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sappi 14 September 2009 Sappi Limited (Reg. no. 1936/008963/06) PO Box 31560 2017 Braamfontein South Africa Tel +27 (0)11 407 8111 Fax +27 (0)11 403 8854 www.sappi.com Sir David Tweedie, Chairman International Accounting Standards Board 30 Cannon Street LONDON EC4M 6XH United Kingdom Email: [email protected] Dear Sir EXPOSURE DRAFT ON FINANCIAL INSTRUMENTS: CLASSIFICATION AND MEASUREMENT Sappi Limited is pleased to comment on the International Accounting Standards Board (the”IASB” or the “Board”)’s Exposure Draft on Financial Instruments: Classification and Measurement (the “ED”). Our primary basis of reporting is International Financial Reporting Standards (IFRS), but we are required to comply with certain filing requirements of the Securities Exchange Commission (SEC) in the United States of America due to our listing on the New York Stock Exchange Stock Exchange. We therefore are encouraged by the Board’s commitment to simplify the accounting for financial instruments as well as the Board’s current projects in converging IFRS with US GAAP. We would also like to encourage that convergence should not merely occur for the sake of convergence, but should also produce higher quality financial statements than those that would result from applying the two frameworks separately. We would like to thank you for the opportunity to provide comments on this document. Our detailed responses to the invitation to comment questions are included in Appendix A. Please do not hesitate to contact me should you wish to discuss any of our comments. Yours sincerely Moses Sekgobela Group Reporting Manager Directors: Dr D C Cronjé (Chairman), Messrs R J Boëttger (Chief Executive Officer), D C Brink, J E Healey (USA), H C Mamsch (Germany), J D McKenzie and M R Thompson, Drs D Konar and F A Sonn, Mses K R Osar (USA) and B Radebe, Prof M Feldberg (USA), Sir A N R Rudd (UK) Secretaries Sappi Management Services (Pty) Ltd (Reg No 1989/001134/07) SAPPI LIMITED SUBMISSION ON THE EXPOSURE DRAFT - FINANCIAL INSTRUMENTS: CLASSIFICATION AND MEASUREMENT Appendix A: Invitation to comment General comments We note that the Board’s intention in undertaking the project on replacing IAS 39 is to simplify the accounting for financial instruments. We are of the view that simplification should also allow easier comparison of financial instruments across the globe. We are therefore not supportive of allowing a number of alternative treatments of financial instruments. The ED asks questions on alternative treatments from the amortised cost and fair value approaches. We support using the two approaches since we appreciate that financial instruments would generally have different characteristics and would be held by entities for different reasons. Allowing alternative approaches with possible variations as the ED suggests would make it difficult to compare entities purely due to accounting policy choices. The proposed alternative treatments are not simple and could add confusion to users of financial statements given that the main intention of the ED is to simplify the accounting for financial instruments. The alternative approaches introduce a concept of dual fair value/amortised cost option which may be confusing for users of financial statements. Users of financial instruments who may be interested in fair values of financial instruments that are carried at cost or amortised cost can have this need met by the disclosures required by IFRS 7. We therefore encourage the Board to limit alternative approaches as far as possible in order to simplify IFRS and broaden the value that users of financial instrument can derive from comparing general purpose financial statements of different entities. Question 1 Does amortised cost provide decision-useful information for a financial asset or financial liability that has basic loan features and is managed on a contractual yield basis? If not, why? Yes. Amortised cost represents a fair reflection of the cash flows expected from a financial asset or financial liability that an entity intends or expects to hold and recover or settle in line with the contractual rights and obligations embodied in the asset or liability. Accounting for temporary movements in fair value that will not affect the recoverable or settlement value of a financial asset or liability would not enhance the decision usefulness of the amount that the asset or liability is carried at, as at balance sheet date. We also note that for some of the financial instruments that meet the Boards’ two conditions for accounting at amortised cost, the fair value approximates amortised cost most of the time. Question 2 Do you believe that the exposure draft proposes sufficient, operational guidance on the application of whether an instrument has ‘basic loan features’ and ‘is managed on a contractual yield basis’? If not, why? What additional guidance would you propose and 2 SAPPI LIMITED SUBMISSION ON THE EXPOSURE DRAFT - FINANCIAL INSTRUMENTS: CLASSIFICATION AND MEASUREMENT why? Yes we believe that the ED outlines sufficient guidance in the application of whether an instrument needs to be measured at amortised cost. The ED also gives examples of instruments that the Board believes to meet the two conditions. We accept that the Board is not expected to provide an exhaustive list of instruments as guidance; stakeholders would need to apply the overriding principles in assessing specific circumstances that are encountered in