Accounting for financial instruments is extremely complex and dealt with by three separate accounting standards as follows:
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.
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.
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.
The financial instrument standards apply to all financial instruments with specific scope exclusions as detailed below:
IFRS 9/IFRS 7 and IAS 32 | ||
Scope exclusions | Exceptions (i.e., considered within scope) | Alternate standards |
Interests in subsidiaries, associates and joint ventures unless required by the alternate standards. | IFRS 9 includes in its scope derivatives on an interest in a subsidiary, associate or joint venture unless the derivative meets the definition of an equity instrument. | IFRS 10 Consolidated Financial Statements IAS 27 Separate Financial Statements IAS 28 Investments in Associates and Joint Ventures |
Rights and obligations under leases. | Finance lease and operating lease receivables recognised by a lessor are subject to the impairment and derecognition criteria. Lease liabilities recognised by a lessee are subject to the derecognition criteria. Derivatives that are embedded in leases are subject to the embedded derivatives criteria. |
IFRS 16 Leases |
Rights and obligations under employee benefit plans. | N/A | IAS 19 Employee Benefits |
Insurance contracts. | Financial guarantee contracts (such as guarantees, types of letters of credit, credit default contracts, insurance contracts, etc.), contracts with discretionary participation features and embedded derivatives are subject to the requirements of IFRS 9. The accounting for financial guarantee contracts is dependent on substance rather than legal form, and although such a contract will meet the definition of an insurance contract, it is accounted for in line with IFRS 9. However, if an issuer of financial guarantee contracts has previously asserted explicitly that it regards such contracts as insurance contracts and has used accounting that is applicable to insurance contracts the issuer may elect to apply either this standard or IFRS 4 to such financial guarantee contracts. The issuer may make that election contract by contract, but the election for each contract is irrevocable. |
IFRS 4 Insurance Contracts |
Forward contracts (where the term of the forward contract does not reasonably exceed a period normally necessary to complete a transaction) between an acquirer and a selling shareholder for a transaction that meets the definition of a business combination (as defined in IFRS 3). | N/A | IFRS 3 Business Combinations |
Loan commitments other than those loan commitments that are designated at FVTPL, loan commitments that can be settled net by delivery of cash or another financial instrument (derivative instruments) and commitments to provide a loan at below market interest rate. | An issuer of loan commitments shall apply the impairment requirements of IFRS 9 to loan commitments that are not otherwise within the scope of this standard. All loan commitments are subject to the derecognition requirements of IFRS 9. Also see below loan commitments that are within the scope of IFRS 9. |
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Share-based payments. | Contracts to buy or sell a non-financial item that can be settled net in cash or another financial instrument, or by exchanging financial instruments, as if the contracts were financial instruments, fall under the scope of IFRS 9. | IFRS 2 Share-based Payments |
Reimbursements of expenditure provisions. | N/A | IAS 37 Provisions, Contingent Liabilities and Contingent Assets |
Financial instruments that represent rights and obligations within the scope of IFRS 15, Revenue from Contracts with Customers, except those which IFRS 15 specifies are accounted for in accordance with IFRS 9. | The impairment requirements of IFRS 9 shall be applied to those rights that IFRS 15 specifies are accounted for in accordance with IFRS 9 for the purposes of recognising impairment gains or losses. | IFRS 15 Revenue from Contracts with Customers |
The following loan commitments are specifically within the scope of IFRS 9:
12 months expected credit loss. This is a portion of the lifetime expected credit loss that represents the expected credit losses that result from default events on a financial instrument that are possible within 12 months after the reporting date.
Accounts receivable. Amounts due from customers for goods or services which have been provided in the normal course of business operations.
Amortised cost of financial asset or financial liability. The amount at which the financial asset or liability is measured upon initial recognition, minus principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount, and, for financial assets, adjusted for any loss allowance.
Cash. Refers to cash on hand and demand deposits with banks or other financial institutions.
Cash equivalents. Short-term, highly liquid investments that are readily convertible to known amounts of cash which are subject to an insignificant risk of changes in value.
Cash shortfall. The difference between the cash flow due to an entity in line with the contract and the cash flow that the entity expects to receive.
Compound instrument. An issued single financial instrument that contains both liability and equity (e.g., a convertible loan). Under IAS 32 principles, such instruments are split accounted.
Contract assets. Those rights that IFRS 15, Revenue from Contracts with Customers, specifies are accounted for in accordance with this standard for the purpose of recognition and measuring impairment gains or losses.
Control. The ability to direct the strategic and financial and operating policies of an entity so as to obtain benefits from its activities.
Credit adjustment effective interest rate. The rate that exactly discounts the estimated future cash payments or receipts through the expected life of the financial asset to the amortised cost of a financial asset that is a purchased or originated credit-impaired financial asset. When calculating the credit-adjusted effective interest rate, an entity shall estimate the expected cash flows by considering all contractual terms of the financial asset (e.g., prepayments, extension, call and similar options) and expected credit losses. The calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums and discounts.
Credit-impaired financial asset. A financial asset is credit impaired at initial recognition when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred. Evidence that a financial asset is credit impaired include observable data about the following events:
Credit loss. The difference between all contractual cash flows that are due to an entity in line with the contract and all the cash flows an entity expects to receive (i.e., the present value of all cash shortfalls, discounted at the original effective interest rate or credit-adjusted effective interest rate for purchased or originated credit-impaired financial assets).
Credit risk. The risk that a loss may occur from the failure of one party to a financial instrument to discharge an obligation according to the terms of a contract.
Derecognition. The removal of a previously recognised financial asset or liability from an entity's statement of financial position.
Derivative. A financial instrument or other contract with all three of the following features:
Dividends. Profit distribution to holders of equity instruments in proportion to their holdings of a particular class of capital.
Effective interest method. The method that is used in the calculation of the amortised cost of a financial asset or a financial liability and in the allocation and recognition of the interest revenue or interest expense in profit or loss over the relevant period.
Effective interest rate. The rate that exactly discounts estimated future cash flows to the net carrying amount of the financial instrument through the expected life of the instrument (or a shorter period, when appropriate). In calculating the effective rate, the entity should estimate future cash flows after considering all of the contractual terms of the financial instrument but without considering future expected credit losses. Fees, points paid or received between parties to the contract, transaction costs and other premiums and discounts are also included.
Embedded derivative. A component of a hybrid (combined) financial instrument, which also includes a non-derivative host contract, with the effect that some of the cash flows of the combined instrument vary in a way similar to a standalone derivative.
Equity instrument. Any contract that evidences a residual interest in the assets of an entity after deducting all its liabilities.
Expected credit losses. The weighted-average of credit losses with the respective risks of a default occurring as the weights.
Fair value. The amount for which an asset could be exchanged, or a liability settled, between knowledgeable and willing parties in an arm's-length transaction.
Financial asset. Any asset that is one of the following:
Financial guarantee contract. A contract that requires the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due in accordance with the original or modified terms of a debt instrument.
Financial instrument. Any contract which gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity.
Financial liability. Any liability which meets either of the following criteria:
Financial liability at fair value through profit or loss. A financial liability that meets one of the following conditions:
Firm commitment. A binding agreement for the exchange of a specified quantity of resource at a specified price on a specified future date or dates.
