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					Memo
To:      International Accounting Standards Board

From:    Accounting Standards Board – Canada, Staff

Date:    January 13, 2009

Re:      Embedded Derivatives: Proposed Amendments to IFRIC 9 and IAS 39



The following comprises the response of the staff of the Canadian Accounting Standards Board
(AcSB) to the IASB’s Exposure Draft on Embedded Derivatives: Proposed amendments to
IFRIC 9 and IAS 39, dated December 2008.

AcSB staff held discussions of the Exposure Draft with the AcSB in the context of considering
the need for similar proposals in Canada. The views expressed in this letter take into account
comments and perspectives raised by members of the AcSB and staff, though they do not
necessarily represent a common view of the AcSB. Views of the AcSB are developed only
through extensive due process.

Overall, we support the proposal in the Exposure Draft that an embedded derivative should be
separated from the host contract when an entity reclassifies a hybrid financial asset out of the fair
value through profit or loss category. However, we are not convinced that the reassessment
must be made on the basis of the circumstances that existed when the entity first became a party
to the contract and we disagree with the transition and effective date for the proposed




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IASB – Embedded Derivatives, December 2008                                   AcSB Staff response


amendments to IAS 39. Our concerns are outlined in our responses to questions 2, 4 and 5 in the
Appendix to this letter.

We would be pleased to elaborate on these points in more detail if you require. If so, please
contact Peter Martin, Director Accounting Standards at +1 416 204-3276 (e-mail
peter.martin@cica.ca) or Ian Hague, Principal at +1 416 204-3270 (e-mail ian.hague@cica.ca).




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IASB – Embedded Derivatives, December 2008                                        AcSB Staff response


Appendix

Responses to questions asked in the Discussion Paper
Question 1

The exposure draft clarifies that an entity must assess whether an embedded derivative is
required to be separated from a host contract when the entity reclassifies a hybrid (combined)
financial asset out of the fair value through profit or loss category.

Do you agree with that clarification? If not, why? What would you propose instead, and why?

We agree that an entity must assess whether an embedded derivative is required to be separated
from a host contract when the entity reclassifies a hybrid (combined) financial asset out of the
fair value through profit or loss category. Without such a requirement, opportunities for
“structuring” contracts to avoid accounting for embedded derivative instruments at fair value
through profit or loss would be available. We agree that accounting for those instruments at fair
value through profit or loss is the only appropriate treatment.

Question 2

The exposure draft requires the assessment to be made on the basis of the circumstances that
existed when the entity first became a party to the contract.

Do you agree with that proposal? If not, why? What would you propose instead, and why?

We are not convinced that reassessment must be made on the basis of the circumstances that
existed when the entity first became a party to the contract.

On the one hand, we agree that reassessment on the basis of the circumstances that existed when
the entity first became a party to the contract ensures that the determination of whether an
embedded derivative is separated remains unaffected by the initial classification of the hybrid
instrument as at fair value through profit or loss. The proposed treatment would maintain
comparability in the accounting for derivative features between:
(i)    those entities that reclassified financial assets with derivatives that were required to be
       separated, and
(ii)   those entities that entered into the same or similar contracts that either (i) remain in the fair
       value through profit or loss category, or (ii) that separated the embedded derivative at
       initial recognition.

On the other hand, we think that the case can be made that the underlying rationale for the
reclassification is the existence of “rare circumstances,” which, by definition, did not exist when
the original classification was made. Thus, there has been an event of economic substance at the
date of reclassification which would justify reassessing based on the circumstances at that date.
Such an approach would avoid the practical difficulties that some might face with obtaining
information to reassess embedded derivatives at the time the entity first became a party to the


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IASB – Embedded Derivatives, December 2008                                     AcSB Staff response


contract. It would also avoid the possibility that entities might apply hindsight in determining fair
values of such embedded derivatives—something that is generally precluded in IFRSs.
Furthermore, we understand that this approach would be more similar to that in US GAAP,
which requires assessment on an ongoing basis, thus requiring assessment at the date of
reclassification.

Question 3

The exposure draft proposes that if the fair value of an embedded derivative that would have to
be separated cannot be reliably measured, the entire hybrid (combined) financial instrument
must remain in the fair value through profit or loss category.

Do you agree with that proposal? If not, why? What would you propose instead, and why?

We agree that if the fair value of an embedded derivative that would have to be separated cannot
be reliably measured, the entire hybrid (combined) financial instrument must remain in the fair
value through profit or loss category.

However, we note that some entities might have reclassified such instruments and could now be
required to put such instruments back into the fair value through profit or loss category, resulting
in a restatement of previously issued financial statements. We return to this issue in questions 4
and 5, below.

Questions 4 and 5

Do you agree with the proposed effective date? If not, why? What would you propose instead,
and why?

Are the transition requirements appropriate? If not, why? What would you propose instead, and
why?

Although we understand that it was always the Board’s intention that embedded derivatives
should have been separated when an entity reclassifies a hybrid (combined) financial asset out of
the fair value through profit or loss category, we understand that some entities might not have
undertaken such an assessment. While the proposed effective date of “annual periods ending on
or after 15 December 2008” is suitable for entities reporting on a calendar year basis, given the
clear statement of the IASB’s position before the end of December 2008, we think that it raises
issues for entities that have reported financial results in November or December 2008,
subsequent to the IASB’s original amendments on reclassification of financial instruments, but
prior to the IASB’s deliberations on this issue.

Application of the transitional provisions in this Exposure Draft could result in such entities
needing to restate previously issued financial statements to reclassify financial instruments back
into the fair value through profit or loss category if an embedded derivative that would have to
be separated cannot be reliably measured. We think that the transitional provision for the
amendment to IAS 39 should be modified so that an entity need not restate previously issued
financial statements. Rather, an entity should be permitted to reclassify the financial instrument



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IASB – Embedded Derivatives, December 2008                                     AcSB Staff response


back into the fair value through profit or loss category at the beginning of the next reporting
period.




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