Introduction to IFRS 9

The International Accounting Standards Board in 2014 completed the final version of its overall response to the 2008 global financial crises leading to the issuance of IFRS 9, Financial Instruments, which replaces IAS 39, Financial Instruments: Recognition and Measurement, with effect from 1 January 2018.

Because IAS 39 was considered to be complex and difficult to understand, simplifying the requirements of IAS 39 was one of the main objectives of the IASB. IFRS 9 uses an increasingly principle-based model as compared to the rule-based model of IAS 39, thus reducing the complexity revolving around classification, recognition and reclassification of financial instruments. In terms of measurement, IFRS 9 includes a completely overhauled methodology for recognition of impairment losses.

IFRS 9 requires all financial assets to be measured at amortised cost or fair value, depending on their classification by reference to the business model within which they are held and their contractual cash flow characteristics. There is therefore significant importance given to the business model under IFRS 9. There is also equal importance given to the nature of underlying cash flows relating to financial instruments, which also plays a significant part in determining classification.

IFRS 9 retains all of the existing requirements of IAS 39 related to the subsequent measurement of financial liabilities except where the fair value through profit or loss option is adopted, under which gains and losses attributable to changes in own credit risk are recognised in other comprehensive income (rather than in profit or loss). This change will result in increases in own credit risk not resulting in gains recognised within profit or loss.

The incurred loss model under IAS 39 had been criticised for delaying the recognition of credit losses until there was evidence of a trigger event. IAS 39 also had multiple and complex impairment models that were difficult to understand, apply and interpret. The new expected credit loss model for the recognition and measurement of impairment aims to address concerns with upfront recognition of expected credit losses. However, the new approach will require considerable time and effort for the development of suitable historical and forward-looking financial models.

IFRS 9 has been significantly amended in relation to hedge accounting with an aim of having a better reflection in financial statements of how risk management activities are undertaken when hedging financial and non-financial risks. The new hedge accounting requirements are meant to more closely reflect the underlying business model and objectives and thus result in improved accounting for hedging arrangements.

Significant Differences Between IFRS 9 and IAS 39

1. Scope: IAS 39 excluded from its scope contracts to buy or sell non-financial items in the entity's expected purchase, sale or usage requirements. IFRS 9 allows an entity to irrevocably designate such contracts as measured at Fair Value through Profit or Loss (FVTPL).
2. Classification of assets: IFRS 9 has only three classifications for financial assets, being FVTPL, Fair Value through Other Comprehensive Income (FVTOCI) and Amortised Cost. Under IAS 39, in addition to FVTPL, there were separate classifications, being Loans and Receivables, Held to Maturity and Available for Sale. There are differing requirements on how the classifications are selected under IFRS 9, including reclassification of items between other comprehensive income and profit or loss depending on whether the instrument is equity or debt in nature. This is covered in more detail under classification later in the chapter.
3. Impairment: IFRS 9 includes an expected credit loss model in determin ing impairment provisions. In addition, IFRS 9 includes requirements for the measurement of expected credit losses on written loan commitments and financial guarantee commitments. IAS 39 was based largely on an incurred credit loss model and did not scope in loan commitments and financial guarantee contracts.
4. Hedge accounting: IFRS 9 more closely aligns hedge accounting with the business risk management model. It also has fewer restrictions as compared to IAS 39 in respect of hedging non-financial items, hedging portfolios or groups of items and hedging net positions.

Financial institutions will be significantly impacted by IFRS 9 and particularly in respect of recognition and measurement of credit losses. It is anticipated that recognition of credit loss provisions will be accelerated. The insurance industry will also be impacted by the adoption of IFRS 9 for both its financial instruments and insurance contracts. IASB issued IFRS 17, Insurance Contracts, on 18 May 2017, which replaces IFRS 4.

Non-financial institutions may also be impacted by IFRS 9, the extent of which will depend on the complexity of their business, the extent of use of complex financial instruments and the profile of their receivables book.

Objective

IFRS 9, IFRS 7 and IAS 32 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.

Scope

The financial instrument standards apply to all financial instruments with specific scope exclusions as detailed below:

The following loan commitments are specifically within the scope of IFRS 9:

1. Loan commitments that are designated as financial liabilities at FVTPL. An entity that has a past practice of selling the assets resulting from its loan commitments shortly after origination is required to apply IFRS 9 to all its loan commitments in the same class.
2. Loan commitments that can be settled net in cash or by delivering or issuing another financial instrument. These loan commitments are derivatives. A loan commitment is not regarded as settled net merely because the loan is paid out in instalments (for example, a mortgage construction loan that is paid out in instalments in line with the progress of construction).
3. Loan commitments to provide a loan at a below-market interest rate.

Initial Recognition

A financial asset or a financial liability should be recognised in the statement of financial position when, and only when, an entity becomes party to the contractual provisions of the instrument.

An entity recognises all of its contractual rights and obligations under derivatives in its statement of financial position as assets and liabilities, respectively, except for derivatives that prevent a transfer of financial assets from being accounted for as a sale. For example:

1. Unconditional receivables and payables are recognised as assets or liabilities when an entity becomes a party to the contractual agreement and, as a consequence, has a legal right to receive or a legal obligation to pay cash.
2. Assets to be acquired and liabilities to be incurred as a result of a firm commitment to purchase or sell goods or services are generally not recognised until at least one of the parties has performed under the agreement.
3. A forward contract is recognised as an asset or a liability on the commitment date, instead of on the date on which settlement takes place.
4. Option contracts are recognised as assets or liabilities when the holder or writer becomes a party to the contract.
5. Planned future transactions, no matter how likely, are not assets or liabilities because the entity has not become a party to a contract.

If, for the transferor, a transfer of a financial asset does not qualify for derecognition, the transferee is also not able to recognise the transferred asset.

Initial Measurement

Financial instruments can arise from various transactions that can be broken down into two main sources:

1. Trade receivables that originate from revenue transactions that are recognised under the provisions of IFRS 15; and
2. All other financial instruments that are acquired or assumed.

Except for trade receivables, which do not contain a significant financing component, at initial recognition, an entity shall measure a financial asset or financial liability at its fair value plus or minus, in the case of a financial asset or financial liability not at FVTPL, transaction costs that are directly attributable to the acquisition or issue of the financial asset or financial liability.

The initial recognition of trade receivables that arise from transactions under the scope of IFRS 15 are determined by the recognition principles of IFRS 15 and are generally measured at the transaction price where the transaction does not include a significant financing component. In respect of all other financial assets or liabilities, IFRS 9 requires that these be measured at initial recognition at fair value.

However, complexity often arises in respect of accounting for the transaction costs that are directly attributed to financial instruments. IFRS 9 provides for the following treatment depending on the classification of the financial instrument:

1. For financial assets or liabilities that are not measured at FVTPL, transaction costs that are directly attributable to the acquisition or issue of the instrument are adjusted for in the fair value at initial recognition; and
2. For financial assets or liabilities that are measured at FVTPL, transaction costs are expensed to profit or loss on initial recognition.

Initial Measurement: Transaction Costs

Transaction costs should be included in the initial measurement of financial assets and financial liabilities other than those at FVTPL. For financial assets not measured at FVTPL, transaction costs are added to the fair value at initial recognition. For financial liabilities, transaction costs are deducted from the fair value at initial recognition.

For financial instruments that are measured at amortised cost, transaction costs are subsequently included in the calculation of amortised cost using the effective interest method and, in effect, amortised through profit or loss over the life of the instrument.

For financial instruments that are measured at FVTOCI (other than debt instruments), transaction costs are recognised in other comprehensive income as part of a change in fair value at the next remeasurement date. If the financial asset is measured at FVTOCI as a debt instrument, transaction costs are amortised to profit or loss using the effective interest method and, in effect, amortised through profit or loss over the life of the instrument.

Transaction costs expected to be incurred on subsequent transfer or disposal of a financial instrument are not included in the measurement of the financial instrument.

Transaction costs on financial instruments measured at FVTPL are recognised in profit or loss.

Fair Value on Initial Recognition?

IFRS 9 refers to the definition of fair valuation as specified within IFRS 13, i.e., fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As a result, measurement of fair value for IFRS 9 purposes is based on a market approach and not on the entity's specific value.

The fair value of a financial instrument at initial recognition is normally the transaction price particularly for financial instruments that are traded on the basis of fair values (i.e., the fair value of the consideration given or received). However, if part of the consideration given or received is for something other than the financial instrument, or where the transaction price is not at true fair value (e.g., transactions between related parties, transactions under duress, etc.), an entity is required to measure the fair value of the financial instrument using the fair valuation techniques and hierarchies as specified within IFRS 13.

For example, the fair value of a long-term loan or receivable that carries no interest can be measured as the present value of all future cash receipts discounted using the prevailing market rate(s) of interest for a similar instrument (similar as to currency, term, type of interest rate and other factors) with a similar credit rating. Any additional amount lent is an expense or a reduction of income unless it qualifies for recognition as some other type of asset.

If an entity originates a loan that bears an off-market interest rate (e.g., 5% when the market rate for similar loans is 8%), and receives an upfront fee as compensation, the entity recognises the loan at its fair value, i.e., net of the fee it receives. Assuming that the upfront fee received is exactly the same as the discounted value differential between the market and contractual rate, the fair value of the debt instrument should in theory equate the amount lent net of the upfront fee.

If an entity determines that the fair value at initial recognition differs from the transaction price, the entity shall account for that instrument at that date as follows:

1. If that fair value is evidenced by a quoted price in an active market for an identical asset or liability (i.e., a level 1 input) or based on a valuation technique that uses only data from observable markets (level 2 input). An entity shall recognise the difference between the fair value at initial recognition and the transaction price as a gain or loss recognised within profit or loss—also referred to as a day 1 profit or loss. However, in some cases, other IFRS may require this gain or loss to be recognised differently. For example, where a gain arises from an interest-free loan received by a subsidiary from a parent, they would ordinarily represent a capital contribution recognised directly within equity.
2. For all other sources of fair value (typically level 3 inputs), the difference between the fair value at initial recognition and the transaction price is deferred. After initial recognition, the entity shall recognise that deferred difference as a gain or loss only to the extent that it arises from a change in a factor (including time) that market participants would consider when pricing the asset or liability. In this case, it would be expected that the difference would be recognised in profit or loss over the term of the instrument or the period to derecognition.

When an entity uses settlement date accounting for an asset that is subsequently measured at amortised cost, the asset is recognised initially at its fair value on the trade date.

Financial Assets

Classification of Financial Assets—Decision Tree

Cash Flow Characteristics

Cash flow characteristics refers to how an entity collects future cash flows from its financial assets and whether these relate to payments of interest, principal or other gains.

Fair Value Through Other Comprehensive Income (FVTOCI)

The FVTOCI category of classification applies when both the following conditions are met:

1. The financial asset is held within the business model whose objective is achieved by both collecting contractual cash flows and selling financial assets; and
2. The contractual term of the financial asset gives rise on specified dates to cash flows that are solely payment of principle and interest on the principal amount outstanding.

Financial assets which are held to collect both to contractual cash flows and cash flows from sale are subsequently classified as FVTOCI. Models designed to manage liquidity needs and maintain yield profiles are examples of such business models. Such models will involve a greater frequency and value of sales due to this being integral, achieving the business model's objective. There is no prescribed threshold for the frequency and value of sales.

Amortised Cost

The amortised cost category of classification applies when both the following conditions are met:

1. The financial asset is held within the business model whose objective is to hold financial assets in order to collect contractual cash flows; and
2. The contractual term of the financial asset gives rise on specified dates to cash flows that are solely payment of principle and interest on the principal amount outstanding.

Principal is defined as the fair value of the financial asset at initial recognition. Interest consists of consideration for the time value of money, credit risk associated with the principal amount outstanding during a particular period of time and for other basic lending risks and costs, as well as a profit margin.

Subsequent Measurement of Financial Assets

After initial recognition, an entity shall measure a financial asset in accordance with IFRS 9 at:

1. Fair Value Through Profit or Loss (FVTPL);
2. Fair Value Through Other Comprehensive Income (FVTOCI); or
3. Amortised Cost.

The determination of the basis of measurement will be based on the classification of the financial asset as discussed above.

An entity shall apply the impairment requirements to financial assets that are measured at amortised cost and to financial assets that are measured at FVTOCI. Impairment is covered in further detail in this chapter.

Investments in Equity Instruments

IFRS 9 requires that investments in equity instruments are measured at fair value. An entity can make an irrevocable election at initial recognition for investments in equity instruments that do not meet the definition of held for trading to be measured at FVTOCI rather than FVTPL. For such equity instruments, changes in fair value are required to be presented within OCI and reclassifications of amounts previously presented in OCI to profit or loss is not permitted, even at derecognition. This is an area of significant change from IAS 39, which required that such gains and losses be recycled to profit or loss on derecognition.

Dividends on such equity instruments are recognised within profit or loss unless they represent a recovery of part or all the cost of the investment.

While IFRS 9 no longer contains an option for measurement of investments in unquoted equity instruments at cost, the standard specifies that only in limited circumstances may cost be an appropriate estimate of fair value. These circumstances would include the following two scenarios:

• Since the date of acquisition of the instrument, recent reliable information is not available to measure the fair value, and there are no factors that may indicate that cost is no longer an appropriate estimate of fair value; and/or
• Only a wide range of possible fair value measurements is possible, and the cost of the instrument is within this determined range.

The application guidance to IFRS 9 specifies the following indicators (which are not exhaustive), which may suggest that cost is not representative of fair value (IFRS 9 B5.2.4):

1. A significant change in the performance of the investee compared with budgets, plans or milestones agreed on acquisition.
2. Changes in expectation that the investee's technical product milestones will be achieved.
3. A significant change in the market for the investee's equity or its products or potential products.
4. A significant change in the global economy or the economic environment in which the investee operates.
5. A significant change in the performance of comparable entities, or in the valuations implied by the overall market.
6. Internal matters of the investee such as fraud, commercial disputes, litigation, changes in management or strategy.
7. Evidence from external transactions in the investee's equity, either by the investee (such as a fresh issue of equity), or by transfers of equity instruments between third parties.

In practice, this is a significant area of difference between IAS 39 and IFRS 9. The approach used by a number of entities of carrying such investments at cost is likely to be no longer permitted. In effect, it is going to be extremely rare for such equity investments to be carried at cost as a realistic estimate of fair value.

Reclassification of Financial Assets

Reclassification of financial assets is permitted if, and only if, the objective of the entity's business model for managing those financial assets changes.

Such changes are expected to be very infrequent and are determined by the entity's senior management as a result of external or internal changes and must be significant to the entity's operations and demonstrable to external parties. Accordingly, a change in an entity's business model will occur only when an entity either begins or ceases to perform an activity that is significant to its operations; for example, when the entity has acquired, disposed of or terminated a business line.

IFRS 9 provides the following examples of circumstances that are or are not changes in the business model:

Change in business model:

1. An entity has a portfolio of commercial loans that it holds to sell in the short term. The entity acquires a company that manages commercial loans and has a business model that holds the loans in order to collect the contractual cash flows. The original portfolio of commercial loans is no longer for sale, and this portfolio is now managed together with the acquired commercial loans. All of the loans are held to collect the contractual cash flows.
2. A financial services firm decides to shut down its retail mortgage business. That business no longer accepts new business and the financial services firm is actively marketing its mortgage loan portfolio for sale.