Forecast transaction. An uncommitted but anticipated future transaction.
Gross carrying amount of a financial asset. The amortised cost of a financial asset, before adjusting for any loss allowance.
Hedge effectiveness. The degree to which changes in the fair value or cash flows of the hedged item that are attributable to a hedged risk are offset by changes in the fair value or cash flows of the hedging instrument.
Hedge ratio. Relationship between the quantity of the hedging instrument and the quantity of the hedged item in terms of their relative weighting.
Held for trading. Financial asset or financial liability that:
Hedged item. An asset, liability, firm commitment, highly probable forecast transaction or net investment in a foreign operation that (1) exposes the entity to risk of changes in fair value or future cash flows, and (2) is designated as being hedged.
Hedging. Involves designating one or more hedging instruments such that the change in fair value or cash flows of the hedging instrument is offset, in whole or part, to the change in fair value or cash flows of the hedged item. The objective is to ensure that the gain or loss on the hedging instrument is recognised in profit or loss in the same period that the hedged item affects profit or loss.
Hedging instrument. For hedge accounting purposes, a designated derivative or (for a hedge of the risk of changes in foreign currency exchange rates only) a designated non-derivative financial asset or non-derivative financial liability whose fair value or cash flows are expected to offset changes in the fair value or cash flows of a designated hedged item.
Impairment gain or loss. Gains or losses that are recognised in profit or loss arising from applying the impairment requirements of IFRS 9.
Lifetime expected credit loss. The expected credit losses that result from all possible default events over the expected life of a financial instrument.
Liquidity risk. The risk that an entity may encounter difficulty in meeting obligations associated with financial liabilities.
Loss allowance. The allowance for expected credit losses on financial assets, lease receivables and contract assets, the accumulated impairment amount for financial assets and the provision of expected credit losses on loan commitments and financial guarantee contracts.
Market risk. The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. There are three types of market risk:
Market value. The amount obtainable from a sale, or payable on acquisition, of a financial instrument in an active market.
Marketable equity instruments. Instruments representing actual ownership interest, or the rights to buy or sell such interests that are actively traded or listed on a national securities exchange.
Modification gain or loss. The amount arising from adjusting the gross carrying amount of a financial asset to reflect the renegotiated or modified contractual cash flows. The entity recalculates the gross carrying amount of a financial asset as the present value of the estimated future cash payments or receipts through the expected life of the renegotiated or modified financial asset that are discounted at the financial asset's original effective interest rate (or the original credit-adjusted effective interest rate for purchased or originated credit-impaired financial assets) or when applicable. When estimating the expected cash flows of a financial asset, an entity shall consider all contractual terms of the financial asset (for example, prepayment, call and similar options) but shall not consider the expected credit losses, unless the financial asset is a purchased or originated credit-impaired financial asset, in which case an entity shall also consider the initial expected credit losses that were considered when calculating the original credit-adjusted effective interest rate.
Monetary financial assets and financial liabilities. Financial assets and financial liabilities to be received or paid in fixed or determinable amounts of currency.
Net realisable value. The estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.
Other price risk. The fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices (other than those arising from interest rate risk or currency risk), whether those changes are caused by factors specific to the individual financial instrument or its issuer, or factors affecting all similar financial instruments traded in the market.
Past due. A financial asset is past due when a counterparty has failed to make a payment when that payment was contractually due.
Percentage-of-sales method. Procedure for computing the adjustment for uncollectible accounts receivable based on the historical relationship between bad debts and gross credit sales.
Pledging. Process of using an asset as collateral for borrowings. It generally refers to borrowings secured by accounts receivable.
Purchased or originated credit-impaired financial asset. Purchased or originated financial assets that are credit impaired on initial recognition.
Puttable instrument. A financial instrument that gives the holder the right to put the instrument back to the issuer for cash or another financial asset. It can also be automatically put back to the issuer on the occurrence of an uncertain future event or the death or retirement of the instrument holder.
Realised gain (loss). Difference between the cost or adjusted cost of a marketable security and the net selling price realised by the seller, which is to be included in the determination of profit or loss in the period of the sale.
Reclassification date. First day of the first reporting period following the change in business model that results in an entity reclassifying financial assets.
Recourse. Right of the transferee (factor) of accounts receivable to seek recovery for an uncollectible account from the transferor. It is often limited to specific conditions.
Regular-way purchase or sale. A purchase or sale of a financial asset under a contract whose terms require delivery of the asset within the timeframe established generally by regulations or convention in the market place concerned.
Repurchase agreement. An agreement to transfer a financial asset to another party in exchange for cash or other considerations, with a concurrent obligation to reacquire the asset at a future date.
Securitisation. The process whereby financial assets are transformed into securities.
Short-term investments. Financial instruments or other assets acquired with excess cash, having ready marketability and intended by management to be liquidated, if necessary, within the current operating cycle.
Trade date. The date at which the entity commits itself to purchase or sell an asset. The trade date refers to:
Transaction costs. The incremental costs directly attributable to the acquisition or disposal of a financial asset or liability.
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:
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.
Financial instruments can arise from various transactions that can be broken down into two main sources:
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:
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.
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:
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.
Contracts to buy or sell non-financial items are treated as financial instruments if it can be settled net in cash or another financial instrument or by exchanging financial instruments. For example:
However, IFRS 9 shall be applied to such contracts that an entity designates as measured at FVTPL. A contract to buy or sell a non-financial item that can be settled net in cash or another financial instrument, or by exchanging financial instruments, as if the contract was a financial instrument, may be irrevocably designated as measured at FVTPL even if it was entered into for the purpose of the receipt or delivery of a non-financial item in accordance with the entity's expected purchase, sale or usage requirements. This designation is available only at the inception of the contract and only if it eliminates or significantly reduces a recognition inconsistency/accounting mismatch that would otherwise arise from not recognising that contract.
IFRS 9 shall also be applied to a written option to buy or sell a non-financial item that can be settled net in cash or another financial instrument, or by exchanging financial instruments on the basis that such a contract cannot be entered into for the purpose of the receipt or delivery of the non-financial item in accordance with the entity's expected purchase, sale or usage requirements.
A regular-way purchase or sale is a transaction under a contract whose terms require delivery of the asset within the time frame established generally by regulations or convention in the market place concerned and is recognised and derecognised using trade date accounting or settlement date accounting (which should be consistently applied to purchases and sales of financial assets that are classified in a similar way).
A contract that requires or permits net settlement of the change in the value of the contract is not a regular-way contract. Instead, such a contract is accounted for as a derivative in the period between the trade date and the settlement date.
When settlement date accounting is applied, an entity accounts for any change in the fair value of the asset to be received during the period between the trade date and the settlement date in the same way as it accounts for the acquired assets.
Simplifying the requirements of IAS 39 was one of the objectives of the IASB when it embarked on the financial instruments project and it set out as one of its aims the requirement to reduce the number of categories of financial assets. As a result, IFRS 9 categorises financial assets into just two main categories, amortised cost and fair value (further broken down into FVTPL and FVTOCI). The “available-for-sale” and “held-to-maturity” categories included in IAS 39 do not form part of IFRS 9.
