Accounting for corporate finance: International Financial Reporting Standards: IAS 39: classification of financial assets: tainted HTM investments
Tainting of HTM investments
A company cannot classify any financial assets as held to maturity if it has, during the current financial year or during the two preceding financial years, sold or reclassified more than an insignificant proportion of its held-to-maturity investments before maturity. A company that sells or classifies any significant proportion of its HTM assets must reclassify all of its remaining HTM assets as available-for-sale (see CFM21590) for the remainder of the current period and the next two financial years. After that, they can once more be classified as HTM.
IAS 39 sets out a number of exceptions. Remaining HTM assets are not ‘tainted’ if:
- the assets sold or reclassified are so close to maturity (for example, less than three months before maturity) that changes in the market rate of interest would not have a significant effect on their fair value;
- the sale or reclassification occurs after the company has collected substantially all of the financial asset’s original principal through scheduled payments or prepayments; or
- the sale or reclassification is attributable to an isolated event that is beyond the company’s control, is non-recurring and could not have been reasonably anticipated by the company.
Q plc is a major supplier to a cash-rich trading group headed by X plc, and X plc has a 20% shareholding in Q plc. In 2005, Q plc decides to raise funds through a £12 million bond issue into the market. X plc wishes to extend long-term financial support to its supplier, and agrees to subscribe for £10 million of the bond issue. It has a positive intention to hold the bonds until they mature in 2010, and does not anticipate any financial exigencies that might force an early sale of the bonds. It therefore classifies the bonds as HTM assets. It already holds other HTM investments, which will mature in 2012.
In its financial year ended 30 September 2006, however, there is a change of management at X plc. The new management decides to diversify its suppliers, and reduce the company’s exposure to Q plc; as part of this, X plc decides to sell half of its holding of the bonds.
X plc must reclassify not only its remaining holding of Q plc bonds but also its other HTM investments, as available-for-sale (AFS) assets in its accounts to 30 September 2006, measuring the assets at fair value rather than amortised cost. The profit or loss arising on the reclassification (the difference between fair value and amortised cost) is taken to equity. The nature, effect and reason for the reclassification must be disclosed in its accounts.
X plc must continue to classify the assets as AFS in years ended 30 September 2007 and 2008. In year ended 30 September 2009, it is free to reclassify them as HTM, provided it still intends and is able to hold them to maturity. In this year, however, Q plc is involved in a financial scandal, which leads to a sharp downgrade in its credit rating. X plc feels it prudent to sell its remaining holding of Q plc bonds.
The sale is necessitated by a non-recurring event that X plc could not reasonably have anticipated. Had it thus reclassified the bonds as HTM in 2009 prior to this event, the sale would not result in tainting of the company’s other HTM assets.