Not a change in business model:

1. An entity changes its intention for particular financial assets (even in circumstances of significant changes in market conditions), e.g., a particular market for financial assets temporarily disappears or financial assets are transferred between parts of an entity with different business models.
2. If an entity reclassifies financial assets it shall apply the reclassification prospectively from the reclassification date. The entity shall not restate any previously recognised gains, losses (including impairment gains or losses) or interest.
3. IFRS 9's reclassification related measurement requirements are as summarised below:

   Initial classification	Revised classification	Notes
   Amortised cost	FVTPL	Fair value is measured at the reclassification date. Any gain or loss arising from a difference between the previous amortised cost of the financial asset and fair value is recognised in profit or loss.
   FVTPL	Amortised cost	Fair value on reclassification date becomes new gross carrying amount. Effective interest rate determined based on this carrying amount.
   Amortised cost	FVTOCI	Fair value measured on reclassification date. No change to recognition of interest income as the original effective interest rate continues to be applied. Also, no changes to measurement of impairment. However, the impairment amount would be recognised within OCI and not as a reduction from carrying amount.
   FVTOCI	Amortised cost	Fair value on reclassification date used for purposes of the transfer; however, cumulative gain or loss previously recognised in OCI is adjusted against this fair value such that asset reverts to measurement basis that would have always been determined under the amortised cost approach. No change to recognition of interest income as the original effective interest rate continues to be applied. Also, no changes to measurement of impairment. However, the impairment amount would now be recognised as a reduction from carrying amount.
   FVTPL	FVTOCI	Continued measurement at fair value with gains or losses subsequently recognised in OCI.
   FVTOCI	FVTPL	Continued measurement at fair value with gains or losses subsequently recognised through profit or loss. However, cumulative gain or loss previously recognised under OCI is reclassified to profit or loss.

Derecognition of Financial Assets

An entity first needs to determine whether the derecognition principles are applied to part of a financial asset (or group of similar assets) or a financial asset (or group) in its entirety as follows:

1. A financial asset can only be derecognised when, and only when, the rights to the contractual cash flows from a financial asset expire and when an entity transfers (see below) a financial asset.
2. Derecognition requirements are applied to a part of a financial asset if, and only if, the part being considered for derecognition meets one of the following three conditions:
   • The part comprises only specifically identified cash flows from a financial asset (e.g., in the case of an interest rate strip where a counterparty only obtains cash flow rights to interest cash flows); or
   • The part comprises only a fully proportionate (pro rata) share of the cash flows from a financial asset (e.g., where a counterparty obtains rights to a percentage of all cash flows); or
   • The part comprises only a fully proportionate (pro rata) share of specifically identified cash flows from a financial asset (e.g., where a counterparty obtains rights to a percentage of interest cash flows).

Transferring of Financial Assets

A transfer occurs when an entity either transfers its contractual right to receive cash flows or retains the contractual rights to receive cash flows, but takes on an obligation to pass these cash flows to a counterparty under an arrangement that meets all of the following three conditions:

1. The entity has no obligation to pass on the amounts to a counterparty unless it collects equivalent amounts for the asset;
2. The entity is prohibited from pledging or selling the asset other than as security to the counterparty; and
3. The entity has an obligation to remit cash flows to the counterparty without any material delay.

At the time of transfer, an entity evaluates the extent to which it retains the risks and rewards of ownership of the financial asset:

1. If the entity transfers substantially all the risks and rewards of ownership of the financial asset, the entity shall derecognise the financial asset and recognise separately as assets or liabilities any rights and obligations created or retained in the transfer. Examples include:
   • An unconditional sale of a financial asset;
   • A sale of a financial asset together with an option to repurchase the financial asset at its fair value at the time or repurchase; and
   • A sale of a financial asset together with a put or call option that is deeply out of the money.

1. If the entity retains substantially all the risks and rewards of ownership of the financial asset, the entity shall continue to recognise the financial asset.
2. If the entity neither transfers nor retains substantially all the risks and rewards of ownership of the financial asset, the entity shall determine whether it has retained control (based on the practical ability to sell the transferred financial asset to a third party in an active market) of the financial asset. In this case:
   • If the entity has not retained control, it shall derecognise the financial asset and recognise separately as assets or liabilities any rights and obligations created or retained in the transfer.
   • If the entity has retained control, it shall continue to recognise the financial asset to the extent of its continuing involvement in the financial asset.

Transferring of Financial Assets that Qualify for Derecognition

Where an entity transfers (a transfer qualifying for derecognition in its entirety) a financial asset and retains the right to service the financial asset for a fee, it shall recognise either a servicing asset or a servicing liability for that servicing contract. In particular:

1. If the fee to be received is not expected to compensate the entity adequately for performing the servicing, a servicing liability for the servicing obligation shall be recognised at its fair value; or
2. If the fee to be received is expected to be more than adequate compensation for the servicing, a servicing asset shall be recognised for the servicing right.

Where an asset is transferred in its entirety, the entity will recognise a new financial asset or assume a new financial liability or service liability at fair value. The difference between the carrying amount at the date of derecognition and the consideration received (including any new asset obtained less any new liability assumed) is recognised in profit or loss.

Where the asset is part of a larger financial asset, the previous carrying amount of the larger financial asset should be allocated between the part that it continues to recognise (i.e., the servicing asset) and the part that has been derecognised based on the relative fair values at the time of transfer. The difference between the carrying amount of the part derecognised at the date of derecognition and the consideration received for the part derecognised (including any new asset obtained less any new liability assumed) is recognised in profit or loss.

Transferring of Financial Assets that do Not Qualify for Derecognition

If a transfer does not result in derecognition because the entity has retained substantially all the risks and rewards of ownership of the transferred asset, the entity shall continue to recognise the transferred asset in its entirety and shall recognise a financial liability for the consideration received. In subsequent periods, the entity shall recognise any income on the transferred asset and any expense incurred on the financial liability.

The following examples relate to when an entity has retained substantially all the risks and rewards of ownership of the transferred asset:

1. A sale and repurchase transaction where the repurchase price is a fixed price or the sale price plus a lender's return;
2. A securities lending agreement;
3. A sale of a financial asset together with a total return swap that transfers the market risk exposure back to the entity;
4. A sale of a financial asset together with a deep in-the-money put or call option (i.e., an option that is so far in the money that it is highly unlikely to go out of the money before expiry); and
5. A sale of short-term receivables in which the entity guarantees to compensate the transferee for credit losses that are likely to occur.

Continuing Involvement in Transferred Financial Assets

If an entity's continuing involvement is in only a part of a financial asset (e.g., when an entity retains an option to repurchase part of a transferred asset, or retains a residual interest that does not result in the retention of substantially all the risks and rewards of ownership and the entity retains control), the entity allocates the previous carrying amount of the financial asset between the part it continues to recognise under continuing involvement and the part it no longer recognises on the basis of the relative fair values of those parts on the date of the transfer. The difference between:

1. The carrying amount (measured at the date of derecognition) allocated to the part that is no longer recognised; and
2. The consideration received for the part no longer recognised shall be recognised in profit or loss.

A simple example of the scenario above is a debt factoring agreement under which a specified % of the debt factored is without recourse and the remainder of the debt remains under recourse to the entity.

If a guarantee provided by an entity to pay for default losses on a transferred asset prevents the transferred asset from being derecognised to the extent of the continuing involvement, the transferred asset at the date of the transfer is measured at the lower of:

1. The carrying amount of the asset; and
2. The maximum amount of the consideration received in the transfer that the entity could be required to repay. The associated liability is initially measured at the guarantee amount plus the fair value of the guarantee (which is normally the consideration received for the guarantee). Subsequently, the initial fair value of the guarantee is recognised in profit or loss when the obligation is satisfied (in accordance with the principles of IFRS 15) and the carrying value of the asset is reduced by any loss allowance.

If a transferred asset continues to be recognised, the asset and the associated liability shall not be offset. Similarly, the entity shall not offset any income arising from the transferred asset with any expense incurred on the associated liability.

If a transferor provides non-cash collateral (such as debt or equity instruments) to the transferee, the accounting for the collateral by the transferor and the transferee depends on whether the transferee has the right to sell or repledge the collateral and on whether the transferor has defaulted. The transferor and transferee shall account for the collateral as follows:

1. If the transferee has the right by contract or custom to sell or repledge the collateral, then the transferor shall reclassify that asset in its statement of financial position separately from other assets.
2. If the transferee sells collateral pledged to it, it shall recognise the proceeds from the sale and a liability measured at fair value for its obligation to return the collateral.
3. If the transferor defaults under the terms of the contract and is no longer entitled to redeem the collateral, it shall derecognise the collateral, and the transferee shall recognise the collateral as its asset initially measured at fair value or, if it has already sold the collateral, derecognise its obligation to return the collateral.
4. Except as provided in the 3^rd point above, the transferor shall continue to carry the collateral as its asset, and the transferee shall not recognise the collateral as an asset.

Classification of Financial Liabilities

All financial liabilities shall be classified as subsequently measured at amortised cost, except for:

1. Financial liabilities designated at FVTPL. Such liabilities, including derivatives that are liabilities, shall be subsequently measured at fair value.
2. Financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or when the continuing involvement approach applies.
3. Financial guarantee contracts—after initial recognition, an issuer of such a contract shall (unless (1) or (2) applies) subsequently measure it at the higher of:
   1. The amount of the loss allowance (impairment); and
   2. The amount initially recognised less, when appropriate, the cumulative amount of income recognised in accordance with the principles of IFRS 15, Revenue from Contracts with Customers.
4. Commitments to provide a loan at a below-market interest rate. An issuer of such a commitment shall (unless (1) applies) subsequently measure it at the higher of:
   1. The amount of the loss allowance (impairment); and
   2. The amount initially recognised less, when appropriate, the cumulative amount of income recognised in accordance with the principles of IFRS 15, Revenue from Contracts with Customers.
5. Contingent consideration recognised by an acquirer in a business combination to which IFRS 3, Business Combinations, applies. Such contingent consideration shall subsequently be measured at fair value with changes recognised in profit or loss.

In respect of transfers that do not qualify for derecognition, the financial liability associated with continuing involvement is measured in such a way that the net carrying amount of the transferred asset and the associated liability is:

1. The amortised cost of the rights and obligations retained by the entity, if the transferred asset is measured at amortised cost; or
2. Equal to the fair value of the rights and obligations retained by the entity when measured on a standalone basis, if the transferred asset is measured at fair value.

An entity may, at initial recognition, irrevocably designate a financial liability as measured at FVTPL (when a contract contains one or more embedded derivatives and the host is not an asset within the scope of this standard) or when doing so results in more relevant information, because either:

1. It 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 recognising the gains and losses on them on different bases; or
2. A group of financial liabilities or financial assets and financial liabilities is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and information about the group is provided internally on that basis to the entity's key management personnel.

Liabilities Designated as at Fair Value Through Profit or Loss and Recognition of Own Credit Risk Related Fair Value Changes

An entity shall present a gain or loss on a financial liability that is designated as at FVTPL as follows:

1. The amount of change in the fair value of the financial liability that is attributable to changes in the own credit risk of the issuer shall be presented in other comprehensive income; and
2. The remaining amount of change in the fair value of the liability shall be presented in profit or loss unless the treatment of the effects of changes in the liability's credit risk described in (1) would create or enlarge an accounting mismatch in profit or loss, in which case the total change is presented in profit or loss.

When an entity designates a financial liability as at FVTPL, it must determine whether presenting the effects of changes in the liability's credit risk in other comprehensive income would create or enlarge an accounting mismatch in profit or loss. An accounting mismatch would be created or enlarged if presenting the effects of changes in the liability's credit risk in other comprehensive income would result in a greater mismatch in profit or loss than if those amounts were presented in profit or loss.

To make that determination, an entity must assess whether it expects that the effects of changes in the liability's credit risk will be offset in profit or loss by a change in the fair value of another financial instrument measured at FVTPL. Such an expectation must be based on an economic relationship between the characteristics of the liability and the characteristics of the other financial instrument.

That determination is made at initial recognition and is not reassessed. For practical purposes, the entity need not enter into all of the assets and liabilities giving rise to an accounting mismatch at exactly the same time. A reasonable delay is permitted provided that any remaining transactions are expected to occur. An entity must apply consistently its methodology for determining whether presenting in other comprehensive income the effects of changes in the liability's credit risk would create or enlarge an accounting mismatch in profit or loss.

However, an entity may use different methodologies when there are different economic relationships between the characteristics of the liabilities designated as at FVTPL and the characteristics of the other financial instruments. IFRS 7 requires an entity to provide qualitative disclosures in the notes to the financial statements about its methodology for making that determination.

Reclassification of Financial Liabilities

An entity shall not reclassify any financial liability.

Recognition of Foreign Exchange Gains and Losses

An entity applies IAS 21 to financial assets and financial liabilities that are monetary items and denominated in a foreign currency. IAS 21 requires any foreign exchange gains and losses on monetary assets and monetary liabilities to be recognised in profit or loss. An exception is a monetary item that is designated as a hedging instrument in a cash flow hedge, a hedge of a net investment or a fair value hedge of an equity instrument for which an entity has elected to present changes in fair value in other comprehensive income.

For the purpose of recognising foreign exchange gains and losses under IAS 21, a financial asset measured at FVTOCI is treated as a monetary item, with the exception of equity instruments which the entity elects to measure at FVTOCI. Accordingly, such a financial asset is initially treated as an asset measured at amortised cost in the foreign currency. Exchange differences on the amortised cost are recognised in profit or loss and other changes in the fair value are recognised in OCI.

A Simplified Decision Tree

The General Approach

Under the general approach to impairment under IFRS 9, impairment loss allowances are recognised at each reporting date as follows:

1. For financial instruments where there has not been any significant increase in credit risk since the date of initial recognition, the loss allowance recognised shall represent the 12-month expected credit loss; and
2. For financial instruments where there has been a significant increase in credit risk since initial recognition, a loss allowance for lifetime expected credit losses will be recognised.

The objective of the impairment requirements under the general approach is to recognise lifetime expected credit losses for all financial instruments for which there have been significant increases in credit risk since initial recognition, whether assessed on an individual or collective basis, considering all reasonable and supportable information, including that which is forward looking.

For loan commitments and financial guarantee contracts, the date that the entity becomes a party to the irrevocable commitment shall be the date of initial recognition for the purposes of applying the impairment requirements.

If an entity has measured the loss allowance for a financial instrument at an amount equal to lifetime expected credit losses in the previous reporting period, but determines at the current reporting date that there is no longer a significant increase in credit risk from the initial recognition date, the entity shall measure the loss allowance at an amount equal to 12-month expected credit losses at the current reporting date.

In respect of assets classified to be measured at FVTOCI, the loss allowance shall be recognised in other comprehensive income and shall not reduce the carrying amount of the financial asset in the statement of financial position, i.e., the carrying amount of the financial instrument must equate to its fair value, which will be expected to have already factored in any impairment.

Determining Significant Increases in Credit Risk Since Initial Recognition

Based on the requirements above, the determination of whether credit risk has increased, and whether that increase is significant is a critical aspect of applying the general approach to impairment under IFRS 9.

IFRS 9 requires an assessment to be made at each reporting date as to whether the credit risk on a financial instrument has increased significantly since initial recognition. When making the assessment, the change in the risk of a default occurring over the expected life of the financial instrument is used 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.

Indicators that are relevant in assessing credit risk include:

1. A change in the internal interest rate, or other pricing, of instruments since the date the instrument was first recognized;
2. A change in other terms of instruments such as conditions and covenants, collateral etc.;
3. Changes in market interest rates and spreads for similar instruments;
4. Internal and external credit rating scores;
5. Changes in the operations of the borrower including financial performance and deviation from forecasts and projections;
6. Changes in economic conditions, including regulatory changes that affect the borrower;
7. Changes in value of collateral;
8. Defaults on other instruments by the same borrower;
9. Changes in the ability or intention of guarantors as well as parent entities of the borrowers that may be instrumental in providing financial support to the borrower; and
10. Past due information, including the rebuttable presumption that has been discussed above.

Lifetime expected credit losses are generally expected to be recognised before a financial instrument becomes past due. Typically, credit risk increases significantly before a financial instrument becomes past due or other lagging borrower-specific factors (for example, a modification or restructuring) are observed. Consequently, when reasonable and supportable information that is more forward looking than past due information is available without undue cost or effort, it must be used to assess changes in credit risk.