A financial asset shall be classified as subsequently measured at either FVTPL, FVTOCI or amortised cost. An entity can still make an irrevocable decision to designate a financial asset as measured through FVTPL if doing so eliminates or significantly reduces an accounting mismatch.
The classification of a financial asset is based on both the business model for managing the financial asset and the contractual cash flow characteristics of the financial asset and in summary is as follows:
Classification categories | What does the category apply to |
FVTPL | This category applies to all financial assets that do not meet the criteria set below for the amortised cost and FVTOCI options, as well as instruments specifically elected to be measured under this category as covered below. |
FVTOCI | This category applies to financial assets whose business model is to hold to collect contractual cash flows and sell, and whose contractual cash flows are made solely of principal and interest. Note as detailed below that IFRS 9 permits equity instruments to also be categorised within this on election. |
Amortised cost | This category applies to financial assets whose business model is to hold to collect contractual cash flows and whose contractual cash flows are made solely of principal and interest. |
Business model refers to how an entity manages its financial assets in order to generate cash flows, i.e., from collecting contractual cash flows, selling or both and is determined by key management personnel.
A business model is normally determined at a level that reflects how groups of financial assets are managed together to achieve a particular business objective and not at individual instrument level. This level may be an aggregation of financial assets to a suitable degree, which reflects a common business model. For example, an entity may hold a portfolio of investments that it manages in order to collect contractual cash flows and another portfolio of investments that it manages in order to trade to realise fair value changes.
In certain circumstances, cash flows are realised in a way that is different from the business model assessed at the time of classification. Such a change does not give rise to a prior period error nor does it change the classification of the remaining financial assets held in that business model (i.e., those assets that the entity recognised in prior periods and still holds) as long as the entity considered all relevant information that was available at the time that it made the business model assessment. However, when an entity assesses the business model for newly originated or newly purchased financial assets, it must consider information about how cash flows were realised in the past, along with all other relevant information.
The assessment of a business model requires a level of judgement and is not determined by a single factor. IFRS 9 requires entities to consider all relevant evidence available at the date of assessment. Suggested evidence includes, but is not limited to:
The assessment of a business model is based on scenarios that are reasonably expected to occur and not worst case or stress case scenarios. For example, an expectation to sell a portfolio of investments only during a stress case scenario does not affect the assessment of a business model for those investments.
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.
Financial assets that are not held within a business model whose objective is to hold assets to collect contractual cash flows or within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets are subsequently measured at FVTPL.
Examples include business models whose objectives are to realise cash flows through the sale of financial assets. Contractual cash flows collected during the time an entity holds such a financial asset do not override the objectives of the business model and are not considered to be integral to achieving the objectives of the model.
However, even though an asset could be classified as amortised cost or FVTOCI, an irrevocable decision may be made at initial recognition to designate a financial asset as measured at FVTPL if doing so eliminates or significantly reduces a measurement or recognition inconsistency (accounting mismatch) that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases and therefore would provide more relevant information.
The above decision to designate a financial asset an FVTPL is like an accounting policy choice except that it does not require to be applied consistently across similar transactions.
An entity must demonstrate that the designation eliminates or significantly reduces an accounting mismatch. An example of a mismatch occurs when the classification of a financial asset and financial liability in a hedging relationship differs, i.e., one is classified at FVTPL while the other is at amortised cost.
The management and evaluation of the performance of a group of financial liabilities or financial assets may be such that measuring that group at FVTPL results in more relevant information—the key here being how the financial instruments are managed and evaluated and not the nature of the instrument.
Documentation of the entity's strategy need not be extensive but should be sufficient to demonstrate compliance with the principle of the standard. Such documentation is not required for each individual item, but may be on a portfolio basis.
The FVTOCI category of classification applies when both the following conditions are met:
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.
The amortised cost category of classification applies when both the following conditions are met:
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.
Financial assets which are held to collect contractual cash flows and those that are managed to realise cash flows by collecting contractual payments over the life of the asset are classified under the amortised cost category. History in relation to the frequency, timing and value of sales needs to be considered when determining whether the business model is that of collecting contractual cash flows.
There are circumstances when financial assets that are held with an aim of collecting contractual cash flows are sold. This in itself does not impact the business model and one must understand the reasons and conditions that existed at the time of a sale. Examples of events that do not impact the business model are sales made due to an increase in credit risk of the instrument.
A determination of whether contractual cash flows from a financial asset are solely payments of principal and interest on principal needs to be made.
Generally, a basic lending arrangement will meet the criteria of having contractual cash flows which are solely payments of principal and interest on principal. This is because in a basic lending arrangement, consideration of time value of money and credit risk are the most significant elements of interest. Interest can also include consideration for other basic lending risks such as liquidity risks, costs associated with holding and servicing the financial asset as well as a profit margin. In extreme economic circumstances, interest can be negative if, for example, the holder of a financial asset either explicitly or implicitly pays for the deposit of its money for a particular period of time (and that fee exceeds the consideration that the holder receives for the time value of money, credit risk and other basic lending risks and costs).
Certain arrangements may also include a margin for exposure to other risks (for example, changes in equity prices/commodity prices). Such margins clearly do not give rise to contractual cash flows that are solely related to payments of principal and related interest.
Time value of money is the element of interest that provides consideration for only the passage of time and provides no consideration for other risks or costs. Judgement needs to be applied in assessing whether the time value of money element does not include other risks. In doing so, consideration of various factors such as the currency denomination and tenor of the financial asset needs to be made.
In certain circumstances, the time value of money element could be modified, e.g., interest rate applied monthly but based on a one-year rate or the periodic resetting of interest rate to an average of short- and long-term rates.
The modification should be assessed to determine whether the contractual payments remain that of principal and interest on principal. The assessment of such a modification would be to calculate the difference between contractual (undiscounted) cash flows of the modified and unmodified time value of money elements. If the modification results in undiscounted contractual cash flows being significantly different, the condition of contractual payments that are solely payments of principal and interest on principal is not met and the financial asset cannot be classified as subsequently measured at amortised cost.
Where interest rates are regulated, the regulated interest rate is considered to meet the requirements of the time value of money element provided that it is broadly consistent with the passage of time and does not provide exposure to risks or volatility in contractual cash flows that are inconsistent with a basic lending arrangement.
Some financial asset arrangements may contain contractual conditions that could change the timing or amount of contractual cash flows (e.g., prepayment or tenor extension options). A determination of whether contractual cash flows from a financial asset are solely payments of principal and interest on principal needs to be made due to the contractual condition, i.e., assess the contractual cash flows that could arise both before, and after, the change in contractual cash flows.
The assessment of the nature of any contingent/trigger event that could change the timing or amount of the contractual cash flows would be required. While the nature of the contingent event in itself is not a determinative factor in assessing whether the contractual cash flows are solely payments of principal and interest, it may be an indicator.
For example, compare a financial instrument with an interest rate that is reset to a higher rate if the debtor misses a particular number of payments to a financial instrument with an interest rate that is reset to a higher rate if a specified equity index reaches a particular level. It is more likely in the former case that the contractual cash flows over the life of the instrument will be solely payments of principal and interest on the principal amount outstanding because of the relationship between missed payments and an increase in credit risk.
