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.
BC214. The issue arises because the assets and liabilities in each repricing time period change over time as prepayment expectations change, as items are derecognised and as new items are originated. Thus the net position, and the amount the entity wishes to designate as the hedged item, also changes over time. If the hedged item decreases, the hedging instrument needs to be reduced. However, entities do not normally reduce the hedging instrument by disposing of some of the derivatives contained in it. Instead, entities adjust the hedging instrument by entering into new derivatives with an offsetting risk profile.
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.
BC215. The Board decided to permit the hedging instrument to be a portfolio of derivatives containing offsetting risk positions for both individual and portfolio hedges. It noted that all of the derivatives concerned are measured at fair value. It also noted that the two ways of adjusting the hedging instrument described in the previous paragraph can achieve substantially the same effect. Therefore the Board clarified paragraph 77 to this effect.
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.

Hedge effectiveness for a portfolio hedge of interest rate risk
BC216. Some respondents to the Exposure Draft questioned whether IAS 39's effectiveness tests* should apply to a portfolio hedge of interest rate risk. The Board noted that its objective in amending IAS 39 for a portfolio hedge of interest rate risk is to permit fair value hedge accounting to be used more easily, whilst continuing to meet the principles of hedge accounting. One of these principles is that the hedge is highly effective. Thus, the Board concluded that the effectiveness requirements in IAS 39 apply equally to a portfolio hedge of interest rate risk.
* see paragraph AG105

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.
BC217. Some respondents to the Exposure Draft sought guidance on how the effectiveness tests are to be applied to a portfolio hedge. In particular, they asked how the prospective effectiveness test is to be applied when an entity periodically 'rebalances' a hedge (ie adjusts the amount of the hedging instrument to reflect changes in the hedged item). The Board decided that if the entity's risk management strategy is to change the amount of the hedging instrument periodically to reflect changes in the hedged position, that strategy affects the determination of the term of the hedge. Thus, the entity needs to demonstrate that the hedge is expected to be highly effective only for the period until the amount of the hedging instrument is next adjusted. The Board noted that this decision does not conflict with the requirement in paragraph 75 that "a hedging relationship may not be designated for only a portion of the time period during which a hedging instrument remains outstanding". This is because the entire hedging instrument is designated (and not only some of its cash flows, for example, those to the time when the hedge is next adjusted). However, expected effectiveness is assessed by considering the change in the fair value of the entire hedging instrument only for the period until it is next adjusted.

 .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.
BC220. The Board also considered whether to permit retrospective designation of a portfolio hedge. The Board noted that this would conflict with the principle in paragraph 88(a) that "at the inception of the hedge there is formal designation and documentation of the hedging relationship" and accordingly, decided not to permit retrospective designation.
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.

Elimination of Selected Differences from US GAAP
BC221. The Board considered opportunities to eliminate differences between IAS 39 and US GAAP. The guidance on measurement and hedge accounting under revised IAS 39 is generally similar to that under US GAAP. The amendments will further reduce or eliminate differences between IAS 39 and US GAAP in the areas listed below. In some other areas, a difference will remain. For example, US GAAP in many, but not all, areas is more detailed, which may result in a difference in accounting when an entity applies an accounting approach under IAS 39 that would not be permitted under US GAAP.
Contracts to buy or sell a non-financial item
(a) The Board decided that a contract to buy or sell a non-financial item is a derivative within the scope of IAS 39 if the non-financial item that is the subject of the contract is readily convertible to cash and the contract is not a 'normal' purchase or sale. This requirement is comparable to the definition of a derivative in SFAS 133, which also includes contracts for which the underlying is readily convertible to cash, and to the scope exclusion in SFAS 133 for 'normal' purchases and sales.
Scope: loan commitments
(b) The Board decided to add a paragraph to IAS 39 to exclude particular loan commitments that are not settled net. Such loan commitments were within the scope of the original IAS 39. The amendment moves IAS 39 closer to US GAAP.
Unrealised gains and losses on available-for-sale financial assets
(c) The Board decided to eliminate the option to recognise in profit or loss gains and losses on available-for-sale financial assets (IAS 39, paragraph 55(b)), and thus require such gains and losses to be recognised in equity. The change is consistent with SFAS 115, which does not provide the option in the original IAS 39 to recognise gains and losses on available-for-sale financial assets in profit or loss. SFAS 115 requires those unrealised gains and losses to be recognised in other comprehensive income (not profit or loss).
Fair value in active markets

(d) The Board decided to amend the wording in IAS 39, paragraph AG71, to state that, instead of a quoted market price normally being the best evidence of fair value, a quoted market price is the best evidence of fair value. This is similar to SFAS 107 Disclosures about Fair Value of Financial Instruments.
Fair value in inactive markets
(e) The Board decided to include in IAS 39 a requirement that the best evidence of the fair value of an instrument that is not traded in an active market is the transaction price, unless the fair value is evidenced by comparison with other observable current market transactions in the same instrument (ie without modification or repackaging) or based on a valuation technique incorporating only observable market data. This is similar to the requirements of EITF 02-3 Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities.
Impaired fixed rate loans: observable market price
(f) The Board decided to permit an impaired fixed interest rate loan to be measured using an observable market price. SFAS 114 allows impairment to be measured on the basis of a loan's observable market price.
Reversal of impairment losses on investments in equity instruments
(g) The Board decided that if an entity recognises an impairment loss on an available-for-sale equity investment and the fair value of the investment subsequently increases, the increase in fair value should be recognised in equity. This is comparable to US GAAP under which reversals of impairment losses are not permitted.
Hedges of firm commitments

