ESMA calls for clear accounting rules for transactions in which assets are sold below or above their fair value

The European Securities and Markets Authority (ESMA) is seeking international clarifications on an accounting issue that could change the way investors read a company's profit. ESMA has sent a request to the IFRS Interpretations Committee regarding the treatment of the difference between the fair value of certain equity instruments or holdings and the actual price received when they are sold.

In short

ESMA is asking the IFRS Interpretations Committee to clarify the application of IFRS 9 for certain capital instruments measured at fair value through other comprehensive income. The issue arises when the price received upon sale is not equal to the fair value of the instrument at the time of derecognition. European supervisors have observed two different interpretations: the difference is recognized in profit or loss, or it is recognized in other comprehensive income. ESMA states that these situations are not isolated and can be common in transactions involving listed shares, such as block trades, private placements, or accelerated bookbuilding. The accounting treatment can have a significant impact on reported performance and investor decisions.

The letter signed by Verena Ross, the chair of ESMA, concerns the application of the IFRS 9 Financial Instruments standard. IFRS standards are used for the financial reporting of many listed companies, and consistent interpretation matters for the comparability of financial statements between companies and markets.

The issue arises in the case of capital instruments for which the company has chosen to measure at fair value through other comprehensive income, known in financial reporting as FVOCI. Under such treatment, certain fluctuations in fair value are not directly reflected in profit or loss, but in other comprehensive income.

In practice, situations can arise where a company sells such an instrument, but the price received is not identical to the fair value recognized at the time of sale. The difference can arise for various reasons. ESMA mentions cases where parties set the price based on the average quotes from an active market or apply premiums or discounts related to the size of the block of shares sold.

The question is where the difference is reported. The first interpretation states that the difference between the carrying amount at the time of derecognition and the price received should be recognized in profit or loss. Proponents of this interpretation refer to paragraph 3.2.12 of IFRS 9, which states that upon full derecognition of a financial asset, the difference between the carrying amount and the consideration received is recognized in profit or loss.

The second interpretation states that the difference should be recognized in other comprehensive income. Proponents of this approach believe that the specific rules for capital instruments designated as FVOCI function as an exception to the general rule and that all gains and losses related to these instruments, except for dividends, should remain in this area of comprehensive income.

The difference between the two treatments is not merely technical. If the amount is recognized in profit or loss, it directly affects the reported performance of the company for that period. If it is recognized in other comprehensive income, the effect on net profit is different, even if the economic transaction is the same.

ESMA states that it has discussed the issue with supervisory groups outside the European Union, as well as with auditors. The authority's conclusion is that situations where the fair value materially differs from the price received are not isolated and are likely widespread.

The issue can arise especially in transactions involving listed shares measured at Level 1 fair value, that is, based on prices quoted in active markets. ESMA mentions block trades, private placements, and accelerated bookbuilding, situations where large blocks of shares can be sold at a discount or premium relative to the market quote.

In such transactions, the price received may reflect commercial realities that the simple market quote does not fully capture. A large block of shares may require a discount to be placed quickly, and a private transaction may include conditions that make the price different from the fair value recognized in accounting.

ESMA is not asking the IFRS Interpretations Committee to clarify how to measure fair value according to IFRS 13. The request concerns only the accounting treatment of the difference between the carrying amount, that is, the fair value at the time of sale, and the consideration received, regardless of the reason that generated the difference.

The European authority states that the accounting literature does not provide a sufficiently uniform answer. Some sources clearly support treatment through profit or loss, while others indicate uncertainties and call for clarification. The lack of a common interpretation can lead to different practices among issuers, auditors, and markets.

For investors, the consequence is significant. Two companies engaging in similar economic transactions could report different effects on profit if they apply different interpretations of IFRS 9. This can affect the comparability of results, financial indicators, and the performance perceived by the market.

ESMA is asking the IFRS Interpretations Committee to clarify the relevant accounting requirements to ensure a clear, robust, and consistently applied treatment. The request is part of ESMA's convergence work in the supervision of financial reporting, through which the authority seeks to reduce differences in the application of accounting standards in the European Union.

The case shows how an apparently accounting difference can influence the financial picture conveyed to the market. In large transactions involving shares, a few percentage points between the fair value and the price received can mean significant amounts. The place where these amounts are reported can alter profit, subsequent indicators for investors, and the way a company's performance is interpreted.

For European markets, clarification would reduce the risk that the same economic situation is reported differently by different companies. Investors need comparable financial statements, and supervisors need rules that are clear enough to apply the standards consistently.