Despite the above, a financial asset that would otherwise meet the conditions in IFRS 9 but does not do so only as a result of a contractual term that permits (or requires) the issuer to prepay a debt instrument or permits (or requires) the holder to put a debt instrument back to the issuer before maturity is eligible to be measured at amortised cost or FVTOCI if:
Based on the guidance above, debt instruments with the following features would normally be construed to be instruments with contractual cash flows that are payments of principal and interest on principal:
Instruments that contain conversion options and pay interest at rates that are inverse to market rates will not normally meet the condition of having contractual cash flows that are solely payments of principal and interest on principal.
After initial recognition, an entity shall measure a financial asset in accordance with IFRS 9 at:
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.
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:
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):
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 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:
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. |
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:
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:
At the time of transfer, an entity evaluates the extent to which it retains the risks and rewards of ownership of the financial asset:
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:
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.
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:
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:
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:
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:
All financial liabilities shall be classified as subsequently measured at amortised cost, except for:
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:
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:
After initial recognition, financial liabilities will be subsequently measured using the same principles as set out under classification of financial liabilities that have been covered above. Exceptions include where hedge accounting is applied. See the section Hedge Accounting later in this chapter for guidance in this respect.
An entity shall present a gain or loss on a financial liability that is designated as at FVTPL as follows:
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.
IFRS 7 defines credit risk as “the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation.” The requirement in IFRS 9 relating to own credit risk on debt instruments relates to the risk that the issuer will fail to perform on that particular liability. It does not necessarily relate to the creditworthiness of the issuer. For example, if an entity issues a collateralised liability and a non-collateralised liability that are otherwise identical, the credit risk of those two liabilities will be different, even though they are issued by the same entity.
The credit risk on the collateralised liability will be less than the credit risk of the non-collateralised liability. The credit risk for a collateralised liability may be close to zero.
For the purposes of applying the requirements above, credit risk is different from asset- specific performance risk. Asset-specific performance risk is not related to the risk that an entity will fail to discharge a particular obligation but instead it is related to the risk that a single asset or a group of assets will perform poorly (or not at all).
For the purposes of applying the requirements above, an entity shall determine the amount of change in the fair value of the financial liability that is attributable to changes in the credit risk of that liability either:
Changes in market conditions that give rise to market risk include changes in a benchmark interest rate, the price of another entity's financial instrument, a commodity price, a foreign exchange rate or an index of prices or rates.
As with all fair value measurements, an entity's measurement method for determining the portion of the change in the liability's fair value that is attributable to changes in its credit risk must make maximum use of relevant observable inputs and minimum use of unobservable inputs.
An entity shall not reclassify any financial liability.
Financial liabilities (or part thereof) are derecognised from an entity's statement of financial position only when the liability is extinguished—i.e., when the obligation specified in the contract is discharged or cancelled or expires.
An exchange between a borrower and lender of debt instruments that carry significantly different terms or a substantial modification of the terms of an existing liability are both accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability.
Significantly different terms or a substantial modification of terms are measured as at least a 10% variance (recommended) of discounted present value (based on the original effective interest rate) of cash flows under the new terms (including transactional costs such as fees) and the discounted present value of cash flows of the original financial liability. Transaction costs (fees, etc.) where a financial liability that had a modification is extinguished are recognised as part of the gain or loss on extinguishment. For transaction costs (fees, etc.) where a financial liability that had a modification is not extinguished are adjusted to the carrying value of the financial liability and amortised over the remaining term of the modified liability.
The difference between the carrying value of a financial liability (or part thereof) extinguished and the consideration paid (including value of non-cash consideration) or liabilities assumed is recognised in profit or loss. Where an entity repurchases part of a financial liability, the previous carrying amount of the financial liability is allocated between the part derecognised and the part continued to be recognised based on the relative fair values at the date of repurchase.
A derivative part of a contract is referred to as an embedded derivative. IFRS 9 defines an embedded derivative as a component of a hybrid contract that also includes a non-derivative host—with the effect that some of the cash flows of the combined instrument vary in a way similar to a stand alone derivative.
An embedded derivative can cause all or part of the cash flows assigned to a contract to be modified to a specific element, e.g., interest rate, commodity price, foreign exchange rate, credit rating, etc.
If a hybrid contract contains a host that is an asset within the scope of IFRS 9, an entity should apply the requirements for the classification of financial assets to the entire hybrid contract.
Where a hybrid contract contains a host that is not an asset within the scope of IFRS 9, an embedded derivative shall be separated from the host and accounted for as a derivative if, and only if:
When an entity becomes a party to a hybrid contract with a host that is not an asset within the scope of IFRS 9, the standard requires the entity to identify any embedded derivative, assess whether it is required to be separated from the host contract and, for those that are required to be separated, measure the derivatives at fair value at initial recognition and subsequently at FVTPL.
The above assessment at the time when the entity first becomes a party to the contract. Any subsequent reassessment is prohibited unless there is a change in the terms of the contract which significantly modifies the cash flows required to service the contract. The subsequent reassessment prohibition does not, however, apply to derivative contracts acquired in:
Some examples of embedded derivatives that will need to be accounted for separately from the host contract are as follows:
If a host contract has no stated or predetermined maturity and represents a residual interest in the net assets of an entity, then its economic characteristics and risks are those of an equity instrument, and an embedded derivative would need to possess equity characteristics related to the same entity to be regarded as closely related. If the host contract is not an equity instrument and meets the definition of a financial instrument, then its economic characteristics and risks are those of a debt instrument.
If a contract contains one or more embedded derivatives and the host is not an asset within the scope of IFRS 9, an entity may designate the entire hybrid contract as at FVTPL unless:
Generally, the requirements in respect of separation of embedded derivatives can be complex, or result in less reliable measures, than measuring the entire instrument at FVTPL. For that reason, this IFRS 9 permits the entire hybrid contract to be designated as at FVTPL. However, in the cases set out in (1) and (2) above, designating the entire contract as FVTPL would not be justified because doing so would not reduce complexity or increase reliability.
Generally, multiple embedded derivatives in a single hybrid contract are treated as a single compound embedded derivative. However, embedded derivatives that are classified as equity (see IAS 32, Financial Instruments: Presentation) are accounted for separately from those classified as assets or liabilities. In addition, if a hybrid contract has more than one embedded derivative and those derivatives relate to different risk exposures and are readily separable and independent of each other, they are accounted for separately from each other.
If an entity is unable to measure reliably the fair value of a separated embedded derivative on the basis of its terms and conditions, the fair value of the embedded derivative can be derived as the difference between the fair value of the hybrid contract and the fair value of the host. If the entity is unable to measure the fair value of the embedded derivative using this method either at acquisition or at the end of a subsequent financial reporting period, it shall designate the entire hybrid contract as at FVTPL.
IFRS 9 requires the effective interest method to be applied to the measurement of all financial instruments that are classified to be measured at amortised cost as well as for determination of interest revenue for debt investments measured at FVTOCI. The effective interest rate method is a method under which interest income or expense is allocated over the relevant period of the financial instrument using the effective interest rate on the financial instrument.
