Reclassification of Financial Assets Impact of amendments to IAS 39 and IFRS 7 on the financial reporting practice by European banks and insurance companies

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Reclassification of Financial Assets

Impact of amendments to IAS 39 and IFRS 7 on the financial reporting practice

by European banks and insurance companies

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Reclassification of Financial Assets

Impact of amendments to IAS 39 and IFRS 7 on the financial reporting practice

by European banks and insurance companies

Author: Geert H.W. Dijkstra

Student number: s1197584

E-mail: ghw.dijkstra@gmail.com

University: University of Groningen

Faculty: Faculty of Economics and Business

Master: MSc Accountancy

Supervisor University of Groningen: dr. C.A. Huijgen

Supervisor PricewaterhouseCoopers: drs. C.J.M. Roozenboom

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PREFACE

This Master thesis marks the end of my studies at the University of Groningen. I put quite some consideration in choosing the subject of my thesis. During the ongoing financial crisis, European banks and insurance companies had to recognise a substantial amount of unrealised losses in their income statements, because they were required to measure certain types of financial instruments at fair value. This concept of fair value intrigued me, which is why I wanted to know more about the subject. In October 2008 the IASB issued an amendment to IAS 39 allowing the reclassification of financial assets, which provided banks and insurance companies with the opportunity to measure certain types of financial assets at their amortised cost instead of fair value. For me this was a great opportunity to study on a topical matter and to learn more about the concept of fair value.

I am very thankful to PricewaterhouseCoopers, who offered me the opportunity to write my thesis during an internship at the Amsterdam Westgate office. The knowledge and expertise of the employees in the Accounting & Valuation Advisory Services department were very helpful for me in understanding the complex issues discussed in this thesis. Especially my colleagues in the AVAS: Financial Instruments group were of great help to me. Moreover, I really enjoyed my four-month internship within the AVAS: FI group, during which I learned a lot about the complex issues concerning the accounting treatment of financial instruments. Furthermore, my internship offered me the opportunity to get acquainted with the profession of auditor.

I especially wish to thank my supervisor at PricewaterhouseCoopers Casper Roozenboom for guiding me through the process of writing my thesis. His input and comments were of great help in understanding and framing the complex subject of this thesis. I also wish to thank Pieter Veuger and Kees-Jan de Vries for their input and comments, as well as Michiel Wijn for reviewing the final version of my thesis.

I also want to thank my supervisor at the University of Groningen, dr. C.A. Huijgen, for his guidance throughout the writing process. Furthermore, I wish to thank him for the cooperation with respect to the tight schedule of completing my thesis.

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This Master thesis marks the end of my student days in the beautiful city of Groningen. My parents once told me I should not just study, but to be a student in the broadest sense of the word. The city of Groningen offered me great opportunities to achieve this goal, which is why I was able to enjoy my studies as well as my student life to the fullest. Consequently, I wish to thank my dear parents, as well as my sister and brother for their support throughout my college days and the process of writing my thesis.

In the meantime I moved to the city of Amsterdam. Now that I finished my studies I look forward to my life in this great city. As of 1 September, 2009 I will join the AVAS: Financial Instruments group with PricewaterhouseCoopers in Amsterdam. I could not leave the city of Groningen entirely behind though, which is why I decided to subscribe to the Executive Master of Accountancy programme at the University of Groningen. In coming years, I want to finish this Executive Master of Accountancy and become a Certified Public Accountant.

Amsterdam, August 2009

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CHAPTER 1 – INTRODUCTION

1.1 - Introduction

It is well-known that the International Accounting Standards Board (IASB) considers the concept of fair value of great importance. The Board’s chairman, Sir David Tweedie, once said in an interview that IAS 39 could as well be reduced to only two sentences: “First,

measure all financial instruments at fair value. Second, re-read the first sentence!” (Keys

2008). It is even believed that the accounting standard setters have taken many steps in the direction of ‘full fair value’, an accounting standard in which increasingly more assets and liabilities should be measured at fair value (Hernández Hernández 2004). Nevertheless, on October 13, 2008, the IASB took an important step in the opposite direction. The standard setter issued an amendment to IAS 39, allowing companies to reclassify some of their financial assets that were measured at fair value, towards categories that are measured based on a financial asset’s historical cost.

The issue of the amendment was a response to problems concerning the worldwide financial crisis. European banks and politicians put pressure on the IASB to change the rules of IAS 39 to allow reclassifications of financial assets. Banks and insurance companies suffered from substantial losses as a consequence of the sharply dropping fair values of their trading assets. They claimed that inactive markets drove down the fair values of their investments, forcing them to recognise large fair value losses in their income statement (Dekker 2009). If they would be allowed to reclassify some of those financial assets towards financial asset categories that are measured based on an asset’s historical cost, the banks could avoid any further fair value losses on those financial asset. This could greatly improve their reported income.

Trying to do something to turn the tide in the ongoing financial crisis, politicians supported the banks in their claims and put massive pressure on the IASB to implement the changes as soon as possible. The European Union even threatened with a so-called ‘carve out’, threatening to suspend the use of fair values entirely if the IASB would not comply with their demands (Dekker 2009).

Eventually, the IASB succumbed under the massive pressure and gave in to their demands. The Board even set aside their principle of ‘due process’, the decision process in which each plan to change the rules is presented to auditors and other parties concerned first.

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These other parties include among others standard-setting organisations and regulatory bodies. Without any due process the IASB issued an amendment to IAS 39 and IFRS 7, named ‘Reclassification of financial assets’. The amendment was issued on October 13, 2008, and endorsed by the European Union two days later, on October 15. This amendment opened opportunities to European banks and insurance companies to reclassify their financial assets.

This thesis will explore the rules for the reclassification of financial assets that were introduced by the amendment to IAS 39 in October 2008, as well as the disclosure requirements on reclassified financial assets brought forward by the simultaneous amendment to IFRS 7. Furthermore, this thesis will report on the extent to which the new reclassification options were used by European banks and insurance companies in their year-end reports for 2008, as well as the effect of those reclassifications on these companies’ reported income in 2008.

1.2 – Research question

The amendment of IAS 39 in October 2008 offered new opportunities to European banks and insurance companies for the reclassification of financial assets. These reclassifications could have a significant impact on the reported income of these companies.

My research question therefore is as follows:

To what extent did European banks and insurance companies benefit from the facilities provided by the amendments to IAS 39 and IFRS 7 ‘Reclassification of financial assets’?

My research question focuses on European banks and insurance companies, a choice that I will explain in detail in section 6.3.

