IFRS 9 - Financial Instruments

Topic

IFRS

IFRS 9 - Financial Instruments

Objective

Set outs requirements for recognition and measurement, impairment, de-recorgnition, and general hedge accounting.

The initial measurement of financial instruments

All financial instruments are initially measured at its fair value plus or minus transaction costs in the case of a financial asset or financial liability not at fair value through profit or loss.

Subsequent measurement of financial assets

IFRS 9 classifies all financial assets into two categories:

• those measured at amortized costs, and
• those measured at fair value.

When assets are measured at fair value, profit and loss is recognized either in the profit or loss statement (fair value through profit and loss statement, FVTPL) or recognized in other comprehensive income (fair value through other comprehensive income statement, FVTOCI).

Debt instruments

A debt instrument that meets the following two conditions can be measured at amortized costs (net of any write-down for impairment) unless the asset is specified under the FVTPL under a fair value option:

• Business model test: The objective of the entity's business model is to hold the financial assets to collect the contractual cash flows (rather than to sell the instrument prior to its contractual maturity to realize its fair value changes).
• Cash flow characteristic test: The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

A debt instrument that meets the following two conditions can be measured at FVTOCI except for assets specified under the FVTPL under a fair value option: 

• Business model test: The financial asset is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets.
• Cash flow characteristics test: The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

All other debt instruments must be measured at fair value through profit or loss (“FVTPL”).

Fair value option

Even if an instrument meets the two requirements to be measured at amortised cost or FVTOCI, IFRS 9 contains an option to designate, at initial recognition, a financial asset as measured at FVTPL if doing so eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an 'accounting mismatch') that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases.

Equity instruments

All equity investments in the scope of IFRS 9 are to be measured at fair value in the balance sheet, with fair value changes recognized in profit or loss, except for equity investments for which the entity has elected to report value changes in "Other Comprehensive Income". There is no "costs exception" for unquoted equities.

Other comprehensive income options

If an equity investment is not held for commercial purposes, an entity may exercise an irrevocable option on initial recognition to measure it against FVTOCI, with only dividend income recognized in the financial statements. profit and loss statement.

Subsequent measurement of financial liabilities

Two methods of recording, including: fair value through profit or loss (“FVTPL”), and amortize cost. Financial liabilities held for trading are measured at FVTPL, and all other financial liabilities are measured at amortized costs unless the fair value option is applied.

IFRS 9 requires that gains and losses on financial liabilities measured under the FVTPL be divided into the change in fair value amortized to the change due to the credit risk of the liability, are presented in the statement of other comprehensive income and the remainder is presented in the statement of profit and loss. The new guidance allows for the full change in fair value to be recognized in the profit and loss statement only if the presentation of the changes in the credit risk of the liability in the other comprehensive income statement creates or exaggerates accounting inconsistencies in the profit and loss statement. This determination is made on initial recognition and is not re-evaluated.

Fair value of financial liabilities option

IFRS 9 contains an option to designate a financial liability measured against the FVTPL if:

• It eliminates or significantly reduces a recognition inconsistency (sometimes referred to as an “accounting mismatch” that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases, or
• A liability is a part or a group of financial liabilities or financial assets and financial liabilities is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and information about the group is provided internally on that basis to the entity’s key management personnel.

De-recognition of financial liabilities

• The basic premise for the de-recognition model in IFRS is to determine whether the asset under consideration for de-recognition.
• Once the asset under consideration for derecognition has been determined, an assessment is made as to whether the asset has been transferred, and if so, whether the transfer of that asset is subsequently eligible for derecognition.
• An asset is transferred if either the entity has transferred the contractual rights to receive the cash flows, or the entity has retained the contractual rights to receive the cash flows from the asset, but has assumed a contractual obligation to pass those cash flows on under an arrangement.
• Once an entity has determined that the asset has been transferred, it then determines whether or not it has transferred substantially all of the risks and rewards of ownership of the asset. If substantially all the risks and rewards have been transferred, the asset is derecognised. If substantially all the risks and rewards have been retained, derecognition of the asset is precluded.
• If the entity has neither retained nor transferred substantially all of the risks and rewards of the asset, then the entity must assess whether it has relinquished control of the asset or not. If the entity does not control the asset then derecognition is appropriate; however if the entity has retained control of the asset, then the entity continues to recognise the asset to the extent to which it has a continuing involvement in the asset.

De-recognition of financial liabilities

A financial liability should be removed from the balance sheet when, and only when, it is extinguished, that is, when the obligation specified in the contract is either discharged or cancelled or expires. Where there has been an exchange between an existing borrower and lender of debt instruments with substantially different terms, or there has been a substantial modification of the terms of an existing financial liability, this transaction is accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. A gain or loss from extinguishment of the original financial liability is recognised in profit or loss.

