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Commentary>All companies to disclose
management of risk
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Accounting standard IFRS 7 brings transparency to financial statements.
It is a common myth that the accounting standard on Financial Instruments: Disclosures, or IFRS 7, is relevant to financial institutions only.
It applies to all entities, financial and non-financial. The extent of disclosure, however, will be driven by the entity's use of financial instruments and exposures to risk.
IFRS 7, which became effective January 1, is now the comprehensive standard on financial instrument disclosures. It consolidates and expands a number of existing reporting requirements and adds some challenging new disclosures.
And, it replaces the disclosure requirements previously contained in: IAS 30 - Disclosures in the Financial Statements of Banks and Similar Financial Institutions (now withdrawn); and IAS 32 - Financial Instruments: Disclosure and Presentation (now renamed Financial Instruments: Presentation).
The presentation requirements of IAS 32 are unaffected. Concurrent with the introduction of IFRS 7, the International Accounting Standards Board (IASB) also amended IAS 1 - Presentation of Financial Statements, to require capital management disclosures with the same effective date as IFRS 7.
More Transparency
The objective of IFRS 7 is to provide more transparency to financial statement users on an entity's exposure to risks and how those risks are managed. The changes arising from IFRS 7 and the revised IAS 1 may be grouped into three main categories: expanded disclosure of financial position and performance; new quantitative and qualitative risk disclosures 'through the eyes of management'; and new capital management disclosures.
POSITION, PERFORMANCE
IFRS 7 requires greater balance sheet and income statement disclosures, including on the following:
The carrying amount and net gains or losses for each of the categories of financial instruments in IAS 39 (at fair value through profit and loss, available-for-sale, loans and receivables, etc.);
Reclassifications of any financial asset as one measured at amortised cost, rather than fair value, or vice versa, and the reasons for such reclassification;
Special disclosures about financial assets and liabilities designated at fair value through profit or loss, including changes in fair value and the portion arising from changes in credit risk;
Financial assets pledged as collateral and financial and non-financial assets held as collateral;
Reconciliation of the allowance for credit losses (bad debt) accounts;
Interest income and expense for financial assets or liabilities not at fair value through profit or loss;
Impairment losses for each class of financial asset and interest income recognised on impaired financial assets
DISCLOSING RISK
IFRS 7 requires both quantitative and qualitative disclosures about an entity's exposure to
liquidity risk, credit risk and market risk arising from the use of financial instruments.
For each type of risk, disclosure of summary quantitative data, based on information provided internally to key management personnel, as well as any concentrations of risk, is required.
In addition, the following minimum disclosures are required:
Liquidity risk: Maturity analysis for financial liabilities showing remaining contractual maturities and a description of the approach to managing liquidity risk.
Credit risk: Maximum exposure to credit risk (without deduction of any collateral held) and any related collateral held; information about credit quality of financial assets that are neither past due nor impaired; ageing analysis of financial assets that are past due but not impaired; and analysis of financial assets individually determined to be impaired.
Market risk: A sensitivity analysis is required for each type of market risk - currency, interest rate, and other price risk - to which the entity is exposed at reporting date.
The analysis should demonstrate how profit or loss and equity would have been affected by 'reasonably possible' changes in the relevant variable - for example a 100 basis point change in interest rates - and the methods and assumptions used in preparing the sensitivity analysis and any changes in these from the previous reporting period.
In conjunction with the quantitative disclosures, qualitative disclosures of the following are also required:
CAPITAL MANAGEMENT
The main requirements here are to disclose the entity's objectives, policies and processes for managing capital and quantitative data about how the entity defines capital, for example, what categories of debt are included.
It should be reported whether the entity has complied with any externally imposed capital requirements and, if not, the consequences of non-compliance.
Compliance with IFRS 7 is likely to present a significant challenge for many entities.
To adequately address the requirements of IFRS 7, management needs to consider the need for new systems or systems enhancements to capture the required data for both the current year and the previous year comparatives.
The sensitivity analyses, for example, are likely to require the development of financial models to the extent that they do not already exist.
Managers must also consider whether the internal controls over systems used to capture the required data are sufficiently robust for financial reporting purposes including the audit.
Appropriate training of staff who will be integral to the preparation of the information to be disclosed. This will include not just the finance function but also treasury, information technology, risk management and investor relations personnel.
The development of an overall communication strategy that demonstrates how financial risks are managed by the entity.
Conclusion
The extensive disclosures required under IFRS 7 will, for the first time, open the internal risk management processes of entities to scrutiny by investors and creditors.
IFRS 7 is not a standard to be taken lightly, as compliance will require significant investment in time and resources.
Contributed by the Institute of Chartered Accountants of Jamaica.