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IFRS Disclosure of risk management policy

IFRS Disclosure of risk management policy

IFRS Disclosure of risk management policy :IFRS 7, Financial Instruments: Disclosures, consolidates and expands a number of existing disclosure requirements and adds some significant and challenging new disclosures. It is applicable for annual periods beginning on or after 1 January 2007, with prior year comparatives required. Some of the requirements of IFRS 7 will be familiar due to the fact that it is, in part, a replacement of IAS 32, Financial Instruments: Presentation, while others – such as the requirement to provide quantitative and qualitative market risk disclosures – are new and may represent a significant challenge for many. Many entities have not yet focused on the extent of the expanded disclosures or the systems and processes required to produce them. Some entities may also be unaware of how they will be impacted by the requirement to disclose internal company management information externally. Outlined below are some of the key elements of IFRS 7 to help you understand its impact, who the standard applies to and how urgently it needs to be tackled.

IFRS Disclosure of risk management policy: Determination of the criteria used to classify financial instruments Entities will need to disclose the measurement basis or bases used, and the criteria used to determine classification for different types of instruments.

The IFRS 7 application guidance requires specific disclosures to be made, including the criteria for:

  • Designating financial assets and liabilities at fair value.
  • Designating financial assets as available-for-sale.
  • Determining when an impairment is recorded against the related financial asset or when an allowance account is used.

Disclosure of the components of the fair value movement for items classified as fair value through profit and loss Where financial assets or liabilities are carried at fair value through profit and loss (FVTPL), IFRS 7 requires disclosure of the breakdown of the change in the fair value of these items.

This would include, for example, showing the split between changes due to benchmark market rate movements and credit. For example, where a company invests in an interest bearing corporate bond, the change in the fair value of that bond will be due, in part, to movements in benchmark interest rates (eg, BBSW or LIBOR) and any changes in the credit worthiness of the issuing corporate. Disaggregating the fair value movements into these two components is likely to be a significant systems challenge for many. At the same time, it will provide investors and users of the financial statements with an unprecedented level of information about the credit quality and trends of the entity’s investments. Where companies elect to designate their own liabilities (such as bonds they have issued) at FVTPL they will be required to inform investors about the impact that movements in their own credit quality have had on the value of those bonds.

Discussion of the capital management strategy

Simultanaously to the release of IFRS 7, an amendment was made to IAS 1, Presentation of Financial Statements. This relates to capital management disclosures that companies may opt to combine with their risk management information for IFRS 7 disclosure purposes. The main requirements are to disclose quantitative and qualitative information about the entity’s objectives, policies and processes for managing capital. When subject to external regulatory requirements, a statement of compliance is also required. This introduces a significantly enhanced level of disclosure about a company’s capital management strategy, as well as the implications of its regulatory requirements. Best practice will be to present a clear and well defined picture of how the strategy enhances shareholder value, while meeting regulators’ expectations.

IFRS Disclosure of risk management policy: Qualitative disclosures about risks faced and the strategies

Used to manage them For each type of risk (credit risk, liquidity risk and market risk) a qualitative narrative is required.

This should:

  • identify the risk exposures of financial instruments and how they arise;
  • identify the objectives, policies and processes for managing the risks and methods used to measure risk; and
  • describe any changes from the previous reporting period.

In conjunction with the required quantitative disclosures (see below), this is perhaps one of the most significant disclosures introduced by IFRS 7.Essentially, IFRS 7 requires the company to tell the world what risks weigh on the minds of management and what it is doing about them. It follows that those who have a good story to tell, and tell it clearly, will potentially be rewarded in the marketplace.

IFRS Disclosure of risk management policy: Quantitative disclosures about the potential impacts of market risks

  • For each type of risk, entities must disclose summary quantitative data on risk exposure at reporting date, based on information provided internally to key management personnel and any concentrations of risk.
  • Entities must also ensure they disclose the following information related to credit risk, liquidity risk and market risk: Credit risk
  • An entity’s maximum exposure to credit risk and any related collateral held.
  • Information on credit quality of assets that are neither past due or impaired.
  • Analysis of the age of financial assets that are past due but not impaired.
  • Analysis of financial assets that are individually determined to be impaired. Liquidity risk
  • A maturity analysis for financial liabilities showing the remaining contractual maturities and a description of the approach to managing the inherent liquidity risk.

IFRS Disclosure of risk management policy: Market risk

  • A sensitivity analysis for each type of market risk (currency, interest rate and other price risk) to which an entity is exposed at reporting date. This should illustrate how profit or loss and equity would have been affected by ‘reasonably possible’ changes in the relevant risk variable, as well as the methods and assumptions used in preparing such an analysis.
  • Any changes in methods and assumptions from the previous period and reasons for such a change.

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