IFRS

First Impressions: IFRS 9 Financial Instruments

September 2014

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Contents

Fundamental changes call for careful planning 2

Setting the standard 3

1 Key facts 4

2 How this could impact you 6

3 Scope 83.1 Overview 83.2 Own-use exemption 83.3 Loan commitments and contract assets 8

4 Recognition and derecognition 9

5 Classification of financial assets 105.1 Introduction 10

5.1.1 Overview of classification 105.1.2 Amortised cost measurement category 135.1.3 FVOCI measurement category 135.1.4 FVTPL measurement category 135.1.5 FVOCI election for equity instruments 14

5.2 Contractual cash flows assessment the SPPI criterion 145.2.1 Meaning of principal and interest 155.2.2 Time value of money 175.2.3 Contractual provisions that change the

timing or amount of contractual cash flows 19

5.2.4 De minimis or non-genuine features 225.2.5 Non-recourse assets 225.2.6 Contractually linked instruments 235.2.7 Examples of instruments that may or

do not meet the SPPI criterion 255.3 Business model assessment 27

5.3.1 Overview of the business models 275.3.2 Assessing the business model 285.3.3 Held-to-collect business model 305.3.4 Both held to collect and for sale

business model 325.3.5 Other business models 33

6 Classification of financial liabilities 346.1 Overview of classification 346.2 Fair value option for financial liabilities 35

6.2.1 Would split presentation create or enlarge an accounting mismatch? 36

6.3 Deletion of the cost exception for derivative financial liabilities 37

7 Embedded derivatives 387.1 Overview 387.2 Host contracts that are financial assets in the

scope of IFRS 9 38

8 Reclassification 398.1 Conditions for reclassification of financial assets 398.2 Timing of reclassification of financial assets 408.3 Measurement on reclassification of financial

assets 41

9 Measurement on initial recognition 42

10 Subsequent measurement 4410.1 Financial assets 4410.2 Financial liabilities 45

10.2.1 General principles 4510.2.2 Measurement of changes in credit risk 45

11 Amortised cost and the effective interest method 5011.1 Calculating amortised cost 5011.2 Calculating the EIR 51

11.2.1 General approach 5111.2.2 Credit-adjusted EIR 52

11.3 Calculating interest revenue and expense using the EIR 5311.3.1 General approach 5311.3.2 Approach for credit-impaired financial

assets 5311.4 Revisions to estimated cash flows 5311.5 Modifications of financial assets 54

11.5.1 Overview 5411.5.2 Gains or losses on modifications of

financial assets 55

12 Impairment 5812.1 Scope of the impairment requirements 58

12.1.1 General requirements 5812.1.2 Equity investments 60

12.2 Overview of the new impairment model 6012.3 The general approach to impairment 61

12.3.1 The expected credit loss concept 6112.3.2 12-month expected credit losses and

lifetime expected credit losses 6412.3.3 When is it appropriate to recognise

12-month expected credit losses or lifetime expected credit losses? 65

12.3.4 Significant increase in credit risk 6612.4 Measurement of expected credit losses 78

12.4.1 Overview 7812.4.2 Definition of cash shortfall 8012.4.3 The estimation period the expected

life of the financial instrument 8212.4.4 Probability-weighted outcome 84

7.3 Host contracts that are not financial assets in the scope of IFRS 9 38

12.4.5 Time value of money 8412.4.6 Reasonable and supportable information 8612.4.7 Collateral 8812.4.8 Individual or collective basis of

measurement 8912.4.9 Financial guarantee contracts and loan

commitments 8912.4.10 Example of measurement of expected

credit losses 9112.5 Write-offs 9212.6 Special approach for assets that are

credit-impaired atinitial recognition 9412.6.1 Definition of credit-impaired asset 9412.6.2 Initial measurement 9512.6.3 Subsequent measurement 9512.6.4 Modifications 97

12.7 Simplified approach for trade and lease receivables and contract assets 9712.7.1 Overview 9712.7.2 Definitions 9812.7.3 Specific measurement issues 98