In my thesis I try to find answers to sub questions in multiple categories, in order to be able to answer my research question in the end. The first set of sub questions focuses on the

development of the amendments:

1. Which events led to the development of the amendments? 2. What were the rules in IAS 39 pre-amendment?

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The second set of sub questions is directed to the IAS 39 amendment and its application: 4. What are the new rules provided by the IAS 39 amendment?

5. To what extent did European banks and insurance companies apply the new IAS 39 amendment during the fiscal year 2008?

The third set of sub questions then focuses on the impact of the IAS 39 amendment:

6. What are the possible implications of the new rules provided by the IAS 39 amendment of October 2008?

7. To what extent did reclassifications of financial assets have an impact on the reported income of European banks and insurance companies in the fiscal year 2008?

8. Which factors predict the use of reclassifications by European banks and insurance companies?

The fourth set of sub questions involves the IFRS 7 amendment and its disclosure

requirements:

9. What disclosures on reclassified financial assets does IFRS 7 require after the amendment of October 2008?

10. To what extent did European banks and insurance companies comply with the disclosure requirements of the IFRS 7 amendment in the fiscal year 2008? 11. What was best practice among European banks and insurance companies in

complying with the disclosure requirements on reclassified financial assets in the financial reports of the fiscal year 2008?

1.3 – Relevance

The amendment to IAS 39 was issued after politicians and banks exerted extensive pressure on the IASB. The IASB even set aside its principle of ‘due process’, making it clear this was not a common amendment. This thesis aims to report to what extent European banks and insurance companies used the facilities provided by this amendment. Moreover, the reclassifications could have a great impact on companies’ reported income, which is why this thesis also aims to record these effects on reported income among European banks and insurance companies. Lastly, disclosures on the reclassifications have been closely examined.

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This thesis adds to the general discussion about the usefulness of fair values, as it examines the impact of the reclassification of financial assets out of categories that are measured at fair value, into categories that are measured at amortised cost. This thesis is also important to the accounting profession and accounting standard setters, as it reports on the extent to which the reclassifications were actually used, as well as their effects on reported income. Furthermore, this thesis adds to the awareness of readers of financial statements about the effects of reclassifications, as they may be unaware of the impact of the reclassifications that are disclosed in the notes beyond the income statement. Finally, this thesis could be helpful in improving the quality of disclosures about reclassified financial assets, as it reports best practices among European banks and insurance companies with respect to these disclosures.

1.4 – Structure

In Chapter Two, I will discuss the concept of fair value and its advantages and disadvantages in contrast to the historical cost system. In Chapter Three, I will report on how financial assets were treated in IAS 39 before the amendment was issued in October 2008. Next, in Chapter Four and Chapter Five I will discuss the new rules provided by the IAS 39 amendment and the new disclosure requirements of IFRS 7, respectively. In Chapter Six, the research design and the hypotheses are presented. Chapter Seven presents the results of my research, after which I will draw conclusions in Chapter Eight. Finally, in Chapter Nine I suggest topics for further research, and discuss future developments in this area.

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CHAPTER 2 – FAIR VALUE

The discussion about whether the IASB should issue an amendment to IAS 39 is part of a more general discussion about ‘fair value’. In this chapter, I will clarify the concept of fair value and the dissension between advocates and opponents of fair value accounting about its usefulness.

2.2 – The concept of fair value

Under Fair Value Accounting (FVA), or Mark-to-Market Accounting as it is often referred to, an asset or liability that is on a company’s balance sheet is measured at fair value. Often, the term ‘fair value’ is used interchangeably with terms like ‘market value’, but in fact it has a wider meaning. The IASB defines fair value as:

“(…) the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.” [IAS 39.9]

The definition contains different factors. The arm’s length principle means the parties in a transaction are in fact, or act like, unrelated parties. Moreover, those parties are well informed about the asset or liability that is to be transferred, and parties are willing to enter into a transaction. In those circumstances, the two parties agree upon how much the asset or liability is worth, which is therefore its fair value.

2.3 – Fair value versus historical cost

Fair value accounting therefore provides a measure for how much an asset or liability is worth at present. In contrast, when assets and liabilities are measured in accordance with the historical cost principle, they are measured at their original transaction price. Whereas under fair value accounting a company’s assets and liabilities will be re-measured at their fair values at the end of each reporting period, assets and liabilities that are measured at their historical cost will still be measured based on their original value, adjusted for amortisation

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and depreciation charges. One of the important differences between fair value accounting and historical cost accounting is the treatment of unrealised gains and losses. In historical cost accounting, an asset that experiences changes in value would still be measures at its historical cost. When the asset is sold, the transaction price will reflect the change in value, and the selling company will realise either a gain or a loss, and recognise this gain or loss in the income statement. In fair value accounting, the changes in value will be recognised in the income statement each reporting period as unrealised holding gains or losses. As a consequence, changes in the value of a company’s assets and liabilities are reflected directly in a company’s reported income. Assets and liabilities measured at fair value therefore better reflect market values than those measured at historical cost. There has been an intensive debate about which measurement base is superior; both valuation methods have numbers of advocates and opponents. In general, accounting standard setters have been moving from historical cost accounting towards fair value accounting in recent decennia (Hernández Hernández 2004) thereby requiring an increasing amount of assets and liabilities to be measured at their fair values.

Fair value is a better measure for obtaining an overview of how much a company is worth at present (DeTijd 2007). It therefore serves the interests of analysts, who like to be informed quickly and timely about a company’s value. Ackerman (2008) argues that it is widely agreed upon that fair values provide the greatest transparency to investors. Schilder (2008) claims that fair value allows investors to make quick and well-informed decisions when trading in dynamic markets. This view is shared by The Bond Market Association et al. (2002), who claim that in comparison to historical cost, fair values provide important additional information about financial assets and liabilities. Because fair values reflect current market conditions, it provides better information for the purpose of comparing the value of financial instruments that are bought at different times (The Bond Market Association et al. 2002). Another advantage of fair value over historical cost is that under fair value accounting management is no longer able to decide about the timing of recognising gains and losses that result from changes in the value of an asset or liability (Gwilliam and Jackson 2008). Under historical cost accounting management could decide to sell an asset whenever it was convenient for its profits, while under fair value accounting those unrealised gains would already be recognised gradually after each reporting period. Gwilliam and Jackson (2008) also state that fair values might provide more relevant, but less reliable values than historical cost might provide. Fair values might be less reliable when market prices are not readily available.

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The fair value of a financial asset or financial liability will in that case be measured by using a valuation model, which could contain subjective information. They state that the use of fair value is most appropriate when the markets for those assets and liabilities are “sufficiently deep that supportable valuations are available” (p.243). Assets that are not traded regularly on an active market could therefore be measured at fair value less reliably. This is a view supported by Khurana and Kim (2003), who claim that historical cost becomes more value relevant when objective measures of fair value are not available.

