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IFRS 9: Financial InstrumentsA Closer Look

Flow of Discussion

IntroductionClassificationRecognition and Measurement

ImpairmentDerecognition

Introduction

Date Phase Completed

November 12, 2009

IASB issued IFRS 9 Financial Instruments as the first step in its project to replace IAS 39. Introduced new requirements for classification and measurement of financial assets. Effective date January 1, 2013 with early adoption permitted.

October 28, 2010

IASB reissued IFRS 9, incorporating new requirements on accounting for financial liabilities, carrying over IAS 39 requirements of derecognition.

Introduction

Date Phase Completed

December 16, 2011

Amended effective date of IFRS 9 to January 1, 2015.

November 19, 2013

IASB issued IFRS 9 Financial Instruments to include the new general hedge accounting model, allow early adoption of the treatment of fair value changes due to own credit on liabilities designated at FVPL and remove January 1, 2015 effective date.

July 24, 2014 IASB issued the final version of IFRS 9 incorporating a new expected credit loss impairment model. Supersedes all versions. Effective January 1, 2018 with early adoption permitted.

IAS 39 vs. IFRS 9

IAS 39 IFRS 9

Classification of financial assets

Four categories:-Fair value through profit or loss (FVTPL)-Loans and receivables-Held to maturity (HTM)-Available-for-sale financial assets

Three categories:-Amortized cost-Fair value through other comprehensive income (FVTOCI)-Fair value through profit or loss (FVTPL)

IAS 39 vs. IFRS 9

IAS 39 IFRS 9

Classification of financial liabilities

Two categories:-Fair value through profit or loss (FVTPL)-Amortized cost

No change to categories. However, for financial liabilities designated at FVTPL under the fair value option, the fair value changes arising from changes in the entity’s own credit risk are recognized in OCI.

IAS 39 vs. IFRS 9

IAS 39 IFRS 9

Hybrid contracts (contracts with embedded derivatives)

Separate (bifurcate) if the embedded derivative is not closely related to the host contract and the entire contract is not measured at FVTPL.

No separation (bifurcation) for financial assets.

Separation (bifurcation) remains for financial liabilities and contracts for non-financial assets and liabilities

Classification of Financial Assets

vDebt

instrument?

Derivative?

Equity instrume

nt?

‘Hold-to-collect’ contractual cash flows business

model?

Cash flows that are solely

payments of principal and

interest (SPPI)?

Conditional fair value option (FVO)

elected?

Financial assets at fair

value through

profit or loss (FVTPL)

Financial assets at amortized

costFinancial assets at FVTOCI

(with recycling)

Held for trading?

FVOCI option

elected?

Financial assets at FVTOCI

(no recycling)

NO

NO

YES

YES

YES

NO

NO

YES

NO

YES YES

NO

YES

YES

NO

Financial assets at amortized cost

IFRS 9 paragraph 4.1.2:“A financial asset shall be measured at amortized

cost if both of the following conditions are met:a. the financial asset is held within a business

model whose objective is to hold financial assets in order to collect contractual cash flows (‘hold-to-collect’ business model test); and

b. 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 (‘SPPI’ contractual cash flow characteristics test).


Examples of financial instruments that are likely to be classified and measured at amortized cost under IFRS 9 include: Trade receivables Loan receivables Investments in government bonds that are

not held for trading Investments in term deposits at standard

interest rates


‘Hold-to-collect’ business model test The entity’s objective is to hold the financial

asset to collect the contractual cash flows from the financial asset, done at an aggregate level.

IFRS 9 does not require that the financial asset is always held until its maturity.

Key management personnel (KMP) determine whether a financial asset meets the business model test (facts and circumstances, how an entity is managed, type of information provided to management).


‘SPPI’ contractual cash flow characteristics test Contractual terms of the financial asset give rise

to cash flows that are solely payments of principal and interest on the principal amount outstanding on specified dates , done at an instrument level

Interest is deemed to be the consideration for the time value of money and credit risk

Prepayment and extension options do not necessarily violate the SPPI contractual cash flow characteristics test

Financial assets at fair value through other comprehensive income (FVTOCI)

IFRS 9 paragraph 4.1.2A:“A financial asset shall be measured at fair value

through other comprehensive income if both of the following conditions are met:

a. the financial asset is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets (business model test); and

b. 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 (‘SPPI’ contractual cash flow characteristics test).


Business model test: Both collecting contractual cash flows and selling

financial assets are integral to achieving the objective of the business model

Example: the objective of the business model may be to manage everyday liquidity needs, to maintain a particular interest yield profile or to match the duration of the financial assets to the duration of the liabilities that those assets are funding

This will typically involve greater frequency and value of sales of financial assets


For debt financial instruments classified as FVTOCI: Fair value changes are recognized in OCI Interest revenue, foreign exchange

revaluation and impairment losses or reversals are recognized in profit or loss

Upon derecognition, the net cumulative fair value gains or losses are recycled to profit or loss (with recycling)


IFRS 9 paragraph 4.1.4:“However, an entity may make an

irrevocable election at initial recognition for particular investments in equity instruments that would otherwise be measured at fair value through profit or loss to present subsequent changes in fair value through other comprehensive income.”


For equity investments elected to be classified as FVTOCI: Not held for trading Fair value changes are recognized in OCI Dividends are recognized in profit or loss On disposal, cumulative fair value

changes are required to remain in OCI, however entities have the ability to transfer amounts between reserves within equity (no recycling)

Financial assets at fair value through profit or loss (FVTPL)

IFRS 9 paragraph 4.1.4:“A financial asset shall be measured at

fair value through profit or loss unless it is measured at amortized cost in accordance with paragraph 4.1.2 or at fair value through other comprehensive income in accordance with paragraph 4.1.2A.”


IFRS 9 paragraph 4.1.5:“Despite paragraphs 4.1.1-4.1.4, an entity may,

at initial recognition, irrevocably designate a financial asset as measured at fair value through profit or loss 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 recognizing the gains and losses on them on different bases.” (fair value option)


A financial asset is classified and measured at fair value through profit or loss (FVTPL) if it is: A held-for-trading financial asset (a derivative that

has not been designated in a hedging relationship, or a financial asset that is held for the purposes of short-term sale or repurchase)

A debt instrument that does not qualify to be measured at amortized cost

An equity instrument for which the entity has not elected to classify the instrument as FVTOCI

A financial asset where the entity has elected to measure the asset at FVTPL under the fair value option (FVO)


Examples of financial instruments that are likely to fall under the FVTPL category include: Investments in shares of listed companies that the

entity has not elected to account for it as at FVTOCI Derivatives that have not been designated in a

hedging relationship (interest rate swaps, commodity futures/options contracts, foreign exchange futures/options contracts)

Investments in convertible notes, commodity linked bonds

Contingent consideration receivable from the sale of a business


The ‘fair value option’ (FVO) The designation is irrevocable. More commonly used by financial

institutions.

Classification of Financial Liabilities

Financial liabilities at

amortized cost

Financial liabilities at fair value

through profit or loss (FVTPL)

Guidance on specific financial

liabilities

Financial liabilities at amortized cost

IFRS 9 requires all financial liabilities to be measured at amortized cost unless: The financial liability is required to be

measured at FVTPL because it is held for trading

The financial liability arise when a transfer of financial asset does not qualify for derecognition or when the continuing involvement approach applies

The financial liability is a financial guarantee contract


IFRS 9 requires all financial liabilities to be measured at amortized cost unless: The financial liability commits to provide a

loan at a below-market interest rate The financial liability is a contingent

consideration recognized by an acquirer in a business combination to which IFRS 3 applies

The entity elects to measure the financial liability at FVTPL (fair value option)


Examples of financial liabilities that are likely to be classified and measured at amortized cost include: Trade payables Loan payable with standard interest

rates (such as benchmark rate plus a margin)

Bank borrowings

Financial liabilities at fair value through profit or loss (FVTPL)

In accordance with IFRS 9, financial liabilities are to be measured at fair value through profit or loss if either: The financial liability is required to be

measured at FVTPL because it is held for trading (e.g. Derivatives that have not been designated in a hedging relationship)

The entity elects to measure the financial liability at FVTPL (fair value option)


Examples of financial liabilities that are likely to be classified and measured at fair value through profit or loss (FVTPL) include: Derivatives that have not been designated in a

hedging relationship (interest rate swaps, commodity futures/options contracts, foreign exchange futures/options contracts)

Convertible note liabilities that have been designated as FVTPL

Contingent consideration payable that arise from business combination


Fair value option (FVO) IFRS 9 permits an entity to designate financial

liabilities at FVTPL if any of the following apply:▪ If electing fair value will eliminate or reduce an

accounting mismatch▪ If the financial liability is managed and evaluated on a

fair value basis with other financial liabilities or financial assets and liabilities as a group

▪ A hybrid contract (e.g. A convertible note or a loan with a leveraged interest rate) contains an embedded derivative that would otherwise be required to be separated.


Fair value option (FVO) If the entity uses the fair value option (FVO),

changes in fair value that relate to changes in the entity’s own credit status are presented in other comprehensive income instead of profit or loss. However, if it creates or enlarges an accounting mismatch in profit or loss, then all gains or loss are required to be presented in profit or loss.

This is not subsequently recycled to profit or loss when the financial liability is derecognized.

Guidance on specific financial liabilities

Financial guarantee contracts Commitments to provide a loan at a

below market interest rate Financial liabilities resulting from the

transfer of a financial asset that does not qualify for derecognition or when the continuing involvement approach applies These are subsequently measured differently

(neither at amortized cost or fair value)

Hybrid Contracts containing Embedded Derivatives

IFRS 9 has eliminated the requirement to separately account for embedded derivatives for financial assets. Instead, IFRS 9 requires entities to assess the hybrid contract as a whole for classification.

Bifurcation is still applicable for embedded derivatives for financial liabilities as also required by IAS 39 previously.

Reclassification

IFRS 9 requires the reclassification of financial assets if an entity changes its business model. Must be determined by senior management

as a result of an external or internal change Must be a significant change to the entity’s

operation These are expected to be rare and infrequent

events An entity shall not reclassify any financial

liability.

Reclassification

The following changes in circumstances are NOT considered changes in the overall business model of the entity: An entity changes its intention in relation to

a specific financial asset The temporary disappearance of a

particular market for financial assets The transfer of financial assets between

different parts of an entity that have different business models

Reclassification

Reclassification mechanics: Accounted for prospectively from the

reclassification date Entities are not permitted to restate

previously recognized gains, losses or interest

Additional disclosures apply when an entity reclassifies its debt instruments

Measurement of Financial Instruments

Initial Measurement: At fair value, plus for those financial

assets and liabilities not classified at fair value through profit or loss, directly attributable transaction costs.

Subsequent Measurement:Classification

Valuation

FV Chang

es

Interest/ Dividen

ds

Impair-

ment

Forex

FAFVPL FV PL PL PL PL

FAFVOCI FV OCI* PL PL/OCI

PL/OCI

FAAC Amortized Cost

None PL PL PL

Impairment of Financial Instruments

An entity shall recognize a loss allowance for expected credit losses on a financial asset that is measured as FAAC or FAFVOCI, a lease receivable, a contract asset or a loan commitment and a financial guarantee.

The new impairment model establishes a three-stage approach, based on changes in expected credit losses of a financial instrument. This determines the recognition of impairment (as well as the recognition of interest revenue).


At initial recognition, an entity recognizes a loss allowance equal to 12 months expected credit losses (present value of all cash shortfalls over the remaining life, discounted at the original effective interest rate).

After initial recognition, the 3-stage expected credit loss model applies as follow: Stage 1: credit risk has not increased significantly since initial

recognition – entities continue to recognize 12 months expected losses, updated at each reporting date

Stage 2: credit risk has increased significantly since initial recognition – entities recognize lifetime expected losses and interest is presented on a gross basis

Stage 3: the financial asset is credit impaired – entities recognize lifetime expected losses but present interest on a net basis (based on the gross carrying amount less credit allowance)


Stage 1 2 3

Recognition of impairment

12 month expected

credit losses

Lifetime expected credit loss

Recognition of interest

Effective interest on the gross carrying amount

(before deducting expected losses)

Effective interest on

the net (carrying) amount


General Approach

Simplified

Approach

Short-term trade receivables

Long-term trade receivables Policy election at entity level

Other debt financial assets measured at AC or FVOCI

Loan commitments and financial guarantee contracts not accounted for at FVPL

Lease receivables Policy election at entity level

Contract assets (do not contain a significant financing component)

Contract assets (contain a significant financing component)

Policy election at entity level

Derecognition of Financial Instruments

Derecognition of Financial Instruments

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