financial health and stability of such institutions. This is a role that should be spearheaded by the bodies that are involved in the setting of accounting standards. Since IFRS 9 is just a modification of IAS 39 and will still be as complex as IAS 39, Hassan (2011) predicts that this complexity will be an obstacle to its full adoption, and there are high chances that it will not receive good reception. This is because it requires a lot of resources and it may also not have a positive impact on the financial instruments of most companies; especially those that deal with stocks, warrants and bonds. The same sentiments are shared by Christian & Lu?Denbach (2013) who speculate whether the introduction of IFRS 9 will reduce the complications experienced in IAS 39. A survey conducted by the Chartered Financial Analysts in the year 2009; with most respondents from Europe and America however proved that there is some degree of positive reception of the new IFRS 9. 47% of respondents believe that the complexity of IAS 39 will be reduced by the introduction of IFRS 9 while 35% were neutral. FASB Preference was also high among Americans, especially from research analysts, corporate financial analysts and portfolio managers. The major complaint raised by most companies about IFRS 9 is based on the notion that not all institutions will benefit equally upon adopting this new standard. This varying net benefit is however inevitable on adoption of this standard as it is obvious that quite a number of companies might experience net losses. Some stakeholders have therefore argued that some factors have to be considered before imposing this new standard to any company. The institution’s typology and nature should be considered; this is a point of concern raised by most of the banks and regulators. This had in the past ensued into a conflict between financial institutions and those involved with standards setting. Bellandi (2012) is still convinced that the effect of IFRS 9 introduction is still not very clear. However, since the IFRS 9 is meant to make financial reporting worthwhile and better, its limits can be overlooked since it fundamentally allows investors and regulators have access to important financial information that can help them gauge or predict the viability of a financial institution. The impact of IFRS is not necessarily a perfect one even though it employs some degree of stabilization. Conceptual framework The proposed changes to IAS 39 outlined in IFRS 9 address the issues regarding cash flow hedge accounting ineptitude and also considerably reduce profit or loss volatility on fair value hedges. The resolution of the of the currency root spread constituent of the fair value of the hedging instrument will add significantly to the operational challenges of hedge accounting. The decision by IASB was to decouple the plan on macro hedging from IFRS 9 while concurrently permitting firms to utilize fair value hedge accounting for case hedges of interest rate risk as described in IAS 39, until the macro hedge accounting project is completed and becomes effectual. However, the IAS 39 Implementation Guidance also includes specific guidance for the use of cash flow hedge accounting when financial institutions control interest rate risk on a net basis. Consequently, most financial institutions raised concerns regarding capability to continue with their macro cash flow hedging policies under IFRS 9. Macro cash flow hedge accounting is only a technique of application of the hedge accounting model while macro fair value hedge accounting is exclusion from the model. Therefore, carrying forward the implementation guidelines might mean that existing macro cash flow hedge accounting is not in agreement with the new hedge accounting model. According to IASB, the objective of macro hedging strategies of financial institutions is to hedge the interest margin risk that occur due to and financial liabilities held at amortized cost and interest bearing financial assets. However, the hedge designation is either a predicted cash flows or a fair value hedge intended to hedge the variability of fair values. Neither of these is fully consistent with the genuine risk management action to hedge the variability in the interest rate margin. Additionally, for cash flow hedges, monetary firms would typically allocate net cash flows as hedged items. However, IFRS 9 limits net position cash flow hedges to hedges of foreign currency risk. This raises the issue of whether a firm can designate hedges that do not entirely reflect the basic risk management activity (proxy hedges). This is of particular significance as the aim of the new hedge accounting model in IFRS 9 is “... to represent, in the financial statements, the effect of an entity’s risk management activities.” (GREUNING, SCOTT & TERBLANCHE, 2011). IASB asserted that proxy hedges are allowed, as long as the designation is ‘directionally consistent’ with the actual risk management action. Assigning a net cash flow as a gross location would be directionally consistent with a risk management strategy of hedging net positions, therefore, taking out the conflict in IFRS 9. Another concern clarified by the board regards its resolution that dynamic hedging strategies have to be partially of fully suspended in line with risk management. The objective of IASB was to have a different project on the accounting for macro hedging while, in the meantime, not limiting companies that presently utilize macro hedging strategies under IAS 39. The new hedge accounting requirements under IFRS 9 aim to more effectively mirror the effect of a firm’s risk management activities in its financial statements. The new requirements under IFRS 9 are more principles based, less intricate and present a better connections with risk management activities of a firm than the present hedge accounting model under IAS 39. IFRS 9 would permit firms to apply hedge accounting more widely to control profit of loss disparities and enhance ‘artificial’ hedge ineffectiveness developed from the current IAS 39 model. Highlights of the new amendments include: • Allowance of more entries to meet the requirements as eligible hedged items e.g. net foreign exchange cash flow positions, risk components of non-financial items and derivative in combination with a non-derivative. • Simplifying testing of effectiveness particularly elimination of the 80-125% potential and presentation quantitative test, with a qualitative potential assessment allowed. • Options to hedge accounting offered to manage the accounting variance for economic hedges of credit risk and ‘own use’ contracts. • Less profit or loss volatility for firms using forwards of options as hedging instruments Entities carrying out economic hedging activities could gain considerably from these new requirements as they give firms with significant economic hedging activities a chance to better reflect their risk management activities in their financial statements. Administration may wish to reflect on the new conditions carefully as there may be gains from early adoption (SUBRAMANI, 2011). Research methodology Independent and Control variables We use three dummy variables