Financial Guarantee Contracts
(paragraphs 2(3), 3 and AG4A)
Editorial note: Reference substituted by IFRS 4 with effect for annual periods beginning on or after 1 January 2005. Earlier application is encouraged. If an entity applies this IFRS for an earlier period, it shall disclose that fact. Previously "(paragraphs 2(f) and 3)".
BC21. The Exposure Draft proposed that financial guarantee contracts that provide for specified payments to be made to reimburse the holder for a loss it has incurred because a specified debtor fails to make payment when due should be initially recognised and measured by the issuer in accordance with IAS 39. Subsequently, they should be measured in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets at the amount an entity would rationally be expected to pay to settle the obligation or to transfer it to a third party. This amendment would have clarified that an issued financial guarantee contract meets the definition of a liability and should be recognised as such.
BC22. Some of the comments received on the Exposure Draft expressed concern that applying IAS 37 after initial recognition would result in individual financial guarantees being measured at nil immediately after initial recognition if the probability threshold in IAS 37 was not met, and thus the entity would recognise an immediate gain.
BC23. In finalising IFRS 4 Insurance Contracts, the Board decided that a financial guarantee should, regardless of its legal form (eg financial guarantee, letter of credit, credit default contract, insurance contract) be within the scope of:
(a) this Standard if it is not an insurance contract, as defined in IFRS 4.
(b) this Standard, for accounting by the issuer, if the issuer incurred or retained the financial guarantee when it transferred to another party financial assets or financial liabilities within the scope of this Standard.
(c) IFRS 4 if it is an insurance contract, as defined in IFRS 4, unless (b) applies. However, the Board also decided to develop an Exposure Draft proposing that financial guarantees within the scope of IFRS 4 should be measured initially at fair value and subsequently in the same way as commitments to provide a loan at a below-market interest rate (see paragraph BC20).

BC19. Some comments received on the Exposure Draft disagreed with the Board's proposal that an entity that has a past practice of selling the assets resulting from its loan commitments shortly after origination should apply IAS 39 to all of its loan commitments. The Board considered this concern and agreed that the words in the Exposure Draft did not reflect the Board's intention. Thus, the Board clarified that if an entity has a past practice of selling the assets resulting from its loan commitments shortly after origination, it applies IAS 39 only to its loan commitments in the same class.
BC20. Finally, the Board decided that commitments to provide a loan at a below-market interest rate should be initially measured at fair value, and subsequently measured at the higher of
(a) the amount that would be recognised under IAS 37 and
(b) the amount initially recognised less, where appropriate, cumulative amortisation recognised in accordance with IAS 18 Revenue.
It noted that without such a requirement, liabilities that result from such commitments might not be recognised in the balance sheet, because in many cases no cash consideration is received.
Editorial note: First sentence substituted by IFRS 4 with effect for annual periods beginning on or after 1 January 2005. Earlier application is encouraged. If an entity applies this IFRS for an earlier period, it shall disclose that fact. Previously "Finally, the Board decided that commitments to provide a loan at a below-market interest rate should be initially measured at fair value, and subsequently measured in the same way as financial guarantees (see paragraph BC23).".

Scope
Loan Commitments
(paragraphs 2(i) and 4)
BC15. Loan commitments are firm commitments to provide credit under pre-specified terms and conditions. In the IAS 39 implementation guidance process, the question was raised whether a bank's loan commitments are derivatives accounted for at fair value under IAS 39. This question arises because a commitment to make a loan at a specified rate of interest during a fixed period of time meets the definition of a derivative. In effect, it is a written option for the potential borrower to obtain a loan at a specified rate.
BC16. To simplify the accounting for holders and issuers of loan commitments, the Board decided to exclude particular loan commitments from the scope of IAS 39. The effect of the exclusion is that an entity will not recognise and measure changes in fair value of these loan commitments that result from changes in market interest rates or credit spreads. This is consistent with the measurement of the loan that results if the holder of the loan commitment exercises its right to obtain financing, because changes in market interest rates do not affect the measurement of an asset measured at amortised cost (assuming it is not designated in a category other than loans and receivables).
BC17. However, the Board decided that an entity should be permitted to measure a loan commitment at fair value with changes in fair value recognised in profit or loss on the basis of designation at inception of the loan commitment as a financial liability through profit or loss. This may be appropriate, for example, if the entity manages risk exposures related to loan commitments on a fair value basis.
BC18. The Board further decided that a loan commitment should be excluded from the scope of IAS 39 only if it cannot be settled net. If the value of a loan commitment can be settled net in cash or another financial instrument, including when the entity has a past practice of selling the resulting loan assets shortly after origination, it is difficult to justify its exclusion from the requirement in IAS 39 to measure at fair value similar instruments that meet the definition of a derivative.

