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COMMISSION REGULATION (EC) No 1329/2006 of 8 September
2006 amending Regulation (EC) No 1725/2003 adopting
certain international accounting standards in accordance
with Regulation (EC) No 1606/2002 of the European
Parliament and of the Council
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Reassessment of Embedded Derivatives
References
— IAS 39 Financial Instruments: Recognition and Measurement
— IFRS 1 First-time Adoption of International Financial Reporting
Standards
— IFRS 3 Business Combinations
Background
1. IAS 39 paragraph 10 describes an embedded derivative as ‘a
component of a hybrid (combined) instrument that also includes a
non-derivative host contract — with the effect that some of the cash
flows of the combined instrument vary in a way similar to a
stand-alone derivative.’
2. IAS 39 paragraph 11 requires an embedded derivative to be
separated from the host contract and accounted for as a derivative
if, and only if:
(a) the economic characteristics and risks of the embedded
derivative are not closely related to the economic
characteristics and risks of the host contract;
(b) a separate instrument with the same terms as the embedded
derivative would meet the definition of a derivative; and
(c) the hybrid (combined) instrument is not measured at fair
value with changes in fair value recognised in profit or loss
(ie a derivative that is embedded in a financial asset or
financial liability at fair value through profit or loss is not
separated).
Scope
3. Subject to paragraphs 4 and 5 below, this Interpretation applies
to all embedded derivatives within the scope of IAS 39.
4. This Interpretation does not address remeasurement issues arising
from a reassessment of embedded derivatives.
5. This Interpretation does not address the acquisition of contracts
with embedded derivatives in a business combination nor their
possible reassessment at the date of acquisition.
Issue
6. IAS 39 requires an entity, when it first becomes a party to a
contract, to assess whether any embedded derivatives contained in
the contract are required to be separated from the host contract and
accounted for as derivatives under the Standard. This Interpretation
addresses the following issues:
(a) Does IAS 39 require such an assessment to be made only when
the entity first becomes a party to the contract, or should the
assessment be reconsidered throughout the life of the contract?
(b) Should a first-time adopter make its assessment on the basis
of the conditions that existed when the entity first became a
party to the contract, or those prevailing when the entity
adopts IFRSs for the first time?
Consensus
7. An entity shall assess whether an embedded derivative is required
to be separated from the host contract and accounted for as a
derivative when the entity first becomes a party to the contract.
Subsequent reassessment is prohibited unless there is a change in
the terms of the contract that significantly modifies the cash flows
that otherwise would be required under the contract, in which case
reassessment is required. An entity determines whether a
modification to cash flows is significant by considering the extent
to which the expected future cash flows associated with the embedded
derivative, the host contract or both have changed and whether the
change is significant relative to the previously expected cash flows
on the contract.
8. A first-time adopter shall assess whether an embedded derivative
is required to be separated from the host contract and accounted for
as a derivative on the basis of the conditions that existed at the
later of the date it first became a party to the contract and the
date a reassessment is required by paragraph 7.
Effective date and
transition
9. An entity shall apply this Interpretation for annual periods
beginning on or after 1 June 2006. Earlier application is
encouraged. If an entity applies the Interpretation for a period
beginning before 1 June 2006, it shall disclose that fact. The
Interpretation shall be applied retrospectively.
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