to test our hypotheses. The first variable points out the application of IAS 39 and IFRS 9, hence variable 1 takes the value 1 if the firm utilizes IAS 39 for reporting and 0 if reporting is done with IFRS 9. A hedging dummy, variable 2 equals to if the firm uses derivatives and reports under IFRS 9 in the existing period and 0 if IAS 39 is used. Finally, we incorporate the association of variable 1 and variable 2 and employ several control variables for the multivariate analysis depending on the extensive literature on predicted accuracy determinants. The literature suggests that predicted error and dispersion depends on several factors such as the firm size, earnings variability, leverage, market to book value, negative earnings, analysts following, time effect, industry effect and level of earnings (ZIKMUND, 2003). Relevant evidence and associated data sources To be able to correctly answer the research questions listed above as guidance for this study, secondary data from books, journals, and online research sites and other published materials are used as the main sources of data used in the analysis and discussion of this topic. The topic requires an individual to seek the opinion from the relevant existing reading materials that have been published in the same context by knowledgeable individuals or experts in hedge accounting. Methods of data collection Suitable data collection schedules will be used to capture such information perceived as relevant to the topic of study and the same coherently studied to determine whether they correlate to the subject under study Since most of the statistics or information to be used in this study will be attained from the secondary sources like books, journals, eBooks, published theses of different author and through the use of online libraries accessible through the internet, it would be appropriate to apply a descriptive approach to data collection (SMITH, 2011). This approach is not only the most effective one but, it also outlines the findings from other studies and relates the same to the subject matter of the current study in a context that is easy to understand. Methods of data analysis The data analysis methods for the data will involve interpretation of the available data collected from the secondary sources and applying the same to relate the research questions and objectives in a concise and accurate manner that provides for conclusive findings on the research topic. This will involve comparison, correlation and correction of the various data thereby giving a final take on the study. Ethics Ethical issues emerge from value conflicts. In research, these conflicts are presented in terms of openness and replication versus confidentiality, persons’ rights to privacy versus the detrimental effects of manipulation, future welfare versus instant relief, including others (HOQUE, 2006). Each judgment made in research engages a potential compromise of one value to another. Researchers must strive to minimize risks to colleagues, participants, and the community while trying to maximize the quality of information they generate. Research ethics are guidelines or code that aid in reconciliation of value conflicts by providing direction. However, the resolutions made in research must be arrived at by taking into consideration the exact alternatives available. The selections made in every case evaluate the prospective contribution of the research against the potential risks to the partakers. Weighing these choices is in essence subjective, involves subjects of degree rather than kind, and entails a comparison between the practices necessary in the research and those anticipated in daily life. This study involves two main areas of risks. First, participants may be hurt as a result of their involvement in the research. The possible harms include stress, reduction in self-respect or self-esteem and minor discomfort. Second, professional associations and the knowledge base may be damaged due to plagiarism, abuse of confidentiality, falsification of data and deliberate violation of regulations. The research may damage relationships with others, for instance, experimental team-building endeavors during data collection upset subsequent relationships on the job (HUMPHREY & LEE, 2008). When bosses, peers, and subordinates candidly trade feelings and views, resentments may arise. In the same way, participants in research may undergo career liabilities and other types of economic harm. Economic harm takes place when partakers earn less money or pay more for items as a result of their engagement. Some participants may receive less public aid than others, or they may receive unemployment reimbursement, while others do not. Damage to professional relationships arises when standards of professional behavior are abused. Falsification of data includes both whole fabrication and choosy reporting while plagiarism includes insufficient citation and registering of credit to borrowed work (ARNOLD & CLINTON, 2008). The ideas in this research will be openly shared and reviewed by the university committees, colleagues and outside researchers and practitioners serving on review panels. This may create opportunities for violation of confidentiality. The research designs and procedures used in this study and results generated can encourage harm as well as be beneficial to society. It is important to identify the potential benefits of this study to society to minimize the potential risks. The ratio of risks to benefits should be evaluated to minimize the potential for harm to occur. Although risk–benefit ratios are inadequate to determine ethical accuracy, they offer a critical first step. A risk–benefit ratio can be used to either justify this study or to provide a strong basis to warrant canceling the study. When the potential harms are unclear, a helpful precaution could be a pilot study with subsequent diagnostic interviews to judge effects and call for advice from experts. Pilot studies usually enhance not only the scientific rigor of the study but also the protections for partakers. Professional codes are another means foe addressing ethical issues in this research, the standards portrayed in ethical codes of professional associations are mostly abstract and relative to specific circumstances (BRYMAN & BELL, 2007). They also put a strong emphasis on researchers' accountability for their research. Finally, government regulations need researchers to take some precautions or prevent them from certain activities on the basis that failure to adhere to the law or regulations raises the risk of harm to an individual or society. Regulations can effectively minimize risks pertaining to ethical issues. Bibliography ANAGNOSTOPOULOS, Y., & BUCKLAND, R. (2011). IAS39 and Measurement Quality: Bankers’ Perceptions. Journal of Applied Accounting Research, 12(2), 157-178. DEVI, S. S., & HOOPER, K. (2011). Accounting in Asia. S.l, s.n.]. HASSAN, K., & MAHLKNECHT, M. 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(2003). Business research methods (7th ed.). Mason, OH: Thomson/South-Western. BRYMAN, A., & BELL, E. (2007). Business research methods. Oxford [u.a.], Oxford Univ. Press. Read More