There is also criticism about the use of fair values though. Barth, Landsman and Wahlen (1995) find that reported earnings that are based on fair value measurements, are more volatile than earnings based on historical cost. According to Hernández Hernández (2004), earnings volatility is caused among other things by the funding of non-financial assets that are measured at historical cost with financial liabilities that are measured at fair value. Barth, Landsman and Wahlen (1995) also state that fair value causes banks to violate regulatory capital requirements more often under fair value accounting than under historical cost accounting.

2.4 – Fair value during the financial crisis

Fair value came under fire during the ongoing financial crisis. As markets for securitised markets dried up, market prices of those financial assets dropped. This resulted in the recognition of large fair value losses. According to Sanders (2008), the drying up of liquidity resulted in a lower demand for mortgage-backed products, even though those instruments continued to perform well in terms of cash flows. This view is supported by Koster (2009), who claims the actual value of financial assets was clearly not reflected in their market prices. Because markets became increasingly inactive, the values derived from those markets were no longer reliable. This view is however not shared by Norris (2009). According to Norris many people claim that asset-backed securities are not trading at what they will be worth at maturity. But, he claims too, there is actually no way to know this. He believes the valuation of such financial instruments is exactly the reason why there are markets.

Many oppose this view. Fair value is causing a vicious circle, claims Schilder (2008). Inactive markets result in dropping prices which in turn affect trust in the markets, which ultimately leads to distress sales and write-downs. Fair value is often said to have a

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pro-cyclical behaviour. According to Koster (2009), fair value might not have caused the collapse of capital markets, but fair value also did not help the markets return to normal behaviour. Koster attributes this to the pro-cyclical behaviour of fair value, having an accelerative effect in driving down markets. Like Schilder, Koster views this accelerative effect as a vicious circle, prompted by falling market prices. These falling market prices lead to impairments and fair value losses, which cause the depletion of capital. To comply with capital adequacy ratios companies would be forced to sell some of their financial assets. These distress sales drive down prices further, closing the vicious circle.

Schilder (2008) concludes with the proposal that banks should be allowed to reclassify their financial assets that are measured at fair value towards categories that are measured on the basis of an asset’s historical cost. Norris (2009) believes changing the rules would be counterproductive, because it would not increase the trust in the market. This view is shared by some analysts who believe such reclassifications can even harm the trust investors have in banks (Financieel Dagblad 2008). They believe that by valuing financial assets too high, banks would rather postpone their losses, rather than avoiding them.

These are just a few of the many views on the role of fair value in the financial crisis. Eventually, the IASB succumbed to the massive pressure that was exerted by those who propose the rules for reclassification changed. On October 13, the IASB presented amendments to IAS 39 and IFRS 7: ‘Reclassification of Financial Assets’.

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CHAPTER 3 – IAS 39

On October 13, the pressure exerted on the IASB resulted in the issuance by the standard setter of an amendment to ‘IAS 39 Financial Instruments: Recognition and

Measurement’. IAS 39 provides rules on when and how financial instruments need to be

recognised and measured in the statement of an entity’s financial position. In this chapter I will discuss those parts of IAS 39 that are relevant for this thesis. In Chapter Four I will present the changes to this standard that follow from the amendment.

3.2 – Financial instruments

Rules for the treatment of financial instruments are laid down in three separate accounting standards. ‘IAS 32 Financial Instruments: Presentation’ (from this point forward: IAS 32) provides requirements for the presentation of information about financial instruments. Among other things this standard gives guidance for the classification of a financial instrument as a financial asset, a financial liability, or equity. How financial assets and financial liabilities should be recognised and measured in the financial statements of a company is set out in ‘IAS 39 Financial Instruments: Recognition and Measurement’ (from this point forward: IAS 39). Furthermore ‘IFRS 7 Financial Instruments: Disclosures’ (from this point forward: IFRS 7) provides detailed requirements for disclosures about these financial instruments in a company’s financial statements.

A definition of a financial instrument is presented by IAS 32. A financial instrument is “any contract that gives rise to a financial asset of one party and a financial liability or equity instrument of another party” [IAS 32.11]. A financial liability typically is a contractual obligation to either deliver a financial asset to an entity, or to exchange a financial asset or financial liability with another entity under (potentially) unfavourable conditions. A more extensive definition of a financial liability is given by IAS 32.11. An equity instrument is “any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities” [IAS 32.11]. As mentioned a financial liability or equity instrument forms one side of the contract. A financial asset forms the other side of the contract. A financial asset

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could be cash, or an equity instrument of another company. Furthermore, a financial asset could be a contractual right to receive either cash or another financial asset from another company, as well as a contractual right to exchange financial instruments with another company under potentially favourable conditions. Also a contract that will or may be settled in a company’s own equity instruments might qualify as a financial asset [IAS 32.11].

As the October 2008 amendment to IAS 39 applies only to financial assets, I will ignore further treatment of financial liabilities and equity instruments in IAS 39 for the purpose of this thesis, and focus on the treatment of financial assets only.

3.3 – Financial Instruments: Recognition and Measurement

3.3.1 – Initial recognition and measurement

Following IAS 39.14, an entity shall recognise a financial asset when it becomes a party to the contractual provisions of that financial asset. The moment in time at which a financial asset is recognised by an entity will differ for a wide range of financial assets. Important in this respect is the moment in time at which the entity has a legal right to receive cash. Some assets will therefore be recognised as soon as the contract is signed, while other assets may be recognised later depending on the characteristics of the contract.

When an entity recognises a financial asset, it will measure that asset initially at its fair value. At the transaction date the fair value of the financial asset generally will equal the price an entity has paid for it. Transaction costs that are directly attributable to the acquisition or issue of the financial asset are added to this amount, except for financial assets that are classified into the ‘fair value through profit or loss’ category, which I will discuss later on. As the expected current value of a derivative is zero at the inception of the contract, the fair value of a derivative at the date of recognition will be equal or close to zero. The measurement of all financial assets will subsequently be revised at the next measurement date.

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3.3.2 – Subsequent measurement

For the purpose of measuring financial assets after the initial measurement at fair value, IAS 39 requires the classification of financial assets into four defined categories. The way financial assets are measured is different for each of the following four categories:

1. Fair value through profit or loss (FVTPL) (Section 3.4.1)

2. Held-to-maturity (HTM) (Section 3.5.1)

3. Loans and receivables (LaR) (Section 3.5.2) 4. Available-for-sale (AFS) (Section 3.4.2)

3.4 – Fair value categories

3.4.1 – Fair value through profit or loss

In the ‘fair value through profit or loss’ category (FVTPL) one can find the financial assets that are either classified as held for trading, or have been designated at fair value through the use of the so-called fair value option. The fair value option allows an entity to classify a financial asset into FVTPL that would have fit in any of the other categories, if this results in more relevant information. That way an entity can choose a different accounting treatment or measurement for the financial asset. More relevant information could be provided if the different measurement of matching assets or liabilities would otherwise lead to a measurement or recognition inconsistency.

