Hi All, hoping someone can shed a little light on what I’m sure should be a simple concept, but one which unfortunately I’m really struggling to get to grips with.
With regard to accounting for financial assets, what are the actual characteristic differences between an asset classified as Available for Sale vs. one classified as Held for Trading? I understand the different impacts on the various financial statements, however after reading through both the Schweser and CFAI materials a couple of times I still can’t explain in my mind how a business would actually reach the conclusion to report one way or the other. Wouldn’t an asset Held for Trading by definition be available for sale?
The lack of understanding flows through to the text’s discussion of IFRS9; there’s a handy decision tree, but unfortunately the branches from the ‘Designated at FVOCI?’ node are simply labelled ‘Yes’ or ‘No’, with no further context - I understand that the business decision/interpretation will follow the same logic here.
Beating my head against the desk over this one haha. Obviously could have important ramifications for company analysis with regard to earnings measurements etc. Appreciate any assistance!
You are referring to two categories for which the accounting treatment differs as per ias 39:
(1) Fin assets at fair value through profit and loss category(includes held for trading assets and those assets that the company at initial recognition decides to include in this category) and
(2) Available for sale category
For (1) above the unrealised gain / loss due to fair value adjustment goes to profit and loss for (2) unrealised gain / loss due to fair value adjustment goes to other comp income (OCI) and when the asset is sold the unrealized accumulated gain / loss in the OCI is routed through PnL by debiting OCI (incase of accumulated gain in OCI) and crediting PnL (remember this for now)
Decision as to the classification b/w (1) and (2) goes this way:
If the company decides to sell the security in the short run then it is held for trading and hence (1) or the company may also designate it as catagory (1) even if it doesn’t intend to sell it in the short run (1 year) i.e. its a choice as well
if either of the above conditions are not met the asset is an available for sale asset i.e. category (2) thats why it is also called default category / residual category
FVOCI category (fair value through other comprehensive income as per IFRS 9 (which will ultimately superseed IAS 39) is similar to the (2) category however upon sale the unrealised accumulated gain / loss in OCI is not routed through PnL . Also in IFRS 9 this is not a default category company has to designate an asset as FVOCI otherwise it will go to FV through PNL.
If the asset is a risky one and is quite volatile company may decide to keep it in default AFS(IAS39) category to avoid volatility in the profit and loss account.
HFT are very similar from an operating point of view to inventory - these are instruments, which are bought and sold constantly and the entity is hardly interested in holding them for their contractual benefits, rather they want to trade them. All gains and losses go through P&L here (both realized and unrealized, i.e. even for instruments not sold, just because of changes in their fair value).
AFS instruments are more similar to HTM instruments, where the entity is kind of interested to collect the contractual cash flows, but is still open to selling them rather than holding them until maturity. Only realized gains and losses go through P&L here (unrealized gains and losses directly impact other comprehensive income, i.e. equity).
Obviously, while there are judgments to be made by companies, in most cases the standards dictate what the classification should be (unless the entity wants to be in breach of the standards).
This is an interesting topic, one comment regards to the cash flow statement classification as it is not covered in the CFAI curriculum.
It is notes that under guidence of latest US Gaap, or IAS 39 and IFRS 9, there is no hard rule set for the classification of cash flow for HFT or AVS. E.g. if HFT or AVS cash activity should go to CFO or CFI should be classified by the business that is carried out by the entity. This is different to what it was shown in old IAS7. Having said that cash flow activity should not include any unrealized gain and loss.