Prospective amendment: Amendments to IAS 39 Financial Instruments: Recognition and Measurement - The Fair Value Option (June 2005) amends this paragraph with effect for annual periods beginning on or after 1 January 2006.
BC82. In addition, the Board decided to include a requirement for an entity to classify a financial liability as held for trading if it is incurred principally for the purpose of repurchasing it in the near term or it is part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent pattern of short-term profit-taking. In these circumstances, the absence of a requirement to measure such financial liabilities at fair value permits cherry-picking of unrealised gains or losses. For example, if an entity wishes to recognise a gain, it can repurchase a fixed rate debt instrument that was issued in an environment where interest rates were lower than in the reporting period and if it wishes to recognise a loss, it can repurchase an issued debt instrument that was issued in an environment in which interest rates were higher than in the reporting period. However, a financial liability is not classified as held for trading merely because it funds assets that are held for trading.
BC83. The Board decided to include in revised IAS 32 a requirement to disclose the settlement amount repayable at maturity of a liability that is designated as at fair value through profit or loss. This gives users of financial statements information about the amount owed by the entity to its creditors in the event of its liquidation.
BC84. The Board also decided to include in IAS 39 the ability for entities to designate a loan or receivable as available for sale (see paragraph 9). The Board decided that, in the context of the existing mixed measurement model, there are no reasons to limit to any particular type of asset the ability to designate an asset as available for sale.
Prospective amendment: Amendments to IAS 39 Financial Instruments: Recognition and Measurement - The Fair Value Option (June 2005) amends this paragraph with effect for annual periods beginning on or after 1 January 2006.
Application of the Fair Value Measurement Option to a Portion (Rather than the Entirety) of a Financial Asset or a Financial Liability
BC85. Some comments received on the Exposure Draft argued that the fair value measurement option should be extended so that it could also be applied to a portion of a financial asset or a financial liability (eg one risk). The arguments included (a) concerns regarding inclusion of own credit risk in the measurement of financial liabilities and (b) the prohibition on using non-derivatives as hedging instruments (cash instrument hedging).

. Prospective amendment: Amendments to IAS 39 Financial Instruments: Recognition and Measurement - The Fair Value Option (June 2005) substitutes this paragraph and inserts new paragraphs BC78A, BC79 and BC79A with effect for annual periods beginning on or after 1 January 2006.
BC79. The fair value measurement option enables (but does not require) entities to measure financial instruments at fair value with changes in fair value recognised in profit or loss. Accordingly, it does not restrict an entity's ability to use other accounting methods (such as amortised cost). Some respondents to the Exposure Draft would have preferred more pervasive changes to expand the use of fair values and limit the choices available to entities, such as the elimination of the held-to-maturity category or the cash flow hedge accounting approach. Although such changes have the potential to make the principles in IAS 39 more coherent and less complex, the Board did not consider such changes as part of this project to improve IAS 39.
Prospective amendment: Amendments to IAS 39 Financial Instruments: Recognition and Measurement - The Fair Value Option (June 2005) amends and renumbers this paragraph as BC80A with effect for annual periods beginning on or after 1 January 2006.
BC80. Some comments received on the Exposure Draft suggested limiting the scope of the fair value option (eg to instruments that are traded in an active market or to exclude financial liabilities-see paragraphs BC87-BC92). The Board concluded it should not restrict the fair value option because to do so would limit its main benefits, discussed above.
BC81. Comments received on the Exposure Draft also questioned the proposal that all items measured at fair value through profit or loss should have the descriptor 'held for trading'. Some comments noted that 'held for trading' is commonly used with a narrower meaning, and it may be confusing for users if instruments designated at fair value through profit or loss are also called 'held for trading'. Therefore the Board considered using a fifth category of financial instruments-'fair value through profit or loss'-to distinguish those instruments to which the fair value option was applied from those classified as held for trading. The Board rejected this possibility because it believed adding a fifth category of financial instruments would unnecessarily complicate the Standard. Rather, the Board concluded that 'fair value though profit or loss' should be used to describe a category that encompasses financial instruments classified as held for trading and those to which the fair value option is applied.