applying the proposed standard. Question 3 Do you believe that other conditions would be more appropriate to identify which financial assets or financial liabilities should be measured at amortised cost? If so, a) b) c) what alternative conditions would you propose? Why are those conditions more appropriate? if additional financial assets or financial liabilities would be measured at amortised cost using those conditions, what are those additional financial assets or financial liabilities? Why does measurement at amortised cost result in information that is more decision-useful than measurement at fair value? if financial assets or financial liabilities that the exposure draft would measure at amortised cost do not meet your proposed conditions, do you think that those financial assets or financial liabilities should be measured at fair value? If not, what measurement attribute is appropriate and why? We have not identified any more conditions which may be appropriate in identifying which financial assets or financial liabilities should be measured at amortised cost. Question 4 a) Do you agree that the embedded derivative requirements for a hybrid contract with a financial host should be eliminated? If not, please describe any alternative proposal and explain how it simplifies the accounting requirements and how it would improve the decision-usefulness of information about hybrid contracts. We agree that eliminating the embedded derivative requirement for hybrid contract with a financial host would simplify the accounting for hybrid contracts in line with the Board’s intention in re-writing IAS 39. b) Do you agree with the proposed application of the proposed classification approach to contractually subordinated interests (ie tranches)? If not, what approach would you propose for such contractually subordinated interests? How is that approach consistent with the proposed classification approach? How would that approach simplify the accounting requirements and improve the decision usefulness of information about contractually subordinated interests? We agree with the proposed classification for the contractually subordinated tranches. Since these no longer have basic loan features it would be consistent with the basic principles of the proposed standard to account for these at fair value. 3 SAPPI LIMITED SUBMISSION ON THE EXPOSURE DRAFT - FINANCIAL INSTRUMENTS: CLASSIFICATION AND MEASUREMENT Question 5 Do you agree that entities should continue to be permitted to designate any financial asset or financial liability at fair value through profit or loss if such designation eliminates or significantly reduces an accounting mismatch? If not, why? Yes. The need to eliminate or reduce accounting mismatches continues to exist and therefore the fair value option is also necessary. In addition, for entities that manage their financial instruments in line with IAS 39.9 (b) (ii), the fair value option would continue to allow such entities to present information that is of a better decision useful nature. Question 6 Should the fair value option be allowed under any other circumstances? If so, under what other circumstances should it be allowed and why? We have not identified any other circumstances under which the fair value option needs to be available to entities. Question 7 Do you agree that reclassification should be prohibited? If not, in what circumstances do you believe reclassification is appropriate and why do such reclassifications provide understandable and useful information to users of financial statements? How would you account for such reclassifications, and why? We agree that re-classifications should be prohibited. Allowing reclassifications makes comparability difficult and entities would be able to reclassify when the result of the initially adopted approach is not what is desired by management while the other approach gives a result that may be favourable. Question 8 Do you believe that more decision-useful information about investments in equity instruments (and derivatives on those equity instruments) results if all such investments are measured at fair value? If not, why? We believe that fair value provides decision useful information in most circumstances for investments in equity instruments. Fair value derived from quoted markets represents the price (or a good starting point in arriving at that price – many investments eventually get sold at a premium or discount to quoted prices) at which the investments in equity instruments can be recovered at, as at balance sheet date. This is decision useful information to users of financial statements. Movements in fair values of quoted equity instruments affect the recoverable value of the investments and therefore accounting for the investments at fair value would enhance the decision usefulness of the amount that the asset or liability is carried at, as at balance sheet date. However for unquoted investments in equity instruments where fair value cannot be measured reliably, we believe the current requirements of IAS 39 are better at providing useful information when the time and cost involved are taken into account. 