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1 CHAPTER 1 INTRODUCTION OF THE STUDY ON FINANCIAL INSTRUMENTS ACCOUNTING FOR NON-FINANCIAL FIRMS IN VIETNAM 1.1 Necessities Vietnam is integrating more intensively and extensively into the global economy, demonstrated by the vigorous flows of capital, technology and products in and out of the country. Numerous foreign companies are investing in Vietnamese market; they formulate financial reports in accordance to international standards. On the other hand, Vietnamese companies are promoting export and establishing their business overseas; thus, they are put under a tighter supervision and must comply with international standards in formulating financial reports. According to the international accounting standards, financial instruments accounting (FIA) must comply with requirements of IAS32 on the “presentation of financial instrument”; IAS39 on the “recognition and measurement of financial instruments” and IFRS7 on the “disclosure of financial instrument information”. Vietnam has not yet succeeded in formulating a systematic standard for FIA. Instead, the regulations on the practice of FIA are scattered in several set of standards such as VAS01, VAS10, VAS16, etc. This situation are causing several difficulties in managing and standardizing the information, as well as in implementing accounting practices in a financial market with the operation of derivatives such as forwards, futures, swaps, options. Meanwhile, the corporate accounting for non-financial firms does not address FIA, resulting in the confusion and inconsistence in the reporting of firms’ financial situation, affecting the trustworthiness and comparativeness of the indexes in the financial reports. Based on the actual demand of businesses, investors’ requirement for information disclosure and the needs of the accounting profession in the context of integration, the author choose to work on the topic “Completing the Financial instruments accounting for non-financial firms in Vietnam” for the PhD. thesis. 1.2 Overview of research context 1.2.1 International research on FIA 1.2.1.1 Identification of financial instruments Most of the studies agree on the main features of a financial instrument, which 2 is a contract binding parties; the instrument implies both right (assets) and obligation (liabilities) in accordance with the contract; depending on the contract, the payment instrument can be exchanged directly or indirectly. 1.2.1.2 Measurement of financial instruments The scientific circle highlights the advantage of the fair value accounting, which still remains a new concept to Vietnamese accounting, particularly FIA. This motivates the author to study the fair value accounting to find a solution in order to complete the FIA for non-financial firms in Vietnam. 1.2.1.3 Recognition of financial instruments The recognition of financial instruments depends on the classification of the instruments. L.EC.Wilson & Bryan (1997) asserts that it is necessary to formulate accounting principles on financial instruments based on their purposes rather than imposing each instrument with specific principles, so that new instruments can be employed to ensure the usefulness of information and, at the same time, minimize the cost of establishing new principles. 1.2.1.3 Presentation of financial instrument Financial instruments are becoming more and more complicated since instruments are hybridized, for example: convertible bond, preferred dividend (possessing the characteristics of both liabilities and equity); new types of derivatives (hybridizing the derivatives), hybrid instrument with embedded derivatives, etc. Hence, the recognition of financial instruments becomes more difficult accordingly. 1.2.1.4 Information disclosure of financial instruments Financial instruments are becoming more and more diversifying and complicated; thus, the requirement for disclosure of information is also getting harsh. Caedo and Tirado (2004) stated that the information on the risks that the firm confronts may affect business’ future profit, and thus, it is necessary to disclose this information to users of the financial reports. 1.2.2 Status-quo of research on accounting financial instruments in nonfinancial firms in Vietnam There are quite a few scientific researches in Viet Nam focusing on the application of international accounting standards on FIA for Vietnamese firms, especially banks. Nevertheless, none of them comprehensively address the general principles of FIA from identification, measurement, recognition, presentation to disclosure of information of financial instruments. Particularly, none of these research evaluate the degree to which financial instruments are presented and disclosed on 3 firm’s financial reports, and figure out the link between this degree and specific characteristics of the firm. 1.3 Research objectives The overall objective of this thesis is to complete the practice of FIA for nonfinancial firms in Vietnam. In order to attain that objective, this thesis outlines the specific objectives as follows: Complete the identification, classification of basic financial instruments and derivatives; Complete the practice of recognizing basic financial instruments and derivatives; Complete the presentation and disclosure of information on basic financial instruments and derivatives; Identify the degree of presentation and disclosure of information of financial instruments of non-financial firms in Vietnam (based on the survey data from companies listed on Ho Chi Minh City Stock Exchange in 2010 -2012) Testify the link between the degree of presentation and disclosing information of financial instruments and the characteristics of the firms by formulating a model using data in 2010, 2011, and 2012. 1.4 Research subject and scope The subject of this research is FIA, including basic financial instruments and derivatives. Studying basic financial instruments and derivatives, the focuses of the research is the identification, measurement, recognition, presentation and disclosure of information of financial instruments. The research scope covers non-financial firms. From the perspective of supply and demand in the economy, businesses are categorized into two main types: financial institutions trading capital, such as commercial banks, finance companies, insurance companies, etc., which are not the target of this research; and non-financial firms manufacturing commodities and providing service. The latter is the focused target of this paper. The time frame of this research is from 2010 o 2012. The survey is on 82 non-financial firms listed on Ho Chi Minh City Stock Exchange. 