IFRS 9 includes 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. This is irrespective of the way an entity measures significant increases in credit risk. An entity can, however, rebut this presumption based on reasonable and supportable information that is available without undue cost or effort, which demonstrates that the credit risk has not increased significantly since initial recognition even though the contractual payments are more than 30 days past due.

Instruments Determined to have Low Credit Risk at the Reporting Date

IFRS 9 allows an entity to 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. Low credit risk applies if the financial instrument has a minimal risk of default, the borrower has a strong capacity to meet its contractual cash flow obligations in the near term and adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce the ability of the borrower to fulfil its contractual cash flow obligations.

Financial instruments are, however, not considered to have low credit risk when they are regarded as having a minimal risk of loss simply because of the value of collateral, and the financial instrument without that collateral would not be considered low credit risk. Financial instruments are also not considered to have low credit risk simply because they have a lower risk of default than the entity's other financial instruments or relative to the credit risk of the jurisdiction within which an entity operates.

Lifetime expected credit losses are not recognised on a financial instrument simply because it was considered to have low credit risk in the previous reporting period and is not considered to have low credit risk at the reporting date. In such a case, an entity shall determine whether there has been a significant increase in credit risk since initial recognition and thus whether lifetime expected credit losses are required to be recognised.

Collective and Individual Assessment Basis for Determining Significant Increases in Credit Risk

To meet the objective of recognising lifetime expected credit losses for significant increases in credit risk since initial recognition, it may be necessary to perform the assessment of significant increases in credit risk on a collective basis by considering information that is indicative of significant increases in credit risk on, for example, a group or subgroup of financial instruments. This is particularly in cases where an entity does not have reasonable and supportable information that is available without undue cost or effort to measure lifetime expected credit losses on an individual instrument basis. In that case, lifetime expected credit losses shall be recognised on a collective basis that considers comprehensive credit risk information. This comprehensive credit risk information must incorporate not only past due information but also all relevant credit information, including forward-looking macroeconomic information, to approximate the result of recognising lifetime expected credit losses when there has been a significant increase in credit risk since initial recognition on an individual instrument level.

For determining significant increases in credit risk and recognising a loss allowance on a collective basis, an entity can group financial instruments based on shared credit risk characteristics with the objective of facilitating an analysis that is designed to enable significant increases in credit risk to be identified on a timely basis. The entity should not obscure this information by grouping financial instruments with different risk characteristics. Examples of shared credit risk characteristics may include, but are not limited to:

1. Instrument type;
2. Credit risk ratings;
3. Collateral type;
4. Date of initial recognition;
5. Remaining term to maturity;
6. Industry;
7. Geographical location of the borrower; and
8. Value of collateral relative to the financial asset if it has an impact on the probability of a default occurring (for example, non-recourse loans in some jurisdictions or loan-to-value ratios).

Reasonable and Supportable Forward-Looking Information

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, IFRS 9 permits that 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.

For IFRS 9, reasonable and supportable information is that which is reasonably available at the reporting date without undue cost or effort, including information about past events, current conditions and forecasts of future economic conditions. Information that is available for financial reporting purposes is considered to be available without undue cost or effort.

While an entity is not required to undertake an exhaustive search for all possible information, the standard requires an entity to consider the information that is available without undue cost of effort. An entity can use various sources for such data collection including internal information on past performance, credit ratings, pricing and margins, as well as external information such as that from credit rating agencies as well as wider macroeconomic and regulatory information.

Significant information can also be obtained from a review of the borrower's financial and operational performance as well as forecast information/budgets and historical performance against such forecasts. It should be borne in mind that while the standard recognises the need for and importance of historical information, it requires such historical data to be adjusted to reflect current conditions and forecasts of future conditions.

An entity shall regularly review the methodology and assumptions used for estimating expected credit losses to reduce any differences between estimates and actual credit loss experience.

Modified Financial Assets

If the contractual cash flows on a financial asset have been renegotiated or modified and the financial asset was not derecognised, an entity shall assess whether there has been a significant increase in the credit risk of the financial instrument in accordance by comparing:

1. The risk of a default occurring at the reporting date (based on the modified contractual terms); and
2. The risk of a default occurring at initial recognition (based on the original, unmodified contractual terms).

In cases where the renegotiation or modification of the contractual cash flows of a financial asset leads to the derecognition of the existing financial asset and the subsequent recognition of the modified financial asset, the modified asset is considered a “new” financial asset. This typically means measuring the loss allowance at an amount equal to 12-month expected credit losses on the newly recognised financial asset until the requirements for the recognition of lifetime expected credit losses are met. However, in some circumstances following a modification that results in derecognition of the original financial asset, there may be evidence that the modified financial asset is credit impaired at initial recognition, and thus the financial asset should be recognised as an originated credit-impaired financial asset.

Purchased or Originated Credit-Impaired Financial Assets

Where an entity initially recognises a financial asset that is purchased or originated credit impaired, the entity shall only recognise the cumulative changes in lifetime expected credit losses since initial recognition as a loss allowance for purchased or originated credit-impaired financial assets.

A financial asset is credit impaired on purchase or origination where one or more events that have a detrimental impact on expected future cash flows of that financial asset have occurred at the date of initial recognition. Such events include significant financial difficulty of the issuer/borrower, breach of contract, probability of bankruptcy or other financial reorganisation, disappearance of an active trading market and purchases of the financial asset at a deep discount.

Simplified Approach for Trade Receivables, Contract Assets and Lease Receivables

As an alternative to the general approach, IFRS 9 provides for a simplified approach to the measurement of loss allowances in respect of:

1. Trade receivables or contract assets that result from transactions that are within the scope of IFRS 15, and that:
   • Do not contain a significant financing component in accordance with IFRS 15 (or when the entity applies the practical expedient in accordance with paragraph 63 of IFRS 15); or
   • Contain a significant financing component in accordance with IFRS 15, if the entity chooses as its accounting policy to measure the loss allowance at an amount equal to lifetime expected credit losses. That accounting policy shall be applied to all such trade receivables or contract assets but may be applied separately to trade receivables and contract assets.
2. Lease receivables that result from transactions that are within the scope of IAS 17, if the entity chooses as its accounting policy to measure the loss allowance at an amount equal to lifetime expected credit losses. That accounting policy shall be applied to all lease receivables but may be applied separately to finance and operating lease receivables.

For such assets, IFRS 9 permits the recognition of lifetime expected credit losses from inception. This is a simplified approach in that it does not require the significant estimation and judgement necessary to determine whether there have been changes in credit risk and whether such changes are significant. It does, however, mean that the credit loss allowances recognised under the simplified approach will likely be higher than the credit losses under the general approach for those assets where the credit risk has not significantly increased.

As a practical expedient, IFRS 9 permits the use of a provision matrix for purposes of measuring lifetime expected credit losses for trade receivables.

Measurement of Expected Credit Losses and Applying Probabilities

An entity shall measure expected credit losses of a financial instrument in a way that reflects:

1. An unbiased and probability-weighted amount that is determined by evaluating a range of possible outcomes;
2. The time value of money; and
3. Reasonable and supportable information that is available without undue cost or effort at the reporting date about past events, current conditions and forecasts of future economic conditions.

When measuring expected credit losses, an entity need not necessarily identify every possible scenario. However, it shall consider the risk or probability that a credit loss occurs by reflecting the possibility that a credit loss occurs and the possibility that no credit loss occurs, even if the possibility of a credit loss occurring is very low.

The estimate of expected credit losses should reflect an unbiased and probability- weighted amount that is determined by evaluating a range of possible outcomes. In practice, this may not need to be a complex analysis. In some cases, relatively simple modelling may be sufficient, without the need for a large number of detailed simulations of scenarios. For example, the average credit losses of a large group of financial instruments with shared risk characteristics may be a reasonable estimate of the probability-weighted amount. In other situations, the identification of scenarios that specify the amount and timing of the cash flows for outcomes and the estimated probability of those outcomes will probably be needed. In those situations, the expected credit losses shall reflect at least two outcomes (i.e., the probability of a credit loss and the probability of no credit loss).

The maximum period to consider when measuring expected credit losses is the maximum contractual period (including extension options) over which the entity is exposed to credit risk and not a longer period, even if that longer period is consistent with business practice.

However, some financial instruments include both a loan and an undrawn commitment component and the entity's contractual ability to demand repayment and cancel the undrawn commitment does not limit the entity's exposure to credit losses to the contractual notice period. For such financial instruments, and only those financial instruments, the entity shall measure expected credit losses over the period that the entity is exposed to credit risk and expected credit losses would not be mitigated by credit risk management actions, even if that period extends beyond the maximum contractual period.

Expected credit losses are a probability-weighted estimate of credit losses (i.e., the present value of all cash flow shortfalls) over the expected life of the financial instrument. A cash shortfall is the difference between the cash flows that are due to an entity in accordance with the contract and the cash flows that the entity expects to receive. Because expected credit losses consider the amount and timing of payments, a credit loss arises even if the entity expects to be paid in full but later than when contractually due.

For financial assets, a credit loss is the present value of the difference between:

1. The contractual cash flows that are due to an entity under the contract; and
2. The cash flows that the entity expects to receive.

For undrawn loan commitments, a credit loss is the present value of the difference between:

1. The contractual cash flows that are due to the entity if the holder of the loan commitment draws down the loan; and
2. The cash flows that the entity expects to receive if the loan is drawn down.

For a financial guarantee contract, the entity is required to make payments only in the event of a default by the debtor in accordance with the terms of the instrument that is guaranteed. Accordingly, cash shortfalls are the expected payments to reimburse the holder for a credit loss that it incurs less any amounts that the entity expects to receive from the holder, the debtor or any other party. If the asset is fully guaranteed, the estimation of cash shortfalls for a financial guarantee contract would be consistent with the estimations of cash shortfalls for the asset subject to the guarantee.

For a financial asset that is credit impaired at the reporting date, but that is not a purchased or originated credit-impaired financial asset, an entity shall measure the expected credit losses as the difference between the asset's gross carrying amount and the present value of estimated future cash flows discounted at the financial asset's original effective interest rate. Any adjustment is recognised in profit or loss as an impairment gain or loss.

When measuring a loss allowance for a lease receivable, the cash flows used for determining the expected credit losses should be consistent with the cash flows used in measuring the lease receivable in accordance with IFRS 16, Leases.

Impact of Collateral

For the purposes of measuring expected credit losses, the estimate of expected cash shortfalls shall reflect the cash flows expected from collateral and other credit enhancements that are part of the contractual terms and are not recognised separately by the entity. The estimate of expected cash shortfalls on a collateralised financial instrument reflects the amount and timing of cash flows that are expected from foreclosure on the collateral less the costs of obtaining and selling the collateral, irrespective of whether foreclosure is probable (i.e. the estimate of expected cash flows considers the probability of a foreclosure and the cash flows that would result from it).

Consequently, any cash flows that are expected from the realisation of the collateral beyond the contractual maturity of the contract should be included in this analysis. Any collateral obtained because of foreclosure is not recognised as an asset that is separate from the collateralised financial instrument unless it meets the relevant recognition criteria for an asset in this or other standards.

Derivatives

As a general principle under IFRS 9, all derivatives are accounted for in the statement of financial position at fair value, irrespective of whether they are used as part of a hedging relationship. Changes in fair value are recognised in profit or loss unless this is part of an effective cash flow hedge of net investment hedge, in which case the change in fair value of the effective portion is recognised in other comprehensive income.

IFRS 9 defines a derivative as a financial instrument or other contract with all three of the following features:

1. Its value changes in response to changes in a specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract;
2. It requires little or no initial net investment relative to the other types of contracts that have a similar response to changes in market conditions; and
3. It is settled at a future date.

The definition is important because it is used in determining the classification and measurement of financial instruments. If any financial instrument meets the above definition it is classified as FVTPL unless the instrument is designated as a hedging instrument.

The underlying variable is that variable that will determine the settlement of a derivative (with a notional amount or a payment provision).

Examples of financial instruments that meet the foregoing definition include the following, along with the underlying variable which affects the derivative's value:

The issue of what is meant by “little or no net investment” has been explored by the IASB's Implementation Guidance Committee (IGC). IGC's view is that professional judgement will be required in determining what constitutes little or no initial net investment, and is to be interpreted on a relative basis. The initial net investment is less than that needed to acquire a primary financial instrument with a similar response to changes in market conditions. This reflects the inherent leverage features typical of derivative agreements compared to the underlying instruments. If, for example, a “deep in the money” call option is purchased (that is, the option's value consists mostly of intrinsic value), a significant premium is paid. If the premium is equal or close to the amount required to invest in the underlying instrument, this would fail the “little initial net investment” criterion.

A margin account is not part of the initial net investment in a derivative instrument. Margin accounts are a form of collateral for the counterparty or clearing house and may take the form of cash, instruments or other specified assets, typically liquid ones. Margin accounts are separate assets that are to be accounted for separately. Accordingly, in determining whether an arrangement qualifies as a derivative, the margin deposit is not a factor in assessing whether the “little or no net investment” criterion has been met.

A financial instrument can qualify as a derivative even if the settlement amount does not vary proportionately. An example of this phenomenon was provided by the IGC.

Objective and Scope of Hedge Accounting

Every entity is exposed to commercial risks from its operations. A number of these risks have an impact on its cash flows or the values of its assets or liabilities and therefore ultimately on profit or loss, or other comprehensive income. To manage these risks, entities enter into derivative and other contracts to hedge them. Hedging is therefore a risk management tool used to manage the entity's risk profile.

The application of IFRS to risk management activities can result in accounting mismatches where gains and losses on a hedging instrument are not recognised in the same period (or in the same place in the financial statements) as gains and losses on the hedged exposure or accounting for the hedging instrument.

The requirement of IFRS 9 is to “represent, in the financial statements, the effect of an entity's risk management activities.” IFRS 9 does not mandate the use of hedge accounting and it is therefore voluntary.

The link between the risk management strategy of an entity and the risk management objective is crucial, as a change in a risk management objective without a change in the risk management strategy may affect the application of hedge accounting. This is further illustrated through an example below.

An entity may choose to designate a hedging relationship between a hedging instrument and a hedged item. For hedging relationships that meet the qualifying criteria described below, an entity shall account for the gains or losses on the hedging instruments and the hedged item in accordance with the provisions of IFRS 9, as explained below.

IFRS 9 recognises three types of hedge accounting, depending on the nature of the risk exposure as follows:

1. A fair value hedge is a hedge of the exposure to changes in fair values of a recognised asset or liability or an unrecognised firm commitment, or an identified portion of such an asset, liability or firm commitment (a binding agreement for the exchange of a specified quantity of goods or services at a specified price and date), which is attributed to a particular risk and could affect profit or loss.
2. A cash flow hedge is a hedge of the exposure to variability in cash flows that is attributed to a particular risk associated with a recognised asset or liability or a highly probable forecast transaction which could affect profit or loss.
3. A net investment hedge is a hedge of a foreign currency exposure to changes in the reporting entity's share in the net assets of that foreign operation.

Derivatives cannot be designated as hedged items and the only exception to this under IFRS 9 is a written option to qualify as a hedging instrument if it is designated as an offset to a purchase option, including one that is embedded in another financial instrument (for example, a written call option used to hedge a callable liability).

Qualifying Criteria for Hedge Accounting

Under IFRS 9, a hedging relationship qualifies for hedge accounting only if all of the following criteria are met:

1. The hedging relationship consists only of eligible hedging instruments and eligible hedged items;
2. At the inception of the hedging relationship, there is formal designation and documentation of the hedging relationship and the entity's risk management objective and strategy for undertaking the hedge. That documentation shall include identification of the hedging instrument, the hedged item, the nature of the risk being hedged and how the entity will assess whether the hedging relationship meets the hedge effectiveness requirements (including its analysis of the sources of hedge ineffectiveness and how it determines the hedge ratio);
3. The hedging relationship meets all the following hedge effectiveness requirements:
   • There is an economic relationship between the hedged item and the hedging instrument;
   • The effect of credit risk does not dominate the value changes that result from that economic relationship; and
   • The hedge ratio of the hedging relationship is the same as that resulting from the quantity of the hedged item that the entity actually hedges and the quantity of the hedging instrument that the entity actually uses to hedge that quantity of the hedged item. However, that designation shall not reflect an imbalance between the weightings of the hedged item and the hedging instrument that would create hedge ineffectiveness (irrespective of whether it is recognised or not) that could result in an accounting outcome that would be inconsistent with the purpose of hedge accounting.

