Unless accounting standard setters and regulators steer a path for convergence between the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) on complex financial instruments standards, Canada’s financial institutions will be caught in the middle of a very delicate situation, Ernst & Young says.

Convergence is particularly important since the credit crisis has shown us that both U.S. and international standards should offer a level playing field for global business, says Ernst & Young.

Applying different accounting methods to international financial institutions can cause confusion and competitive disadvantage, while at the same time challenging the integrity of standard setting processes, it adds.

“As it stands, the IASB and the FASB deal with financial instruments differently,” says Andre de Haan, Partner at Ernst & Young. “This situation will result in a continued lack of uniformity as countries pick and choose approaches they feel are best for them. That defeats the very concept of International Financial Reporting Standards (IFRS).”

He says this is particularly relevant for Canada’s financial institutions, which will have to follow IFRS commencing in 2011. “We’ll be dealing with financial instruments in a very different way than the U.S. — our neighbour and most important trade partner. That leaves Canadian organizations in an awkward and complicated spot.”

In commenting on the IASB’s proposals for International Accounting Standard (IAS) 39, Financial Instruments: Recognition and Measurement, Ernst & Young set out a blueprint, which it believes paves the way forward for the development of a single set of accounting standards for financial instruments. The plan makes proposals on fundamental principles, debt instruments, secured debt, equity instruments, financial liabilities and more. Ernst & Young believes there is common ground, and that the IASB and the FASB should work in a co-ordinated manner to arrive at a mutually acceptable result.

“The inherent complexity and riskiness of financial instruments — not the way they are accounted for — is one of the underlying causes of the financial crisis,” explains de Haan. “Our proposals address the many views of differing stakeholders, and offer a way forward for standards convergence.”

Among the key suggestions, Ernst & Young proposes the following fundamental principles:

• financial instruments would be measured at fair value through other comprehensive income (OCI), fair value through profit or loss or amortized cost; and

• all assets and liabilities held for trading and all derivatives (other than those used for cash flow hedge accounting) should be measured at fair value through profit or loss.

Ernst & Young also proposes that debt instruments, including loans and receivables, should be measured at amortized cost if they meet the following criteria:

• contain only “basic loan features”;

• are “primarily held for collection of principal and interest” (similar to the terminology used in the FASB model, which Ernst & Young believe is clearer than the “managed on a contractual yield basis” proposed by the IASB); and

• meet the IAS 39 definition of loans and receivables, including the absence of quotations from an active market.

IE