1.5 Research questions On the foundation of the research objectives, the thesis aims to answer the following questions: 4 Question 1: What are the solutions for the completion of identification and classification of basic financial instruments and derivatives used in non-financial firms? Question 2: How to complete the measurement of basic financial instruments and derivatives used in non-financial firms in Vietnam? Question 3: What are the solution to complete the recognition of basic financial instruments and derivatives used in non-financial firms in Vietnam? Question 4: How to complete the presentation and disclosure of information on basic financial instruments and derivatives used in non-financial firms in Vietnam? Question 5: How to identify the degree to which financial instruments in nonfinancial firms in Vietnam are presented and disclosed on financial reports in 2010 -2012 period? Which factors affect the degree of presentation and information disclosure of financial instruments on the financial reports of non-financial firms in Vietnam? 1.6 Research methods In order to attain objectives mentioned above, based on the methodologies of dialectical materialism and historical materialism, this thesis employs several research approaches including investigation, survey, grouping, expert consultation, etc. The thesis synthesizes, analyzes and evaluates the achievements as well as limitations of the current practice of FIA for non-financial firms in Vietnam and recommends the solutions, accompanied by conditions, to complete the FIA for non-financial firms in Vietnam. The research methods are specified into research steps as follows: Step 1: Disseminate questionnaires to firms; Step 2: Disseminate questionnaire and conduct in-depth interview with individuals; Step 3: Collect financial reports; Step 4: Process survey data; Step 5: Recommend the solutions to complete FIA for non-financial firms in Vietnam. 1.7 Significances of the thesis Academic and theoretical significances Complete the theory framework on FIA for non-financial firms in Vietnam, including: Completing the recognition and measurement of basic financial instruments and derivatives; Completing the measurement of basic financial instruments and derivatives; Completing the presentation and information disclosure on basic financial 5 instruments and derivatives. Practical significance: Applying the theory framework on FIA for non-financial firms in Vietnam to complete the practice of FIA in surveyed firms; Identifying the degree of presentation and information disclosure of nonfinancial firms in Vietnam in 2010 - 2012 (DQ index). The DDQ index helps policy makers evaluate the impact of Circular 210/2009/TT-BTC (guiding the application of international accounting standards on the presentation and information disclosure of financial instruments) on the quality of financial reports. Figuring out the link among the degree of presentation and information disclosure of financial instruments to firm’s scale, business result and scale of the auditing firm so that the users of accounting information are more active in using the financial reports and making investment decision. 1.8 Structure of the thesis The thesis comprises of four Chapters: Chapter 1: Introduction of FIA for non-financial firms in Vietnam Chapter 2: Theoretical basis of FIA in non-financial firms Chapter 3: Analysis on the status – quo of FIA in non-financial firms in Vietnam Chapter 4: Solutions to complete FIA for non-financial firms in Vietnam. 6 CHAPTER 2 THEORETICAL BASIS OF FINANCIAL INSTRUMENTS ACCOUNTING IN NON-FINANCIAL FIRMS 2.1 Identification and classification of financial instruments 2.1.1 Identification of financial instruments 2.1.1.1 Basic financial instrument identification In financial terms, financial instruments refer to a specific financial category employed in order to achieve certain purposes. Hence, financial instruments those applied to explore mobilize and allocate financial sources. This, in fact, is a broad concept related to financial instruments, which is closely attached with the State’s utilization of financial instrument system to explore, motivate as well as apply financial resources in the most effective basis. Following is the definition of financial instruments from the micro-economics perspective: It is stated in the Business dictionary that financial instrument is a document (such as a check, draft, bond, share, bill of exchange, futures or options contract) that has a monetary value or represents a legally enforceable (binding) agreement between two or more parties regarding a right to payment of money. Characteristics to identify financial instruments is that it is an agreement binding two parties, which brings about asset to one party, but a financial liability or equity capital instrument to the other at the same time. Therefore, financial instruments are comprised of asset, financial liability and equity capital instrument. Derivatives are a special category of financial instruments which might be receivables (asset) or payables (financial liability). 2.1.1.2 Identification of derivatives According to IAS 39, derivatives are those: - of which, the prices change in accordance with price changes of another basic asset (securities, foreign exchange rate, commodities, limit or credit rate, etc) - of which, there is no or low initial investment costs - which are paid at a designated date in the future 7 Then, derivatives are closely linked with future receivables (assets) or liabilities. Therefore, it is essential to record them in the balance sheet. 2.1.2 Financial instrument classification The thesis presents financial instrument classification by different criteria, including by types of items in the balance sheet; by requirement on measurement and disclosure; by the origin of the basic financial instruments and derivatives. Basic financial instrument classification: Basic financial instruments are divided into asset, liability and equity capital instruments. Derivatives classification: Derivatives are divided into 4 basic types: forwards, futures, options and swaps contract. 