Designation of Hedging Instruments

A qualifying instrument must be designated in its entirety as a hedging instrument. The only exceptions permitted are:

1. Separating the intrinsic value and time value of an option contract and designating as the hedging instrument only the change in intrinsic value of an option and not the change in its time value;
2. Separating the forward element and the spot element of a forward contract and designating as the hedging instrument only the change in the value of the spot element of a forward contract and not the forward element; similarly, the foreign currency basis spread may be separated and excluded from the designation of a financial instrument as the hedging instrument; and
3. A proportion of the entire hedging instrument, such as 50% of the nominal amount, may be designated as the hedging instrument in a hedging relationship. However, a hedging instrument may not be designated for a part of its change in fair value that results from only a portion of the time period during which the hedging instrument remains outstanding.

For hedges other than hedges of foreign currency risk, when an entity designates a non-derivative financial asset or a non-derivative financial liability measured at FVTPL as a hedging instrument, it may only designate the non-derivative financial instrument in its entirety or a proportion of it.

An entity may view in combination, and jointly designate as the hedging instrument, any combination of the following (including those circumstances in which the risk or risks arising from some hedging instruments offset those arising from others):

1. Derivatives or a proportion of them; and
2. Non-derivatives or a proportion of them.

However, a derivative instrument that combines a written option and a purchased option (for example, an interest rate collar) does not qualify as a hedging instrument if it is, in effect, a net written option at the date of designation (unless it qualifies in accordance with the written options provisions discussed above). Similarly, two or more instruments (or proportions of them) may be jointly designated as the hedging instrument only if, in combination, they are not, in effect, a net written option at the date of designation.

A single hedging instrument may be designated as a hedging instrument of more than one type of risk, if there is a specific designation of the hedging instrument and of the different risk positions as hedged items. Those hedged items can be in different hedging relationships.

For hedge accounting purposes, only contracts with a party external to the reporting entity (i.e., external to the group or individual entity that is being reported on) can be designated as hedging instruments.

An entity may designate an item in its entirety or a component of an item as the hedged item in a hedging relationship. An entire item comprises all changes in the cash flows or fair value of an item. A component comprises less than the entire fair value change or cash flow variability of an item. In that case, an entity may designate only the following types of components (including combinations) as hedged items:

1. Only changes in the cash flows or fair value of an item attributable to a specific risk or risks (risk component), provided that, based on an assessment within the context of the particular market structure, the risk component is separately identifiable and reliably measurable. Risk components include a designation of only changes in the cash flows or the fair value of a hedged item above or below a specified price or other variable (a one-sided risk);
2. One or more selected contractual cash flows; or
3. Components of a nominal amount, i.e., a specified part of the amount of an item.

A derivative measured at fair value through profit or loss may be designated as a hedging instrument, except for some written options (see below), derivatives that are embedded in hybrid contracts but that are not separately accounted for and an entity's own equity instruments.

A written option does not qualify as a hedging instrument unless it is designated as an offset to a purchased option, including one that is embedded in another financial instrument (for example, a written call option used to hedge a callable liability).

A non-derivative financial asset or a non-derivative financial liability measured at fair value through profit or loss may be designated as a hedging instrument unless it is a financial liability designated as at fair value through profit or loss for which the amount of its change in fair value that is attributable to changes in the credit risk of that liability is presented in other comprehensive income.

For a hedge of foreign currency risk, the foreign currency risk component of a non-derivative financial asset or a non-derivative financial liability (as determined in accordance with IAS 21) may be designated as a hedging instrument provided that it is not an investment in an equity instrument for which an entity has elected to present changes in fair value in other comprehensive income.

Designation of Hedged Items

To be eligible for designation as a hedged item, a risk component must be a separately identifiable component of the financial or the non-financial item, and the changes in the cash flows or the fair value of the item attributable to changes in that risk component must be reliably measurable.

When identifying what risk components qualify for designation as a hedged item, an entity assesses such risk components within the context of the market structure to which the risk or risks relate and in which the hedging activity takes place. Such a determination requires an evaluation of the relevant facts and circumstances, which differ by risk and market.

When designating risk components as hedged items, an entity considers whether the risk components are explicitly specified in a contract (contractually specified risk components) or whether they are implicit in the fair value or the cash flows of an item of which they are a part (non-contractually specified risk components). Non-contractually specified risk components can relate to items that are not a contract (for example, forecast transactions) or contracts that do not explicitly specify the component (for example, a firm commitment that includes only one single price instead of a pricing formula that references different underlying).

When designating a risk component as a hedged item, the hedge accounting requirements apply to that risk component in the same way as they apply to other hedged items that are not risk components. For example, the qualifying criteria apply, including that the hedging relationship must meet the hedge effectiveness requirements, and any hedge ineffectiveness must be measured and recognised. (See below for measurement of hedge effectiveness.)

An entity can also designate changes only in the cash flows or fair value of a hedged item above or below a specified price or other variable (a “one-sided risk”). The intrinsic value of a purchased option hedging instrument (assuming that it has the same principal terms as the designated risk), but not its time value, reflects a one-sided risk in a hedged item. For example, an entity can designate the variability of future cash flow outcomes resulting from a price increase of a forecast commodity purchase. In such a situation, the entity designates only cash flow losses that result from an increase in the price above the specified level. The hedged risk does not include the time value of a purchased option, because the time value is not a component of the forecast transaction that affects profit or loss.

IFRS 9 includes a rebuttable presumption that unless inflation risk is contractually specified, it is not separately identifiable and reliably measurable and hence cannot be designated as a risk component of a financial instrument. However, in limited cases, it is possible to identify a risk component for inflation risk that is separately identifiable and reliably measurable because of the circumstances of the inflation environment and the relevant debt market.

Components of a Nominal Amount

A component of a nominal amount is a specified part of an item. Examples include:

1. As a monetary value, e.g., first €1 million from a customer from sales volumes;
2. A physical volume, e.g., second sale of 1,000 kilograms of salt.

There are two types of components of nominal amounts that can be designated as the hedged item in a hedging relationship: a component that is a proportion of an entire item or a layer component. The type of component changes the accounting outcome. IFRS 9 requires an entity to designate the component for accounting purposes consistently with its risk management objective.

An example of a component that is a proportion is 50% of the contractual cash flows of a loan.

Relationship Between Components and the Total Cash Flows of an Item

If a component of the cash flows of a financial or a non-financial item is designated as the hedged item, that component must be less than or equal to the total cash flows of the entire item. However, all of the cash flows of the entire item may be designated as the hedged item and hedged for only one particular risk (for example, only for those changes that are attributable to changes in LIBOR or a benchmark commodity price).

For example, in the case of a financial liability whose effective interest rate is below LIBOR, an entity cannot designate:

1. A component of the liability equal to interest at LIBOR (plus the principal amount in case of a fair value hedge); and
2. A negative residual component.

However, in the case of a fixed-rate financial liability whose effective interest rate is (for example) 100 basis points below LIBOR, an entity can designate as the hedged item the change in the value of that entire liability (i.e., principal plus interest at LIBOR minus 100 basis points) that is attributable to changes in LIBOR. If a fixed-rate financial instrument is hedged some time, after its origination and interest rates have changed in the meantime, the entity can designate a risk component equal to a benchmark rate that is higher than the contractual rate paid on the item. The entity can do so provided that the benchmark rate is less than the effective interest rate calculated on the assumption that the entity had purchased the instrument on the day when it first designates the hedged item.

Designation of Financial Items as Hedged Items

As along as the effectiveness can be measured, it is possible to designate only a portion of either the cash flows or fair value of a financial instrument as a hedged item.

When designating the hedged item on the basis of the aggregated exposure, an entity considers the combined effect of the items that constitute the aggregated exposure for the purpose of assessing hedge effectiveness and measuring hedge ineffectiveness. However, the items that constitute the aggregated exposure remain accounted for separately. This means that, for example:

1. Derivatives that are part of an aggregated exposure are recognised as separate assets or liabilities measured at fair value; and
2. If a hedging relationship is designated between the items that constitute the aggregated exposure, the way in which a derivative is included as part of an aggregated exposure must be consistent with the designation of that derivative as the hedging instrument at the level of the aggregated exposure. For example, if an entity excludes the forward element of a derivative from its designation as the hedging instrument for the hedging relationship between the items that constitute the aggregated exposure, it must also exclude the forward element when including that derivative as a hedged item as part of the aggregated exposure. Otherwise, the aggregated exposure shall include a derivative, either in its entirety or a proportion of it.

IFRS 9 clarifies the range of eligible hedged items by including aggregated exposures that are a combination of an exposure that could qualify as a hedged item and a derivative.

Consequently, in the scenario above, the entity could designate the foreign exchange forward contract in a cash flow hedge of the combination of the original exposure and the steel futures contract (i.e., the aggregated exposure) without affecting the first hedging relationship. In other words, it would no longer be necessary to discontinue and redesignate the first hedging relationship.

For hedge accounting purposes, only assets, liabilities, firm commitments or highly probable forecast transactions with a party external to the reporting entity can be designated as hedged items. Hedge accounting can be applied to transactions between entities in the same group only in the individual or separate financial statements of those entities and not in the consolidated financial statements of the group, except for the consolidated financial statements of an investment entity, as defined in IFRS 10, where transactions between an investment entity and its subsidiaries measured at fair value through profit or loss will not be eliminated in the consolidated financial statements.

However, as an exception to this, the foreign currency risk of an intragroup monetary item (for example, a payable/receivable between two subsidiaries) may qualify as a hedged item in the consolidated financial statements if it results in an exposure to foreign exchange rate gains or losses that are not fully eliminated on consolidation in accordance with IAS 21, The Effects of Changes in Foreign Exchange Rates.

In accordance with IAS 21, foreign exchange rate gains and losses on intragroup monetary items are not fully eliminated on consolidation when the intragroup monetary item is transacted between two group entities that have different functional currencies. In addition, the foreign currency risk of a highly probable forecast intragroup transaction may qualify as a hedged item in consolidated financial statements provided that the transaction is denominated in a currency other than the functional currency of the entity entering into that transaction and the foreign currency risk will affect consolidated profit or loss.

An equity method investment cannot be a hedged item in a fair value hedge. This is because the equity method recognises in profit or loss the investor's share of the investee's profit or loss, instead of changes in the investment's fair value. For a similar reason, an investment in a consolidated subsidiary cannot be a hedged item in a fair value hedge. This is because consolidation recognises in profit or loss the subsidiary's profit or loss, instead of changes in the investment's fair value. A hedge of a net investment in a foreign operation is different because it is a hedge of the foreign currency exposure, not a fair value hedge of the change in the value of the investment.

Hedge Effectiveness

Hedge effectiveness is the extent to which changes in the fair value or the cash flows of the hedging instrument offset changes in the fair value or the cash flows of the hedged item (for example, when the hedged item is a risk component, the relevant change in fair value or cash flows of an item is the one that is attributable to the hedged risk). Hedge ineffectiveness is the extent to which the changes in the fair value or the cash flows of the hedging instrument are greater or less than those on the hedged item.

IFRS requires an entity to assess at the inception of the hedging relationship, and on an ongoing basis, whether a hedging relationship meets the hedge effectiveness requirements. At a minimum, an entity shall perform the ongoing assessment at each reporting date or upon a significant change in the circumstances affecting the hedge effectiveness requirements, whichever comes first. The assessment relates to expectations about hedge effectiveness and is therefore only forward looking.

When designating a hedging relationship on an ongoing basis, IFRS 9 requires an entity to analyse the sources of hedge ineffectiveness that are expected to affect the hedging relationship during its term. This analysis (including any updates in arising from rebalancing a hedging relationship) is the basis for the entity's assessment of meeting the hedge effectiveness requirements.

For the avoidance of doubt, the effects of replacing the original counterparty with a clearing counterparty and making the associated changes shall be reflected in the measurement of the hedging instrument and therefore in the assessment of hedge effectiveness and the measurement of hedge effectiveness.

Entities no longer need to perform a retrospective qualitative effectiveness assessment using the 80% to 125% bright lines as was required under IAS 39. A prospective effectiveness assessment is still required as a minimum at each reporting date. Hedge effectives is now based on three assessments. All three assessments need to be met for the hedging relationship to be effective and thus meeting the qualifying criteria for hedge accounting. If assessment 1 and 2 are no longer met, hedge accounting is stopped. However, assessment 3, the hedging ratio, could be rebalanced to continue hedge accounting.

Rebalancing the Hedging Relationship and Changes to the Hedge Ratio

IFRS 9 requires rebalancing in circumstances where the quantities of the hedged item or hedging instrument need to be changed to maintain the hedge ratio (as discussed above) such that the hedging relationship continued to meet the hedge accounting requirements. Rebalancing to maintain this hedge ratio can be achieved by increasing or decreasing the volume of the hedged item or the hedging instrument. Such increases or decreases in quantities do not necessarily require change in contracted quantities of either the hedged item or hedging instrument but relate more to the amounts that are, or are not, designated within the hedging relationship.

Rebalancing refers to the adjustments made to the designated quantities of the hedged item or the hedging instrument of an already existing hedging relationship for the purpose of maintaining a hedge ratio that complies with the hedge effectiveness requirements. Changes to designated quantities of a hedged item or of a hedging instrument for a different purpose do not constitute rebalancing for the purpose of IFRS 9.

Rebalancing is accounted for as a continuation of the hedging relationship (see explanations below). On rebalancing, the hedge ineffectiveness of the hedging relationship is determined and recognised immediately before adjusting the hedging relationship.

Adjusting the hedge ratio allows an entity to respond to changes in the relationship between the hedging instrument and the hedged item that arise from their underlying's or risk variables. For example, a hedging relationship in which the hedging instrument and the hedged item have different but related underlying's changes in response to a change in the relationship between those two underlyings (for example, different but related reference indices, rates or prices). Hence, rebalancing allows the continuation of a hedging relationship in situations in which the relationship between the hedging instrument and the hedged item changes in a way that can be compensated for by adjusting the hedge ratio.

For example, an entity hedges an exposure to Foreign Currency A using a currency derivative that references Foreign Currency B and Foreign Currencies A and B are pegged (i.e., their exchange rate is maintained within a band or at an exchange rate set by a central bank or other authority).

If the exchange rate between Foreign Currency A and Foreign Currency B were changed (i.e., a new band or rate was set), rebalancing the hedging relationship to reflect the new exchange rate would ensure that the hedging relationship would continue to meet the hedge effectiveness requirement for the hedge ratio in the new circumstances. In contrast, if there was a default on the currency derivative, changing the hedge ratio could not ensure that the hedging relationship would continue to meet that hedge effectiveness requirement. Hence, rebalancing does not facilitate the continuation of a hedging relationship in situations in which the relationship between the hedging instrument and the hedged item changes in a way that cannot be compensated for by adjusting the hedge ratio.

Not every change in the extent of offset between the changes in the fair value of the hedging instrument and the hedged item's fair value or cash flows constitutes a change in the relationship between the hedging instrument and the hedged item. An entity analyses the sources of hedge ineffectiveness that it expected to affect the hedging relationship during its term and evaluates whether changes in the extent of offset are:

1. Fluctuations around the hedge ratio, which remains valid (i.e., continues to appropriately reflect the relationship between the hedging instrument and the hedged item); or
2. An indication that the hedge ratio no longer appropriately reflects the relationship between the hedging instrument and the hedged item.