Prospective amendment: Amendments to IAS 39 Financial Instruments: Recognition and Measurement - The Fair Value Option (June 2005) substitutes this paragraph and inserts new paragraphs BC76A and BC76B with effect for annual periods beginning on or after 1 January 2006.
BC77. An additional benefit of permitting classification by designation is that the choice in the original IAS 39 of recognising fair value gains and losses on available-for-sale financial assets either in equity or in profit or loss is no longer necessary. An entity can achieve recognition of gains and losses on such assets in profit or loss by designating the asset at fair value through profit or loss. It also increases comparability across entities in how gains and losses on available-for-sale financial assets are recognised. Accordingly, the Board decided that the choice that was in the original IAS 39 should be removed and that gains and losses on available-for-sale financial assets should be recognised in equity.
Prospective amendment: Amendments to IAS 39 Financial Instruments: Recognition and Measurement - The Fair Value Option (June 2005) substitutes this paragraph and inserts new paragraphs BC77A and BC77B with effect for annual periods beginning on or after 1 January 2006.
BC78. Permitting designation at fair value through profit or loss mitigates problems arising from a mixed measurement model when assets are measured at fair value and related liabilities are measured at amortised cost. For example, the inability to classify non-derivative liabilities as held for trading under IAS 39 creates problems for entities with matched asset and liability positions. Under IAS 39, an entity is not permitted to designate non-derivative financial assets or non-derivative financial liabilities as hedging instruments, except for foreign currency exposures, and thus cannot use hedge accounting to eliminate such a mismatch. Because financial liabilities may now be designated at fair value through profit or loss, an entity can consistently recognise fair value changes on matched financial asset and financial liability positions.

 .Prospective amendment: Amendments to IAS 39 Financial Instruments: Recognition and Measurement - The Fair Value Option (June 2005) amends this paragraph and inserts new paragraph BC74A with effect for annual periods beginning on or after 1 January 2006.
BC75. Permitting entities to designate at inception any financial instrument at fair value through profit or loss reduces the need for hedge accounting for hedges of fair value exposures and the resulting complexity in accounting for such hedges. Rather than being designated as a hedged item, the item could be designated at fair value through profit or loss to achieve recognition of offsetting fair value gains and losses in the same periods.
Prospective amendment: Amendments to IAS 39 Financial Instruments: Recognition and Measurement - The Fair Value Option (June 2005) substitutes this paragraph and inserts new paragraphs BC75A and BC75B with effect for annual periods beginning on or after 1 January 2006.
BC76. Permitting classification by designation also reduces the burden of separating embedded derivatives from hybrid instruments into host instruments and embedded derivative contracts. For example, under the previous version of IAS 39, an entity did not separate embedded derivatives in financial instruments that were held for trading. The Board noted that many preparers, auditors and others find the requirements to separate embedded derivatives difficult to apply in practice. For example, when applying these requirements an entity will need to carry out a detailed analysis of its financial instruments to identify embedded derivatives. Often it may be easier for the entity to determine the fair value of the combined instrument as a whole rather than to identify the terms of the embedded derivative and separately measure the embedded derivative at fair value, if, for example, the combined instrument is traded in an active market.

Prospective amendment: Amendments to IAS 39 Financial Instruments: Recognition and Measurement - The Fair Value Option (June 2005) amends this paragraph with effect for annual periods beginning on or after 1 January 2006.
BC73. The Board decided to permit entities to designate irrevocably on initial recognition any financial instrument as one to be measured at fair value with gains and losses recognised in profit or loss ('fair value through profit or loss'). To impose discipline on this approach, the Board decided that financial instruments should not be reclassified into or out of the category of fair value through profit or loss. In particular, some comments received on the Exposure Draft suggested that entities could use the fair value option to recognise selectively changes in fair value in profit or loss. The Board noted that the requirement to designate irrevocably on initial recognition the financial instruments for which the fair value option is to be applied results in an entity being unable to 'cherry pick' in this way. This is because it will not be known at initial recognition whether the fair value of the instrument will increase or decrease.
Prospective amendment: Amendments to IAS 39 Financial Instruments: Recognition and Measurement - The Fair Value Option (June 2005) amends this paragraph and inserts new paragraph BC73A with effect for annual periods beginning on or after 1 January 2006.
BC74. The change simplifies the application of IAS 39 by mitigating some anomalies that result from the different measurement attributes in the Standard. In particular, for financial instruments designated in this way:
(a) it eliminates the need for hedge accounting for hedges of fair value exposures when there are natural offsets, and thereby eliminates the related burden of designating, tracking and analysing hedge effectiveness.
(b) it eliminates the burden of separating embedded derivatives.
(c) it eliminates problems arising from a mixed measurement model where financial assets are measured at fair value and related financial liabilities are measured at amortised cost. In particular, it eliminates volatility in profit or loss and equity that results when matched positions of financial assets and financial liabilities are not measured consistently.
(d) the option to recognise unrealised gains and losses on available-for-sale financial assets in profit or loss is no longer necessary.
(e) it de-emphasises interpretive issues around what constitutes trading.