The effective interest rate is the rate that exactly discounts expected future cash payments and receipts over the life of the financial instrument to the initial carrying amount of the financial asset or liability. It requires determination and estimation of all such cash payments that are relevant to the instrument, including fees paid that are an integral part of the interest rate, transaction costs and any other premiums or discounts. Because transaction costs are included within this calculation, the overall effect of applying the effective interest rate is to spread such costs over the life of the instrument.
IFRS 9 requires that interest revenue shall be calculated by using the effective interest method. This shall be calculated by applying the effective interest rate to the gross carrying amount of a financial asset except for:
In applying the effective interest method, an entity identifies fees that are an integral part of the effective interest rate of a financial instrument. The description of fees for financial services may not be indicative of the nature and substance of the services provided. Fees that are an integral part of the effective interest rate of a financial instrument are treated as an adjustment to the effective interest rate, unless the financial instrument is measured at fair value, with the change in fair value being recognised in profit or loss. In those cases, the fees are recognised in profit or loss when the instrument is initially recognised.
Fees that are an integral part of the effective interest rate of a financial instrument include:
Fees that are not an integral part of the effective interest rate of a financial instrument and are accounted for in accordance with IFRS 15 include:
For floating-rate financial assets and floating-rate financial liabilities, periodic re-estimation of cash flows to reflect the movements in the market rates of interest alters the effective interest rate. If a floating-rate financial asset or a floating-rate financial liability is recognised initially at an amount equal to the principal receivable or payable on maturity, re-estimating the future interest payments normally has no significant effect on the carrying amount of the asset or the liability and therefore there is normally no immediate impact on profit or loss of such a change in cash flows.
If an entity revises its estimates of payments or receipts (excluding modifications in accordance with the paragraph above and changes in estimates of expected credit losses), it shall adjust the gross carrying amount of the financial asset or amortised cost of a financial liability (or group of financial instruments) to reflect actual and revised estimated contractual cash flows. The entity recalculates the gross carrying amount of the financial asset or amortised cost of the financial liability as the present value of the estimated future contractual cash flows that are discounted at the financial instrument's original effective interest rate (or credit-adjusted effective interest rate for purchased or originated credit-impaired financial assets). The adjustment is recognised in profit or loss as income or expense.
In some cases, a financial asset is considered credit-impaired at initial recognition because the credit risk is very high, and in the case of a purchase it is acquired at a deep discount. An entity is required to include the initial expected credit losses in the estimated cash flows when calculating the credit-adjusted effective interest rate for financial assets that are considered to be purchased or originated credit impaired at initial recognition. However, this does not mean that a credit-adjusted effective interest rate should be applied solely because the financial asset has high credit risk at initial recognition.
When the contractual cash flows of a financial asset are renegotiated or otherwise modified and the renegotiation or modification does not result in the derecognition of that financial asset in accordance with IFRS 9 (i.e., it does not meet the definition of a substantial modification as it does not exceed the 10% threshold), an entity shall recalculate the gross carrying amount of the financial asset and shall recognise a modification gain or loss in profit or loss. The gross carrying amount of the financial asset shall be recalculated as the present value of the renegotiated or modified contractual cash flows that are discounted at the financial asset's original effective interest rate (or credit-adjusted effective interest rate for purchased or originated credit-impaired financial assets). Any costs or fees incurred adjust the carrying amount of the modified financial asset and are amortised over the remaining term of the modified financial asset.
An entity shall directly reduce the gross carrying amount of a financial asset when the entity has no reasonable expectations of recovering a financial asset in its entirety or a portion thereof. A write-off constitutes a derecognition event.
Write-offs can relate to a financial asset in its entirety or to a portion of it. For example, an entity plans to enforce the collateral on a financial asset and expects to recover no more than 30% of the financial asset from the collateral. If the entity has no reasonable prospects of recovering any further cash flows from the financial asset, it should write off the remaining 70% of the financial asset.
Write-offs will result in an immediate impact to profit or loss in most cases. In certain cases, however, e.g., where the write-off relates to transactions between parties having a parent/subsidiary relationship, the impact can be either recognised within equity (as a capital contribution) or as a distribution.
A gain or loss on a financial asset or financial liability that is measured at fair value shall be recognised in profit or loss unless:
Dividends are recognised in profit or loss only when:
Gains or losses on financial assets and financial liabilities that are measured at amortised cost and are not part of a hedging relationship shall be recognised in profit or loss when the financial asset or liability is derecognised through the amortisation process or in order to recognise impairment gains or losses (for financial assets).
A gain or loss on a financial asset measured at FVTOCI shall be recognised in other comprehensive income, except for impairment gains or losses and foreign exchange gains and losses, until the financial asset is derecognised or reclassified.
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.
Paragraphs 32 and 48 of IAS 21 state that all exchange differences resulting from translating the financial statements of a foreign operation should be recognised in other comprehensive income until disposal of the net investment. This would include exchange differences arising from financial instruments carried at fair value, which would include both financial assets measured at FVTPL and financial assets that are measured at FVTOCI in accordance with IFRS 9.
IFRS 9 requires that changes in fair value of financial assets measured at FVTPL should be recognised in profit or loss and changes in fair value of financial assets measured at FVTOCI should be recognised in other comprehensive income.
If the foreign operation is a subsidiary whose financial statements are consolidated with those of its parent, in the consolidated financial statements, how are IFRS 9 and paragraph 39 of IAS 21 applied?
IFRS 9 applies in the accounting for financial instruments in the financial statements of a foreign operation and IAS 21 applies in translating the financial statements of a foreign operation for incorporation in the financial statements of the reporting entity. Therefore, the requirements of IFRS 9 would be applied at the subsidiary financial statements level using the functional currency of the subsidiary. IAS 21 would then be applied in recognising gains and losses arising from foreign exchange on consolidation of the subsidiary into the parent company financial statements.
IFRS 9 includes requirements about the measurement of financial assets and financial liabilities and the recognition of gains and losses on remeasurement in profit or loss. IAS 21 includes rules about the reporting of foreign currency items and the recognition of exchange differences in profit or loss. In what order are IAS 21 and IFRS 9 applied?
Generally, the measurement of a financial asset or financial liability at fair value or amortised cost is first determined in the foreign currency in which the item is denominated in accordance with IFRS 9. Then, the foreign currency amount is translated into the functional currency using the closing rate or a historical rate in accordance with IAS 21 (paragraph B5.7.2 of IFRS 9). For example, if a monetary financial asset (such as a debt instrument) is measured at amortised cost in accordance with IFRS 9, amortised cost is calculated in the currency of denomination of that financial asset.
Then, the foreign currency amount is recognised using the closing rate in the entity's financial statements (paragraph 23 of IAS 21). That applies regardless of whether a monetary item is measured at amortised cost or fair value in the foreign currency. A non-monetary financial asset (such as an investment in an equity instrument) that is measured at fair value in the foreign currency is translated using the closing rate (paragraph 23(c) of IAS 21).