Prospective amendment: Amendments to IAS 39 Financial Instruments: Recognition and Measurement - The Fair Value Option (June 2005) inserts new paragraph BC11C with effect for annual periods beginning on or after 1 January 2006.
BC12. The Board did not reconsider the fundamental approach to accounting for financial instruments contained in IAS 39. Some of the complexity in existing requirements is inevitable in a mixed measurement model based in part on management's intentions for holding financial instruments and given the complexity of finance concepts and fair value estimation issues. The amendments reduce some of the complexity by clarifying the Standard, eliminating internal inconsistencies and incorporating additional guidance into the Standard.
BC13. The amendments also eliminate or mitigate some differences between IAS 39 and US GAAP related to the measurement of financial instruments. Already, the measurement requirements in IAS 39 are, to a large extent, similar to equivalent requirements in US GAAP, in particular, those in FASB SFAS 114 Accounting by Creditors for Impairment of a Loan, SFAS 115 Accounting for Certain Investments in Debt and Equity Securities and SFAS 133 Accounting for Derivative Instruments and Hedging Activities.
BC14. The Board will continue its consideration of issues related to the accounting for financial instruments. However, it expects that the basic principles in the improved IAS 39 will be in place for a considerable period.

BC11A. Some of the comment letters on the June 2002 Exposure Draft and participants in the roundtables raised a significant issue for which the June 2003 Exposure Draft had not proposed any changes. This was hedge accounting for a portfolio hedge of interest rate risk (sometimes referred to as 'macro hedging') and the related question of the treatment in hedge accounting of deposits with a demand feature (sometimes referred to as 'demand deposits' or 'demandable liabilities'). In particular, some were concerned that it was very difficult to achieve fair value hedge accounting for a macro hedge in accordance with previous versions of IAS 39.
Editorial note: Inserted by Amendments to IAS 39, March 2004 with effect for annual periods beginning on or after 1 January 2005. An entity shall apply the amendments to an earlier period when it applies IAS 39 (as revised in 2003) and IAS 32 (as revised in 2003) to that period.
BC11B. In the light of these concerns, the Board decided to explore whether and how IAS 39 might be amended to enable fair value hedge accounting to be used more readily for a portfolio hedge of interest rate risk. This resulted in a further Exposure Draft of Proposed Amendments to IAS 39 that was published in August 2003 and on which more than 120 comment letters were received. The amendments proposed in the Exposure Draft were finalised in March 2004.
Editorial note: Inserted by Amendments to IAS 39, March 2004 with effect for annual periods beginning on or after 1 January 2005. An entity shall apply the amendments to an earlier period when it applies IAS 39 (as revised in 2003) and IAS 32 (as revised in 2003) to that period.

BC9. In July 2001 the Board announced that it would undertake a project to improve the existing requirements on the accounting for financial instruments in IAS 32 and IAS 39. The improvements deal with practice issues identified by audit firms, national standard-setters, regulators and others, and issues identified in the IAS 39 implementation guidance process or by IASB staff.
BC10. In June 2002 the Board published an Exposure Draft of proposed amendments to IAS 32 and IAS 39 for a 116-day comment period. More than 170 comment letters were received.
BC11. Subsequently, the Board took steps to enable constituents to inform it better about the main issues arising out of the comment process, and to enable the Board to explain its views of the issues and its tentative conclusions. These consultations included:
(a) discussions with the Standards Advisory Council on the main issues raised in the comment process.
(b) nine roundtable discussions with constituents during March 2003 conducted in Brussels and London. Over 100 organisations and individuals took part in those discussions.
(c) discussions with the Board's liaison standard-setters of the issues raised in the roundtable discussions.
(d) meetings between members of the Board and its staff and various groups of constituents to explore further issues raised in comment letters and at the roundtable discussions.