IFRS 9 recognises that an entity performs the evaluation against the hedge effectiveness requirement for the hedge ratio, i.e., to ensure that the hedging relationship does not reflect an imbalance between the weightings of the hedged item and the hedging instrument that would create hedge ineffectiveness (irrespective of whether it is recognised or not) that could result in an accounting outcome that would be inconsistent with the purpose of hedge accounting. Hence, this evaluation requires judgement.

Fluctuation around a constant hedge ratio (and hence the related hedge ineffectiveness) cannot be reduced by adjusting the hedge ratio in response to each outcome. Hence, in such circumstances, the change in the extent of offset is a matter of measuring and recognising hedge ineffectiveness but does not require rebalancing.

Conversely, if changes in the extent of offset indicate that the fluctuation is around a hedge ratio that is different from the hedge ratio that is currently used for that hedging relationship, or that there is a trend leading away from that hedge ratio, hedge ineffectiveness can be reduced by adjusting the hedge ratio, whereas retaining the hedge ratio would increasingly produce hedge ineffectiveness.

Hence, in such circumstances, an entity must evaluate whether the hedging relationship reflects an imbalance between the weightings of the hedged item and the hedging instrument that would create hedge ineffectiveness (irrespective of whether it is recognised or not) that could result in an accounting outcome that would be inconsistent with the purpose of hedge accounting. If the hedge ratio is adjusted, it also affects the measurement and recognition of hedge ineffectiveness because, on rebalancing, the hedge ineffectiveness of the hedging relationship must be determined and recognised immediately before adjusting the hedging relationship.

Rebalancing means that, for hedge accounting purposes, after the start of a hedging relationship an entity adjusts the quantities of the hedging instrument or the hedged item in response to changes in circumstances that affect the hedge ratio of that hedging relationship. Typically, that adjustment should reflect adjustments in the quantities of the hedging instrument and the hedged item that it uses. However, IFRS 9 requires an entity to adjust the hedge ratio that results from the quantities of the hedged item or the hedging instrument that it uses if:

1. The hedge ratio that results from changes to the quantities of the hedging instrument or the hedged item that the entity actually uses would reflect an imbalance that would create hedge ineffectiveness that could result in an accounting outcome that would be inconsistent with the purpose of hedge accounting; or
2. An entity would retain quantities of the hedging instrument and the hedged item that it actually uses, resulting in a hedge ratio that, in new circumstances, would reflect an imbalance that would create hedge ineffectiveness that could result in an accounting outcome that would be inconsistent with the purpose of hedge accounting (i.e., an entity must not create an imbalance by omitting to adjust the hedge ratio).

Rebalancing does not apply if the risk management objective for a hedging relationship has changed. Instead, hedge accounting for that hedging relationship shall be discontinued (even if an entity might designate a new hedging relationship that involves the hedging instrument or hedged item of the previous hedging relationship). If a hedging relationship is rebalanced, the adjustment to the hedge ratio can be effected in different ways:

1. The weighting of the hedged item can be increased (which at the same time reduces the weighting of the hedging instrument) by:
   1. Increasing the volume of the hedged item; or
   2. Decreasing the volume of the hedging instrument.
2. The weighting of the hedging instrument can be increased (which at the same time reduces the weighting of the hedged item) by:
   1. Increasing the volume of the hedging instrument; or
   2. Decreasing the volume of the hedged item.

Changes in volume refer to the quantities that are part of the hedging relationship. Hence, decreases in volumes do not necessarily mean that the items or transactions no longer exist, or are no longer expected to occur, but that they are not part of the hedging relationship. For example, decreasing the volume of the hedging instrument can result in the entity retaining a derivative, but only part of it might remain a hedging instrument of the hedging relationship. This could occur if the rebalancing could be effected only by reducing the volume of the hedging instrument in the hedging relationship, but with the entity retaining the volume that is no longer needed. In that case, the undesignated part of the derivative would be accounted for at FVTPL (unless it was designated as a hedging instrument in a different hedging relationship).

Adjusting the hedge ratio by increasing the volume of the hedged item does not affect how the changes in the fair value of the hedging instrument are measured. The measurement of the changes in the value of the hedged item related to the previously designated volume also remains unaffected.

However, from the date of rebalancing, the changes in the value of the hedged item also include the change in the value of the additional volume of the hedged item. These changes are measured starting from, and by reference to, the date of rebalancing instead of the date on which the hedging relationship was designated.

When rebalancing a hedging relationship, an entity shall update its analysis of the sources of hedge ineffectiveness that are expected to affect the hedging relationship during its remaining term and the documentation of the hedging relationship shall be updated accordingly.

Discontinuation of Hedge Accounting

Discontinuing hedge accounting can either affect a hedging relationship in its entirety or only a part of it (in which case hedge accounting continues for the remainder of the hedging relationship).

Discontinuation of hedge accounting applies prospectively from the date on which the qualifying criteria are no longer met.

IFRS 9 states that an entity shall not de-designate and thereby discontinue a hedging relationship that:

1. Still meets the risk management objective on the basis of which it qualified for hedge accounting (i.e., the entity still pursues that risk management objective); and
2. Continues to meet all other qualifying criteria (after taking into account any rebalancing of the hedging relationship, if applicable).

The discontinuation of hedge accounting can affect:

1. A hedging relationship in its entirety; or
2. A part of a hedging relationship (which means that hedge accounting continues for the remainder of the hedging relationship).

A hedging relationship is discontinued in its entirety when it ceases to meet the qualifying criteria. For example:

1. The hedging relationship no longer meets the risk management objective on the basis of which it qualified for hedge accounting (i.e., the entity no longer pursues that risk management objective);
2. The hedging instrument or instruments have been sold or terminated (in relation to the entire volume that was part of the hedging relationship); or
3. There is no longer an economic relationship between the hedged item and the hedging instrument or the effect of credit risk starts to dominate the value changes that result from that economic relationship.

A part of a hedging relationship is discontinued (and hedge accounting continues for its remainder) when only a part of the hedging relationship ceases to meet the qualifying criteria. For example:

1. On rebalancing of the hedging relationship, the hedge ratio might be adjusted in such a way that some of the volume of the hedged item is no longer part of the hedging relationship and as a result hedge accounting is discontinued only for the volume of the hedged item that is no longer part of the hedging relationship; or
2. When the occurrence of some of the volume of the hedged item that is (or is a component of) a forecast transaction is no longer highly probable, hedge accounting is discontinued only for the volume of the hedged item whose occurrence is no longer highly probable. However, if an entity has a history of having designated hedges of forecast transactions and having subsequently determined that the forecast transactions are no longer expected to occur, the entity's ability to predict forecast transactions accurately is called into question when predicting similar forecast transactions. This affects the assessment of whether similar forecast transactions are highly probable and hence whether they are eligible as hedged items.

An entity can designate a new hedging relationship that involves the hedging instrument or hedged item of a previous hedging relationship for which hedge accounting was (in part or in its entirety) discontinued. This does not constitute a continuation of a hedging relationship but is a restart. For example:

1. A hedging instrument experiences such a severe credit deterioration that the entity replaces it with a new hedging instrument. This means that the original hedging relationship failed to achieve the risk management objective and is hence discontinued in its entirety. The new hedging instrument is designated as the hedge of the same exposure that was hedged previously and forms a new hedging relationship. Hence, the changes in the fair value or the cash flows of the hedged item are measured starting from, and by reference to, the date of designation of the new hedging relationship instead of the date on which the original hedging relationship was designated.
2. A hedging relationship is discontinued before the end of its term. The hedging instrument in that hedging relationship can be designated as the hedging instrument in another hedging relationship (for example, when adjusting the hedge ratio on rebalancing by increasing the volume of the hedging instrument or when designating a whole new hedging relationship).

Fair Value Hedges

So long as a fair value hedge meets the qualifying criteria as stated above, the hedging relationship shall be accounted for as follows:

1. The gains or losses on the hedging instrument shall be recognised in profit or loss (or other comprehensive income, if the hedging instrument hedges an equity instrument for which an entity has elected to present changes in fair value in other comprehensive income).
2. The hedging gain or loss on the hedged item shall adjust the carrying amount of the hedged item (if applicable) and be recognised in profit or loss. If the hedged item is a financial asset (or a component thereof) that is measured at FVTOCI, the hedging gain or loss on the hedged item shall be recognised in profit or loss. However, if the hedged item is an equity instrument for which an entity has elected to present changes in fair value in other comprehensive income, those amounts shall remain in other comprehensive income. When a hedged item is an unrecognised firm commitment (or a component thereof), the cumulative change in the fair value of the hedged item subsequent to its designation is recognised as an asset or a liability with a corresponding gain or loss recognised in profit or loss.

When a hedged item in a fair value hedge is a firm commitment (or a component thereof) to acquire an asset or assume a liability, the initial carrying amount of the asset or the liability that results from the entity meeting the firm commitment is adjusted to include the cumulative change in the fair value of the hedged item that was recognised in the statement of financial position.

Any adjustment arising from the above recognition principles shall be amortised to profit or loss if the hedged item is a financial instrument (or a component thereof) measured at amortised cost. Amortisation may commence as soon as an adjustment exists and shall begin no later than when the hedged item ceases to be adjusted for hedging gains and losses. The amortisation is based on a recalculated effective interest rate at the date that amortisation begins. In the case of a financial asset (or a component thereof) that is a hedged item and that is measured at FVTOCI, amortisation applies in the same manner but to the amount that represents the cumulative gain or loss previously recognised instead of by adjusting the carrying amount.

Cash Flow Hedges

So long as cash flow hedges meet the qualifying criteria as stated above, the hedging relationship shall be accounted for as follows:

1. The separate component of equity associated with the hedged item (cash flow hedge reserve) is adjusted to the lower of the following (in absolute amounts):
   • The cumulative gain or loss on the hedging instrument from inception of the hedge; and
   • The cumulative change in fair value (net present value) of the hedged item (i.e., the present value of the cumulative change in the hedged expected future cash flows) from inception of the hedge.
2. The portion of the gain or loss on the hedging instrument that is determined to be an effective hedge (i.e., the portion that is offset by the change in the cash flow hedge reserve calculated in accordance with (1)) shall be recognised in other comprehensive income.
3. Any remaining gain or loss on the hedging instrument (or any gain or loss required to balance the change in the cash flow hedge reserve calculated in accordance with (1)) is hedge ineffectiveness that shall be recognised in profit or loss.
4. The amount that has been accumulated in the cash flow hedge reserve in accordance with (1) shall be accounted for as follows:
   • If a hedged forecast transaction subsequently results in the recognition of a non-financial asset or non-financial liability, or a hedged forecast transaction for a non-financial asset or a non-financial liability becomes a firm commitment for which fair value hedge accounting is applied, the entity shall remove that amount from the cash flow hedge reserve and include it directly in the initial cost or other carrying amount of the asset or the liability. This is not a reclassification adjustment (see IAS 1) and hence it does not affect other comprehensive income.
   • For cash flow hedges other than those covered by (1), that amount shall be reclassified from the cash flow hedge reserve to profit or loss as a reclassification adjustment (see IAS 1) in the same period or periods during which the hedged expected future cash flows affect profit or loss (for example, in the periods that interest income or interest expense is recognised or when a forecast sale occurs).
   • However, if that amount is a loss and an entity expects that all or a portion of that loss will not be recovered in one or more future periods, it shall immediately reclassify the amount that is not expected to be recovered into profit or loss as a reclassification adjustment (see IAS 1).

When an entity discontinues hedge accounting for a cash flow hedge it shall account for the amount that has been accumulated in the cash flow hedge reserve as follows:

1. If the hedged future cash flows are still expected to occur, that amount shall remain in the cash flow hedge reserve until the future cash flows occur.
2. If the hedged future cash flows are no longer expected to occur, that amount shall be immediately reclassified from the cash flow hedge reserve to profit or loss as a reclassification adjustment (see IAS 1).

Hedges of a Net Investment in a Foreign Operation

Hedges of a net investment in a foreign operation, including a hedge of a monetary item that is accounted for as part of the net investment (see IAS 21), shall be accounted for similarly to cash flow hedges, i.e.:

1. The portion of the gain or loss on the hedging instrument that is determined to be an effective hedge shall be recognised in other comprehensive income; and
2. The ineffective portion shall be recognised in profit or loss.

The cumulative gain or loss on the hedging instrument relating to the effective portion of the hedge that has been accumulated in the foreign currency translation reserve shall be reclassified from equity to profit or loss as a reclassification adjustment (see IAS 1) on the disposal or partial disposal of the foreign operation.

Accounting for the Time Value of Options

The time value of options consists of the intrinsic value and the time value. When using an option for hedging activities, only the intrinsic value is used for offsetting the fair value changes attributable to the hedged risk, unless the hedged item is also an option.

When an entity separates the intrinsic value and time value of an option contract and designates as the hedging instrument only the change in intrinsic value of the option, it shall account for the time value of the option as follows:

1. An entity shall distinguish the time value of options by the type of hedged item that the option hedges:
   • A transaction-related hedged item; or
   • A time period-related hedged item.
2. The change in fair value of the time value of an option that hedges a transaction-related hedged item shall be recognised in other comprehensive income to the extent that it relates to the hedged item and shall be accumulated in a separate component of equity. The cumulative change in fair value arising from the time value of the option that has been accumulated in a separate component of equity (the “amount”) shall be accounted for as follows:
   • If the hedged item subsequently results in the recognition of a non-financial asset or a non-financial liability, or a firm commitment for a non-financial asset or a non-financial liability for which fair value hedge accounting is applied, the entity shall remove the amount from the separate component of equity and include it directly in the initial cost or other carrying amount of the asset or the liability. This is not a reclassification adjustment (refer to IAS 1) and hence does not affect other comprehensive income.
   • For hedging relationships other than those covered by (1), the amount shall be reclassified from the separate component of equity to profit or loss as a reclassification adjustment (refer to IAS 1) in the same period or periods during which the hedged expected future cash flows affect profit or loss (for example, when a forecast sale occurs).
   • However, if all or a portion of that amount is not expected to be recovered in one or more future periods, the amount that is not expected to be recovered shall be immediately reclassified into profit or loss as a reclassification adjustment (refer to IAS 1).
3. The change in fair value of the time value of an option that hedges a time period-related hedged item shall be recognised in other comprehensive income to the extent that it relates to the hedged item and shall be accumulated in a separate component of equity. The time value at the date of designation of the option as a hedging instrument, to the extent that it relates to the hedged item, shall be amortised on a systematic and rational basis over the period during which the hedge adjustment for the option's intrinsic value could affect profit or loss (or other comprehensive income, if the hedged item is an equity instrument for which an entity has elected to present changes in fair value in other comprehensive income). Hence, in each reporting period, the amortisation amount shall be reclassified from the separate component of equity to profit or loss as a reclassification adjustment (refer to IAS 1). However, if hedge accounting is discontinued for the hedging relationship that includes the change in intrinsic value of the option as the hedging instrument, the net amount (i.e., including cumulative amortisation) that has been accumulated in the separate component of equity shall be immediately reclassified into profit or loss as a reclassification adjustment (refer to IAS 1).

The characteristics of the hedged item, including how and when the hedged item affects profit or loss, also affect the period over which the time value of an option that hedges a time period-related hedged item is amortised, which is consistent with the period over which the option's intrinsic value can affect profit or loss in accordance with hedge accounting. For example, if an interest rate option (a cap) is used to provide protection against increases in the interest expense on a floating rate bond, the time value of that cap is amortised to profit or loss over the same period over which any intrinsic value of the cap would affect profit or loss:

1. If the interest rate option (a cap) hedge increases in it's interest rates for the first three years, out of a total life of the floating rate bond of five years, the time value of that interest rate option hedge (the cap) is amortised over the first three years; or
2. If the interest rate option hedge is a forward start option that hedges increase in interest rates for two years and three, out of a total life of the floating rate bond of five years, the time value of that cap is amortised during years two and three.

