IFRS 9 Financial Instruments
IFRS 9, the new standard on financial instruments, has been endorsed by the EU and will be applicable for financial years beginning on or after 1 January 2018.
| Key change | Implication for companies |
| Impairment of trade receivables will move from an incurred loss model to an expected loss model. | Bad debt provisions are likely to increase as provisions are made against expected losses and not just when there is evidence of impairment. |
| Existing four categories of financial assets replaced by three. | Accounting should be aligned with the underlying business model. |
| Relaxed and simplified hedge accounting rules compared to IAS 39. | Hedge accounting is easier to apply and hence a more attractive accounting option. |
Recognition and measurement – financial assets
IFRS 9 follows a principles approach based on assessing the entity's business model for managing financial assets and the contractual cash flow characteristics of the financial asset. Financial assets are then recognised in one of the following three categories:
| Category | Characteristics | Treatment |
| Amortised cost | The business model is to hold the asset in order to collect the contractual cashflows, those cashflows are solely payments of principal and interest and the cashflows arise on specified dates. | Recognised at amortised cost in the balance sheet with no recognition of fair value changes. |
| Fair value through other comprehensive income | The business model is achieved by both holding the asset to collect the contractual cash flows and by selling financial assets. In addition the cashflows are solely payments of principal and interest and the cashfows arise on specified dates. | Recognised at fair value in the balance sheet with fair value changes recognised in other comprehensive income and then reclassified to profit or loss on derecognition. |
| Fair value through profit or loss | Residual category that may also be used to reduce or eliminate an accounting mismatch. | Recognised at fair value in the balance sheet with fair value changes recognised in profit or loss. |
An entity may have more than one business model in some cases; for example, it may have one portfolio which is held to collect contractual cash flows and one which is held to be sold.
Reclassification between categories is only permitted when an entity changes its business model for managing financial assets. Reclassification is expected to occur only very rarely.
Recognition and measurement – financial liabilities
The recognition and measurement requirements for financial liabilities are largely unchanged from IAS 39 with most financial liabilities being measured at amortised cost. For those liabilities that are held for trading or where the option is taken to measure at fair value through profit or loss changes in the fair value attributable to changes in own credit risk will be recognised in other comprehensive income and not subsequently reclassified to profit or loss.
Impairment
IFRS 9 replaces the incurred loss model used in IAS 39, where impairments were only recognised when they occurred, with an expected loss model where expected losses are provided for. To measure impairment IFRS 9 introduces a three stage approach to measuring impairments as follows:
| Stage One Initial recognition (unless credit impaired) |
Recognise 12 month expected credit losses | Interest revenue on gross carrying amount |
| Stage two Significant increase in credit risk |
Lifetime expected credit losses | Interest revenue on gross carrying amount |
| Stage three Non-performing (credit impaired) |
Lifetime expected credit losses | Interest revenue on net carrying amount |
The standard does introduce a simplified approach for trade receivables and contract assets that arise from transactions within the scope of IFRS 15 and for lease receivables. Under the simplified approach provision should be made for the estimated lifetime equivalent credit losses. In practice this will mean that provisions will be made earlier, probably based on historic experience, as opposed to waiting for evidence of impairment (such as a customer entering administration). As an example of the difference:
| Receivables aging | Receivables £'000 | Historic loss estimate % | IFRS 9 provision £'000 | IAS 39 provision £'000 |
| 1-30 days | 600 | 0.5 | 8 | ⁃ |
| 31-90 days | 400 | 0.75 | 3 | ⁃ |
| 90 days + | 150 | 4 | 6 | ⁃ |
| Customers in administration | 10 | 100 | 10 | 10 |
| Total provision | 22 | 10 |
Hedge accounting
As with IAS 39 hedge accounting remains an accounting policy choice under IFRS 9 though the ability to voluntarily revoke a hedging designation, available under IAS 39, has been removed. In general the requirements for hedge accounting have been relaxed, principally by relaxing the requirements around hedge effectiveness (including the requirement for this to be within 80%–125%). Whilst IFRS 9 makes it easier to qualify to use hedge accounting the underlying accounting for hedged transactions is very similar.
Transition
IFRS 9 is effective for periods commencing on or after 1 January 2018 with earlier application permitted. The standard shall be applied retrospectively though there are transitional provisions for where retrospective application of the classification and measurement requirements of the standard may be impracticable.
