New Standards for the Classification and Measurement of Financial Instruments

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Abstract

        This research project is a look at the current changes that the Financial Accounting Standards Board (IFRS) and the International Accounting Standards Board (IASB) have made regarding the classification and measurement of financial instruments. This was a joint effort for both Boards in an attempt to standardize accounting processes between the U.S. and other countries so as to avoid another economic crisis that occurred in 2008. The mutual goal was to simplify accounting for financial instruments and to make financial reporting more transparent.

        I begin with a general definition of financial instruments, then move into detailed changes FASB has made. I then go over the changes the IASB has made to the International Financial Reporting Standards (IFRS). I conclude with my opinion on how I think the Standards will affect financial statement users and if I believe the new Standards will actually add clarity to the financial statements.

Introduction

We live in an increasingly complex global economy where, due to economic crisis’ like the which occurred in 2008, it’s becoming clear that there needs to be more standardization between U.S. GAAP and IFRS in financial statement reporting. Thankfully, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) have taken another step toward standardizing accounting processes worldwide by issuing IFRS 9 Financial Instruments (established in July 2014 and replaces IAS 39) and updates to Subtopic 825-10: Financial Instruments—Overall-Recognition and measurement of Financial Assets and Financial Liabilities (expected in the second quarter of 2016). The changes in these standards will create a new framework for the classification and measurement of financial instruments.

For example, under IFRS 9 the “Business Strategy,” financial instruments will be measured by the Fair value through net income (FV-NI), the Fair value through other comprehensive income (FV-OCI), and through amortized cost, all depending on the type of instrument that is being measured ^[1] and ties specific instruments to the overall business strategy. The idea of measuring the instruments in the above fashion is to more clearly identify the cash flows generated by the instrument so companies can no longer hide where the gains and losses are coming from. While FASB was considering following the same model they decided to keep the current GAAP and instead changed the accounting for equity instruments to look more like IFRS’s.

With the changes that FASB and IASB are making we will see significant improvements in the quality of financial statements, making it harder for companies to mislead financial statement users. According to both Boards this was a joint effort to “significantly improve the decision usefulness of financial reporting for users of financial statements” and “simplify the accounting requirements for financial instruments.” ^[2]

Literature Review

        In today’s economy financial instruments take many forms, Bonds, Notes, Stocks, etc., but they all have something in common. They are used to provide businesses and investors with capital. Typically, financial instruments are classified as either an asset, a liability, or an equity investment, and each of these are required to be reported on the financial statements so interested parties can make knowledgeable assessments of the company’s financial health.