BC71. The Board concluded that it could simplify the application of IAS 39 for some entities by permitting the use of fair value measurement for any financial instrument. With one exception (see paragraph BC82), this greater use of fair value is optional. The fair value measurement option does not require entities to measure more financial instruments at fair value.
Prospective amendment: Amendments to IAS 39 Financial Instruments: Recognition and Measurement - The Fair Value Option (June 2005) amends this paragraph, and the heading preceding it, with effect for annual periods beginning on or after 1 January 2006.
BC72. The previous version of IAS 39 did not permit an entity to measure particular categories of financial instruments at fair value with changes in fair value recognised in profit or loss. Examples included:
(a) originated loans and receivables, including a debt instrument acquired directly from the issuer, unless they met the conditions for classification as held for trading in paragraph 9.
(b) financial assets classified as available for sale, unless they met the conditions for classification as held for trading in paragraph 9.
(c) non-derivative financial liabilities even if the entity had a policy and practice of actively repurchasing such liabilities or they formed part of an arbitrage/customer facilitation strategy or fund trading activities.

BC67. The Board decided that if the entity determines that it has neither retained nor transferred substantially all of the risks and rewards of an asset and that it has retained control, the entity should continue to recognise the asset to the extent of its continuing involvement. This is to reflect the transferor's continuing exposure to the risks and rewards of the asset and that this exposure is not related to the entire asset, but is limited in amount. The Board noted that precluding derecognition to the extent of the continuing involvement is useful to users of financial statements in such cases, because it reflects the entity's retained exposure to the risks and rewards of the financial asset better than full derecognition.
BC68. When the entity transfers some significant risks and rewards and retains others and derecognition is precluded because the entity retains control of the transferred asset, the entity no longer retains all the upside and downside exposure to gains and losses resulting from the transferred asset. Therefore, the revised IAS 39 requires the asset and the associated liability to be measured in a way that ensures that any changes in value of the transferred asset that are not attributed to the entity are not recognised by the entity.
BC69. For example, special measurement and income recognition issues arise if derecognition is precluded because the transferor has retained a call option or written a put option and the asset is measured at fair value. In those situations, in the absence of additional guidance, application of the general measurement and income recognition requirements for financial assets and financial liabilities in IAS 39 may result in accounting that does not represent the transferor's rights and obligations related to the transfer.
BC70. As another example, if the transferor retains a call option on a transferred available-for-sale financial asset and the fair value of the asset decreases below the exercise price, the transferor does not suffer a loss because it has no obligation to exercise the call option. In that case, the Board decided that it is appropriate to adjust the measurement of the liability to reflect that the transferor has no exposure to decreases in the fair value of the asset below the option exercise price. Similarly, if a transferor writes a put option and the fair value of the asset exceeds the exercise price, the transferee need not exercise the put. Because the transferor has no right to increases in the fair value of the asset above the option exercise price, it is appropriate to measure the asset at the lower of (a) the option exercise price and (b) the fair value of the asset.
Measurement
Fair Value Measurement Option
(paragraph 9)