The ‘held for trading’ subcategory (HFT) contains – as the name suggests – financial assets that are held for the purpose of trading. These are generally financial assets that are acquired with the purpose of selling them in the near future. Also included are financial assets that are part of a portfolio of identified financial instruments that are managed together, and for which there is evidence of a recent actual pattern of short-term profit-taking [IAS 39.9]. A financial asset that meets the definitions of any other category therefore would have to be classified as HFT, if it is clear, or likely, that it is held with the intention to make a profit in the near term.

A third kind of financial asset within the HFT subcategory is the derivative with a positive market value. A derivative is a financial instrument or contract that is settled at a future date, and the value of a derivative changes in response to changes in an underlying value. Among other things this underlying value can be a financial instrument price, commodity price, foreign exchange rate, or an interest rate. To meet the definition of a

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derivative it also has to have no initial investment requirement, or a relatively small one compared to contracts that are in a similar way affected by the changes in market factors [IAS 39.9]. Typical examples of derivatives are (stock) options, futures, forward contracts, and interest rate swaps. Derivatives are standard classified into the FVTPL, with the exception of financial guarantee contracts and derivatives used for the purpose of hedge accounting, which I will not cover in this thesis.

The FVTPL category is summarised in table 1.2. For the purpose of this thesis I treated derivatives as a separate subcategory.

Table 3.1 – Fair Value Through Profit or Loss (FVTPL) category

Fair Value Through Profit or Loss (FVTPL) category

Trading assets  Acquired with purpose of selling in the near term

 Part of portfolio with evidence of actual pattern of short-term profit-taking

Held-for-Trading (HFT)

Derivatives  Always classified as held for trading Designated at FVTPL  Use of fair value option

3.4.2 – Available-for-sale

The ‘available-for-sale’ category (AFS) is a category that contains all non-derivative financial assets that are not classified in any of the other three categories. It is therefore a residual category.

As with the FVTPL category, the AFS category provides for a fair value option, allowing an entity to classify a financial asset that meets the definition of the ‘held-to-maturity’ or ‘loans and receivables’ categories into the AFS category voluntarily.

3.4.3 – Measurement at fair value

The classification of a financial asset on its initial recognition determines the way it is measured subsequently. Financial assets in both the FVTPL and AFS categories are measured at fair value. Changes in fair value though are accounted for differently. Changes in the fair value of financial assets classified into FVTPL are recognised directly in the income

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statement. For financial assets in the AFS category, changes in fair value do not go directly to the income statement, but are recognised in other comprehensive income instead. These fair value gains or losses on an AFS financial asset are added to a revaluation reserve until the financial asset is derecognised. When such a financial asset is derecognised, the gain or loss cumulated in the revaluation reserve is transferred towards the income statement. As the recognition of fair value gains and losses through the income statement is postponed until derecognition, financial assets in the AFS category have to be tested for impairment on a yearly basis [IAS 39.58]. When there is objective evidence that an AFS financial asset is impaired, the cumulative loss in the revaluation reserve is transferred to the income statement [IAS 39.67]. Financial assets in the FVTPL category are not required to be tested for impairment, as changes in their fair values are already being recognised in the income statement directly.

Fair value is defined as “a price agreed by a willing buyer and a willing seller in an arm’s length transaction” [IAS 39.AG71], where an arm’s length transaction means a transaction between two unrelated parties at equal footing. Determining the fair value of a financial asset is done using a number of measurement approaches, providing different results in terms of reliability and relevance. The most preferable approach is measuring fair value by using quoted prices in an active market, as these quoted prices present the best evidence of fair value [IAS 39.48A]. Quoted prices in an active market meet the definition presented above most closely, as transactions on an active market are agreed upon between unrelated parties, and the quoted prices represent consent between buyers and sellers about the true value of the traded financial assets. Quoted market prices could be acquired from exchanges and dealers, and present the most reliable measurement of fair value when they are readily and regularly available. If available the current bid price would be the appropriate quoted market price for measuring a financial asset.

There are situations though in which current bid and asking prices are not available. When this occurs, an entity shall for the purpose of measuring fair value turn to the price of the most recent market transaction. The most recent transaction provides some evidence about the current fair value [IAS 39.AG72]. Using the prices of recent transactions instead of current market prices possibly provides less reliable information about how much a financial asset is worth at balance sheet date. An entity should also consider the circumstances under which a recent transaction was established, because it could well have been a forced transaction, involuntary liquidation or distress sale. In those cases the transaction price would

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probably reflect a value that is lower than the actual fair value of a financial asset, and the entity is allowed to adjust its price, provided that the entity can demonstrate that the transaction does not actually represent fair value [IAS 39.AG72]. This is important to note, because during the current financial crisis many critics have suggested that distress sales are causing chain reactions resulting in large-scale fair value write-downs.

IAS 39 also provides rules for measuring fair value when there is no active market. In October 2008 an IASB Expert Advisory Panel provided guidance on how it should be determined whether a market is inactive or not. Determining whether a market is inactive is a complicated task and takes a lot of professional judgement. A significant decline in trading volume and the level of trading activity could be a sign of market inactivity, as well as substantially varying prices of financial instruments, either over time or among pricing sources (IASB, 2008a). Market inactivity could also be detected when the available prices are not current, or when all observable transactions are forced or distressed (PwC, 2008a). Markets with these characteristics could provide unreliable estimates of fair value. For the purpose of measuring fair value entities may under those circumstances turn to the use of valuation techniques [IAS 39.AG74]. Typical examples of these techniques are using recent transactions that where concluded under normal conditions, referring to current fair values of financial instruments that are substantially the same, and the use of discounted cash flow analysis [IAS 39.AG74]. Valuation techniques may use a wide range of factors as an input, and are as such subject to a great amount of judgement. Valuation techniques therefore provide less comparable and possibly less reliable measures of fair value compared to the use of quoted prices in an active market.

3.5 – Amortised cost categories

3.5.1 – Held-to-Maturity

The fair value categories contain financial assets that are susceptible to market values, either because of the nature of the financial asset or because of the management’s intention to trade them in the short run. However, an entity could also have the intention not to sell a financial asset in the short run, but instead hold it until its maturity date. A non-derivative financial asset with fixed or determinable payments and fixed maturity may therefore be classified as ‘held-to-maturity’ (HTM), given that the entity has the positive intention and ability to hold that financial asset to its maturity date [IAS 39.9]. Financial assets that are measured at fair value following one of the fair value options described before are of course

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excluded from this category, as are those that meet the definition of the ‘loans and receivables’ category, which is discussed in the next section.