As an exception, if the financial asset or financial liability is designated as a hedged item in a fair value hedge of the exposure to changes in foreign currency rates under IFRS 9 (or IAS 39 if an entity elects to apply the hedge accounting requirements in IAS 39), the hedged item is remeasured for changes in foreign currency rates even if it would otherwise have been recognised using a historical rate under IAS 21 (paragraph 6.5.8 of IFRS 9), i.e., the foreign currency amount is recognised using the closing rate. This exception applies to non-monetary items that are carried in terms of historical cost in the foreign currency and are hedged against exposure to foreign currency rates (paragraph 23(b) of IAS 21).
The approach to impairment is probably the most significant area of change under IFRS 9 when compared against IAS 39. IAS 39 in general adopted an approach of recognising impairment losses when an impairment event had occurred. In stark contrast, IFRS 9 requires impairment losses to be recognised for financial assets measured at amortised cost or FVTOCI on recognition using an expected credit loss model. IFRS 9 also requires the recognition of impairment losses on lease receivables, contract assets, loan commitments and financial guarantees. Under IFRS 9 it is not necessary for an impairment event to have taken place before credit losses are recognised.
In general, it is expected that impairment provisions will increase by varying degrees depending on the nature and quality of financial assets for most reporters. The new requirements for impairment require significant judgement and estimation and for more complex businesses, such as those involved in lending, the development of models that will need to consider historic as well as forward-looking information to be able to reliably measure expected credit losses.
The requirements to recognise expected credit losses on loan commitments and guarantees follow the thinking that under each of these arrangements, the holder of the instrument has a contractual obligation to the issuer and under that contractual obligation is exposed to credit risk, irrespective of the fact that at the reporting date neither has the loan commitment been drawn nor a guarantee event taken place.
IFRS 9 sets out two approaches to the recognition of expected credit losses: a general approach and a simplified approach.
Under the general approach to impairment under IFRS 9, impairment loss allowances are recognised at each reporting date as follows:
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.
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:
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.
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.
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:
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.
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:
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.
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.
As an alternative to the general approach, IFRS 9 provides for a simplified approach to the measurement of loss allowances in respect of:
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.
An entity shall measure expected credit losses of a financial instrument in a way that reflects:
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:
For undrawn loan commitments, a credit loss is the present value of the difference between:
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.
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.
The topic of hedging is almost intertwined with the subject of derivatives, since most (but not all) hedging is accomplished using derivatives. In this section, derivatives and derivative financial instruments will be presented first, followed by hedging activities.
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:
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:
Type of contract | Main pricing—settlement variable (underlying variable) |
Interest rate swap | Interest rates |
Currency swap (foreign exchange swap) | Currency rates |
Commodity swap | Commodity prices |
Equity swap (equity of another entity) | Equity prices |
Credit swap | Credit rating, credit index or credit price |
Total return swap | Total fair value of the reference asset and interest rates |
Purchased or written treasury bond option (call or put) | Interest rates |
Purchased or written currency option (call or put) | Currency rates |
Purchased or written commodity option (call or put) | Commodity prices |
Purchased or written share option (call or put) | Equity prices (equity of another entity) |
Interest rate futures linked to government debt (treasury futures) | Interest rates |
Currency futures | Currency rates |
Commodity futures | Commodity prices |
Interest rate forward linked to government debt (treasury forward) | Interest rates |
Currency forward | Currency rates |
Commodity forward | Commodity prices |
Equity forward | Equity prices (equity of another entity) |
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.
The definition of derivatives has already been addressed. While seemingly straightforward, the almost limitless and still expanding variety of “engineered” financial products often makes definitive categorisation more difficult than this at first would appear to be.
The IGC illustrates this with examples of two variants on interest rate swaps, both of which involve prepayments. The first of these, a prepaid interest rate swap (fixed-rate payment obligation prepaid at inception or subsequently) qualifies as a derivative; the second, a variable-rate payment obligation prepaid at inception or subsequently, would not be a derivative. The reasoning is set forth in the next paragraphs, which are adapted from the IGC guidance.
This follows the provisions under IFRS 9 under which contracts to buy or sell non-financial items will not be within the scope of financial instruments accounting when they were entered into, and continue to be held, for the purpose of the receipt of the non-financial item in accordance with the entity's expected purchase, sale or usage requirements (unless the entity elects to treat such contracts as FVTPL because they eliminate or reduce a financial reporting mismatch).
For example, Autoco enters into forward contracts to purchase steel for use in the manufacturing of motor vehicles. It has established past practice of settling such contracts through actual delivery and subsequent consumption of the steel within its manufacturing process. Such forward contracts will be excluded under the provisions of IFRS 9 discussed above. Just as some seemingly derivative transactions may be accounted for as not involving a derivative instrument, the opposite situation can also occur, where some seemingly non-derivative transactions would be accounted for as being derivatives.
Forward contracts to purchase, for example, fixed-rate debt instruments (such as mortgages) at fixed prices are to be accounted for as derivatives. They meet the definition of a derivative because there is no or little initial net investment, there is an underlying variable (interest rates) and they will be settled in the future. However, such transactions are to be accounted for as a regular-way transaction, if regular-way delivery is required. “Regular-way” delivery is defined to include contracts for purchases or sales of financial instruments that require delivery in the timeframe generally established by regulation or convention in the marketplace concerned. Regular-way contracts are explicitly defined as not being derivatives.
Future contracts are financial instruments that require delivery of a commodity, for example, an equity instrument or currency, at a specified price agreed to on the contract inception date (exercise price), on a specified future date. Futures are like forward contracts except futures have standardised contract terms and are traded on organised exchanges.
Options are contracts that give the buyer (option holder) the right, but not the obligation, to acquire from or sell to the option seller (option writer) a certain quantity of an underlying financial instrument or other commodity, at a specified price (the strike price) and up to a specified date (the expiration date). An option to buy is referred to as a “call”; an option to sell is referred to as a “put.”
Interest rate (and currency) swaps have become widely used financial arrangements. Swaps are to be accounted for as derivatives whether an interest rate swap settles gross or net. Regardless of how the arrangement is to be settled, the three key defining characteristics are present in all interest rate swaps:
Thus, swaps are always derivatives.
Not all derivatives involve financial instruments. Corboy owns an office building and enters a put option, with a term of five years, with an investor that permits it to put the building to the investor for €15 million. The current value of the building is €17.5 million. The option, if exercised, may be settled through physical delivery or net cash at Corboy's option. Corboy's accounting depends on Corboy's intent and past practice for settlement. Although the contract meets the definition of a derivative, Corboy does not account for it as a derivative if it intends to settle the contract by delivering the building if it exercises its option and there is no past practice of settling net.
The investor, however, cannot conclude that the option was entered to meet the investor's expected purchase, sale or usage requirements because the investor does not have the ability to require delivery. Therefore, the investor has to account for the contract as a derivative. Regardless of past practices, the investor's intention does not affect whether settlement is by delivery or in cash. The investor has written an option, and a written option in which the holder has the choice of physical delivery or net cash settlement can never satisfy the normal delivery requirement for the exemption for the investor. However, if the contract required physical delivery and the reporting entity had no past practice of settling net in cash, the contract would not be accounted for as a derivative.
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.