The accounting for the time value of options in accordance with the paragraphs above also applies to a combination of a purchased and a written option (one being a put option and one being a call option) that at the date of designation as a hedging instrument has a net nil time value (commonly referred to as a “zero-cost collar”). In that case, an entity shall recognise any changes in time value in other comprehensive income, even though the cumulative change in time value over the total period of the hedging relationship is nil. Hence, if the time value of the option relates to:

1. A transaction-related hedged item, the amount of time value at the end of the hedging relationship that adjusts the hedged item or that is reclassified to profit or loss would be nil.
2. A time period-related hedged item, the amortisation expense related to the time value is nil.

The accounting for the time value of options applies only to the extent that the time value relates to the hedged item (aligned time value). The time value of an option relates to the hedged item if the critical terms of the option (such as the nominal amount, life and underlying) are aligned with the hedged item. Hence, if the critical terms of the option and the hedged item are not fully aligned, an entity shall determine the aligned time value, i.e., how much of the time value included in the premium (actual time value) relates to the hedged item. An entity determines the aligned time value using the valuation of the option that would have critical terms that perfectly match the hedged item.

If the actual time value and the aligned time value differ, an entity shall determine the amount that is accumulated in a separate component of equity as follows:

1. If, at inception of the hedging relationship, the actual time value is higher than the aligned time value, the entity shall:
   • Determine the amount that is accumulated in a separate component of equity on the basis of the aligned time value; and
   • Account for the differences in the fair value changes between the two-time values in profit or loss.
2. If, at inception of the hedging relationship, the actual time value is lower than the aligned time value, the entity shall determine the amount that is accumulated in a separate component of equity by reference to the lower of the cumulative change in fair value of:
   • The actual time value; and
   • The aligned time values.

Any remainder of the change in fair value of the actual time value shall be recognised in profit or loss.

Accounting for the Forward Element of Forward Contracts

Forward contracts comprise a spot element and a forward element. IFRS 9 allows an entity to designate only changes in the spot element of the contract in a hedging relationship, under which the changes in the spot element are accounted for in line with the nature of the hedge. When only the spot element is designated, the forward element (which remains undesignated) can be accounted for under one of the following two options, which are choices that are made on a hedge to hedge basis:

• The changes in the forward element can be accounted for in profit or loss; or
• The changes in the forward element that relates to the hedged item can be accounted for in OCI with subsequent reclassification from equity to profit or loss.

Hedges of a Group of Items

IFRS 9 stipulates that a group of items that constitute a net position is eligible for a hedged item only if:

1. It consists of items (including components of items) that are, individually, eligible hedged items;
2. The items in the group are managed together on a group basis for risk management purposes; and
3. In the case of a cash flow hedge of a group of items whose variabilities in cash flows are not expected to be approximately proportional to the overall variability in cash flows of the group so that offsetting risk positions arise:
   • It is a hedge of foreign currency risk; and
   • The designation of that net position specifies the reporting period in which the forecast transactions are expected to affect profit or loss, as well as their nature and volume.

Designation of a Component of a Nominal Amount

A component that is a proportion of an eligible group of items is an eligible hedged item if designation is consistent with the entity's risk management objective.

A layer component of an overall group of items (for example, a bottom layer) is eligible for hedge accounting only if:

1. It is separately identifiable and reliably measurable;
2. The risk management objective is to hedge a layer component;
3. The items in the overall group from which the layer is identified are exposed to the same hedged risk (so that the measurement of the hedged layer is not significantly affected by which particular items from the overall group form part of the hedged layer);
4. For a hedge of existing items (for example, an unrecognised firm commitment or a recognised asset) an entity can identify and track the overall group of items from which the hedged layer is defined (so that the entity is able to comply with the requirements for the accounting for qualifying hedging relationships); and
5. Any items in the group that contain prepayment options meet the requirements for components of a nominal amount.

A net position is eligible for hedge accounting only if an entity hedges on a net basis for risk management purposes. Whether an entity hedges in this way is a matter of fact (not merely of assertion or documentation). Hence, an entity cannot apply hedge accounting on a net basis solely to achieve an accounting outcome if that would not reflect its risk management approach. Net position hedging must form part of an established risk management strategy. Normally this would be approved by key management personnel as defined in IAS 24.

Layers of Groups of Items Designated as the Hedged Item

A hedging relationship can include layers from several different groups of items. For example, in a hedge of a net position of a group of assets and a group of liabilities, the hedging relationship can comprise, in combination, a layer component of the group of assets and a layer component of the group of liabilities.

Impracticability

Where it is impracticable (refer to IAS 8) to retrospectively apply the effective interest method, the fair value of the financial instrument at the end of each comparative period is presented as the previous carrying value under IAS 39 and is assumed to be the carrying value at the date of initial application.

Where equity instruments were previously measured at cost under IAS 39, and it is impracticable to determine the fair values for comparative periods, the instrument is measured at fair value at the date of initial application and the difference between fair value and the previous carrying value is adjusted in opening retained earnings.

Where entities prepare interim financial reports (refer to IAS 34), retrospective application to previous interim reports are not required, if impracticable.

Impairment

At the date of initial application, reasonable and supportable information that is available without undue cost or effort must be used to determine credit risk at the date of initial recognition of the financial instrument and compare that to the credit risk at the date of initial application of IFRS 9 in order to determine changes in credit risk.

Impairment of financial instruments for comparative periods needs to be based on the information available at the respective reporting dates without the application of hindsight.

When an entity determines if there has been a significant increase in credit risk since initial recognition, it may:

1. Apply the low credit risk exception (described earlier in the chapter)
2. Apply the rebuttable presumption for contractual payments that are more than 30 days past due if an entity will apply the impairment requirements by identifying significant increases in credit risk since initial recognition for those financial instruments on the basis of past due information.

At the date of initial application, an entity is required to use reasonable and supportable information that is available without undue cost or effort to determine the credit risk at the date that a financial instrument was initially recognised (for loan commitments and financial guarantee contracts at the date that the entity became a party to the irrevocable commitment) and compare that to the credit risk at the date of initial application.

An exhaustive search for information is not required when determining if there has been a significant increase in credit risk from the time of initial recognition.

Such information comprises all internal and external information, including portfolio information. An entity with little historical information can use the following sources of information:

1. Information from internal reports and statistics, e.g., that may have been generated when deciding whether to launch a new product;
2. Information about similar products; or
3. Peer group experience for comparable financial instruments.

If it is deemed that undue cost or effort will be required to determine if there has been a significant increase in credit risk, the loss allowance or provision is measured as lifetime expected credit losses, each reporting a date until that financial instrument is derecognised, unless the credit risk of the financial instrument is low credit risk at a reporting date. If the credit risk of a financial instrument is low, an entity may assume that the credit risk on that asset has not increased significantly since initial recognition, and may recognise a loss allowance equal to 12 months' expected credit losses.

Classification and Measurement

Distinguishing Liabilities from Equity

Financial instruments of a given issuer may have attributes of both liabilities and equity. A compound instrument is a single financial instrument that contains both a liability and an equity element (e.g., a convertible bond). From a financial reporting perspective, the central issue is whether to account for these “compound” instruments as either liabilities or equity in total, or to disaggregate them into both liabilities and equity instruments.

Under the provisions of IAS 32, the issuer of a financial instrument must classify it, or its component parts, in accordance with the substance of the respective contractual arrangement and the definitions of a financial liability, financial asset and equity instrument.

A contractual arrangement refers to an agreement between two or more parties that has clear economic consequences that the parties have little, if any, discretion to avoid, usually because the agreement is enforceable by law.

IAS 32 requires that an issuer classifies a financial instrument as equity only if both conditions below are met:

1. The instrument includes no contractual obligations:
   • To deliver cash or another financial asset; or
   • To exchange financial assets or financial liabilities with another entity under potentially unfavourable conditions to the issuer; and
2. If the instrument will or may be settled in the issuer's own shares (equity instruments), it is a non-derivative that includes no contractual obligation for the issuer to deliver a variable number of its own shares, or a derivative that will be settled by the issuer exchanging a fixed amount of cash or another financial asset for a fixed number of its own shares. (For this purpose, the issuer's own shares do not include instruments that are themselves contracts for the future receipt or delivery of the issuer's own shares.)

Thus, it is quite clear when the instrument gives rise to an obligation on the part of the issuer to deliver cash or another financial asset or to exchange financial instruments on potentially unfavourable terms, it is to be classified as a liability and not as equity. Mandatorily redeemable preference shares and preference shares issued with put options (options that can be exercised by the holder, potentially requiring the issuer to redeem the shares at agreed-upon prices) must, under this definition, be presented as liabilities.

Puttable Financial Instruments

Under IAS 32, puttable financial instruments are presented as equity, only if all the following criteria are met:

1. The holder is entitled to a pro rata share of the entity's net assets on liquidation;
2. The instrument is in the class of instruments that is the most subordinate and all instruments in that class have identical features;
3. The instrument has no other characteristics that would meet the definition of a financial liability; and
4. The total expected cash flows attributable to the instrument over its life are based substantially on either:
   • Profit or loss;
   • The change in the recognised net assets; or
   • The change in the fair value of the recognised and unrecognised net assets of the entity (excluding any effects of the instrument itself). Profit or loss or change in recognised net assets for this purpose is as measured in accordance with relevant IFRS.

In addition to the above criteria, the reporting entity is not permitted to have any other instruments or contracts with terms equivalent to (4) above that has the effect of substantially restricting or fixing the residual return to the holders of the puttable financial instruments.

Based on these requirements:

1. Shares that are puttable throughout their lives at fair value, which are also the most subordinate of the instruments issued by the reporting entity, which do not contain any other obligation, and which have only discretionary (i.e., non-fixed) dividends based on profits of the issuer, will be classified as equity.
2. Shares that are puttable at fair value, but which are not the most subordinate class of instrument issued, must be classified as liabilities.
3. Shares that are puttable at fair value only on liquidation, and that are also the most subordinate class of instrument, but which specify a fixed non-discretionary dividend obligation, will be treated as compound financial instruments (that is, as being part equity, part liability).
4. Shares that are puttable at fair value only on liquidation, and that are also part of the most subordinate class of instruments issued, but are entitled to fixed, discretionary dividends, and do not contain any other obligation, are classified as equity and not liabilities.

Instruments are classified as equity from the time that they meet the criteria above. An entity shall reclassify a financial instrument from the date that the instrument ceases to have all the features or meet all the conditions set out above.

Settlement in the Entity's Own Equity Instruments

A contract is not an equity instrument solely because it may result in the receipt or delivery of an entity's own equity instruments. Such contracts will be financial liabilities where the number of equity instruments used as a means of settlement is variable.

Interests in Cooperatives

IFRIC 2, Members' Shares in Cooperative Entities and Similar Instruments, states that the contractual right of the holder of a financial instrument (including members' shares in cooperative entities) to request redemption does not require that financial instrument to be classified as a financial liability. Rather, the entity must consider all the terms and conditions of the financial instrument in determining its classification as a financial liability or equity, including relevant local laws, regulations and the entity's governing charter in effect at the date of classification.

Members' shares are equity if the entity has an unconditional right to refuse redemption of the members' shares or if redemption is unconditionally prohibited by local law, regulation or the entity's governing charter. However, if redemption is prohibited only if defined conditions—such as liquidity constraints—are met (or are not met), members' shares are not equity.

The unconditional prohibition for redemption may be absolute or partial. Members shares in excess of the prohibition are financial liabilities, unless an unconditional right of refusal to redeem exists.

Convertible Debt Instruments

Bonds are frequently issued with the right to convert them into ordinary shares of the company at the holder's option when certain terms and conditions are met (i.e., a target market price is reached). Convertible debt is used for two reasons. Firstly, when a specific amount of funds is needed, convertible debt often allows fewer shares to be issued (assuming that conversion ultimately occurs) than if the funds were raised by directly issuing the shares. Thus, less dilution is suffered by the other shareholders. Secondly, the conversion feature allows debt to be issued at a lower interest rate and with fewer restrictive covenants than if the debt were issued without it. That is because the bondholders are receiving the benefit of the conversion feature in lieu of higher current interest returns.

This dual nature of debt and equity, however, creates a question as to whether the equity element should receive separate recognition. Support for separate treatment is based on the assumption that this equity element has economic value. Since the convertible feature tends to lower the rate of interest, it can easily be argued that a portion of the proceeds should be allocated to this equity feature. On the other hand, a case can be made that the debt and equity elements are inseparable, and thus that the instrument is either all debt or all equity. IAS 32 defines convertible bonds (among other instruments) as being compound financial instruments, the component parts of which must be classified according to their separate characteristics.

Features of Convertible Debt Instruments

IAS 32 addresses the accounting for compound financial instruments from the perspective of issuers. Convertible debt probably accounts for most of the compound instruments that will be of concern to those responsible for financial reporting. IAS 32 requires the issuer of such a financial instrument to present the liability component and the equity component separately in the statement of financial position. Allocation of proceeds between liability and equity proceeds as follows:

1. Upon initial recognition, the fair value of the liability component of compound (convertible) debt instruments is computed as the present value of the contractual stream of future cash flows, discounted at the rate of interest applied at inception by the market to instruments of comparable credit status and providing substantially the same cash flows, on the same terms, but absent the conversion option. For example, if a 5% interest-bearing convertible bond would have commanded an 8% yield if issued without the conversion feature, the contractual cash flows are to be discounted at 8% in order to calculate the fair value of the unconditional debt component of the compound instrument.
2. The equity portion of the compound instrument is actually an embedded option to convert the liability into equity of the issuer. The fair value of the option is determined by time value and by the intrinsic value, if there is any. This option has value on initial recognition even when it is out of the money.

The issuance proceeds from convertible debt should be assigned to the components as described above.

Convertible debt also has its disadvantages. If the share price increases significantly after the debt is issued, the issuer would have been better off simply by issuing the share. Additionally, if the price of the share does not reach the conversion price, the debt will never be converted (a condition known as overhanging debt).

Classification of Compound Instruments

Compound instruments are those which are sold or acquired jointly, but which provide the holder with more than a single economic interest in the issuing entity. For example, a bond sold with share purchase warrants provides the holder with an unconditional promise to pay (the bond, which carries a rate of interest and a fixed maturity date) plus a right to acquire the issuer's shares (the warrant, which may be for common or preferred shares, at either a fixed price per share or a price based on some formula, such as a price that increases over time). In some cases, one or more of the component parts of the compound instrument may be financial derivatives, as a share purchase warrant would be. In other instances, each element might be a traditional, non-derivative instrument, as would be the case when a debenture is issued with common shares as a unit offering.

The accounting issue that is most obviously associated with compound instruments is how to allocate price or proceeds to the constituent elements. This becomes most important when the compound instrument consists of parts that are both liabilities and equity items. Proper classification of the elements is vital to accurate financial reporting, affecting potentially such matters as debt covenant compliance (if the debt-to-equity ratio, for example, is a covenant to be met by the debtor entity). Under IFRS, there is no mezzanine equity section as is sometimes observed under US GAAP and, for example, redeemable shares, including contingently redeemable shares, are classified as liabilities (exceptions: redeemable only at liquidation, redemption option not genuine or certain puttable instruments representing the most residual interest in the entity).

IAS 32 requires that fair value be ascertained and then allocated to the liability components, with only the residual amount being assigned to equity. This position has been taken in order to be fully consistent with the definition of equity as instruments that evidence only a residual interest in the assets of an entity, after satisfying all of its liabilities.

If the compound instruments include a derivative element (e.g., a put option), the value of those features, to the extent they are embedded in the compound financial instrument other than the equity component, is included in the liability component.

The sum of the carrying amounts assigned to the liability and equity components on initial recognition is always equal to the fair value that would be ascribed to the instrument as a whole. In other words, there can be no “day one” gains from issuing financial instruments.

Debt Instruments Issued with Share Warrants

Warrants are certificates enabling the holder to purchase a stated number of shares at a certain price within a certain period. They are often issued with bonds to enhance the marketability of the bonds and to lower the bond's interest rate.

Detachable warrants are similar to other features, such as the conversion feature discussed earlier, which under IAS 32 make the debt a compound financial instrument and which necessitates that there is an allocation of the original proceeds among the constituent elements using the principles set out above.

Instruments Having Contingent Settlement Provisions

Some financial instruments are issued which have contingent settlement provisions—that is, which may or may not require the issuer/obligor to utilise its resources in subsequent settlement. For example, a note can be issued that will be payable either in cash or in the issuer's shares, depending on whether certain contingent events, such as the share price exceeding a defined target over a defined number of days immediately preceding the maturity date of the note, are met or not. This situation differs from convertible debt, which is exchangeable into the shares of the borrower at the holder's option.

IAS 32 requires that a financial instrument is classified as a financial liability when the manner of settlement depends on the occurrence or non-occurrence of uncertain future events or on the outcome of uncertain circumstances that are beyond the control of both the issuer and the holder. Contingent settlement provisions are ignored when they apply only in the event of liquidation of the issuer or are not genuine.

Examples of such contingent conditions would be changes in a stock market index, the consumer price index, a reference interest rate or taxation requirements or the issuer's future revenues, profit or loss or debt to equity ratio. The issuer cannot impact these factors and thus cannot unilaterally avoid settlement as a liability, delivering cash or other assets to resolve the obligation.

Under IAS 32, certain exceptions to the foregoing rule have been established. These exist when:

1. The part of the contingent settlement provision that could require settlement in cash or another financial asset (or otherwise in such a way that it would be a financial liability) is not genuine; or
2. The issuer can be required to settle the obligation in cash or another financial asset (or otherwise to settle it in such a way that it would be a financial liability) only in the event of liquidation of the issuer.

By “not genuine,” IAS 32 means that there is no reasonable expectation that settlement in cash or other asset will be triggered. Thus, a contract that requires settlement in cash or a variable number of the entity's own shares only on the occurrence of an event that is extremely rare, highly abnormal and very unlikely to occur is an equity instrument. Similarly, settlement in a fixed number of the entity's own shares may be contractually precluded in circumstances that are outside the control of the entity, but if these circumstances have no genuine possibility of occurring, classification as an equity instrument is appropriate.

If the settlement option is only triggered upon liquidation, this possibility is ignored in classifying the instrument, since the going concern assumption, underlying IFRS-basis financial reporting, presumes ongoing existence rather than liquidation.

Treasury Shares

When an entity reacquires its own equity instruments (“treasury shares”), the consideration paid is deducted from equity. Treasury shares are not treated as assets, but are to be deducted from equity. No gain or loss should be recognised in profit or loss on the purchase, sale, issue or cancellation of an entity's own equity instruments since transactions with shareholders do not affect profit or loss. Treasury shares may be acquired and held by the entity or by other members of the consolidated group. Consideration paid or received from transactions with treasury shares should be recognised directly in equity. An entity must disclose the number of treasury shares held either in the statement of financial position or in the notes, in accordance with IAS 1. In addition, disclosures under IAS 24 must be provided if an entity reacquires its own shares from related parties.

Reporting Interest, Dividends, Losses and Gains

IAS 32 establishes that interest, dividends, losses and gains relating to a financial instrument or a component that is a financial liability should be recognised as income or expense in profit or loss. Distributions (dividends) paid on equity instruments issued should be charged directly to equity, and reported in the statement of changes in equity.

Transaction costs of an equity transaction should be accounted for as a deduction from equity. Income tax relating to distributions to holders of an equity instrument and to transaction costs of an equity transaction is accounted for in accordance with IAS 12, Income Taxes.

The statement of financial position classification of the instrument drives the statement of comprehensive income classification of the related interest or dividends. For example, if mandatorily redeemable preferred shares have been categorised as debt in the issuer's statement of financial position, dividend payments on those shares must be recognised in profit or loss in the same manner as interest expense. Similarly, gains or losses associated with redemptions or refinancing of financial instruments classed as liabilities would be recognised in profit or loss, while gains or losses on equity are credited or charged to equity directly.

Offsetting Financial Assets and Liabilities

Offsetting financial assets and liabilities is required only when the entity both:

1. Has the legally enforceable right to set off the recognised amounts; and
2. Intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.

Simultaneous settlement of a financial asset and a financial liability can be presumed only under defined circumstances. The most typical of such cases is when both instruments will be settled through a clearing house functioning for an organised exchange. Other situations may superficially appear to warrant the same accounting treatment but in fact do not give rise to legitimate offsetting. For example, if the entity will exchange cheques with a single counterparty for the settlement of both instruments, it becomes exposed to credit risk for a time, however brief, when it has paid the other party for the amount of the obligation owed to it but has yet to receive the counterparty's funds to settle the amount it is owed by the counterparty. Offsetting would not be warranted in such a context.

Legally enforceable right of setoff means that the right of setoff must be a legal contractual right, not be contingent on a future event and must be legally enforceable in all of the following circumstances:

1. The normal course of business;
2. The event of default; and
3. The event of insolvency or bankruptcy of the entity and all of the counterparties.

The nature and extent of the right of setoff, including any conditions attached to its exercise and whether it would remain in the event of default or insolvency or bankruptcy, may vary from jurisdiction to jurisdiction. As such, it cannot be assumed that the right of setoff is automatically available outside of the normal course of business. For example, bankruptcy or insolvency laws of a jurisdiction may prohibit, or restrict, the right of setoff in some circumstances and this needs to be taken into consideration in assessing whether or not the criteria set out above are met.

The standard sets forth a number of circumstances in which offsetting would not be justified. These include:

1. When several different instruments are used to emulate the features of a single type of instrument (which typically would involve a number of different counterparties, thus violating a basic principle of offsetting).
2. When financial assets and financial liabilities arise from instruments having the same primary risk exposure (such as when both are forward contracts) but with different counterparties.
3. When financial assets are pledged as collateral for non-recourse financial liabilities (as the intention is not typically to effect offsetting, but rather to settle the obligation and gain release of the collateral).
4. When financial assets are set aside in a trust for the purpose of discharging a financial obligation but the assets have not been formally accepted by the creditor (as when a sinking fund is established, or when in-substance defeasance of debt is arranged).
5. When obligations incurred as a consequence of events giving rise to losses are expected to be recovered from a third party by virtue of an insurance claim (again, different counterparties mean that the entity is exposed to credit risk, however slight).

Even the existence of a master netting agreement does not automatically justify the offsetting of financial assets and financial liabilities. Only if both the stipulated conditions (both the right to offset and the intention to do so) are met can this accounting treatment be employed.

Disclosures Required under IFRS 7

IFRS 7 has superseded the disclosure requirements previously found in IAS 32, as well as the financial institution-specific disclosure requirements of IAS 30, which were accordingly withdrawn. Presentation requirements set forth in IAS 32 continue in effect under that standard. IFRS 7 became effective for years beginning in 2007. Some of the amendments to IFRS 7 since 2007 are highlighted below:

1. Improving disclosures about financial instruments issued in March 2009 amended the required disclosures of fair value measurement and liquidity risk.
2. Improvements to IFRS standards issued in May 2010 included amendments to IFRS 7 that mostly clarified and refined certain disclosure requirements. Amendments are effective for financial periods beginning on or after January 1, 2011.
3. Transfer of financial assets issued in October 2010 on transfer of financial assets determining the recognition or derecognition (effective financial periods beginning on or after January 7, 2011).
4. IFRS 13, Fair Value Measurement, which transferred all the fair value disclosure from IFRS 7 to IFRS 13 (effective for financial periods beginning on or after January 1, 2013).
5. The amendments to IFRS 7 effective January 1, 2013 required entities to disclose information about rights of offset and related arrangements for financial instruments under an enforceable master netting agreement or similar arrangements irrespective of whether they are offset in the statement of financial position.
6. The latest amendments to IFRS 7 deal with additional disclosure requirements and amendments related to IFRS that are applicable from the same date that an entity applies IFRS 9.

IFRS 7 was made necessary by the increasingly sophisticated (but opaque) methods that reporting entities had begun using to measure and manage their exposure to risks arising from financial instruments. At the same time, new risk management concepts and approaches have gained acceptance. IASB concluded that users of financial statements need information about the reporting entities' exposures to risks and how those risks are being managed.

The principal objectives of this standard are to enable users to evaluate and assess:

1. Significance of financial instruments to an entity's financial position and subsequent performance;
2. Nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the end of the reporting period, and how the entity manages those risks.

Risk management information can influence the users' assessments of the financial position and performance of reporting entities, as well as of the amount, timing and uncertainty of the respective entity's future cash flows. In short, greater transparency regarding those risks allows users to make more informed judgements about risk and return. This is entirely consistent with the fundamental objective of financial reporting and is consistent with the widely accepted efficient markets hypothesis.

Paragraph 7 of IFRS 7 requires an entity to disclose information that enables users of its financial statements to evaluate the significance of financial instruments for its financial performance and financial position. Therefore, IFRS 7 applies to all risks arising from all financial instruments, with limited exceptions. It furthermore applies to all entities, including those that have only few basic financial instruments (e.g., an entity whose only financial instruments are accounts receivable and payable), as well as those that have many complex financial instruments (e.g., a financial institution, most assets and liabilities of which are financial instruments). Under IFRS 7, the extent of disclosure required depends on the extent of the entity's use of financial instruments and of its exposure to risk.

IFRS 7 sets out the requirements for the disclosure of financial instruments under two broad categories, quantitative disclosures and qualitative disclosures. The quantitative disclosures provide information about the effect of financial instruments on the financial position and financial performance of the entity, whereas the qualitative disclosures provide useful information about how risks relating to financial instruments arise in the entity and how these risks are being managed. The nature of the reporting entity's business and the extent to which it holds financial assets or is obligated by financial liabilities will affect the manner in which such disclosures are presented, and no single method of making such disclosures will be suitable for every entity. The standard therefore adopts an approach that requires the entity to disclose the information required in the form that it is presented internally for use by management and in those areas where management does not prepare the required information it must develop the appropriate disclosures. This approach means that financial instrument disclosures may not be easily comparable between entities.

The risks arising from financial instruments are categorised as follows:

1. Market risk, which implies not merely the risk of loss but also the potential for gain, and which is in turn comprised of:
2. Currency risk—The risk that the value of an instrument will vary due to changes in currency exchange rates.
3. Interest rate risk—The risk that the value of the instrument will fluctuate due to changes in market interest rates. Interest rate risk is the risk associated with holding fixed-rate instruments in a changing interest rate environment. As market rates rise, the price of fixed interest rate instruments will decline, and vice versa. This relationship holds in all cases, irrespective of other specific factors, such as changes in perceived creditworthiness of the borrower. However, with certain complex instruments such as mortgage-backed bonds (a popular form of derivative instrument), where the behavior of the underlying debtors can be expected to be altered by changes in the interest rate environment (i.e., as market interest rates decline, prepayments by mortgagors increase in frequency, raising reinvestment rate risk to the bondholders and accordingly tempering the otherwise expected upward movement of the bond prices), the inverse relationship will become distorted.
4. Other price risk—A broader concept that subsumes interest rate risk; this is the risk that the fair value or future cash flows of a financial instrument will fluctuate due to factors specific to the financial instrument or due to factors that are generally affecting all similar instruments traded in the same markets (e.g., where financial instruments comprise derivative contracts in commodity markets, such price risk will include the risks of changes in the respective commodity prices on international markets).
5. Credit risk is related to a loss that may occur from the failure of another party to a financial instrument to discharge an obligation according to the terms of a contract.
6. Liquidity risk is the risk that an entity may encounter difficulty in meeting obligations associated with financial liabilities.

Applicability of IFRS 7

IFRS 7 applies to both recognised and unrecognised financial instruments. Recognised financial instruments include financial assets and financial liabilities that are within the scope of IFRS 9. Unrecognised financial instruments include some financial instruments that, although outside the scope of IFRS 9, are within the scope of this IFRS (such as some loan commitments). The requirements also extend to contracts involving non-financial items if they are subject to IFRS 9.

Under the IFRS 9 related amendments, IFRS 7 also applies to receivables arising from IFRS 15 which IFRS 15 requires be accounted for under IFRS 9 for purposes of recognising impairment gains or losses.

Classes of Financial Instruments and Level of Disclosure

Many of the IFRS 7 requirements pertain to grouped data. In such cases, the grouping into classes is to be effected in the manner that is appropriate to the nature of the information disclosed and that takes into account the characteristics of the financial instruments. Importantly, sufficient information must be provided so as to permit reconciliation to the line items presented in the statement of financial position. Enough detail is required so that users are able to assess the significance of financial instruments to the reporting entity's financial position and results of operations.

IFRS 7 requires that carrying amounts of each of the following categories, as defined in IFRS 9, are to be disclosed either on the face of the statement of financial position or in the notes:

1. Financial assets at FVTPL, showing separately:
   • Those designated as such upon initial recognition; and
   • Those mandatorily classified as FVTPL in accordance with IFRS 9.
2. Financial liabilities at FVTPL, showing separately:
   • Those designated as such upon initial recognition; and
   • Those meeting the definition of held-for-trading in accordance with IFRS 9.
3. Financial assets measured at amortised cost.
4. Financial liabilities measured at amortised cost.
5. Financial assets measured at FVTOCI, showing separately:
   • Financial assets that are measured at FVTOCI mandatorily under IFRS 9; and
   • Investments in equity instruments designated as FVTOCI at initial recognition under IFRS 9.

Special disclosures apply to those financial assets and liabilities that an entity designates to be classified and accounted for at FVTPL that would otherwise have been measured at FVTOCI or amortised cost as follows:

1. The maximum exposure to credit risk of the loan or receivable (or group thereof) at the reporting date.
2. The amount by which any related credit derivatives or similar instruments mitigate that maximum exposure to credit risk.

3. The amount of change, both during the reporting period and cumulatively, in the fair value of the loan or receivable (or group thereof) that is attributable to changes in the credit risk of the financial asset determined either:

   • As the amount of change in its fair value that is not attributable to changes in market conditions that give rise to market risk; or
   • Using an alternative method the entity believes more faithfully represents the amount of change in its fair value that is attributable to changes in the credit risk of the asset.

   Changes in market conditions that give rise to market risk include changes in an observed (benchmark) interest rate, commodity price, foreign exchange rate or index of prices or rates.

4. The amount of the change in the fair value of any related derivatives or similar instruments that has occurred during the period and cumulatively since the loan or receivable was designated.

If the reporting entity has designated a financial liability to be reported at FVTPL, and is required to present the effects of changes in that liability's credit risk in OCI, it is to disclose:

1. The amount of change, cumulatively, in the fair value of the financial liability that is attributable to changes in the credit risk of that liability.
2. The difference between the financial liability's carrying amount and the amount the entity would be contractually required to pay at maturity to the holder of the obligation.
3. Any transfers of the cumulative gain or loss within equity during the period including the reason for such transfers.
4. If a liability is derecognised during the period, the amount (if any) presented in other comprehensive income that was realised at derecognition.

If an entity has designated a financial liability as at FVTPL and is required to present all changes in the fair value of that liability (including the effects of changes in the credit risk of the liability) in profit or loss (to eliminate an accounting mismatch), it shall disclose:

1. The amount of change, during the period and cumulatively, in the fair value of the financial liability that is attributable to changes in the credit risk of that liability; and
2. The difference between the financial liability's carrying amount and the amount the entity would be contractually required to pay at maturity to the holder of the obligation.

The entity shall also disclose:

1. A detailed description of the methods used to comply with the above disclosure requirements including an explanation of why the method is appropriate.
2. If the entity believes that the disclosure it has given, either in the statement of financial position or in the notes, to comply with the requirements above, does not faithfully represent the change in the fair value of the financial asset or financial liability attributable to changes in its credit risk, the reasons for reaching this conclusion and the factors it believes are relevant.
3. A detailed description of the methodology or methodologies used to determine whether presenting the effects of changes in a liability's credit risk in other comprehensive income would create or enlarge an accounting mismatch in profit or loss. If an entity is required to present the effects of changes in a liability's credit risk in profit or loss, the disclosure must include a detailed description of the economic relationship.