The intention and ability to hold the financial asset to maturity is the key requirement in this category. This factor allows an entity to measure that specific financial asset on a historical cost-basis. However, not meeting its intention will have consequences for the entity in the form of an accounting penalty called tainting. These tainting rules come into force when an entity sells a more than insignificant amount of HTM assets before maturity. Apart from situations in which such a sale is an isolated event or does not have a significant impact – because the sale took place close to the maturity date, or substantially all payments were collected – selling a significant amount of HTM financial assets will mean the entity is forced to reclassify all of its HTM financial assets to AFS [IAS 39.9]. The measurement of these financial assets will change accordingly, from measurement at amortised cost to measurement at fair value through equity. An entity is from that moment prohibited to classify any financial assets into the HTM category for a period of two years. Therefore, not acting in accordance to the declared intention and ability to hold HTM financial assets until maturity will have financial consequences for the entity.

3.5.2 – Loans and Receivables

Like the HTM category, the ‘loans and receivables’ category (LaR) contains non-derivative financial assets with fixed or determinable payments. Unlike the HTM investments they do not necessarily have fixed maturity dates. Financial assets in the LaR category are not quoted in an active market, a characteristic that excludes them from the HTM category.

Excluded from this category are financial assets that meet the definition, but for which the entity has the intention to sell them immediately or in the near term. Those assets shall be classified as HFT into the FVTPL category. Financial assets that are designated to the FVTPL or AFS category on initial recognition are also excluded. It is also possible that an entity holds a financial asset for which it may not recover substantially all of its initial investment. Such an asset shall be classified into the AFS category.

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3.5.3 – Measurement at historical cost

Financial assets in either the HTM or LaR category are not hold by a company to be sold in the short run. Therefore, these financial assets need not to be measured at the price the company would receive if it sold the assets immediately in the market. HTM and LaR financial assets are instead measured at a historical cost basis, more specifically at amortised cost. Amortised cost is defined by IAS 39.9 as:

“(…) the amount at which the financial asset (…) is measured at initial recognition minus principal repayments, plus or minus the cumulative amortisation (…) of any difference between that initial amount and the maturity amount, and minus any reduction (…) for impairment or uncollectibility.” [IAS 39.9]

Therefore, if there is any difference between the maturity amount of the financial asset and the amount at which it is measured at initial recognition, part of that difference is periodically added to the carrying amount of the financial asset. The difference is in other words amortised in order to make sure that the carrying amount equals the maturity amount when the financial asset matures. The amortisation is at the same time recognised as income in the income statement. This way, the discount that was received on initial recognition is spread over the life of the financial asset. The periodical amount of amortisation is calculated using the effective interest method. In addition to calculating the amortised cost of a financial asset, the effective interest rate method also allocates the interest income over that same period. The effective interest rate is:

“(…) the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument (…) to the net carrying amount of the financial asset or financial liability.” [IAS 39.9]

Because HTM and LaR financial assets are not regularly measured at their fair values, financial assets in these categories need to be tested periodically for impairment instead. Impairment charges go directly to the income statement.

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3.6 – Reclassification facilities

3.6.1 – Recapitulation of classifications

It is not always easy to determine in which category a financial asset should be classified. Almost similar financial assets could be classified into different categories depending on among other things the intention of management, or evidence of how the entity treated similar financial assets in the past.

A bond for instance is a non-derivative financial asset with fixed (or determinable) payments and fixed maturity. If management has the intention and ability to hold that bond to maturity, it could be classified into the HTM category. If the bond is not quoted in an active market though, it meets the definition of a loan or receivable and could be classified into the LaR category. It could also be the case that the entity has a history of selling bonds before maturity for the purpose of profit making, because of which the bond would have to be classified as a HFT investment in the FVTPL category. The bond shall also be classified into this category if it is part of a portfolio of financial instruments that were managed together, and this portfolio is measured at fair value. Of course the entity can also designate the bond to the FVTPL or AFS category using the fair value options of these categories, thereby choosing a different measurement base.

3.6.2 – Reclassification facilities pre-amendment

The different rules for measuring the financial assets might be a reason for an entity to reclassify a financial asset at a certain point in time. A different accounting treatment might be desired to align the treatment of a certain financial asset with that of similar or matching assets or liabilities. A different accounting treatment could also be driven by the different rules on recognising gains and losses in the income statement. Before the amendment in October 2008 though, IAS 39 hardly permitted any voluntary reclassifications of financial assets from the one category into the other after initial recognition. The tainting rules discussed in section 3.5.1 could force an entity to reclassify all of its HTM financial assets to the AFS category. These tainting rules would mark the beginning of a two-year period during which no financial assets may be classified as HTM, after which period an entity would be allowed to reclassify these AFS financial assets back to the HTM category again. An entity could furthermore reclassify financial assets from AFS to HTM if there was a clear change in intention and ability to hold these assets until maturity [IAS 39.54]. These were the only reclassifications possible under the pre-amendment IAS 39 rules. Banks and insurance

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companies therefore barely had possibilities to revise a financial asset’s initial classification and to adjust its measurement accordingly.

With fair values dropping and fair value losses piling up in banks’ income statements during the financial crisis, banks felt an increasing desire to be able to reclassify some of their financial assets into other categories. After great pressure by banks and governments, the IASB met their wish for these reclassification facilities to a certain extent with the issue of an amendment to IAS 39 in October 2008. I will discuss the implications of this amendment in the next chapter.

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CHAPTER 4 – IAS 39 AMENDMENT

4.1 – Introduction

The call for more extensive reclassification possibilities resulted on October 13, 2008 in the issuance by the IASB of an amendment to IAS 39 titled ‘Reclassification of Financial

Assets’. In this chapter I will discuss the scope of this amendment and its implications for the

measurement of financial assets.

4.2 – Scope of the amendment

The amendment focuses on rules for the reclassification of financial assets. Financial liabilities are outside the scope of the amendment, as are some kinds of financial assets. The amended text of IAS 39.50 and IAS 39.50E explains which kinds of financial assets the new rules are not applicable to.

The first kind of financial asset that has been excluded from the new reclassification facilities is the derivative. The value of a derivative, because of its nature, is highly dependent on how a market is performing. IAS 39 therefore requires derivatives to be measured at fair value. The amendment consequently does not provide any opportunities to reclassify derivatives to a category that is measured at amortised cost. An entity is furthermore not allowed to reclassify any financial assets that on initial recognition were designated as FVTPL. If a company has voluntarily chosen to measure a financial asset at fair value in the FVTPL category, it is therefore not allowed to reclassify that financial asset towards a category that is measured at amortised cost. In contrast to this the amendment does provide the option to reclassify a financial asset that was designated as AFS.