Risk management strategy | Risk management objective |
Maintain 40% of borrowings in floating interest rates | Designate an interest rate swap as a fair value hedge of a Euro 10 million fixed rate borrowing |
Hedge foreign currency risk exposure of up to 85% of revenue forecasts in Euros up to 9 months | Designate a foreign exchange forward contract to hedge the foreign exchange risk |
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:
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).
Under IFRS 9, a hedging relationship qualifies for hedge accounting only if all of the following criteria are met:
A qualifying instrument must be designated in its entirety as a hedging instrument. The only exceptions permitted are:
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):
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:
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.
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.
A component of a nominal amount is a specified part of an item. Examples include:
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.
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:
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.
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:
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 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.
The requirement that an economic relationship (there needs to be an economic rationale rather than just a chance of an event occurring) exists means that the hedging instrument and the hedged item have values that generally move in the opposite direction because of the same risk, which is the hedged risk. Hence, there must be an expectation that the value of the hedging instrument and the value of the hedged item will systematically change in response to movements in either the same underlying or an underlying that is economically related in such a way that they respond in an analogous way to the risk that is being hedged (for example, Brent and WTI crude oil).
If the underlying is not the same but is economically related, there can be situations in which the values of the hedging instrument and the hedged item move in the same direction, for example, because the price differential between the two related underlying changes while the underlying themselves do not move significantly. That is still consistent with an economic relationship between the hedging instrument and the hedged item if the values of the hedging instrument and the hedged item are still expected to typically move in the opposite direction when the underlying moves.
The assessment of whether an economic relationship exists includes an analysis of the possible behaviour of the hedging relationship during its term to ascertain whether it can be expected to meet the risk management objective. The mere existence of a statistical correlation between two variables does not, by itself, support a valid conclusion that an economic relationship exists.
IFRS 9 does not specify a method for assessing whether a hedging relationship meets the hedge effectiveness requirements. However, it gives direction on the methods that capture the relevant characteristics of the hedging relationship, including the sources of hedge ineffectiveness. Depending on those factors, the method can be a qualitative or a quantitative assessment.
For example, when the critical terms (such as the nominal amount, maturity and underlying) of the hedging instrument and the hedged item match or are closely aligned, it might be possible for an entity to conclude on the basis of a qualitative assessment of those critical terms that the hedging instrument and the hedged item have values that will generally move in the opposite direction because of the same risk and hence that an economic relationship exists between the hedged item and the hedging instrument.
The fact that a derivative is in or out of the money when it is designated as a hedging instrument does not in itself mean that a qualitative assessment is inappropriate. It depends on the circumstances whether hedge ineffectiveness arising from that fact could have a magnitude that a qualitative assessment would not adequately capture.
If the critical terms of the hedging instrument and the hedged item are not closely aligned, there is an increased level of uncertainty about the extent of offset. Consequently, the hedge effectiveness during the term of the hedging relationship is more difficult to predict. In such a situation, it might only be possible for an entity to conclude on the basis of a quantitative assessment that an economic relationship exists between the hedged item and the hedging instrument. In some situations, a quantitative assessment might also be needed to assess whether the hedge ratio used for designating the hedging relationship meets the hedge effectiveness requirements. An entity can use the same or different methods for those two different purposes.
If there are changes in circumstances that affect hedge effectiveness, an entity may have to change the method for assessing whether a hedging relationship meets the hedge effectiveness requirements to ensure that the relevant characteristics of the hedging relationship, including the sources of hedge ineffectiveness, are still captured.
An entity's risk management is the main source of information to perform the assessment of whether a hedging relationship meets the hedge effectiveness requirements. This means that the management information (or analysis) used for decision-making purposes can be used as a basis for assessing whether a hedging relationship meets the hedge effectiveness requirements.
An entity's documentation of the hedging relationship includes how it will assess the hedge effectiveness requirements, including the method or methods used. The documentation of the hedging relationship shall be updated for any changes to the methods.
IFRS 9 requires that to achieve hedge accounting, the impact of the changes in credit risk should not be of a magnitude such that it dominates the value changes.
Since the hedge accounting model is based on a general notion of offset between gains and losses on the hedging instrument and the hedged item, hedge effectiveness is determined not only by the economic relationship between those items (i.e., the changes in their underlying) but also by the effect of credit risk on the value of both the hedging instrument and the hedged item. The effect of credit risk means that even if there is an economic relationship between the hedging instrument and the hedged item, the level of offset might become erratic.
This can result from a change in the credit risk of either the hedging instrument or the hedged item that is of such a magnitude that the credit risk dominates the value changes that result from the economic relationship (i.e., the effect of the changes in the underlying). A level of magnitude that gives rise to dominance is one that would result in the loss (or gain) from credit risk frustrating the effect of changes in the underlying on the value of the hedging instrument or the hedged item, even if those changes were significant. Conversely, if during a particular period there is minor change in the underlying, the fact that even small credit risk-related changes in the value of the hedging instrument or the hedged item might affect the value more than the underlying does not create dominance.
An example of credit risk dominating a hedging relationship is when an entity hedges an exposure to commodity price risk using an uncollateralised derivative. If the counterparty to that derivative experiences a severe deterioration in its credit standing, the effect of the changes in the counterparty's credit standing might outweigh the effect of changes in the commodity price on the fair value of the hedging instrument, whereas changes in the value of the hedged item depend largely on the commodity price changes.
To meet hedge accounting requirements, where an entity hedges less than 100% of the hedged item, it needs to designate the hedging ratio on the basis of the actual % that is hedged. For example, where an entity hedges 75% of an underlying risk, and documents this as such, for hedge accounting purposes 75% will used as the effective hedge ratio. The hedging ratio of 100% could be created by designating only a portion of the hedge item or hedging instrument. Then an ineffective portion need not be determined. The portion of the movement in a hedging instrument, such as a derivative, not designated would then automatically be recognised in profit or loss.
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:
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:
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:
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.
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:
The discontinuation of hedge accounting can affect:
A hedging relationship is discontinued in its entirety when it ceases to meet the qualifying criteria. For example:
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:
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:
So long as a fair value hedge meets the qualifying criteria as stated above, the hedging relationship shall be accounted for as follows:
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.
So long as cash flow hedges meet the qualifying criteria as stated above, the hedging relationship shall be accounted for as follows:
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:
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.:
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.
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:
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:
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:
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:
Any remainder of the change in fair value of the actual time value shall be recognised in profit or loss.
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:
IFRS 9 stipulates that a group of items that constitute a net position is eligible for a hedged item only if:
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:
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.
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.
When a hedged item is a group that is a nil net position (i.e., the hedged items among themselves fully offset the risk that is managed on a group basis), an entity is permitted to designate it in a hedging relationship that does not include a hedging instrument, provided that:
IFRS 9 is effective for annual periods beginning on or after 1 January 2018 and, subject to local endorsement requirements, is available for early adoption.
Entities are, however, allowed earlier adoption for specific areas related to the requirements for presentation of gains and losses on financial liabilities designated at FVTPL, without applying other principles for early adoption.
On initial application, entities are required to apply the standard retrospectively except in respect of:
Entities are required to designate financial assets measured at FVTPL and equity instruments measured at FVTOCI based on facts and circumstances that exist at the date of initial application. This is applied retrospectively.
All revocations and designations of financial assets and liabilities are made based on facts and circumstances that exist at the date of initial application and are applied retrospectively.
