For example, assume that a bond with a face value and bullet payment of P50-million and bearing interest of 10-percent per annum is issued for P49-million. The amount of amortization under the effective interest method is lower than that of the straight-line method in the early years, but increases in subsequent years at an increasing rate as the capital value of the bond increases.
IAS 39 requires that transaction costs be included in the initial measurement of financial assets and liabilities, and that these costs also be amortized using the effective interest method for financial assets carried at amortized cost. To implement the effective interest method, several current operational procedures will need to be revisited and amended.
For instance, several areas of data capture would be impacted. In the case of fees, for example, some banks capture such fees as facility level and not at deal level. For IAS 39, it will be necessary to capture fees at trade level upon booking of the transaction.
Treatment of repos and securities borrowing and lending IAS 39 applies the control test in determining whether a financial asset should be de-recognized. For instance, a transferor is considered not to have lost control if it has the right to reacquire the transferred asset on terms that effectively provide the transferee with a lenders return. Instead of de-recognizing the financial asset and recording a sale, such transaction will be treated as collateralized/secured borrowings. Most repos and securities borrowing and lending transactions are, in substance, secured borrowings. IAS 39 requires such transactions to be treated as secured lending/borrowing transactions. The seller/borrower retains the securities lent out on its balance sheet and recognizes a liability to return the cash proceeds received. The buyer/lender recognizes a financial asset for the right to receive "sold" or lent under a repo or securities lending transaction is not derecognized.
IAS 30 will also bring another change in the treatment of loan impairment. IAS 30 requires that amounts set aside for losses on loans and advances in addition to those losses that have been specifically identified should be accounted for as appropriations of retained earnings. Philippine banks now provide for one percent of the general reserves on their total loan portfolio as a charge against current income. Banks should consider the impact of this new requirement on regulatory capital levels, important ratios, and the formulation of their dividend policy.
One of the most common sources of deductible temporary difference is the loan loss provision. Banks in the Philippines have significant deferred tax assets attributable to loan loss provisions. With the implementation of ED 52, banks may have to revisit their recorded deferred tax asset. Future realization of deferred tax assets ultimately depends on the existence of sufficient taxable income. By its very nature, future taxable income requires estimates and judgements about future events that, although predictable, are far less certain than events that have already occurred and can be objectively measured. It is this judgement on future taxable income that will pose the greatest challenge for management in determining the amount of deferred tax asset to be recorded. (To be continued)
(Reprinted from The SGV Review, December 2003 issue)