The amendment is therefore applicable to non-derivative financial assets measured at fair value, excluding financial assets that were designated as FVTPL. All financial assets within the scope of the amendment may be reclassified, provided that they meet certain conditions.

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4.3 – Reclassification conditions

Even though the amendment provides rules for a more flexible treatment of financial assets, an entity cannot reclassify those financial assets without adequate reason. Depending on the kind of reclassification an entity wishes to perform, certain conditions will have to be met. I will present these conditions below.

4.3.1 – Altered intentions

Recall that an entity could be compelled to measure a financial asset at fair value when it holds that asset for the purpose of trading, or it has a history of selling such kind of assets soon after acquiring them. Such an asset would have to be classified as FVTPL initially. The intention of an entity may change though. An entity could be holding financial assets which it in fact no longer wants to hold for the purpose of selling or repurchasing them in the near term. One reason for this could be that the prices in the markets have dropped significantly, and the entity expects to receive a better price if it will sell the financial asset in the future.

4.3.2 – Intention and ability to hold

A second condition that an entity may need to meet is having the intention and ability to hold a financial asset for the foreseeable future or until maturity. A financial asset which is no longer held for the purpose of selling or repurchasing it in the near term, would obviously as a result be held with the intention to at least hold it for the foreseeable future, and possibly until maturity. A financial asset that had to be classified into the residual AFS category could also in fact be held with this intention by the entity. Having just the intention however is not enough for meeting this condition. An entity should also have the actual ability to hold the financial asset for the foreseeable future or until maturity. An entity might not be able to fulfil its intentions because of lack of funds, insolvency issues or contractual obligations. Such matters could make it impossible for an entity to hold the financial asset for even the foreseeable future, let alone that it will be able to hold the asset until maturity.

4.3.3 – Rare circumstances

A third condition requires that there are rare circumstances underlying an entity’s wish to reclassify a financial asset. An amendment to the ‘Basis for Conclusions’ of IAS 39 explains that rare circumstances “arise from a single event that is unusual and highly unlikely to recur in the near term” [IAS 39.BC104D]. The global deterioration in the financial markets

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in the third quarter of 2008 can be considered to be such a rare circumstance, according to the IASB (IASB 2008a).

4.4 – Reclassifications out of Fair Value Through Profit or Loss

Financial assets within the scope of the amendment could be reclassified out of the FVTPL category into any other category. As may be recalled financial assets in this category that are outside the scope of the amendment are derivatives and those financial assets that were designated at FVTPL at initial recognition.

The Held-for-Trading financial assets that remain may be reclassified towards any other category, provided they are actually no longer held for the purpose of selling or repurchasing them in the near term [IAS 39.50(c)]. This is the primary requirement for reclassifying out of the FVTPL category. Paragraphs 50B and 50D then divide the financial assets that are to be reclassified into two categories – those that would have met the definition of the LaR category at initial recognition, and those that would not have met this definition. In the case of a financial asset that would have met the LaR definition, but had been required to be classified as HFT instead, IAS 39.50D states that the financial asset may be reclassified if the entity now has the intention and ability to hold it for the foreseeable future or until maturity. This intention and ability is of no concern in the case of a financial asset that would not have met the LaR definition at initial recognition. Such a financial asset may only be reclassified in rare circumstances, as stated by IAS 39.50B. If a financial asset also meets the requirements of either IAS 39.50B or IAS 39.50D in addition to the primary requirement of IAS 39.50(c), the reclassification amendment may be applied. An entity is then allowed to reclassify such a financial asset to any other category, provided that the financial asset in question meets the definition of that category. Figure 4.1 provides a detailed schedule.

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Figure 4.1 – Flowchart for reclassifications (source: PricewaterhouseCoopers, 2008b)

Summarising, an entity may select a financial asset classified as FVTPL and reclassify it, choosing between three possible destination categories. A financial asset may be reclassified out of FVTPL into LaR, provided it meets the definition of this category and the entity now has the intention and ability to hold the financial asset for the foreseeable future or until maturity. Furthermore a financial asset may be reclassified out of FVTPL into either HTM or AFS in rare circumstances only, provided it meets the definition of the destination category.

A reclassification out of FVTPL into either LaR or HTM will mean that the reclassified financial asset is now measured at its amortised cost rather than at its fair value. Such a financial asset will suffer no more fair value losses from the date of reclassification.

A reclassification out of FVTPL into AFS will mean that fair value adjustments are not recognised directly in the income statement anymore, but are added to a reclassification reserve in other comprehensive income instead.

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4.5 – Reclassifications out of Available-for-Sale towards Loans and Receivables Whereas a FVTPL financial asset may be reclassified into any other category, the amendment provides only one option to reclassify financial assets out of the AFS category. Provided it would have met the LaR definition – if it had not been designated as AFS at initial recognition – an AFS financial asset may only be reclassified into that particular category. IAS 39.50E further requires an entity’s intention and ability to hold the financial asset for the foreseeable future or until maturity for the application of this reclassification.

4.6 – Application date of the amendment

The amendments to IAS 39 and IFRS 7 were issued by the IASB on October 13, 2008, and enforced by the European Union on October 15, 2008. The facilities of the amendment could be applied retrospectively to a date on or after July 1, 2008, provided that the decision to carry out the reclassification was made by management before November 1, 2008. From that date, reclassifications could only be carried out prospectively. European banks and insurance companies therefore had a very short time frame in which they would have to consider the possible benefits of such a retrospective reclassification, as well as to decide whether to go through with it. When applied retrospectively, the reclassification was carried out as if it was carried out at the chosen date on or after July 1, 2008. The reclassified financial asset’s fair value on that specific date would than become its new amortised cost (in case of a reclassification towards the amortised cost categories).

4.7 – Implications for reported income

By using reclassifications entities can choose a different measurement or accounting treatment for selected financial assets. Such a change will have an impact on the reported income of the entity. Reported income may be affected by three possible effects, including the fair value effect, the pull-to-par effect and the future treatment of increased recoverability.

