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With the FASB taking a lot of flak for its standard on FAS 157 and being forced to make some amendments, IASB in response also decided to make certain amendments to IFRS 7 and IAS 39.
The amendments to IAS 39 introduces the possibility of reclassification of investments from a "held for sale" assets classification to a "held to maturity." The switch eliminates the need to record the instruments at fair value (at market prices), and; instead allows companies to record these instruments at historical costs unless there is a permanent impairment. (explained with an example at the bottom of the blog).
Reclassifying the assets to held to maturity will be a big boost for banks, which now can continue to hold these investments at book value and only test for impairment rather than marking them to fair value prices in distressed market conditions.
The only glitch or rather advantage which firms applying IFRS will have over USGAAP, is that the reclassification can be done retroactively from July 1, 2008. This will give bank managements to essentially 'cherry-pick' which instruments to reclassify and, in some instances, avoid the recognition of markdowns on assets that declined in value since that date.
IAS 39 was deemed a stronger standard than FAS 115, for the fact it did not allow reclassification of investments. I feel that, the current move has given a silver lining to a lot of companies to reclassify those investments retroactively which have been worst hit in the financial turmoil (Q3) and will have a very minimal chance of their appreciation in the next year (even over their book value). This reclassification will enable companies to restate their Q3 earnings and boost Q4 earnings.
Accountants who have an eye on the stock markets and have a punting trait in them will be much in demand to cherry pick these investments to boost their companies growth.
• For instance, consider a bank has an equal portfolio mix of real estate investments and FMCG stocks, say $50M each and both were classified as held for sale.
• On July 1, 2008, the value of the real estate portfolio was $30M and FMCG stocks were $40M.
• Losses recorded on account of the fair valuations in the company are $30M ($50M-$30M for real estate) & ($50M-$40M) for FMCG.
• Your company's investment analyst has forecasted a bearish view on real estate stocks, while being bullish on the FMCG stocks for the next year
Given this view, accountants reclassify only real estate stocks from held for sale to held for maturity, thereby restating their values back to $50M and reversing the $20M loss in the books. Total revised losses on account of the reclassification are now $10M (on FMCG stocks). There is an earnings boost to the extent of $20M (real estate reclass) for the current quarter of reclassification.
If the FMCG stocks rebound in the next quarter, these losses will also reverse on the basis of their fair valuations. A smart accountant will retain the losses on the FMCG stocks as "rainfall provisions" to be utilised in the next quarter. In case the stock prices rebound, the losses reverse, if the economic crisis deepens, he still has the option to reclassify this investment to held for maturity and thereby giving his company an earnings boost in a deeper economic crisis. Ain't IFRS getting accountants to be more creative and albeit triggering a sense of punting in them.
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