BC63. The Board recognises that many securitisations may fail to qualify for derecognition either because one or more of the three conditions in paragraph 19 are not met or because the entity has retained substantially all the risks and rewards of ownership.
BC64. Whether a transfer of a financial asset qualifies for derecognition does not differ depending on whether the transfer is direct to investors or through a consolidated SPE or trust that obtains the financial assets and, in turn, transfers a portion of those financial assets to third party investors.
Transfers that Do Not Qualify for Derecognition
(paragraph 29)
BC65. The original IAS 39 did not provide guidance about how to account for a transfer of a financial asset that does not qualify for derecognition. The amendments include such guidance. To ensure that the accounting reflects the rights and obligations that the transferor has in relation to the transferred asset, there is a need to consider the accounting for the asset as well as the accounting for the associated liability.
BC66. When an entity retains substantially all the risks and rewards of the asset (eg in a repurchase transaction), there are generally no special accounting considerations because the entity retains upside and downside exposure to gains and losses resulting from the transferred asset. Therefore, the asset continues to be recognised in its entirety and the proceeds received are recognised as a liability. Similarly, the entity continues to recognise any income from the asset along with any expense incurred on the associated liability.
Continuing Involvement in a Transferred Asset
(paragraphs 30-35)

BC61. The Board decided that the derecognition tests that apply to other transfers of financial assets (ie the tests of transferring substantially all the risks and rewards and control) should also apply to arrangements to pass through cash flows that meet the three conditions but do not involve a fully proportional share of all or specifically identified cash flows. Thus, if the three conditions are met and the entity passes on a fully proportional share, either of all cash flows (as in the example in paragraph BC55) or of specifically identified cash flows (eg 10 per cent of all interest cash flows), the proportion sold is derecognised, provided the entity has transferred substantially all the risks and rewards of ownership. Thus, in the example in paragraph BC55, Entity A would report a loan asset of CU10 and derecognise CU90. Similarly, if an entity enters into an arrangement that meets the three conditions above, but the arrangement is not on a fully proportionate basis, the contractual arrangement would have to meet the general derecognition conditions to qualify for derecognition. This ensures consistency in the application of the derecognition model, whether a transaction is structured as a transfer of the contractual right to receive the cash flows of a financial asset or as an arrangement to pass through cash flows.
BC62. To illustrate a disproportionate arrangement using a simple example, assume the following. Entity A originates a portfolio of five-year interest-bearing loans of CU10,000. Entity A then enters into an agreement with Entity C in which, in exchange for a cash payment of CU9,000, Entity A agrees to pay to Entity C the first CU9,000 (plus interest) of cash collected from the loan portfolio. Entity A retains rights to the last CU1,000 (plus interest), ie it retains a subordinated residual interest. If Entity A collects, say, only CU8,000 of its loans of CU10,000 because some debtors default, Entity A would pass on to Entity C all of the CU8,000 collected and Entity A keeps nothing of the CU8,000 collected. If Entity A collects CU9,500, it passes CU9,000 to Entity C and retains CU500. In this case, if Entity A retains substantially all the risks and rewards of ownership because the subordinated retained interest absorbs all of the likely variability in net cash flows, the loans continue to be recognised in their entirety even if the three pass-through conditions are met.

BC57. Respondents to the Exposure Draft were generally supportive of the proposed changes. Some respondents asked for further clarification of the requirements and the interaction with the requirements for consolidation of special purpose entities (in SIC-12). Respondents in the securitisation industry noted that under the proposed guidance many securitisation structures would not qualify for derecognition.
BC58. Considering these and other comments, the Board decided to proceed with its proposals to issue guidance on pass-through arrangements and to clarify that guidance in finalising the revised IAS 39.
BC59. The Board concluded that the following three conditions must be met for treating a contractual arrangement to pass through cash flows from a financial asset as a transfer of that asset:
(a) The entity has no obligation to pay amounts to the eventual recipients unless it collects equivalent amounts from the original asset. However, the entity is allowed to make short-term advances to the eventual recipient so long as it has the right of full recovery of the amount lent plus accrued interest.
(b) The entity is prohibited by the terms of the transfer contract from selling or pledging the original asset other than as security to the eventual recipients for the obligation to pay them cash flows.
(c) The entity has an obligation to remit any cash flows it collects on behalf of the eventual recipients without material delay. In addition, during the short settlement period, the entity is not entitled to reinvest such cash flows except for investments in cash or cash equivalents and where any interest earned from such investments is remitted to the eventual recipients.
BC60. These conditions follow from the definitions of assets and liabilities in the Framework. Condition (a) indicates that the transferor has no liability (because there is no present obligation to pay cash), and conditions (b) and (c) indicate that the transferor has no asset (because the transferor does not control the future economic benefits associated with the transferred asset).