TOPIC 27 - IFRS 9 FINANCIAL INSTRUTMENTS (2014)studyonline.ie/wp-content/uploads/2016/09/TOPIC-27-IFRS-9... · At the Period End, ... o In addition, once the change has been entered

CPA P2 Advanced Corporate Reporting

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TOPIC 27 - IFRS 9 FINANCIAL INSTRUTMENTS (2014)

To be applied from 1st January 2018

Supersedes all previous versions of IFRS 9

In accordance with IFRS 9, financial assets may be classified under

Amortised Cost

Fair value through profit or loss (fvtpl)

Fair value through Other Comprehensive Income (fvtoci)

Measurement

o Financial assets are now to be sub-divided into just 2 categories

Those measured at amortised cost, and

Those measured at fair value

Classification is determined on the date of initial recognition

The amortised cost of a financial asset or financial liability is

(f) the amount at which the asset or liability is measured at initial

recognition (usually "cost")

(g) minus any repayments of principal,

(h) minus any reduction for impairment or uncollectibility, and

(i) plus or minus the cumulative amortisation of the difference between

that initial amount and the maturity amount.

You work out the amortisation using the effective interest method.



1. Amortised Cost is used to record the financial asset where

o The financial asset is a debt instrument

o Can be measured at amortised cost if they satisfy 2 conditions

Business model test – the asset is held with the intention of realising its

cash flows rather than being held for early sale, and

Cash flow characteristics test – the asset terms are such that cash flows

will arise on specific dates in the future representing interest payments

and principal repayments

o if they do not satisfy these 2 tests, the debt instrutment must be measured at

fvtpl

o Fair Value Option for Debt Instruments

Even if they do, in fact, satisfy these 2 tests, Investments in Debt may

still be valued at fvtpl if, by doing so, it eliminates or significantly

reduces a measurement or recognition inconsistency

2. Fair Value Through Profit or Loss: This is the default classification for all financial

assets, unless they are designated to be measured in another way. Fair value changes

are taken directly to SOPL

Equity Instruments i.e. Shares

o Any contract that evidences a residual interest in the assets of an entity after

deducting all of its 2liabilities

o Measured at fair value through profit or loss, as they are held for trading and

so, the business model test is not passed

3. Fair Value through Other Comprehensive Income

o N.B. One exception exists – On initial recognition, an entity can make an

irrevocable election to recognise changes in Fair Value of an Equity

Instrutment not held for trading, through Other Comprehensive Income (and



not through profit or loss) . Note: For instrutments designated as FVtOCI, fair

value changes are recognised in OCI and there is no recycling of gains or

losses on impairment or sale of investment. As a result, only dividend income

is recognised in arriving at profit or loss for the period.

o For certain debt instrutments, the FVTOCI classification is mandatory unless

the fvtpl option is elected.

Example – Irrevocable Election

Example - Amortised Cost: The amount at which the financial asset or liability is

measured at initial recognition minus principal repayments, plus or minus the

cumulative amortisation of any difference between that initial amount and the

maturity amount, and minus any write down for impairment or uncollectability

Example

Galaxy Co issues a bond for $503,778 on 1 January 20x2. No interest is payable on

the bond, but it will be held to maturity and redeemed on 31 December 20x4 for

$600,000. The bond has not been designated as at fair value through profit or loss.

The effective interest rate is 6%.

On 8.2.08, Orange Co acquires an investment in the shares of Lemon Co

with the intention of holding it in the long term. The Investment cost

$850,000. At Orange Co Year End of 31 March 2008, the market price of

the investment is $900,000. How is the asset initially & subsequently

measured?

Orange Co has elected to recognise changes in fair value of the equity

investment in Other Comprehensive Income

Solution

Asset is initially recognised at fair value of $850,000

At the Period End, it is remeasured to $900,000

This results in the disclosure of $50,000 in Other Comprehensive Income

and recognition of $50,000 gain in Retained Earnings



Calculate the charge to statement of profit or loss of Galaxy Co for the year ended 31

December 20x2 and the balance outstanding at 31 December 20x2.

The bond is a “deep discount” bond and is a financial liability of Galaxy Co. It is

measured at amortised cost. Although there is no interest as such, the difference

between the initial cost of the bond and the price at which it will be redeemed is a

finance cost. This must be allocated over the term of the bond at a constant rate on the

carrying amount. This is done by applying the effective interest rate.

Date Year Opening

Balance - $

Effective

Interest Rate –

6%

Closing

Balance

31.12.X2 1 503,778 30,227 534,005

31.12.X3 2 534,005 32,040 566,045

31.12.X4 3 566,045 33,963 600,000

Charge to Statement of profit or loss for Y/e 31/12/x2 = $30,227

Balance Outstanding at 31/12/x2 = 534,005

Example – Held at Fair Value through Profit and Loss - Llama





Example – Dune – FVTPL











4. Fair Value of an Asset

o It may well be that “cost” is the best indicator of fair value – but the IFRS

allows other means

Derivatives are always measured at fair value

o A derivative is a financial instrument or other contract with all three of the

following characteristics

Its value changes in response to the change in a specified interest rate

or index

It requires no initial net investment

It is settled at a future date

Examples: Swaps, Forward Rate Agreements



5. Subsequent measurement of financial liabilities

o Still the same 2 possibilities as before:

Fvtpl, and

Amortised cost

o Financial liability held for trading? – fvtpl

o Otherwise at amortised cost unless the fair value option is exercised

Financial liabilities may be measured at fvtpl if:

o It eliminates or significantly reduces a measurement or recognition

inconsistency, or

o It is part of a group of financial liabilities that is managed and performance is

evaluated on a fair value basis in accordance with a documented risk

management or investment strategy and information is provided to

management on that basis

o A financial liability which does not meet either of these criteria may still be

measured at fvtpl when it contains one or more embedded derivatives that

would otherwise require separation

Gains and losses from financial liabilities at fvtpl should be split between:

o Any change attributable to credit risk (show in SOPLAOCI) and

o Any other change (show in I/S)

o However, all change may go through I/S if to include within SOPLAOCI

would create or enlarge an accounting mismatch in I/S

o This decision is made on initial recognition and is not reversible



o In addition, once the change has been entered through SOPLAOCI, it cannot

later be transferred back through I/S

o The only transfer available is through the Statement of Changes in Equity

Derecognition of financial assets

o It is necessary to determine whether a financial asset is:

An asset in its entirety, or

Specifically identified cash flows from an asset, or

Fully proportionate share of the cash flows from an asset, or

Fully proportionate share of specifically identified cash flows from an

asset

If it satisfies any of these four , then assess whether the asset has in fact been

transferred and, if so, is the asset eligible for derecognition

it is transferred if

o contractual rights to cash flows have been transferred, or

o the rights have not been transferred but the entity has assumed an obligation to

pass on these flows, or

o under an arrangement which meets three criteria:

the entity has no obligation to pay the “transferee” unless it collects

equivalent amounts on the asset, and

the entity is prohibited from selling or pledging the asset, and

the entity has an obligation to remit these cash flows without material

delay



Once it has been established that the asset has in fact been transferred, then it’s

necessary to determine whether “substantially the whole of the risks and rewards of

ownership” have also been transferred

o If they have, then the asset is derecognised

o If not, then it is not derecognised

o If neither “yes” nor “no”, the entity must assess whether it has relinquished

control

If yes, then derecognise

If no, then continue to recognise to the extent of the entity’s continuing

involvement

Derecognition of financial liabilities

o Derecognise when the liability has been extinguished by

Discharge, or

Cancellation, or

Expiry

Where a liability is exchanged for a different liability with substantially different

terms

o The replacement is recognised, and

o The original liability is extinguished, and

o Any gain or loss on extinguishing the original is taken through SoI

Reclassification

o Financial assets are held at either fvtpl or at amortised cost



o They can only be reclassified if the business model changes and no longer

applies

o If reclassification is appropriate, this should be done prospectively

So, no re-statement of prior gains or losses

And no restatement of interest

o Cannot reclassify where

A financial asset was treated under the SOPLAOCI option, nor

Where the fair value option has been exercised

o When an entity changes its business model for managing financial assets then

it should reclassify all affected financial assets

o Example of where reclassification is permitted – A financial services firm

decides to shut down its commercial mortgage business. The business no

longer accepts new business and the financial services firm is actively

marketing its mortgage laon portfolio for sale

o Example of where reclassification is not permitted –A change in intention

related to a particular financial asset (remember, there has to be a change in

the business model , assessment is not made at the individual asset level)

Business Model Test – more detail

o In order to meet the criteria to classify a financial instrutment at amortised

cost, the entity must have a business model whose objective is to collect the

contractual cashflows from an investment

The assessment of a “business model” is not made at individual

financial instrutment level

The assessment is based on how key management personnel actually

manage the business, rather than management’s intentions for specific

financial assets



An entity may have anumber of portfolios of financial assets and may

have a business model to collect contractual cashflows from some but

to hold others with the objective of realising changes in fair value. In

this instance, the assessment for classification would be carried out at

portfolio level

Periodic sales of financial assets does not preclude a company

assessing that its business model is to hold investments for collection

of contractual cashflows

Contractual cashflow test in more detail

o Only instrutments with contractual cashflows of principal and interest may

qualify for the amortised cost approach

o Would an interest in a convertible loan qualify? No because the inclusion of

the conversion option is not deemed to represent payments of interest and

principal

o A loan that pays an inverse floating interest rate does not qualify either – eg it

pays 8% minus LIBOR (inverse floating interest is where, as interest rates rise,

the coupon falls)

Impairment: The IFRS 9 impairment model, which is based on the premise of

providing for expected losses, should be applied to:

o Financial assets measured at amortised cost

o Financial assets measured at FVTOCI

Expected credit losses are required to be measured through a loss allowance at an

amount equal to:

o The 12 month expected credit losses or

o Full lifetime expected credit losses (i.e. expected credit losses that result from

all possible default events over the life of the financial instrument)



PAST EXAM QUESTIONS – IFRS 9

P1 Corporate Reporting P2 Advanced Corporate Reporting

Q4,Q5 April 2015 Q (A) April 15

Q2 Aug 2013

Q1 August 2014

Q3 (5) Aug 2013

Q (A) April 14

Q4 April 2012

Q (a) April 2013

Q3 April 2012

Issue 2 August 2012

Documents

TOPIC 27 - IFRS 9 FINANCIAL INSTRUTMENTS (2014)studyonline.ie/wp-content/uploads/2016/09/TOPIC-27-IFRS-9... · At the Period End, ... o In addition, once the change has been entered