4.7.1 – Fair value effect

When an entity decides to reclassify a financial asset from the FVTPL category into either the HTM category or the LaR category, the fair value at the reclassification date becomes the financial asset’s new amortised cost. From that point on, changes in the fair value of the financial asset will no longer affect its carrying amount. One reason for

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reclassifying financial assets could be that the entity expects further fair value losses, in which case reported income would be negatively impacted. By reclassifying those financial assets, the entity makes sure it does not have to recognise any further fair value losses in the income statement. If the financial assets would not have been reclassified, the year-end income would consequently have included additional fair value losses. The fair value effect is therefore the difference between the fair value at year-end and – adjusted for currency effects and other interfering effects – the carrying amount at the reclassification date. Reclassifying financial assets from FVTPL towards AFS will also mean any further fair value losses are no longer recognised in the income statement, and will therefore impact reported income. Those fair value losses will be recognised in other comprehensive income, so they will have an impact only on an entity’s equity.

Reclassifying from the AFS category towards LaR will also result in a fair value effect, but these reclassifications do not affect reported income. Equity is affected however, as fair value losses after the date of reclassification will no longer be recognised in other comprehensive income. As a consequence, an entity will report in its year-end balance sheet a greater amount of equity than it would have reported if it had not reclassified any financial assets.

If applied retrospectively, the fair value effect could be even greater. A reclassification that was carried out before November 1, 2008 could be applied retrospectively to dates on or after July 1, 2008. The financial asset’s fair value on that specific date, and not its fair value on the date at which the reclassification was actually carried out, would then become its new amortised cost. As a consequence, changes in fair value that had occurred between that date and the date at which the reclassification was carried out would not be recognised. Therefore, retrospective use of the amendment could potentially have a large impact on reported income. Companies could identify financial assets that had suffered from sharp drops in fair value since that date, and select those for reclassification.

4.7.2 – Pull-to-par effect

Financial assets reclassified towards the HTM or LaR category will be measured at amortised cost instead of fair value after the reclassification. The fair value of the financial asset at the date of reclassification becomes its new amortised cost. At maturity though, a financial asset that has not been impaired will be worth its maturity amount. Any difference between the carrying amount at the reclassification date and the maturity amount is amortised over the remaining life of the financial asset using the effective interest method discussed in

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Chapter Three. The carrying amount is in other words ‘pulled to par’. Assuming that the carrying amount is at that time lower than the financial asset’s maturity amount, reported income will be positively affected as the amortisation of the financial asset is recognised in the income statement.

4.7.3 – Future increased recoverability

Before the issue of the IAS 39 amendment, IAS 39.AG8 provided a beneficial facility with respect to financial assets that are measured at amortised cost. If an entity revised its estimates of receipts, the entity was allowed to directly adjust the carrying amount of the financial asset to reflect this change in estimated recoverability. The carrying amount was then recalculated using the financial asset’s original effective interest rate as the input of the effective interest rate method, and the adjustment would be recognised directly in the income statement.

IAS 39.AG8 was amended though, adding a different set of rules with regard to financial assets that have been reclassified in accordance to the amendment. Now, if an entity increases its estimates of recoverable cash flows from a financial asset that has been reclassified, it is not allowed to adjust the carrying amount of that financial asset directly. Instead, the entity is allowed to recognise the effect of the increased recoverability as an adjustment of the effective interest rate from the date of that change in estimate.

This new set of rules makes the use of reclassifications less attractive. If the estimated recoverable cash flows of a financial asset that has been reclassified have been improved, this effect will result in a higher amount of amortisation – due to the increased effective interest rate – instead of an immediate increase of the financial asset’s carrying amount.

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CHAPTER 5 – IFRS 7 AMENDMENT

As I have presented in Chapter Four, the reclassification of a financial asset can have major implications for reported income. In order to safeguard the comparability of annual reports and to ensure that stockholders receive reliable information, such a reclassification should be well documented and disclosed. This is why the IAS 39 amendment was accompanied by an amendment to ‘IFRS 7 Financial Instruments: Disclosures’. This amendment imposes additional rules on the disclosure of extensive information about the reclassified financial assets. I will present these disclosure requirements in sections 5.2 and 5.3.

5.2 – Disclosures in fiscal year of reclassification

IFRS 7 imposes disclosure requirements for financial instruments. The introduction of reclassifications of financial assets asked for extensive reporting on the scale and impact of these reclassifications. Therefore the amendment to IFRS 7 added new disclosure requirements through paragraph IFRS 7.12A.

First, the annual report of the period in which the reclassification was carried out must disclose for which amount the financial assets were reclassified into and out of each category. It must also show the amount of fair value gain or loss it recognised during the previous reporting period, as well as the recognised fair value gain or loss during the current reporting period up to the reclassification date. This information allows users of the annual report to get a clear picture of the history and quality of the reclassified financial asset. With respect to these assets’ quality, the amendment also requires the disclosure of the amounts of cash flows the entity expects to recover on the reclassified financial assets, as well as their effective interest rates on the date of reclassification.

In addition, the financial statements must also provide the carrying amounts and fair values of the reclassified financial assets at year end. This is particularly important when an entity reclassified financial assets out of the fair value categories into the amortised cost categories. Because these reclassifications help the entity avoiding any further fair value losses, the amendments to IFRS 7 also require an entity to disclose the amount of the fair

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value gain or loss that would have been recognised in the income statement or equity without those reclassifications. By requiring these disclosures, the IASB ensures that users of the annual report get an adequate overview of how much the financial assets in the balance sheet would have been worth, had the entity not reclassified these into a category that is measured at amortised cost. In addition, the amounts of gain, loss, income and expense (for instance: interest income) that are recognised in the income statement after the reclassification date also need to be disclosed.

Last, an entity must also disclose the rare circumstances underlying the reclassifications, in the case the reclassifications were made in accordance to paragraph IAS 39.50B. As set out in Chapter Four, this will typically concern reclassifications out of the FVTPL category into either the HTM or AFS category. The IFRS 7 amendment especially requires the facts that indicate that the circumstances were indeed rare. These disclosures, together with those mentioned before, are meant to provide users of the annual report with adequate information about the reasons for and impact of the reclassifications.

5.3 – Disclosures in subsequent fiscal years

The new disclosure requirements do not end with the annual report over the fiscal year in which the financial assets were reclassified. IFRS 7 additionally requires an entity to disclose certain information about the reclassified financial assets in each reporting period after the one in which the reclassifications took place until the derecognition of the assets concerned. That way, users of the annual report are able to monitor how the reclassified financial assets are performing in the subsequent reporting periods.

Therefore an entity is required to disclose the carrying amounts and fair values of the reclassified assets in each following reporting period until the derecognition of the reclassified assets, as well as the fair value gains or losses that would have been recognised in the income statement or equity, had those assets not been reclassified. The gains, losses, (interest) income and expense that are recognised in the income statement also need to be disclosed in each reporting period subsequent to the one in which the reclassifications took place. With this information, users of the annual report can screen the developments concerning the previously reclassified financial assets, and may be able to judge whether the entity had in fact valid reasons to reclassify those financial assets.