2.2 Measurement of financial instrument 2.2.1 Measurement of basic financial instrument This thesis presents how to measure basic financial instruments including asset, liability, equity capital instruments; Measurement of assets; Measurement of liabilities; Measurement of equity capital instruments. 2.2.2 Derivatives measurement The basis for measurement of derivatives is fair value. In case that derivatives are regarded as assets: Fair value of the derivative is identified as the quoted market price. If quoted market price is not available, the enterprise itself has to identify the fair value through valuation techniques in order to specify the value of underlying assets on the valuing date of exchange of equal values. In the case that derivatives are regarded as liabilities: Fair value the derivatives regarded as a liability is no less than the value stated in the contract, calculated from the first day of payment. 2.3. Recognition of financial instruments 2.3.1. Recognition of basic financial instruments 2.3.1.1. Initial recognition of basic financial instruments 8 Assets and liabilities are recognized at the time the enterprise becomes a party of the contract. Hague (2004) explained this as the moment financial instruments bring about rights as well as obligations which are compatible with the definition of assets and liabilities [42]. 2.3.1.2. Subsequent recognition of basic financial instruments During the holding period, the value of basic financial instruments would be recognized in the balance sheet, either at fair value or amortized cost, and the recognition of the instrument shall be made accordingly. 2.3.1.3. Derecognition of basic financial instruments This means that the recognized assets and liabilities are derecognized in the balance sheet. The derecognition happens when: the right to collect money or assets as in the contract expires; or the asset has already been transferred under appropriate terms and conditions. An enterprise ceases the recognition of a liability in the balance sheet partially or completely when it not longer has the obligation to pay. In other words, the recognition ceases when all duties in the contract have been carried out, exempted, cancelled or expired. 2.3.2 The recognition of derivatives 2.3.2.1. Initial recognition of derivatives Recognition of derivatives requires specific categories of business instruments or risk hedging ones. The classification of these instruments used for business purpose or risk hedging purpose should be clarified when the contract takes effect. The enterprise should perform accounting practices for derivative consistently and must not reclassify these derivatives during their validity period, except when the derivative for the purpose of risk hedging no longer meet the requirements of risk hedging accounting. 2.3.2.2. Subsequent record of derivatives Derivatives are subsequently recognized according to fair value. Concerning those for business purpose, the value change is recognized in financial collection. Concerning those for risk hedging purpose, the value change is recognized in equity capital in the balance sheet. 2.3.2.3. Derecognition of derivatives. 9 Derivatives are derecognized when the contract expires or it is transferred to another party under the following conditions: - Most risks and benefits attached with ownership have been transferred - The right to control derivatives expires The difference in fair value of derivative already recognized into equity capital would be transferred into income/expense in income statement if there is a derecognition of derivatives for risk hedging purpose. 2.4 Financial instrument presentation and disclosure 2.4.1 Financial instrument presentation Following are rules to present financial instruments in the balance sheet: - General rule: A financial instruments issued or invested by an enterprise as a liability, asset or equity capital instrument has to respect the financial nature of the transaction rather than the formality. - Derivatives with underlying assets are treated as assets. The embedded derivatives are not separated from this contract. - Although most assets and liabilities are only deducted under certain circumstances, they are normally not deducted in the balance sheet presentation. 2.4.2 Financial instrument information disclosure 2.4.2.1 Main issues of information disclosure of financial instruments Financial instruments are more and more diversifying and complicated. This results in strict requirement for information disclosure, which should include the followings: - Disclosing additional information to clarify items of financial instruments presented on the balance sheet - Disclosing information on income, interest/interest income of current financial instrument; gain/loss of disposal financial instrument - Disclosing information (qualitative and quantitative) in terms of potential risks of financial instruments including credit risk, pay risk and market risk - For each individual risk hedging instrument, it is necessary to disclosure information describing the hedging measure, financial instrument employed to hedge risk and the nature of risk to be hedge. 10 2.4.2.2. Degree of presentation and information disclosure of financial instruments Financial reports are a channel for enterprises to announce their business results as well as financial status. The regulatory bodies, accounting associations always make best efforts to issue the most qualified accounting standards as well as more specific and widespread regulations on the practice of information disclosure related to financial instruments. HYPOTHESIS DEVELOPMENT Hypothesis 1: Degree of presentation and information disclosure of financial instruments in the financial statement closely connects to and parallels with the enterprise’s scale. Hypothesis 2: Degree of presentation and information disclosure of financial instruments in the financial statement is closely linked with the enterprise business results. Hypothesis 3: Degree of presentation and information disclosure of financial instruments in the financial statement has a close connection with the enterprise’s auditing firms. Enterprise scale (Size, DTA) Enterprise Degree of presentation and information disclosure (DQ) Auditing firm (Audit) business results (PTA, PE) Figure 2.5 Elements of presentation and information disclosure degree of financial instruments Those three hypotheses are testified by using the following function (1): DQ= α0 + α1 Size + α2 PTA + α3 PE + α4 DTA + α5 Audit + α6 Yafter + ε (1) Denote: