...for a true and fair view of financial statements


Oct 14 - 20, 2002

The International Accounting Standard (IAS) 39 "Financial Instruments: Recognition and Measurement" was adopted by the Securities and Exchange Commission of Pakistan (SEC) in July 2001 on the recommendation of the Institute of Chartered Accountants of Pakistan (ICAP). It became applicable to listed companies for accounting periods beginning on or after July 1, 2001. As such, the first year of implementation of the IAS in Pakistan was the recently concluded financial year 2001-02.

IAS 39 establishes principles for recognizing, measuring and disclosing information about financial assets and financial liabilities. It has been adopted by the SEC to further improve the financial reporting framework of listed companies in Pakistan. The principles contained in IAS 39 have been adopted in other jurisdictions as well, including UK and Singapore, where comparable national standards have been issued.

IAS 39 significantly increases the use of fair values in accounting for financial instruments. This IAS addresses a major shortcoming of the previously used IAS 25 "Accounting for Investments", which allowed investments to be reported at cost, lower of cost and market, or fair value. As a result, the accounting policies followed by companies for measurement of investments under IAS 25 largely varied. It is expected that with the adoption of IAS 39, there will be a consistent basis for recognition and measurement of financial instruments. IAS 39 has also categorized financial assets as 'financial assets held for trading', 'held to maturity investments', 'loans and receivables originated by enterprise' and 'available for sale financial assets' as opposed to the classification of investments as current or long term, used in IAS 25.

Under IAS 39, use of fair values is required for (i) debt securities, equity securities and other financial assets held for trading (ii) debt securities, equity securities and other financial assets that are not held for trading but nonetheless are available for sale (iii) nearly all derivative assets and derivative liabilities (iv) certain non-derivative assets and liabilities (v) fixed maturity instruments that a company does not designate as held to maturity and (vi) purchased loans and receivables that a company does not designate as held to maturity. It is pertinent to consider that not only was there an inconsistent recognition and measurement basis for investments before the adoption of IAS 39 but also the derivative assets and derivative liabilities were often not recognized, let alone measured at fair value.

The three classes of financial assets that are required to be carried at cost under IAS 39 are loans and receivables originated by the enterprise, other fixed maturity investments that a company intends and is able to hold to maturity and unquoted financial instruments whose fair value cannot be reliably measured. The IAS also provides detailed guidance on estimating fair value of financial instruments.

Although IAS 39 was adopted and notified by the SEC in July last year, the listed companies did not play a proactive role in its implementation. It was not until the accounting year-end approached that companies raised queries about the application of IAS 39. As a result, implementation of IAS 39 has recently been deferred by the State Bank of Pakistan (SBP) for banks and those Non-Banking Financial Institutions (NBFI) that fall under its purview. The deferral has come about due to conflicts between certain requirements of IAS 39 and prudential regulations of the SBP regarding provision on non- performing assets and recognition of profit/ interest on such assets. It is essential to ensure early resolution of these conflicts so that IAS 39 can be applied to the entire financial sector.

As regards the NBFIs that are subject to regulation by the SEC, no deferment of IAS 39 has been announced. The SEC is cognizant of tax anomalies that would arise in case of certain NBFIs once IAS 39 is implemented. These tax anomalies will result primarily from a rigid application of tax laws and not from IAS 39. It must be appreciated that adherence to IAS 39 in preparation of financial statements will help improve the presentation and disclosures of such statements. Any deferment or suspension of IAS 39 will not be a plausible solution; rather it is essential that application of the IAS is rigorously pursued by companies while th,e tax laws are suitably amended by the Central Board of Revenue (CBR).

The SEC, at different forums, has expressed its commitment to ensure effective implementation of IAS 39 by all listed companies under its purview. However, it has made necessary relaxations, where so deemed necessary, to give relief to different sectors without drastically mutating the requirements of IAS 39. Consequently, mutual funds have been allowed to recognize unrealized gain directly in equity in case of investments held for trading although the same is required by IAS 39 to be included in the profit/ loss for the year. The relaxation has been given to mutual funds in consideration of tax implications arising from inclusion of unrealized gain in income statement. This relaxation has been given until suitable amendments are made in tax laws. The SEC has already forwarded its recommendations to the Finance Division in this regard.

IAS 39 does not apply to leasing companies insofar as their leasing operations are concerned since rights and obligations under leases are covered by IAS 17 and are specifically excluded from the scope of IAS 39. As regards any other business undertaken by leasing companies, including investments in listed/ unlisted equity and debt securities, the SEC has explained that IAS 39 will fully apply. An exception, however, exists in case of term loans given by leasing companies. For term loans, Rule 10 of the Leasing Rules, 2000 will override the requirements of IAS 39 for recognizing impairment loss and interest income after impairment. It is pertinent to consider that term loans constitute a very small portion of investment by leasing companies and this exception is not likely to have a material impact.

It is essential that the impediments in effective implementation of IAS 39 are appropriately addressed. We must strive to improve the quality of our corporate financials; compliance with internationally accepted accounting standards is one of the most significant requirements in this regard. While the SEC has adopted a firm approach in implementing IAS 39, the desired outcome cannot be achieved unless it is applied across the entire sector. The focus should, therefore, be on removing inconsistencies between the relevant laws, in particular the tax laws, and the accounting standards.