If an entity has designated investments in equity instruments to be measured at FVTOCI, as permitted by IFRS 9, it shall disclose:

1. Which investments in equity instruments have been designated to be measured at FVTOCI.
2. The reasons for using this presentation alternative.
3. The fair value of each such investment at the end of the reporting period.
4. Dividends recognised during the period, showing separately those related to investments derecognised during the reporting period and those related to investments held at the end of the reporting period.
5. Any transfers of the cumulative gain or loss within equity during the period including the reason for such transfers.

If an entity derecognised investment in equity instruments measured at FVTOCI during the reporting period, it shall disclose:

1. The reasons for disposing of the investments.
2. The fair value of the investments at the date of derecognition.
3. The cumulative gain or loss on disposal.

Disclosures Relating to Reclassifications

An entity shall disclose if, in the current or previous reporting periods, it has reclassified any financial assets in accordance with IFRS 9. For each such event, an entity shall disclose:

1. The date of reclassification.
2. A detailed explanation of the change in business model and a qualitative description of its effect on the entity's financial statements.
3. The amount reclassified into and out of each category.

For each reporting period following reclassification until derecognition, an entity shall disclose for assets reclassified out of the FVTPL category so that they are measured at amortised cost or FVTOCI in accordance with IFRS 9:

1. The effective interest rate determined on the date of reclassification; and
2. The interest revenue recognised.

If, since its last annual reporting date, an entity has reclassified financial assets out of the FVTOCI category so that they are measured at amortised cost or out of the FVTPL category so that they are measured at amortised cost or FVTOCI, it shall disclose:

1. The fair value of the financial assets at the end of the reporting period; and
2. The fair value gain or loss that would have been recognised in profit or loss or other comprehensive income during the reporting period if the financial assets had not been reclassified.

Offsetting Financial Assets and Financial Liabilities

IFRS 7 requires entities to disclose information about rights of offset and related arrangements for financial instruments under an enforceable master netting agreement or similar arrangements irrespective of whether they are offset in the statement of financial position.

The entity shall disclose the information to enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on the entity's financial position. This includes the effect or potential effect of rights of setoff associated with the entity's recognised financial assets and recognised financial liabilities. Some of the quantitative disclosures required are:

1. Gross amounts of those recognised financial assets and recognised financial liabilities;
2. Amounts that are set off in accordance with the criteria in paragraph 42 of IAS 32 when determining the net amounts presented in the statement of financial position;
3. Net amounts presented in the statement of financial position;
4. The amounts subject to enforceable master netting arrangement or a similar agreement that are not otherwise included in paragraph 13c(b) including:
   • Amounts related to recognised financial instruments that do not meet some or all of the offsetting criteria in paragraph 42 of IAS 32;
   • Amounts related to financial collateral (including cash collateral).
5. The net amount after deducting the amounts in (d) from the amounts in (c) above.

The total amount disclosed in accordance with (d) above for an instrument shall be limited to the amount in (c) above for that same instrument. This means that if the amount in (c) is a net financial liability the deducting amount in (d) will not result in it being disclosed as an asset.

The entity shall include a description in the disclosures of the rights of setoff associated with the entity's recognised financial assets and recognised financial liabilities subject to an enforceable master netting arrangement, and a similar agreement that is disclosed in accordance with (d) above, including the nature of those rights.

IFRS 7 paragraph 13E suggests that where disclosures have been made in more than one note, the entity shall cross refer between the notes.

Illustrative examples relating to offsetting disclosures are as below:

Collateral

The reporting entity must disclose the carrying amount of financial assets it has pledged as collateral for liabilities or contingent liabilities, including amounts that have been reclassified in accordance with the provision of IFRS 9 pertaining to rights to repledge, and the terms and conditions relating to its pledge.

Conversely, if the reporting entity holds collateral (of either financial or non-financial assets) and is permitted to sell or repledge the collateral in the absence of default by the owner of the collateral, it must now disclose the fair value of the collateral held and the fair value of any such collateral sold or repledged, whether it has an obligation to return it, and the terms and conditions associated with its use of the collateral.

Loss Allowances for Financial Assets Measured at FVTOCI

The carrying amount of financial assets measured at FVTOCI in accordance with IFRS 9 is not reduced by a loss allowance and an entity shall not present the loss allowance separately in the statement of financial position as a reduction of the carrying amount of the financial asset. However, an entity shall disclose the loss allowance in the notes to the financial statements.

Certain Compound Instruments

If the reporting entity is the issuer of compound instruments, such as convertible debt, having multiple embedded derivatives having interdependent values (such as the conversion feature and a call feature, such that the issuer can effectively force conversion), these matters must be disclosed.

Defaults and Breaches

If the reporting entity is the obligor under loans payable at the date of the statement of financial position, it must disclose:

1. The details of any defaults during the period, involving payment of principal or interest, or into a sinking fund, or of the redemption terms of those loans payable;
2. The carrying amount of the loans payable in default at the reporting date; and
3. Whether the default was remedied, or the terms of the loans payable were renegotiated, before the financial statements were authorised for issue.

Similar disclosures are required for any other breaches of loan agreement terms, if such breaches gave the lender the right to accelerate payment, unless these were remedied or terms were renegotiated before the reporting date.

Disclosures in the Statements of Comprehensive Income and Changes in Equity

The reporting entity is to disclose the following items of revenue, expense, gains or losses, either on the face of the financial statements or in the notes thereto:

1. Net gain or net losses on:
   • Financial assets or financial liabilities carried at FVTPL, showing separately those incurred on financial assets or financial liabilities designated as such upon initial recognition, and those on financial assets or financial liabilities that are classified as such in accordance with IFRS 9;
   • Financial liabilities carried at amortised cost;
   • Financial assets measured at amortised cost;
   • Investments in equity instruments designated at FVTOCI; and
   • Financial assets measured at FVTOCI under IFRS 9 showing separately the gain or loss recognised in OCI during the period and the amount reclassified upon derecognition from accumulated OCI to profit or loss during the period.
2. Total interest income and total interest expense (calculated using the effective interest method) for financial assets that are measured at either amortised cost of FVTOCI or financial liabilities that are not measured at FVTPL;
3. Fee income and expense (other than amounts included in determining the effective interest rate) arising from:
   • Financial assets or financial liabilities that are not carried at FVTPL; and
   • Trust and other fiduciary activities that result in the holding or investing of assets on behalf of individuals, trusts, retirement benefit plans and other institutions.
4. An entity shall disclose an analysis of the gain or loss recognised in the statement of other comprehensive income arising from the derecognition of financial assets measured at amortised cost separating the gains and losses arising from derecognition. Reasons for derecognition of such financial assets shall also be provided.

Accounting Policies Disclosure

The reporting entity is to disclose the measurement basis (or bases) used in preparing the financial statements and the other accounting policies used that are relevant to an understanding of the financial statements.

Example: Note 2. Accounting Policies

Hedging Disclosures

Hedge accounting is one of the more complex aspects of financial instruments accounting under IFRS 9, as discussed above in more detail. IFRS 7 requires disclosures about hedge accounting that provide information about:

1. The entity's risk management strategy and how it is applied to manage risk;
2. How the entity's hedging activities may affect the amount, timing and uncertainty of its future cash flows; and
3. The effect that hedge accounting has had on the entity's statement of financial position, statement of comprehensive income and statement of changes in equity.

IFRS 7 requires the following key disclosures in respect of each risk category of risk exposures that the entity decides to hedge. It should be noted that IFRS 7 requires the entity from determining how much detail to disclose, how much emphasis to place on different aspects of the disclosure requirements, the appropriate level of aggregation and disaggregation and whether users of financial statements are likely to need additional explanations to evaluate quantitative information disclosed.

Fair Value Disclosures

IFRS 9 requires that for each class of financial assets and financial liabilities, the reporting entity is to disclose the fair value of that class of assets and liabilities in a way that permits it to be compared with its carrying amount. Grouping by class is required, but offsetting assets and liabilities is generally not permitted (but will conform to statement of financial position presentation).

In instances where the market for a financial instrument is not active, the reporting entity establishes the fair value using a valuation technique. The best evidence of fair value at initial recognition is the transaction price, so there could be a difference between the fair value at initial recognition and the amount that would be determined at that date using the valuation technique. In such a case, disclosure is required by the class of financial instrument of:

1. The entity's accounting policy for recognising that difference in profit or loss to reflect a change in factors (including time) that market participants would consider in setting a price; and
2. The aggregate difference yet to be recognised in profit or loss at the beginning and end of the period and a reconciliation of changes in the balance of this difference.
3. Why the entity concluded that the transaction price was not the best evidence for fair value, including a description of the evidence that supports the fair value.

Disclosures of fair value are not required in these circumstances:

1. When the carrying amount is a reasonable approximation of fair value (e.g., for short-term trade receivables and payables);
2. For an insurance contract containing a discretionary participation feature if the fair value of that feature cannot be measured reliably; or
3. For lease liabilities.

In instances identified in point 2 immediately above, the reporting entity must disclose information to help users of the financial statements make their own judgements about the extent of possible differences between the carrying amount of those financial assets or financial liabilities and their fair value, including:

1. The fact that fair value information has not been disclosed for these instruments because their fair value cannot be measured reliably;
2. A description of the financial instruments, their carrying amount and an explanation of why fair value cannot be measured reliably;
3. Information about the market for the instruments;
4. Information about whether and how the entity intends to dispose of the financial instruments; and
5. If financial instruments whose fair value previously could not be reliably measured are derecognised, their carrying amount at the time of derecognition and the amount of gain or loss recognised.

Disclosures About the Nature and Extent of Risks Flowing from Financial Instruments

Reporting entities are required to disclose various information that will enable the users to evaluate the nature and extent of risks the reporting entity is faced with as a consequence of financial instruments it is exposed to at the date of the statement of financial position. Both qualitative and quantitative disclosures are required, as described in the following paragraphs.

Credit Risk Disclosures

IFRS 7 requires credit risk disclosures that enable users of financial statements to understand the effect of credit risk on the amount, timing and uncertainty of future cash flows. To achieve this objective, credit risk disclosures should provide:

1. Information about an entity's credit risk management practices and how they relate to the recognition and measurement of expected credit losses, including the methods, assumptions and information used to measure expected credit losses;
2. Quantitative and qualitative information that allows users of financial statements to evaluate the amounts in the financial statements arising from expected credit losses, including changes in the amount of expected credit losses and the reasons for those changes; and
3. Information about an entity's credit risk exposure (i.e., the credit risk inherent in an entity's financial assets and commitments to extend credit) including significant credit risk concentrations.

To meet the objectives in the paragraph above, an entity shall (except as otherwise specified within the requirements of IFRS 7) consider how much detail to disclose, how much emphasis to place on various aspects of the disclosure requirements, the appropriate level of aggregation or disaggregation and whether users of financial statements need additional explanations to evaluate the quantitative information disclosed.

Market Risk Disclosures

A number of informative disclosures are mandated, as described in the following paragraphs.

Sensitivity analysis:

1. A sensitivity analysis for each type of market risk to which the entity is exposed at the reporting date, showing how profit or loss and equity would have been affected by changes in the relevant risk variable that were reasonably possible at that date;
2. The methods and assumptions used in preparing the sensitivity analysis; and
3. Changes from the previous period in the methods and assumptions used, and the reasons for such changes.

If the reporting entity prepares a sensitivity analysis, such as value-at-risk, that reflects interdependencies between risk variables (e.g., between interest rates and exchange rates) and uses it to manage financial risks, it may use that sensitivity analysis in place of the analysis specified in the preceding paragraph. The entity would also have to disclose:

1. An explanation of the method used in preparing such a sensitivity analysis, and of the main parameters and assumptions underlying the data provided; and
2. An explanation of the objective of the method used and of limitations that may result in the information not fully reflecting the fair value of the assets and liabilities involved.

Other market risk disclosures may also be necessary to fully inform financial statement users. When the sensitivity analyses are unrepresentative of a risk inherent in a financial instrument (e.g., because the year-end exposure does not reflect the actual exposure during the year), the entity is to disclose that fact, together with the reason it believes the sensitivity analyses are unrepresentative.

Disclosures Required on Initial Application of IFRS 9

In the reporting period that includes the date of initial application of IFRS 9, the entity shall disclose the following information for each class of financial assets and financial liabilities as at the date of initial application:

1. The original measurement category and carrying amount determined in accordance with IAS 39 or in accordance with a previous version of IFRS 9 (if the entity's chosen approach to applying IFRS 9 involves more than one date of initial application for different requirements);
2. The new measurement category and carrying amount determined in accordance with IFRS 9;
3. The amount of any financial assets and financial liabilities in the statement of financial position that were previously designated as measured at FVTPL but are no longer so designated, distinguishing between those that IFRS 9 requires an entity to reclassify and those that an entity elects to reclassify at the date of initial application.

Depending on the entity's chosen approach to applying IFRS 9, the transition can involve more than one date of initial application. Therefore, this paragraph may result in disclosure on more than one date of initial application. An entity shall present these quantitative disclosures in a table unless another format is more appropriate.

In the reporting period that includes the date of initial application of IFRS 9, an entity shall disclose qualitative information to enable users to understand:

1. How it applied the classification requirements in IFRS 9 to those financial assets whose classification has changed because of applying IFRS 9.
2. The reasons for any designation or de-designation of financial assets or financial liabilities as measured at FVTPL at the date of initial application.

In the reporting period that an entity first applies the classification and measurement requirements for financial assets in IFRS 9 (i.e., when the entity transitions from IAS 39 to IFRS 9 for financial assets), it shall present the disclosures as set out in the below paragraphs as required by IFRS 9.

An entity shall disclose the changes in the classifications of financial assets and financial liabilities as at the date of initial application of IFRS 9, showing separately:

1. The changes in the carrying amounts on the basis of their measurement categories in accordance with IAS 39 (i.e., not resulting from a change in measurement attribute on transition to IFRS 9); and
2. The changes in the carrying amounts arising from a change in measurement attribute on transition to IFRS 9.

The disclosures above need not be made after the annual reporting period in which the entity initially applies the classification and measurement requirements for financial assets in IFRS 9.

An entity shall disclose the following for financial assets and financial liabilities that have been reclassified so that they are measured at amortised cost and, in the case of financial assets, that have been reclassified out of FVTPL so that they are measured at FVTOCI, as a result of the transition to IFRS 9:

1. The fair value of the financial assets or financial liabilities at the end of the reporting period; and
2. The fair value gain or loss that would have been recognised in profit or loss or other comprehensive income during the reporting period if the financial assets or financial liabilities had not been reclassified.

The disclosures above need not be made after the annual reporting period in which the entity initially applies the classification and measurement requirements for financial assets in IFRS 9.

An entity shall disclose the following for financial assets and financial liabilities that have been reclassified out of the FVTPL category as a result of the transition to IFRS 9:

1. The effective interest rate determined on the date of initial application; and
2. The interest revenue or expense recognised.

If an entity treats the fair value of a financial asset or a financial liability as the new gross carrying amount at the date of initial application, the disclosures above shall be made for each reporting period until derecognition. Otherwise, these disclosures need not be made after the annual reporting period in which the entity initially applies the classification and measurement requirements for financial assets in IFRS 9.

When an entity presents the disclosures, those disclosures must permit reconciliation between:

1. The measurement categories presented in accordance with IAS 39 and IFRS 9; and
2. The class of financial instrument as at the date of initial application.

On the date of initial application, an entity is required to disclose information that would permit the reconciliation of the ending impairment allowances in accordance with IAS 39 and the provisions in accordance with IAS 37 to the opening loss allowances determined in accordance with IFRS 9. For financial assets, this disclosure shall be provided by the related financial assets' measurement categories in accordance with IAS 39 and IFRS 9, and shall show separately the effect of the changes in the measurement category on the loss allowance at that date.