Background
BC4. The original version of IAS 39 became effective for financial statements covering financial years beginning on or after 1 January 2001. It reflected a mixed measurement model in which some financial assets and financial liabilities are measured at fair value and others at cost or amortised cost, depending in part on an entity's intention in holding an instrument.
BC5. The Board recognises that accounting for financial instruments is a difficult and controversial subject. The Board's predecessor body, the International Accounting Standards Committee (IASC) began its work on the issue some 15 years ago, in 1988. During the next eight years it published two Exposure Drafts, culminating in the issue of IAS 32 on disclosure and presentation in 1995. IASC decided that its initial proposals on recognition and measurement should not be progressed to a Standard, in view of:
•   the critical response they had attracted;
•   evolving practices in financial instruments; and
•   the developing thinking by national standard-setters.
BC6. Accordingly, in 1997 IASC published, jointly with the Canadian Accounting Standards Board, a discussion paper that proposed a different approach, namely that all financial assets and financial liabilities should be measured at fair value. The responses to that paper indicated both widespread unease with some of its proposals and that more work needed to be done before a standard requiring a full fair value approach could be contemplated.
BC7. In the meantime, IASC concluded that a standard on the recognition and measurement of financial instruments was needed urgently. It noted that although financial instruments were widely held and used throughout the world, few countries apart from the United States had any recognition and measurement standards for them. In addition, IASC had agreed with the International Organization of Securities Commissions (IOSCO) that it would develop a set of 'core' International Accounting Standards that could be endorsed by IOSCO for the purpose of cross-border capital raising and listing in all global markets. Those core standards included one on the recognition and measurement of financial instruments. Accordingly, IASC developed the version of IAS 39 that was issued in 2000.
BC8. In December 2000 a Financial Instruments Joint Working Group of Standard Setters (JWG), comprising representatives or members of accounting standard-setters and professional organisations from a range of countries, published a Draft Standard and Basis for Conclusions entitled Financial Instruments and Similar Items. That Draft Standard proposed far-reaching changes to accounting for financial instruments and similar items, including the measurement of virtually all financial instruments at fair value. In the light of feedback on the JWG's proposals, it is evident that much more work is needed before a comprehensive fair value accounting model could be introduced.

Editorial note: Paragraph B8 inserted by IAS Corrections List 9, May 2004

Basis for Conclusions
This Basis for Conclusions accompanies, but is not part of, IAS 39.
BC1. This Basis for Conclusions summarises the International Accounting Standards Board's considerations in reaching the conclusions on revising IAS 39 Financial Instruments: Recognition and Measurement in 2003. Individual Board members gave greater weight to some factors than to others.
BC2. In July 2001, the Board announced that, as part of its initial agenda of technical projects, it would undertake a project to improve a number of Standards, including IAS 32 Financial Instruments: Disclosure and Presentation and IAS 39 Financial Instruments: Recognition and Measurement. The objectives of the Improvements project were to reduce the complexity in the Standards by clarifying and adding guidance, eliminating internal inconsistencies and incorporating into the Standards elements of Standing Interpretations Committee (SIC) Interpretations and IAS 39 implementation guidance. In June 2002 the Board published its proposals in an Exposure Draft of Proposed Amendments to IAS 32 Financial Instruments: Disclosure and Presentation and IAS 39 Financial Instruments: Recognition and Measurement, with a comment deadline of 14 October 2002. In August 2003 the Board published a further Exposure Draft of Proposed Amendments to IAS 39 on Fair Value Hedge Accounting for a Portfolio Hedge of Interest Rate Risk, with a comment deadline of 14 November 2003.
Editorial note: Last sentence inserted by Amendments to IAS 39, March 2004 with effect for annual periods beginning on or after 1 January 2005. An entity shall apply the amendments to an earlier period when it applies IAS 39 (as revised in 2003) and IAS 32 (as revised in 2003) to that period.
BC3. Because the Board's intention was not to reconsider the fundamental approach to the accounting for financial instruments established by IAS 32 and IAS 39, this Basis for Conclusions does not discuss requirements in IAS 39 that the Board has not reconsidered.

(b) At 31 December 2000
Present obligation as a result of a past obligating event - The obligating event is the giving of the guarantee, which gives rise to a legal obligation.
An outflow of resources embodying economic benefits in settlement - At 31 December 2000, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation.
Conclusion - The guarantee is subsequently measured at the higher of (a) the best estimate of the obligation (see paragraphs 14 and 23), and (b) the amount initially recognised less, when appropriate, cumulative amortisation in accordance with IAS 18 Revenue.
Note: Where an entity gives guarantees in exchange for a fee, revenue is recognised under IAS 18 Revenue.

(b) At 31 December 2000
Present obligation as a result of a past obligating event - The obligating event is the giving of the guarantee, which gives rise to a legal obligation.
An outflow of resources embodying economic benefits in settlement - At 31 December 2000, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation.
Conclusion - The guarantee is subsequently measured at the higher of (a) the best estimate of the obligation (see paragraphs 14 and 23), and (b) the amount initially recognised less, when appropriate, cumulative amortisation in accordance with IAS 18 Revenue.
Note: Where an entity gives guarantees in exchange for a fee, revenue is recognised under IAS 18 Revenue.