The Standard includes requirements for recognition and measurement, impairment, de-recognition and general hedge accounting. This standard has replaced IAS 39 and responds to the criticisms that IAS 39 was too complex,
inconsistent with the way entities manage their businesses and risks, and defer the recognition of credit losses on loans and receivables until too late in the credit cycle.
The new standard is based on the concept that financial assets should
be classified and measured at fair value, with changes in fair value recognized
in profit and loss as they arise (“FVPL”). That is unless restrictive criteria are met for classifying and measuring the asset at either Amortized Cost or Fair Value Through Other Comprehensive Income (“FVOCI”) subject to a special
FVOCI designation option for investments in equity instruments, only
loans, receivables, investments in debt instruments and other similar
assets ( “loans and receivables”), can qualify for measurement at Amortized Cost or FVOCI. The key questions are whether:
• The objective of the entity’s business model is to hold assets only to collect
cash flows, or to collect cash flows and to sell (“the Business Model test”),
and
• The contractual cash flows of an asset give rise to payments on specified
dates that are solely payments of principal and interest (“SPPI”) on the
principal amount outstanding (“the SPPI test”).
Both of these tests determine whether to account for an instrument at
Amortized Cost or FVOCI
IFRS 9 specifies how an entity should classify and measure financial assets, financial liabilities, and some contracts to buy or sell non-financial items. IFRS 9 , deals separately with the classification and measurement of financial assets, impairment and hedging.
IFRS 9 requires an entity to recognise a financial asset or a financial liability in its statement of financial position when it becomes party to the contractual provisions of the instrument. At initial recognition, an entity measures a financial asset or a financial liability at its fair value plus or minus, in the case of a financial asset or a financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial asset or the financial liability.
So why does it matter if you are not in the Financial services sector?
Any entity with long-term loans, equity investments, or any non-standard financial assets, or only holding short-term receivables may find that it requires
significant changes to its financial reporting as the result of this standard.
Possible consequences of IFRS 9:
• Income statement volatility. More assets will
have to be measured at fair value with changes in fair value recognized in
profit and loss as they arise.
• Earlier recognition of impairment losses on receivables and loans,e.g. trade receivables. Entities will have to provide for possible
future credit losses in the first reporting period that a loan goes on the books
– even when it is highly likely that the asset will be fully collectible.
• New disclosure requirements—the more significantly impacted may even need new systems and processes to collect the necessary data.
IFRS 9 is an opportunity for balance sheet optimization, enhanced efficiency of
the reporting process and cost savings.
Before your year end audit consider the possible impact on financial statements, systems, processes, controls.
Financial assets
When an entity first recognises a financial asset, it classifies it based on the entity’s business model for managing the asset and the asset’s contractual cash flow characteristics, as follows:
Amortised cost—a financial asset is measured at amortised cost when both of the following conditions are met:
◦ the asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows; 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.
Fair value through other comprehensive income—financial assets are classified and measured at fair value through other comprehensive income when these are held in a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets.
Fair value through profit or loss—any financial assets that are not held in one of the two business models mentioned are measured at fair value through profit or loss.
When, and only when, an entity changes its business model for managing financial assets it must reclassify all affected financial assets.
Financial liabilities
All financial liabilities are measured at amortised cost, except for financial liabilities at fair value through profit or loss. Such liabilities include derivatives (other than derivatives that are financial guarantee contracts or are designated and effective hedging instruments), other liabilities held for trading, and liabilities that an entity designates to be measured at fair value through profit or loss (see ‘fair value option’ below).
After initial recognition, an entity cannot reclassify any financial liability.
Fair value option
An entity may, at initial recognition, irrevocably designate a financial asset or liability that would otherwise have to be measured at amortised cost or fair value through other comprehensive income to be measured at fair value through profit or loss when doing so will either eliminate, or significantly reduce a measurement or recognition inconsistency (sometimes referred to as an ‘accounting mismatch’) or will otherwise result in more relevant information.
Impairment
Impairment of financial assets is recognised in stages:
Stage 1—as soon as a financial instrument is originated or purchased, 12-month expected credit losses are recognised in profit or loss and a loss allowance is established. This serves as a proxy for the initial expectations of credit losses. For financial assets, interest revenue is calculated on the gross carrying amount (ie without deduction for expected credit losses).
Stage 2—when the credit risk increases significantly and is not considered low, full lifetime expected credit losses are recognised in profit or loss. The calculation of interest revenue is the same as for Stage 1.
Stage 3—when the credit risk of a financial asset increases to the point that it is considered credit-impaired, interest revenue is calculated based on the amortised cost (ie the gross carrying amount less the loss allowance). Financial assets in this stage will generally be assessed individually. Lifetime expected credit losses are recognised on these financial assets.
Hedge accounting
The objective of hedge accounting is to represent, in the financial statements, the effect of an entity’s risk management activities that use financial instruments to manage exposures arising from particular risks that could affect profit or loss or other comprehensive income.
Hedge accounting is optional. An entity applying hedge accounting designates a hedging relationship between a hedging instrument and a hedged item. For hedging relationships that meet the qualifying criteria in IFRS 9, an entity accounts for the gain or loss on the hedging instrument and the hedged item in accordance with the special hedge accounting provisions of IFRS 9.
IFRS 9 identifies three types of hedging relationships and prescribes special accounting provisions for each:
fair value hedge: a hedge of the exposure to changes in fair value of a recognised asset or liability or an unrecognised firm commitment, or a component of any such item, that is attributable to a particular risk and could affect profit or loss.
cash flow hedge: a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated with all, or a component of, a recognised asset or liability (such as all or some future interest payments on variable-rate debt) or a highly probable forecast transaction, and could affect profit or loss.
hedge of a net investment in a foreign operation as defined in IAS 21.
When an entity first applies IFRS 9, it may choose to continue to apply the hedge accounting requirements of IAS 39, instead of the requirements in IFRS 9, to all of its hedging relationships.
IFRS 9 is effective for annual periods beginning on or after 1 January 2018.