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Summarising, the IFRS 7 amendment of October 2008 requires the following disclosures about financial assets that were reclassified in accordance to the IAS 39 amendment:

Table 5.1 - IFRS 7 disclosure requirements on reclassified financial assets

IFRS 7 disclosure requirements on reclassified financial assets

Information about period: Which information: In which reporting period(s):

Fair value gains/losses previous period

Before reclassification

Fair value gains/losses current period up until reclassification

Year of reclassification

Amounts into/out of each category

Fair value on reclassification date

Effective interest rate and estimated recoverable amounts Reclassification date

Rare circumstance (if applicable)

Year of reclassification

Fair values and carrying amounts at year end Fair value gains/losses that would have been recognised if the assets had not been

reclassified After reclassification

Any gains, losses, income and expense recognised in the income statement

Year of reclassification and every subsequent reporting period until derecognition

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CHAPTER 6 – RESEARCH DESIGN AND METHODOLOGY

The amendments to IAS 39 and IFRS 7, the political pressure on enforcing these amendments, and their implications for banks’ reported income raise the question to what extent banks actually applied the facilities that were provided by the amendments. In section 6.2 I will present my research question and the focus of my research. In section 6.3 I will then define the framework within which my research takes place. In section 6.4 I will conclude by specifying which data I collected for my research.

6.2 – Research question and focus

6.2.1 – Research question

Banks and politicians insisted on the issue of an amendment to IAS 39 making it possible to reclassify financial assets into different categories. Now the amendment has been issued, this puts forward the question to what extent it has had an impact on the financial reporting practise of companies that have applied this amendment. My research question therefore is as follows:

To what extent did European banks and insurance companies benefit from the facilities provided by the amendments to IAS 39 and IFRS 7 ‘Reclassification of financial assets’?

My research question focuses primarily on European banks and insurance companies, a choice that I will explain in detail in section 6.3.

6.2.2 – IAS 39 amendment

First, my research focuses on the extent to which European banks and insurance companies actually used the reclassification facilities that were provided by the IAS 39 amendment. My aim is to give an adequate overview of how many European banks and insurance companies applied the amendment.

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Second, my research focuses on to what extent these banks and insurance companies have benefited from the reclassification of financial assets into different categories. I try to provide an overview of the extent to which the reclassifications have had an impact to the companies’ balance sheets and income statements.

Third, I try to determine which factors might influence a company’s decision to apply the amendment. I therefore performed a logistic regression to find a model that helps to predict whether a company used reclassifications.

I studied the influence of several variables on the predictive value of that model. I expect that the size of a company would influence its decision to apply the amendment. The amendment to IFRS 7 requires extensive disclosures if a company decides to apply the IAS 39 amendment. Due to the high administrative costs of preparing these disclosures, a small company could decide not to use reclassifications if it considers these costs too high. I measured a company’s size by total assets. I added the logarithm of a company’s year-end 2007 total assets (‘TA2007_LOG’) as an input variable to the model.

The second variable I added to the model is the Return on Assets (‘ROA’). I defined ROA as the income a company would have reported in 2008 provided that no reclassifications had been carried out, divided by the amount of total assets at year-end 2007. I expect a low ROA might positively influence the decision to apply the amendment. By reclassifying some of its financial assets, a company could improve its ROA.

Furthermore, the change in Return on Assets (‘delta_ROA’) might also influence the decision positively. I defined ‘delta_ROA’ as the difference between the income in 2007 and 2008, both divided by total assets at year-end 2007. I expect a decrease in the ROA of a company might positively influence the company’s decision to use reclassifications.

The decision to apply the amendment might also be influenced by the extent to which companies have opportunities to use reclassifications. A company having substantial amounts of financial assets might be more enticed to apply the amendment. I therefore defined the variable ‘FA_TA’ as the proportion of a company’s financial assets in terms of total assets.

Not all financial assets are within the scope of the amendment. Companies are not allowed to reclassify derivatives and financial assets designated at FVTPL. Only financial assets classified as HFT or AFS may be reclassified into other categories. Therefore, the amount of financial assets classified as either HFT or AFS might influence a company’s

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decision to use a reclassification. I therefore defined ‘HFTAFS_FA’ as the proportion of financial assets classified as either HFT or AFS in terms of financial assets.

In addition to these variables, I also measured the influence of two categorical variables: ‘Country’ and ‘Industry’. The variable ‘Country’ is defined as the country from which a company originates. The variable ‘Industry’ contains information about whether a company is either a bank or an insurance company.

6.2.3 – IFRS 7 amendment

Companies that apply the IAS 39 amendment are required to make extensive disclosures on these reclassified assets due to the disclosure requirements provided by the IFRS 7 amendment. In addition to the extent to which companies used reclassifications, my research also focuses on the extent to which these companies met the disclosure requirements. Furthermore, I will provide some examples of adequate disclosures on the reclassification of financial assets by European banks and insurance companies.

6.3 – Framework

The amendments to IAS 39 and IFRS 7 focus on the reclassification of financial assets. Although the amendments are applicable to each listed company that to some extent report financial assets, they potentially are particularly beneficial to companies that actively trade in financial instruments. My research consequently concentrates on banks and insurance

companies. These types of companies typically report large quantities of financial

instruments, and it therefore is not surprising that these companies were responsible for a considerable part of the pressure that was exerted on the IASB.

More specifically, my research concentrates on European banks and insurance companies. IFRS is now well established in the European Union, and EU ministers played a substantial part in the realisation of the amendments by urging the IASB to consider improvements to the standard.

As the amendments came into force during 2008, my thesis focuses on the financial reports of these banks and insurance companies that have a year end at December 31, 2008. These financial reports are the first since the issue of the amendments to IAS 39 and IFRS 7 in October 2008, and consequently the first in which banks and insurance companies disclosed if and to what extent they used the facilities provided by the amendments. Furthermore, 2008 is the only year in which the amendments may be applied retrospectively.

Reclassification of Financial Assets Impact of amendments to IAS 39 and IFRS 7 on the financial reporting practice by European banks and insurance companies

Reclassification of Financial Assets

Impact of amendments to IAS 39 and IFRS 7 on the financial reporting practice

by European banks and insurance companies

Reclassification of Financial Assets

Impact of amendments to IAS 39 and IFRS 7 on the financial reporting practice

by European banks and insurance companies

PREFACE

CONTENTS

CHAPTER 1 – INTRODUCTION

CHAPTER 2 – FAIR VALUE

CHAPTER 3 – IAS 39

CHAPTER 4 – IAS 39 AMENDMENT

CHAPTER 5 – IFRS 7 AMENDMENT

CHAPTER 6 – RESEARCH DESIGN AND METHODOLOGY