(IFRS) 9 Financial Instruments
After the first version of IFRS 9 was issued in 2009, the next five years saw were numerous edits, additions and consultations which resulted in the final version published in July of 2014. IFRS 9 sets out the requirements for recognizing and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items. IFRS 9 replaces International Accounting Standard (IAS) 39 Financial Instruments: Recognition and Measurement.
IFRS 9 is based on three pillars: classification and measurement, impairment and hedge accounting. The aim of this article is to summarize the first two pillars. The objective of IFRS 9 is to establish principles for the financial reporting of financial assets and financial liabilities that will present relevant and useful information to users of financial statements for their assessment of the amounts, timing and uncertainty of an entity’s future cash flows.
An entity shall recognize a financial asset or a financial liability in its statement of financial position when, and only when, the entity becomes party to the contractual provisions of the instrument. An entity shall derecognize a financial asset when, and only when: (i) the contractual rights to the cash flows from the financial asset expire, or, (ii) it transfers the financial asset and the transfer qualifies for derecognition.
In determining whether a transfer qualifies for derecognition an entity has to evaluate the extent to which it retains the risks and rewards of ownership. An entity shall remove a financial liability from its statement of financial position when, and only when, it is extinguished, i.e. when the obligation specified in the contract is discharged or cancelled or expires. The above recognition and derecognition rules are not materially different from IAS 39.
Classification/measurement – financial assets
Note – all financial assets and financial liabilities are measured initially at fair value
In determining the category for a financial asset under IFRS 9 the entity considers both (i) the entity’s business model for managing financial assets and (ii) the contractual cash flow characteristics of the financial asset.
|AC – both conditions||FVTOCI – both conditions|
|The financial asset is held within a business model whose objective is to hold financial assets in order to collect contractual cash flows, and;||The financial asset is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets, and;|
|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.||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 financial asset shall be measured at fair value through profit or loss (FVTPL) unless it is measured at amortized cost or at fair value through other comprehensive income. 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 in other comprehensive income.
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 that would otherwise arise from measuring assets or liabilities or recognizing the gains and losses on them on different bases.
Classification/measurement – financial liabilities
After initial recognition an entity shall measure all financial liabilities at amortized cost except:
|IFRS 9||IAS 39|
|Financial liabilities at fair value through profit and loss ||YES||YES|
|Financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or when the continuing involvement approach applies||YES||YES|
|Financial guarantee contracts||YES||YES|
|Commitments to provide a loan at a below-market interest rate||YES||YES|
|Contingent consideration recognized by an acquirer in a business combination||YES||YES|
As can be seen from the above there were a few changes for financial assets and only one minor edit for financial liabilities in the evolution from IAS 39 to IFRS 9 as it relates to classification and measurement.
An entity shall recognize a loss allowance for expected credit losses on a financial asset where required as noted above.
When making the assessment, an entity shall use the change in the risk of a default occurring over the expected life of the financial instrument instead of the change in the amount of expected credit losses. To make that assessment, an entity shall compare the risk of a default occurring on the financial instrument as at the reporting date with the risk of a default occurring on the financial instrument as at the date of initial recognition and consider reasonable and supportable information, that is available without undue cost or effort, that is indicative of significant increases in credit risk since initial recognition. An entity may assume that the credit risk on a financial instrument has not increased significantly since initial recognition if the financial instrument is determined to have low credit risk at the reporting date.
If reasonable and supportable forward-looking information is available without undue cost or effort, an entity cannot rely solely on past due information when determining whether credit risk has increased significantly since initial recognition. However, when information that is more forward-looking than past due status (either on an individual or a collective basis) is not available without undue cost or effort, an entity may use past due information to determine whether there have been significant increases in credit risk since initial recognition. Regardless of the way in which an entity assesses significant increases in credit risk, there is a rebuttable presumption that the credit risk on a financial asset has increased significantly since initial recognition when contractual payments are more than 30 days past due.
An entity can rebut this presumption if the entity has reasonable and supportable information that is available without undue cost or effort, that demonstrates that the credit risk has not increased significantly since initial recognition even though the contractual payments are more than 30 days past due. When an entity determines that there have been significant increases in credit risk before contractual payments are more than 30 days past due, the rebuttable presumption does not apply.
Effective date and transition
An entity shall apply IFRS 9 for annual periods beginning on or after Jan. 1, 2018. Earlier application is permitted. If an entity elects to apply the standard early, it must disclose that fact and apply all of the requirements in the standard at the same time (with certain limited exceptions). An entity shall apply IFRS 9 retrospectively, in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, (with certain limited exemptions).
IFRS 9 has been a standard in progress since 2008-2009, soon after the credit crisis. It has gone through multiple exposure drafts, feedback from industry participants and effective dates. Will the finalized standard result in more useful information to the users of financial statements? Will it prevent another credit crisis? The answers to these questions will remain outstanding in the foreseeable future until it becomes effective and is applied across all impacted entities. However it is a step forward in analyzing the use of financial instruments by an entity.