ipsas 29—financial instruments: recognition and measurement - IFAC

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FINANCIAL INSTRUMENTS: RECOGNITION AND MEASUREMENT B.12 Definition of Held-to-Maturity Financial Assets: Index-Linked Principal Entity A purchases a five-year equity-index-linked note with an original issue price of CU10 at a market price of CU12 at the time of purchase. The note requires no interest payments before maturity. At maturity, the note requires payment of the original issue price of CU10 plus a supplemental redemption amount that depends on whether a specified share price index exceeds a predetermined level at the maturity date. If the share index does not exceed or is equal to the predetermined level, no supplemental redemption amount is paid. If the share index exceeds the predetermined level, the supplemental redemption amount equals the product of 1.15 and the difference between the level of the share index at maturity and the level of the share index when the note was issued divided by the level of the share index at the time of issue. Entity A has the positive intention and ability to hold the note to maturity. Can Entity A classify the note as a held-to-maturity investment? Yes. The note can be classified as a held-to-maturity investment because it has a fixed payment of CU10 and fixed maturity and Entity A has the positive intention and ability to hold it to maturity (IPSAS 29.10). However, the equity index feature is a call option not closely related to the debt host, which must be separated as an embedded derivative under IPSAS 29.12. The purchase price of CU12 is allocated between the host debt instrument and the embedded derivative. For example, if the fair value of the embedded option at acquisition is CU4, the host debt instrument is measured at CU8 on initial recognition. In this case, the discount of CU2 that is implicit in the host bond (principal of CU10 minus the original carrying amount of CU8) is amortized to surplus or deficit over the term to maturity of the note using the effective interest method. B.13 Definition of Held-to-Maturity Financial Assets: Index-Linked Interest Can a bond with a fixed payment at maturity and a fixed maturity date be classified as a held-to-maturity investment if the bond’s interest payments are indexed to the price of a commodity, and the entity has the positive intention and ability to hold the bond to maturity? Yes. However, the commodity-indexed interest payments result in an embedded derivative that is separated and accounted for as a derivative at fair value (IPSAS 29.12). IPSAS 29.14 is not applicable since it should be straightforward to separate the host debt investment (the fixed payment at maturity) from the embedded derivative (the index-linked interest payments). B.14 Definition of Held-to-Maturity Financial Assets: Sale Following Rating Downgrade Would a sale of a held-to-maturity investment following a downgrade of the issuer’s credit rating by a rating agency raise a question about the entity’s intention to hold other investments to maturity? 1165 IPSAS 29 IMPLEMENTATION GUIDANCE PUBLIC SECTOR
FINANCIAL INSTRUMENTS: RECOGNITION AND MEASUREMENT Not necessarily. A downgrade is likely to indicate a decline in the issuer’s creditworthiness. IPSAS 29 specifies that a sale due to a significant deterioration in the issuer’s creditworthiness could satisfy the condition in IPSAS 29 and therefore not raise a question about the entity’s intention to hold other investments to maturity. However, the deterioration in creditworthiness must be significant judged by reference to the credit rating at initial recognition. Also, the rating downgrade must not have been reasonably anticipated when the entity classified the investment as held to maturity in order to meet the condition in IPSAS 29. A credit downgrade of a notch within a class or from one rating class to the immediately lower rating class could often be regarded as reasonably anticipated. If the rating downgrade in combination with other information provides evidence of impairment, the deterioration in creditworthiness often would be regarded as significant. B.15 Definition of Held-to-Maturity Financial Assets: Permitted Sales Would sales of held-to-maturity financial assets due to a change in management compromise the classification of other financial assets as held to maturity? Yes. A change in management is not identified under IPSAS 29.AG35 as an instance where sales or transfers from held-to-maturity do not compromise the classification as held to maturity. Sales in response to such a change in management would, therefore, call into question the entity’s intention to hold investments to maturity. To illustrate: Entity X has a portfolio of financial assets that is classified as held to maturity. In the current period, at the direction of the governing body, the senior management team has been replaced. The new management wishes to sell a portion of the held-to-maturity financial assets in order to carry out an expansion strategy designated and approved by the governing body. Although the previous management team had been in place since the entity’s inception and Entity X had never before undergone a major restructuring, the sale nevertheless calls into question Entity X’s intention to hold remaining held-to-maturity financial assets to maturity. B.16 Definition of Held-to-Maturity Investments: Sales in Response to Entity- Specific Capital Requirements In some countries, regulators of banks or other industries may set entity-specific capital requirements that are based on an assessment of the risk in that particular entity. IPSAS 29.AG35(e) indicates that an entity that sells held-to-maturity investments in response to an unanticipated significant increase by the regulator in the industry’s capital requirements may do so under IPSAS 29 without necessarily raising a question about its intention to hold other investments to maturity. Would sales of held-to-maturity investments that are due to a significant increase in entityspecific capital requirements imposed by regulators (i.e., capital requirements applicable to a particular entity, but not to the industry) raise such doubt? Yes, such sales “taint” the entity’s intention to hold other financial assets as held to maturity unless it can be demonstrated that the sales fulfill the condition in IPSAS 29.10 in that they result from an increase in capital requirements, which is an isolated event that IPSAS 29 IMPLEMENTATION GUIDANCE 1166
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ipsas 29—financial instruments: recognition and measurement - IFAC

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