AG12. A regular way purchase or sale gives rise to a fixed price commitment between trade date and settlement date that meets the definition of a derivative. However, because of the short duration of the commitment it is not recognised as a derivative financial instrument. Rather, this Standard provides for special accounting for such regular way contracts (see paragraphs 38 and AG53-AG56).
AG12A The definition of a derivative refers to non-financial variables that are not specific to a party to the contract. These include an index of earthquake losses in a particular region and an index of temperatures in a particular city. Non-financial variables specific to a party to the contract include the occurrence or non-occurrence of a fire that damages or destroys an asset of a party to the contract. A change in the fair value of a non-financial asset is specific to the owner if the fair value reflects not only changes in market prices for such assets (a financial variable) but also the condition of the specific non-financial asset held (a non-financial variable). For example, if a guarantee of the residual value of a specific car exposes the guarantor to the risk of changes in the car's physical condition, the change in that residual value is specific to the owner of the car.
Editorial note: Inserted 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 "A commitment to provide a loan at a below-market interest rate is measured in the same way as a financial guarantee that is outside the scope of IAS 39 (see paragraph IN5)".
Transaction Costs

AG10. The definition of a derivative in this Standard includes contracts that are settled gross by delivery of the underlying item (eg a forward contract to purchase a fixed rate debt instrument). An entity may have a contract to buy or sell a non-financial item that can be settled net in cash or another financial instrument or by exchanging financial instruments (eg a contract to buy or sell a commodity at a fixed price at a future date). Such a contract is within the scope of this Standard unless it was entered into and continues to be held for the purpose of delivery of a non-financial item in accordance with the entity's expected purchase, sale or usage requirements (see paragraphs 5-7).
AG11. One of the defining characteristics of a derivative is that it has an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors. An option contract meets that definition because the premium is less than the investment that would be required to obtain the underlying financial instrument to which the option is linked. A currency swap that requires an initial exchange of different currencies of equal fair values meets the definition because it has a zero initial net investment.

Derivatives
AG9. Typical examples of derivatives are futures and forward, swap and option contracts. A derivative usually has a notional amount, which is an amount of currency, a number of shares, a number of units of weight or volume or other units specified in the contract. However, a derivative instrument does not require the holder or writer to invest or receive the notional amount at the inception of the contract. Alternatively, a derivative could require a fixed payment or payment of an amount that can change (but not proportionally with a change in the underlying) as a result of some future event that is unrelated to a notional amount. For example, a contract may require a fixed payment of CU1,000[*] if six-month LIBOR increases by 100 basis points. Such a contract is a derivative even though a notional amount is not specified.
* In this Standard, monetary amounts are denominated in 'currency units' (CU).

AG7. For floating rate financial assets and floating rate financial liabilities, periodic re-estimation of cash flows to reflect movements in market rates of interest alters the effective interest rate. If a floating rate financial asset or floating rate financial liability is recognised initially at an amount equal to the principal receivable or payable on maturity, re-estimating the future interest payments normally has no significant effect on the carrying amount of the asset or liability.
AG8. If an entity revises its estimates of payments or receipts, the entity shall adjust the carrying amount of the financial asset or financial liability (or group of financial instruments) to reflect actual and revised estimated cash flows. The entity recalculates the carrying amount by computing the present value of estimated future cash flows at the financial instrument's original effective interest rate. The adjustment is recognised as income or expense in profit or loss.

Editorial note: Inserted 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.

Prospective amendment: Amendments to IAS 39 Financial Instruments: Recognition and Measurement - The Fair Value Option (June 2005) inserts new paragraphs 4B-4K with effect for annual periods beginning on or after 1 January 2006.
Definitions
(paragraphs 8-9)
Effective Interest Rate
AG5. In some cases, financial assets are acquired at a deep discount that reflects incurred credit losses. Entities include such incurred credit losses in the estimated cash flows when computing the effective interest rate.
AG6. When applying the effective interest method, an entity generally amortises any fees, points paid or received, transaction costs and other premiums or discounts included in the calculation of the effective interest rate over the expected life of the instrument. However, a shorter period is used if this is the period to which the fees, points paid or received, transaction costs, premiums or discounts relate. This will be the case when the variable to which the fees, points paid or received, transaction costs, premiums or discounts relate is repriced to market rates before the expected maturity of the instrument. In such a case, the appropriate amortisation period is the period to the next such repricing date. For example, if a premium or discount on a floating rate instrument reflects interest that has accrued on the instrument since interest was last paid, or changes in market rates since the floating interest rate was reset to market rates, it will be amortised to the next date when the floating interest is reset to market rates. This is because the premium or discount relates to the period to the next interest reset date because, at that date, the variable to which the premium or discount relates (ie interest rates) is reset to market rates. If, however, the premium or discount results from a change in the credit spread over the floating rate specified in the instrument, or other variables that are not reset to market rates, it is amortised over the expected life of the instrument.

