R.S. Bernaldo & Associates

IFRS 9 FINANCIAL INSTRUMENTS

This publication will discuss the general concepts of the standard, including the following:

Reasons for Issuing the Standard

Many users of financial statements and other interested parties have found that the requirements in IAS 39 were difficult to understand, apply and interpret mainly due to the following:

• Classification of financial assets and liabilities:

        √  rule-based

        √  complex and difficult to apply

        √ multiple impairment models

        √  own credit gains and losses recognized in profit or loss for fair value option liabilities

        √  complicated reclassification rules

• Impairment: delayed recognition of credit losses on loans
• Hedged accounting requirements:

       √ do not reflect risk management appropriately

       √  insufficient disclosure on entity’s risk management activities

Scope

Generally, the scope of IAS 39 is only carried forward to IFRS 9 with certain other instruments added only. This is shown in the diagram below

Note

Certain contracts that are subject to own-use exemption:

• A contract to buy or sell a non-financial item that can be settled net in cash or another financial instrument, or by exchanging financial instruments, as if the contract was a financial instrument.
• May be irrevocably designated as measured at fair value through profit or loss even if it was entered into for the purpose of the receipt or delivery of a non-financial item in accordance with the entity’s expected purchase, sale or usage requirements. 

Recognition and Derecognition

Generally, the requirements for recognition and derecognition of IAS 39 are carried forward to IFRS 9 with certain minor amendments only. These include the following:

• clarification that a write-off constitutes a derecognition event for a financial asset or a portion thereof, and
• modification of the terms of a financial asset may lead to its derecognition.

The definition of financial instrument, including financial asset, financial liability and equity instrument did not change. (See IAS 32 Financial Instruments: Presentation) 

Classification of Financial Assets

IFRS 9 provides three (3) principal measurement categories, namely:

• amortised cost,
• fair value through other comprehensive income (FVOCI), and
• fair value through profit or loss (FVTPL) (residual category).

Notice that the existing categories under IAS 39 such as held-to-maturity, loans and receivables, and available-for-sale are already removed. In addition, the exception that allows certain equity investments and derivatives linked to such investments, to be measured at cost are removed.

Now in order to determine the classification of a financial asset, IFRS 9 provides two (2) criteria:

• business model for managing the financial asset (Business model criterion),and
• contractual cash flow characteristics of the financial asset (SPPI criterion).

Note: SPPI means solely payment of principal and interest.

The assessment of the foregoing criteria and its resulting measurement categories are as follows:

• Amortised cost measurement category

      A financial asset is classified as subsequently measured at amortised cost if it:

      √  meets the SPPI criterion; and

      √  is held within a business model whose objective is to hold financial assets in order to collect contractual cash flows.

• FVOCI measurement category

A financial asset is classified as subsequently measured at FVOCI if it:

• meets the SPPI criterion; and
• is held in a business model in which assets are managed both in order to collect contractual cash flows and for sale.

• FVTPL measurement category (residual category)

       All other financial assets that do not meet the criteria for classification as subsequently measured at either amortised       cost or FVOCI are classified as subsequently measured at fair value, with changes in fair value recognised in profit or          loss.

• FVTPL election for financial assets

       Similar to IAS 39, an entity has the option at initial recognition to irrevocably designate a financial asset as at FVTPL if        doing so eliminates or significantly reduces a measurement or recognition inconsistency.

• FVOCI election for equity instruments

     At initial recognition, an entity may make an irrevocable election to present in OCI subsequent changes in the fair value      of an investment in an equity instrument that is neither held for trading nor contingent consideration recognised by an         acquirer in a business combination to which IFRS 3 Business Combinations applies.

To reiterate one of the criteria for determining the classification of financial asset is whether the cash flows meet the SPPI criterion. A financial asset that does not meet the SPPI criterion is automatically measured at FVTPL, unless it is an equity instrument for which an entity applies the OCI election.

And as previously discussed, SPPI criterion constitute two types of cash flows, namely:

• Principal

      √ Fair value of the financial asset at initial recognition. However, principal may change over time – e.g. if there are                  repayments of principal.

• Interest is consideration for:

       √  the time value of money; and

       √  the credit risk associated with the principal amount outstanding during a particular period of time.

        It can also include:

       √ consideration for other basic lending risks (e.g. liquidity risk) and costs (e.g.  administrative costs); and

       √  a profit margin.

It is important to understand that in order for contractual cash flows to be SPPI they must include returns consistent with a basic lending arrangement. The following are considered in assessing the SPPI criterion:

• contractual features that introduce exposure to risks or volatility in the contractual cash flows;
• financial asset with modified time value element;
• regulated interest rates;
• ‘de minimis’ features;
• contingent events affecting cash flows;
• prepayments and extension options;
• contractually linked instruments; and
• non-recourse provision.

On the other hand, in assessing the business model we should understand the how the entity manages its financial assets in order to generate cash flows. That is, the entity’s business model determines whether cash flows will result from collecting contractual cash flows, selling the financial assets or both.

The following table summarises the key features of each type of business model and the resultant measurement category.

Note

(a)     Subject to meeting the SPPI criterion and fair value option

(b)     SPPI criterion is irrelevant – assets in all such business model are measured at FVTPL

The diagram below provides a summary of the classification of financial assets.

Note

The diagram above does not include the following:

√ FVTPL election for financial assets

√ FVOCI election for equity instruments

Please download the PDF below should you wish to further read the remaining topics:

• Classification of Financial Liabilities
• Embedded Derivatives
• Reclassification
• Measurement on Initial Recognition
• Subsequent Measurement
• Impairment
• Hedge Accounting
• Presentation
• Effectivity Date and Transition

If you wish to have a more detailed discussion, please contact our Quality Assurance Unit thru email: qau [at] rsbernaldo [dot] com (qau [at] rsbernaldo [dot] com). Thank you.

PDF version: 

QAU Alert 02-2015 IFRS 9 Financial Instruments