4 SAPPI LIMITED SUBMISSION ON THE EXPOSURE DRAFT - FINANCIAL INSTRUMENTS: CLASSIFICATION AND MEASUREMENT Question 9 Are there circumstances in which the benefits of improved decision-usefulness do not outweigh the costs of providing this information? What are those circumstances and why? In such circumstances, what impairment test would you require and why? Yes, there are circumstances in which the benefits of improved decision-usefulness do not outweigh the costs of providing this information. Whereas we agree with the view that the IAS 39 requirement to calculate the recoverable amount of investments in equity instruments that are not quoted and are carried at cost requires an effort similar to a fair value calculation which in most cases would be classified as requiring level 3 inputs in terms of the IFRS 7 fair value hierarchy, we note that this requirement to calculate fair value is only necessary when there is an indication that an impairment may have occurred. Where there is no indication of impairment, the costs of a fair value calculation would outweigh the benefits that may be obtained from doing the calculation. Some entities hold ‘investments in unquoted equity investments for which a reliable fair value measure cannot be determined’ for strategic reasons and where there is no indication of impairment, entities should not be required to calculate a recoverable amount for such investments. The investments would not be carried at amounts in excess of recoverable values and therefore will not result in overstatement of assets. The costs of calculating a value in such a case would outweigh the benefits obtained. As the investment is held for strategic reasons there is no benefit that can be derived from writing up the value of the investment due to temporary movements in market factors. We therefore believe that more cost effective and decision useful information would be provided if unquoted equity investments are carried at cost and an impairment calculation that is similar to a fair value calculation is only performed when there is an indication that the investment may be impaired. Where there is no objective evidence of impairment the cost method is the simpler and cost effective measurement basis. Question 10 Do you believe that presenting fair value changes (and dividends) for particular investments in equity instruments in other comprehensive income would improve financial reporting? If not, why? For entities whose main business is to benefit from changes in fair values of equity instruments (for example; investment entities) presenting fair value changes and dividends in profit or loss would be appropriate. This is because the company’s performance from core operations can be judged from its profit or loss for the period, which includes changes in fair values of equity investments and dividends from such investments. However for entities that do not invest in equity instruments as part of their core operations (for example; mining or retail entities) presenting fair value changes and dividends in other comprehensive income would be more appropriate. This is because the company’s performance from core operations can be judged from its profit or loss for the period before taking other comprehensive income into account. This will aid decision making by stakeholders. 5 SAPPI LIMITED SUBMISSION ON THE EXPOSURE DRAFT - FINANCIAL INSTRUMENTS: CLASSIFICATION AND MEASUREMENT Question 11 Do you agree that an entity should be permitted to present in other comprehensive income changes in the fair value (and dividends) of any investment in equity instruments (other than those that are held for trading), only if it elects to do so at initial recognition? Yes, we agree that only when the election is made at initial recognition should changes in fair values of equity instruments (and dividends) be presented in other comprehensive income. As explained in the previous question, the business decision to enter into the investment in the first place must drive how the changes in the fair value of the investments are presented in the financial statements. If not, a) how do you propose to identify those investments for which presentation in other comprehensive income is appropriate? Why? Only changes in the fair value and dividends received on equity instruments which the entity has designated to be accounted for at fair value though other comprehensive income at initial recognition and in line with the business rationale for acquiring the investment in the equity instruments should be presented in other comprehensive income. Subsequent changes could allow entities to report desired results in financial statement and not what has actually occurred in line with their original business intentions and elected accounting policies. b) should entities present changes in fair value in other comprehensive income only in the periods in which the investments in equity instruments meet the proposed identification principle in (a)? Why? Yes. Strict principles that are in line with an entity’s intention when investing in an equity instrument should be applied without allowing for changes that could allow entities to change the reporting for investment in equity instrument because such changes could be driven by the favourability of the outcome of the fair value calculation. Business reasons for entering into equity investments can be expected to align to each entity’s operations and therefore only changes to business intentions or strategies should result in a change in the intention to acquire equity investments. It is accepted that an entity’s main business strategy will not change very often and therefore the intention on initial recognition should dictate the accounting treatment. Some business may be such that an entity may hold an equity investment for different reasons at