12.8 Presentation of expected credit losses in the financial statements 10012.8.1 Assets measured at amortised cost,

lease receivables and contract assets 10012.8.2 Loan commitments and financial

guarantee contracts 10112.8.3 Debt instruments measured at FVOCI 101

12.9 Interaction between expected credit losses and interest revenue 102

12.10 Comparison with Basel regulatory model 102

13 Hedge accounting 106

14 Presentation and disclosures 10714.1 Presentation 10714.2 Disclosures 107

14.2.1 Overview 10714.2.2 Classification and measurement of

financial assets and financial liabilities 10714.2.3 Credit risk and expected credit losses 109

15 Effective date and transition 11715.1 Overview 11715.2 Transition 118

15.2.1 General principle 118

15.2.2 Transition requirements for classification and measurement 119

15.2.3 Transition requirements for impairment 12315.2.4 Previous versions of IFRS 9 124

15.3 Disclosures on initial application of IFRS 9 12615.3.1 Classification and measurement 12615.3.2 Impairment 127

15.4 First-time adopters of IFRS 127

16 FASB proposals and US GAAP convergence 12916.1 Classification and measurement of financial

assets and financial liabilities 12916.2 Impairment 12916.3 Hedge accounting 129

About this publication 130

Acknowledgements 132

2 | First Impressions: IFRS 9 Financial Instruments

2014 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.

Fundamental changes call for careful planning On 24 July 2014, the IASB issued the fourth and final version of its new standard on financial instruments accounting IFRS9 Financial Instruments. This completes a project that was launched in 2008 in response to the financial crisis. After long debate about this complex area, the implementation effort can begin in earnest.

The new standard includes revised guidance on the classification and measurement of financial assets, including impairment, and supplements the new hedge accounting principles published in 2013.

In the past, concerns have been raised about too little, too late provisioning for loan losses. The new expected credit loss model for the recognition and measurement of impairment aims to address these concerns, and accelerates the recognition of losses by requiring provisions to cover both already-incurred losses and some losses expected in the future.

The new standard will have a massive impact on how banks account for credit losses on their loan portfolios. Provisions for bad debts will be bigger and are likely to be more volatile, and adopting the new rules will require a lot of time, effort and money. A major issue for banks and investors in banks will be how adoption of the new standard will affect regulatory capital ratios. Banks will need to factor this into their capital planning, and users are likely to be looking for information on the expected capital impact.

Insurers will also be significantly impacted by IFRS 9. The industry has to plan for the adoption of new standards on both financial instruments and insurance contracts over the next few years. The overall effect cannot be assessed until the insurance standard is finalised over the next 12 months, but we can expect a sea-change in financial reporting for most insurers.

Other corporates should not automatically assume that the impact of the classification, measurement and impairment requirements of the new standard will be small, as this depends on the exposures they have and how they manage them. Planning for IFRS 9 adoption including implementation of the new hedge accounting requirements published in 2013 is likely to be an important issue for corporate treasurers and accountants generally.

The new standard has a mandatory effective date of 1 January 2018, but may be adopted early. As the standard has been completed in stages, the relatively few entities that have adopted a previously released version of IFRS 9 can continue to use it until then. In addition, entities can adopt in isolation the part of the standard that allows them to reflect the effects of changes in credit risk on certain marked-to-market liabilities outside of profit or loss.

Entities need to think about when they plan to adopt the new standard. Many banks may need the whole three and a half years up to 2018 to prepare for adoption of the expected credit loss requirements. However, the possibility of early adopting only the own credit amendment would provide some welcome relief from profit or loss volatility caused by fluctuations in an entitys own credit risk.

Chris Spall (Leader)Enrique Tejerina (Deputy leader)Terry Harding (Deputy leader)Ewa Bialkowska

KPMGs global IFRS financial instruments leadership teamKPMG International Standards Group

2014 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.

Setting the standardA phased approach to completing IFRS 9

Since November 2008, the IASB has been working to replace its standard on financial instruments, IAS 39 Financial Instruments: Recognition and Measurement. The IASB structured the project in three phases:

Phase 1: Classification and measurement of financial assets and financial liabilities

Phase 2: Impairment

Phase 3: Hedge accounting.

The issuance in July 2014 of the complete version of IFRS 9: Financial Instruments, hereafter referred to as IFRS 9, marks the culmination of this project. However, the IASB has decided to separate the accounting for macro hedging from t