Question on IAS39

Gill Gittings

Can someone explain how the tainting rules work in this standard please? I'm clueless on financial instruments.

Steve Collings

Hi

Entities cannot classify a financial instrument as 'held-to-maturity' if they have sold or reclassified a significant amount of held-to-maturity investments before maturity. The standard itself requires management to confirm that the relevant criteria have been met to classify investments as held-to-maturity. If management have sold/reclassified (or where put options have been exercised) this will call into question (taint) management's intentions to hold all securities in the held-to-maturity category. So if management have sold/reclassified a significant amount of investments in the held-to-maturity category the entity will be prohibited from classifying any financial asset as held to maturity category for 2 years after the occurrence of this event. To illustrate:

consider an entity which has a portfolio of investments consisting of corporate bonds, treasury bonds and eurodollar bonds. Year end = 31 December and during September of the reporting year it sold a certain eurodollar bond to realise a large gain.

Just because the entity has sold 1 eurodollar investment (which is not considered insignifcant in relation to the total held-to-maturity portfolio) it does not mean that only the eurodollar sub-category has been tainted. The tainting rule is very clear - if an entity has sold or reclassified more than an insignificant amount of held-to-maturity investments, the entire portfolio and all remaining investments must be reclassified to the available-for-sale category. It follow that sub-classification of securities for the purpose of limiting the impact of sales/transfers of held-to-maturity investments is not acceptable in practice.

The reclassification is recorded in the reporting period in which the sales occurred (ie to 31 December) and the entity will be prohibited from reclassifying any investments in the held-to-maturity category for 2 full financial years.

When the portfolio becomes cleansed after 2 full financial years, and it once again becomes appropriate to carry investments at held-to-maturity, the fair value of the affected securities becomes the new amortised cost. Also, worth mentioning, is that in the year tainting occurs the held-to-maturity classification in the comparative year prior to tainting is not affected.

I hope that helps - it's relatively easy once you get your head around it.

Best regards
Steve

Gill Gittings

Wow! Thanks Steve. Just one more question . How would the sale of a held to maturity investment for replenishing capital affect the portfolio of instruments held for maturity?
I'm revising for P2 and it's doing my head in.

Steve Collings

If the sale was to realise a gain to replenish regulatory capital then this would taint the entire held-to-maturity portfolio because undertaking a sale to realise gains for this purpose is inconsistent with the held-to-maturity classification.

Gill Gittings

Steve thanks for this. I've been struggling with these issues for days. You're brill!
Gill xx

Steve Collings

Would you object if I were to use this question as part of a future article for AccountingWEB?

Kind regards
Steve

Gill Gittings

Oh no Steve feel free. I always read your stuff on Accountingweb. When will it be in?

Steve Collings

I'm not sure at the moment as my slots are pretty much covered for the time being. Your question would feature in a 'FAQ' sort of article. I have drafted one for this week's wire so it's too late for that, but I'll try and get it in a slot soon.

Best regards
Steve