initial recognition; in this case, because of an entity’s business model investments with similar characteristics may be held for different reasons, that reason at initial recognition should drive the accounting treatment without subsequent changes. Question 12 Do you agree with the additional disclosure requirements proposed for entities that apply the proposed IFRS before its mandated effective date? If not, what would you propose instead and why? 6 SAPPI LIMITED SUBMISSION ON THE EXPOSURE DRAFT - FINANCIAL INSTRUMENTS: CLASSIFICATION AND MEASUREMENT We do not agree with the proposed additional disclosure for entities that apply the proposed IFRS before its mandated effective date because: the additional disclosures are only required for entities who adopt the proposed IFRS early and because such disclosures may involve extra investments in time and costs they may discourage early adoption – this would go against one of the Board’s intentions in undertaking the replacement project one of which includes simplified accounting for financial instruments as soon as this is practicable generally entities that adopt IFRS early only have to disclose this fact with no additional disclosures the additional disclosures are not in line with the principle to simplify the accounting for financial instruments The adoption of the proposed IFRS should follow the established practice of adopting other IFRSs. Entities that adopt the draft IFRS on the effective date would not have disclose the comparison of carrying amounts at initial adoption while early adaptors would be required to. The requirements for early adaptors will be similar to retrospective application (disclosing comparable amounts under IAS 39 for the same period) while entities adopting from the effective date are allowed to apply what is similar to prospective application (without the need to disclose comparable amounts derived under IAS 39 for the same period). Comparison of carrying values under IAS 39 and the proposed IFRS should not be necessary given that the new approach will be simplified and easier to use for decision making. Question 13 Do you agree with applying the proposals retrospectively and the related proposed transition guidance? If not, why? What transition guidance would you propose instead and why? We agree with the proposed retrospective application of the proposed IFRS. With the proposed transition guidance, the Board provides relief where retrospective application may be impracticable and we therefore welcome the inclusion of the transition guidance. Question 14 Do you believe that this alternative approach provides more decision-useful information than measuring those financial assets at amortised cost, specifically: a) b) in the statement of financial position? in the statement of comprehensive income? If so, why? We do not believe that the alternative approach will provide more decision useful information because: 7 SAPPI LIMITED SUBMISSION ON THE EXPOSURE DRAFT - FINANCIAL INSTRUMENTS: CLASSIFICATION AND MEASUREMENT It deviates from the IASB intention to simplify the accounting for financial instruments. It will continue to confuse investors as it has the effect of allowing a dual fair value/amortised cost approach. It would be better for financial reporting if IFRSs move away from allowing alternative treatments as these hinder comparison of financial statements between different entities The alternative approach may encourage entities to adopt policies that show results that in reality may not be achievable because entities managing instruments on a contractual yield basis may be encouraged to report instruments at fair values that appear favourable albeit different amounts will be recovered from assets or required to settle liabilities in terms of the contractual terms of the instruments. (a) Statement of financial position - For entities whose financial instruments meet the two criteria to be accounted for at amortised cost there would be no need to account for the difference between amortised cost and fair value as this is not in line with how their operations are run or how the instruments are managed and it would not provide any extra information essential for decision making. We also note that IFRS 7 currently requires disclosures of fair value for financial instruments as at balance sheet date – this would continue to meet the need for users who are still interested in fair value. (b) Statement of comprehensive income - The statement of comprehensive income may report profits or losses that could potentially never be realised. Assets managed on a contractual yield basis would be expected to be recovered at contracted cash flow amounts. Depending on movements in market factors, the fair values may change in any direction but in reality the financial instruments may never be recovered or settled at those fair values but these fluctuations would be reported in other comprehensive income. Such presentation may lead to incorrect decisions by the users of financial statements. Question 15 Do you believe that either of the possible variants of the alternative approach provides more decision-useful information than the alternative approach and the approach proposed in the exposure draft? If so, which variant and why? Per answer to Question 14, we do not believe that the alternative approach or its variants would provide more decision useful information nor would these alternatives or variants simplify the accounting for financial instruments. 8