AG4. This Standard applies to the financial assets and financial liabilities of insurers, other than rights and obligations that paragraph 2(e) excludes because they arise under contracts within the scope of IFRS 4.
Editorial note: 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 "This Standard applies to the financial assets and financial liabilities of insurers other than rights and obligations arising under insurance contracts that are excluded by paragraph 2(d).".
AG4A Financial guarantee contracts may have various legal forms, such as a financial guarantee, letter of credit, credit default contract or insurance contract. Their accounting treatment does not depend on their legal form. The following are examples of the appropriate treatment (see paragraphs 2(e) and 3):
(a) If the contract is not an insurance contract, as defined in IFRS 4, the issuer applies this Standard. Thus, a financial guarantee contract that requires payments if the credit rating of a debtor falls below a particular level is within the scope of this Standard.
(b) If the issuer incurred or retained the financial guarantee on transferring to another party financial assets or financial liabilities within the scope of this Standard, the issuer applies this Standard.
(c) If the contract is an insurance contract, as defined in IFRS 4, the issuer applies IFRS 4 unless (b) applies.
(d) If the issuer gave a financial guarantee in connection with the sale of goods, the issuer applies IAS 18 in determining when it recognises the resulting revenue.

Appendix A Application Guidance
This appendix is an integral part of the Standard.
Scope
(paragraphs 2-7)
AG1. Some contracts require a payment based on climatic, geological or other physical variables. (Those based on climatic variables are sometimes referred to as 'weather derivatives'.) If those contracts are not within the scope of IFRS 4 Insurance Contracts, they are within the scope of this Standard.
Editorial note: 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 "Contracts that require a payment based on climatic, geological or other physical variables are commonly used as insurance policies. (Those based on climatic variables are sometimes referred to as 'weather derivatives'.) Under such contracts, the payment made is based on the amount of loss to the insured entity. Rights and obligations under insurance contracts that do not principally involve the transfer of financial risks are excluded from the scope of this Standard by paragraph 2(d). The payout under some contracts that require a payment based on climatic, geological or other physical variables is unrelated to the amount of an insured entity's loss. Such contracts are excluded from the scope of this Standard by paragraph 2(h).".
AG2. This Standard does not change the requirements relating to employee benefit plans that comply with IAS 26 Accounting and Reporting by Retirement Benefit Plans and royalty agreements based on the volume of sales or service revenues that are accounted for under IAS 18 Revenue.
AG3. Sometimes, an entity makes what it views as a 'strategic investment' in equity instruments issued by another entity, with the intention of establishing or maintaining a long-term operating relationship with the entity in which the investment is made. The investor entity uses IAS 28 Investments in Associates to determine whether the equity method of accounting is appropriate for such an investment. Similarly, the investor entity uses IAS 31 Interests in Joint Ventures to determine whether proportionate consolidation or the equity method is appropriate for such an investment. If neither the equity method nor proportionate consolidation is appropriate, the entity applies this Standard to that strategic investment.

Approval of IAS 39 by the Board
International Accounting Standard 39 Financial Instruments: Recognition and Measurement was approved for issue by eleven of the fourteen members of the International Accounting Standards Board. Messrs Cope, Leisenring and McGregor dissented. Their dissenting opinions are set out after the Basis for Conclusions.
Sir David Tweedie    Chairman
Thomas E Jones    Vice-Chairman
Mary E Barth    
Hans-Georg Bruns    
Anthony T Cope    
Robert P Garnett    
Gilbert Géélard    
James J Leisenring    
Warren J McGregor    
Patricia L O'Malley    
Harry K Schmid    
John T Smith    
Geoffrey Whittington    
Tatsumi Yamada    

109. This Standard supersedes IAS 39 Financial Instruments: Recognition and Measurement revised in October 2000.
Editorial note: IAS Corrections List 7, 7 April 2004 substitutes "October 2000" for "March 2000".
110. This Standard and the accompanying Implementation Guidance supersede the Implementation Guidance issued by the IAS 39 Implementation Guidance Committee, established by the former IASC.
* paragraphs 48, 49 and AG69-AG82 of Appendix A contain requirements for determining the fair value of a financial asset or financial liability.

108. An entity shall not adjust the carrying amount of non-financial assets and non-financial liabilities to exclude gains and losses related to cash flow hedges that were included in the carrying amount before the beginning of the financial year in which this Standard is first applied. At the beginning of the financial period in which this Standard is first applied, any amount recognised directly in equity for a hedge of a firm commitment that under this Standard is accounted for as a fair value hedge shall be reclassified as an asset or liability, except for a hedge of foreign currency risk that continues to be treated as a cash flow hedge.
Prospective amendment: Amendments to IAS 39 Financial Instruments: Recognition and Measurement (April 2005) inserts two new paragraphs after paragraph 108 with effect for annual periods beginning on or after 1 January 2006.
Withdrawal of Other Pronouncements