Derivatives

All derivatives in scope of IFRS 9, including those linked to unquoted equity investments, are measured at fair value. Value changes are recognised in profit or loss unless the entity has elected to apply hedge accounting by designating the derivative as a hedging instrument in an eligible hedging relationship.

Reclassification

For financial assets, reclassification is required between FVTPL, FVTOCI and amortised cost, if and only if the entity's business model objective for its financial assets changes so its previous model assessment would no longer apply.

If reclassification is appropriate, it must be done prospectively from the reclassification date which is defined as the first day of the first reporting period following the change in business model. An entity does not restate any previously recognised gains, losses, or interest.

IFRS 9 does not allow reclassification:

• Equity investments measured at the FVTOCI, or
• Where the fair value option has been exercised in any circumstance for a financial assets or financial liability.

Hedge accounting

The hedge accounting requirements in IFRS 9 are optional. If certain eligibility and qualification criteria are met, hedge accounting allows an entity to reflect risk management activities in the financial statements by matching gains or losses on financial hedging instruments with losses or gains on the risk exposures they hedge.

Qualifying criteria for hedge accounting: A hedging relationship qualifies for hedge accounting only if all of the following criteria are met:

• The hedging relationship consists only of eligible hedging instruments and eligible hedged items.
• At the inception of the hedging relationship there is formal designation and documentation of the hedging relationship and the entity’s risk management objective and strategy for undertaking the hedge.
• The hedging relationship meets all of the hedge effectiveness requirements. 

Accounting for qualifying hedging relationships

• Fair value hedging: a hedge of the exposure to changes in fair value of a recognised asset or liability or an unrecognised firm commitment, or a component of any such item, that is attributable to a particular risk and could affect profit or loss (or OCI in the case of an equity instrument designated as at FVTOCI).
• Cash flow hedging: a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated with all, or a component of, a recognised asset or liability (such as all or some future interest payments on variable-rate debt) or a highly probable forecast transaction, and could affect profit or loss.
• Hedge of a net investment in a foreign operation (as defined in IAS 21), including a hedge of a monetary item that is accounted for as part of the net investment, is accounted for similarly to cash flow hedges:

+ The portion of the gain or loss on the hedging instrument that is determined to be an effective hedge is recognised in OCI; and

+ The ineffective portion is recognised in profit or loss.

Impairment

IFRS 9 requires that the same impairment model apply to all of the following:

• Financial assets measured at amortised cost;
• Financial assets mandatorily measured at FVTOCI;
• Loan commitments when there is a present obligation to extend credit (except where these are measured at FVTPL):

+ Financial guarantee contracts to which IFRS 9 is applied (except those measured at FVTPL);

+ Lease receivables within the scope of IAS 17 Leases; and

+ Contract assets within the scope of IFRS 15 Revenue from Contracts with Customers (i.e. rights to consideration following transfer of goods or services).

Credit-impaired financial asset

Under IFRS 9 a financial asset is credit-impaired when one or more events that have occurred and have a significant impact on the expected future cash flows of the financial asset. It includes observable data that has come to the attention of the holder of a financial asset about the following events:

• Significant financial difficulty of the issuer or borrower;
• A breach of contract, such as a default or past-due event;
• The lenders for economic or contractual reasons relating to the borrower’s financial difficulty granted the borrower a concession that would not otherwise be considered;
• It becoming probable that the borrower will enter bankruptcy or other financial reorganisation;
• The disappearance of an active market for the financial asset because of financial difficulties; or
• The purchase or origination of a financial asset at a deep discount that reflects incurred credit losses.

Basis for estimating expected credit losses

Any measurement of expected credit losses under IFRS 9 shall reflect an unbiased and probability-weighted amount that is determined by evaluating the range of possible outcomes as well as incorporating the time value of money. Also, the entity should consider reasonable and supportable information about past events, current conditions and reasonable and supportable forecasts of future economic conditions when measuring expected credit losses.

The Standard defines expected credit losses as the weighted average of credit losses with the respective risks of a default occurring as the weightings. Whilst an entity does not need to consider every possible scenario, it must consider the risk or probability that a credit loss occurs by considering the possibility that a credit loss occurs and the possibility that no credit loss occurs, even if the probability of a credit loss occurring is low.

Disclosures

IFRS 9 amends some of the requirements of IFRS 7 Financial Instruments: Disclosures including adding disclosures about investments in equity instruments designated as at FVTOCI, disclosures on risk management activities and hedge accounting and disclosures on credit risk management and impairment