(h) The Board decided to require hedges of firm commitments to be treated as fair value hedges instead of cash flow hedges as was required under the original IAS 39 (except foreign currency risk when the hedge may be designated as either a cash flow hedge or a fair value hedge). This change brings IAS 39 closer to SFAS 133.
Basis adjustments to financial assets or financial liabilities resulting from hedges of forecast transactions
(i) Basis adjustments to financial assets or financial liabilities resulting from hedges of forecast transactions are not permitted under SFAS 133. The revised IAS 39 also precludes such basis adjustments.
Basis adjustments to non-financial assets or non-financial liabilities resulting from hedges of forecast transactions
(j) The Board decided to permit entities to apply basis adjustments to non-financial assets or non-financial liabilities that result from hedges of forecast transactions. Although US GAAP precludes basis adjustments, permitting a choice in IAS 39 allows entities to meet the US GAAP requirements.

Editorial note: Renumbered 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. Formerly "BC173".
Summary of Changes from the Exposure Draft
BC222. The main changes from the Exposure Draft's proposals are as follows:
Scope
(a) The Standard adopts the proposal in the Exposure Draft that loan commitments that cannot be settled net and are not classified at fair value through profit or loss are excluded from the scope of the Standard. The Standard requires, however, that a commitment to extend a loan at a below-market interest rate is initially recognised at fair value, and subsequently measured at the higher of (i) the amount determined under IAS 37 and (ii) the amount initially recognised, less where appropriate, cumulative amortisation recognised in accordance with IAS 18.
(b) The Standard adopts the proposal in the Exposure Draft that financial guarantees are initially recognised at fair value, but clarifies that subsequently they are measured at the higher of (a) the amount determined under IAS 37 and (b) the amount initially recognised, less, where appropriate, cumulative amortisation recognised in accordance with IAS 18.
Definitions
(c) The Standard amends the definition of 'originated loans and receivables' to 'loans and receivables'. Under the revised definition, an entity is permitted to classify as loans and receivables purchased loans that are not quoted in an active market.

(d) The Standard amends the definition of transaction costs in the Exposure Draft to include internal costs, provided they are incremental and directly attributable to the acquisition, issue or disposal of a financial asset or financial liability.
(e) The Standard amends the definition of the effective interest rate proposed in the Exposure Draft so that the effective interest rate is calculated using estimated cash flows for all instruments. An exception is made for those rare cases in which it is not possible to estimate cash flows reliably, when the Standard requires the use of contractual cash flows over the contractual life of the instrument. The Standard further stipulates that when accounting for a change in estimates, entities adjust the carrying amount of the instrument in the period of change with a corresponding gain or loss recognised in profit or loss. To calculate the new carrying amount, entities discount revised estimated cash flows at the original effective rate.
Derecognition of a financial asset
(f) The Exposure Draft proposed that an entity would continue to recognise a financial asset to the extent of its continuing involvement in that asset. Hence, an entity would derecognise a financial asset only if it did not have any continuing involvement in that asset. The Standard uses the concepts of control and of risks and rewards of ownership to determine whether, and to what extent, a financial asset is derecognised. The continuing involvement approach applies only if an entity retains some, but not substantially all, the risks and rewards of ownership and also retains control (see also (i) below).
(g) Unlike the Exposure Draft, the Standard clarifies when a part of a larger financial asset should be considered for derecognition. The Standard requires a part of a larger financial asset to be considered for derecognition if, and only if, the part is one of:
•   only specifically identified cash flows from a financial asset;
•   only a fully proportionate (pro rata) share of the cash flows from a financial asset; or
•   only a fully proportionate (pro rata) share of specifically identified cash flows from a financial asset.
In all other cases, the Standard requires the financial asset to be considered for derecognition in its entirety.

(h) The Standard retains the conditions proposed in the Exposure Draft for 'pass-through arrangements' in which an entity retains the contractual rights to receive cash flows of a financial asset, but assumes a contractual obligation to pay those cash flows to one or more entities. However, because of confusion over the meaning of the term 'pass-through arrangements', the Standard does not use this term.
(i) The Standard requires that an entity first assesses whether it has transferred substantially all the risks and rewards of ownership. If an entity has retained substantially all such risks and rewards, it continues to recognise the transferred asset. If it has transferred substantially all such risks and rewards, it derecognises the transferred asset. If an entity has neither transferred nor retained substantially all the risks and rewards of ownership of the transferred asset, it assesses whether it has retained control over the transferred asset. If it has retained control, the Standard requires the entity to continue recognising the transferred asset to the extent of its continuing involvement in the transferred asset. If it has not retained control, the entity derecognises the transferred asset.
(j) The Standard provides guidance on how to evaluate the concepts of risks and rewards and of control for derecognition purposes.
Measurement