TREASURY AND  CASH MANAGEMENT ESSENTIALS

Treasury accounting

An important feature of accounting standards is how quickly they change. They change faster in the treasury arena than in almost any other area.

International Financial Reporting Standards (IFRS)

IFRSs are being increasingly adopted as the global standards. There are five major international standards which particularly affect treasury:

  • IAS 39 covers accounting for derivatives and for hedging decisions, to be superseded by IFRS 9 from 1 January 2018.
  • IFRS 7 covers financial-instrument presentation and disclosure.
  • IAS 17 covers leases, to be superseded by IFRS 16 from 1 January 2019.
  • IAS 21 sets out how reporting entities should include foreign-currency transactions and foreign operations in their financial statements.

IAS 39 and its successor IFRS 9 are considered to be the most demanding of standards, as they cover the rules for hedge accounting for derivatives. In broad terms, all derivatives must be recognized on the balance sheet and carried at fair value; this can create significant income-statement volatility. If the transaction qualifies for hedge accounting and the company chooses to hedge account, some or all of this volatility can be removed or deferred. The ability to use hedge accounting is subject to very demanding criteria, and the introduction of a new general hedge-accounting model in IFRS 9 is generally perceived as a positive change. Compared to IAS 39, IFRS 9 allows more hedging instruments and hedged items to qualify for hedge accounting. Overall, it is trying to align hedge accounting more closely with the organization’s risk management strategies (i.e. the underlying economic rationale for hedging).

Leases provide a source of financing for lessees. However, under current accounting (IAS 17), most leases are not reported on a lessee’s balance sheet. Instead, they are only disclosed in the notes to the financial statements. The International Accounting Standards Board (IASB) has been consulting on changes to lease accounting since 2009. It has decided that a lessee would be required to recognize assets and liabilities arising from all leases, apart from leases of 12 months or less.

IAS 21 has two major objectives: to prescribe how to include foreign-currency transactions and foreign operations in an entity’s financial statements; and to determine how to translate financial statements into a presentation currency. The principal issues are which exchange rate(s) to use and how to report the effects of changes in exchange rates in the financial statements. Because IAS 39 applies to hedge accounting, IAS 21 does not apply to hedge accounting for foreign currency items, including the hedging of a net investment in a foreign operation.

US GAAP

In the US, the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) is the source of authoritative and generally accepted accounting principles (GAAP) recognized by the FASB. The ASC topics that are most specific to treasury are:

  • ASC Topic 815 -Derivatives and Hedging
  • ASC Topic 830 - Foreign Currency Matters
  • ASC Topic 840 – Leases.

ASC Topic 815 – Derivatives and Hedging –
sets out the definition of a derivative instrument and specifies how to account for such instruments, including derivatives embedded in hybrid instruments. There are numerous differences in definitions and criteria in this area, and US GAAP contains more interpretive and implementation guidance than IFRS.

In September, 2016, the FASB issued proposed Accounting Standards Update ASU 216-310 that would make targeted improvements to the accounting guidance for hedging activities and disclosures, including those involving non-financial risk and interest rate risk.

ASC Topic 830 – Foreign Currency Matters –
establishes standards for accounting for foreign-currency transactions. It also provides guidance for translating foreign-currency statements incorporated into an entity’s financial statements.

While there are some minor technical differences between ASC 830 and IAS 21, both require the translation into the ‘functional currency’ of a unit before translation into the reporting currency.

ASC 840 – Leases –
describes and explains the accounting policies and disclosures applicable to leases.

In February 2016, the FASB issued a new leasing Accounting Standards Update (ASU) that will require a lessee to recognize assets and liabilities for finance and operating leases with lease terms of more than 12 months. The new ASU will be effective for public companies (beginning in 2019) and private companies (beginning in 2020).

Changing standards can have a major effect on covenants in loan agreements. A change might alter how some ratios are calculated, and these changes might possibly cause a loan default. For this reason, those standards in place at the date of the loan agreement are used to calculate covenants (in a process known as ‘frozen GAAP’). Multiple sets of accounts may be required as a result, one to meet IFRS and the other(s) to comply with various loan agreements.

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