An entity should restate prior periods if, and only if, it is possibly to do so without the use of hindsight.
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.
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:
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:
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.
The business model in which a financial asset is held is assessed as at the date of initial application. As an exception to retrospective application, the assessment is based on facts and circumstances at the date of initial application. An entity is not required to consider business models that may have applied in previous periods. The resulting classification is then applied retrospectively (irrespective of the entity's business model in prior reporting periods).
On the basis of facts and circumstances at the time of initial application an entity may retrospectively designate:
The assessment of whether contractual payments are solely payments of principal and interest on principal is made on the basis of facts and circumstances existing at the time of initial recognition of the financial asset with the two exceptions below:
Where a hybrid contract has been measured at fair value, but the fair value of the hybrid contract had not been measured in comparative reporting periods, the fair value of the hybrid contract in the comparative reporting periods shall be the sum of the fair values of the components (i.e., the non-derivative host and the embedded derivative) at the end of each comparative reporting period if the entity restates prior periods.
If an entity has applied the above then at the date of initial application the entity shall recognise any difference between the fair value of the entire hybrid contract at the date of initial application and the sum of the fair values of the components of the hybrid contract at the date of initial application in the opening retained earnings (or other component of equity, as appropriate) of the reporting period that includes the date of initial application.
For financial liabilities, at the date of initial application, an entity:
Equity instruments can be retrospectively designated at FVTOCI at the date of initial application provided they meet the requirements set out earlier in the chapter. The designation is made based on facts and circumstances available at the date of initial application.
An entity may choose its accounting policy to continue to apply the hedge accounting principles of IAS 39. If any entity choses this approach, it must apply this to all of its hedge relationships, including IFRIC 16, on Hedges of a Net Foreign Operation.
To apply hedge accounting under IFSR 9 from the date of initial application of the hedge accounting requirements, all qualifying criteria must be met as at that date.
On initial application of the hedge accounting requirements under IFRS 9, an entity:
Hedge accounting requirements are prospectively accounted for except:
On application of IFRS 9, hedge relationships should be treated as continuing where they previously met the IAS 39 criteria and continue to meet the IFRS 9 criteria, i.e., the previous hedge relationship is not discontinued on transition.
IAS 32 establishes the principles for presenting financial instruments as liabilities or equity and for the offsetting of financial assets and financial liabilities. It deals with classifying financial instruments from the perspective of the issuer into financial assets, financial liabilities and equity instruments (and classification of related interest, dividends, losses and gains).
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:
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.
Under IAS 32, puttable financial instruments are presented as equity, only if all the following criteria are met:
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:
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.
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.
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.
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.
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:
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).
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.
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.
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:
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.
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.
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 is required only when the entity both:
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:
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:
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.
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:
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:
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:
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.
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:
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:
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:
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.
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:
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:
The entity shall also disclose:
If an entity has designated investments in equity instruments to be measured at FVTOCI, as permitted by IFRS 9, it shall disclose:
If an entity derecognised investment in equity instruments measured at FVTOCI during the reporting period, it shall disclose:
EXAMPLE OF DISCLOSURES: Note 3.8 Financial instruments and financial risk management Sub-note 3.8.1 Categories of financial instruments |
||||
20XX | ||||
Assets as per balance sheet | Amortised cost | Assets at fair value through profit or loss | Derivatives used for hedging | Assets at fair value through other comprehensive income |
Equity investments | X | X | ||
Trade receivables | X | |||
Other current assets at fair value through profit or loss | X | X | ||
Cash and cash equivalents | X | |||
Total | X | X | X | X |
Liabilities as per balance sheet | Liabilities at fair value through profit or loss | Financial liabilities measured at amortised cost | Derivatives used for hedging |
Non-current borrowings | X | ||
Current borrowings | X | ||
Current portion of non-current borrowings | X | ||
Finance lease liability | X | ||
Total | - | X | - |
20XX | ||||
Assets as per balance sheet | Amortised cost | Assets at fair value through profit or loss | Derivatives used for hedging | Assets at fair value through other comprehensive income |
Equity investments | X | X | ||
Trade receivables | X | |||
Other current assets at fair value through profit or loss | X | X | ||
Cash and cash equivalents | X | |||
Total | X | X | X | X |
Liabilities as per balance sheet | Liabilities at fair value through profit or loss | Financial liabilities measured at amortised cost | Derivatives used for hedging |
Non-current borrowings | X | ||
Current borrowings | X | ||
Current portion of non-current borrowings | X | ||
Finance lease liability | X | ||
Total | – | X | – |
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:
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:
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:
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:
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:
FINANCIAL ASSETS SUBJECT TO OFFSETTING, ENFORCEABLE MASTER NETTING ARRANGEMENTS AND SIMILAR AGREEMENTS
Description | (a) Gross amounts of recognised financial assets | (b) Gross amounts of recognised financial liabilities set off in the statement of financial position | (c)=(a)–(b) Net amounts of financial assets presented in the statement of financial position | (d) Related amounts not set off in the statement of financial position | (e) = (c)–(d)Net amount | |
Financial instruments | Cash collateral received | |||||
Derivatives | xx | (xx) | xx | (xx) | (xx) | xx |
Reverse repurchase, securities borrowing and similar agreements | xx | – | xx | (xx) | – | – |
Other financial instruments | – | – | – | – | – | – |
Total | xx | (xx) | xx | (xx) | (xx) | xx |
FINANCIAL LIABILITIES SUBJECT TO OFFSETTING, ENFORCEABLE MASTER NETTING ARRANGEMENTS AND SIMILAR AGREEMENTS
Description | (a) Gross amounts of recognised financial assets | (b) Gross amounts of recognised financial assets set off in the statement of financial position | (c)=(a)–(b) Net amounts of financial liabilities presented in the statement of financial position | (d) Related amounts not set off in the statement of financial position | (e) = (c)–(d) Net amount | |
Financial instruments | Cash collateral pledged | |||||
Derivatives | xx | (xx) | xx | (xx) | (xx) | – |
Reverse repurchase, securities lending and similar agreements | xx | – | xx | (xx) | – | – |
Other financial instruments | – | – | – | – | – | – |
Total | xx | (xx) | xx | (xx) | – | – |
NET FINANCIAL ASSETS SUBJECT TO ENFORCEABLE MASTER NETTING ARRANGEMENTS AND SIMILAR AGREEMENTS, BY COUNTERPARTY
Description | (c) Net amounts of financial assets presented in the statement of financial position | (d) Related amounts not set off in the statement of financial position | (e)=(c)–(d) Net amounts | |
Financial instruments | Cash collateral received | |||
Counterparty A | xx | – | (xx) | xx |
Counterparty B | xx | (xx) | (xx) | – |
Counterparty C | xx | (xx) | – | – |
Other | – | – | – | – |
Total | xx | (xx) | (xx) | xx |
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.
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.
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.
If the reporting entity is the obligor under loans payable at the date of the statement of financial position, it must disclose:
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.
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:
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.
The group classifies financial instruments, or their component parts, on initial recognition as a financial asset, a financial liability or an equity instrument in accordance with the substance of the contractual arrangement. Financial instruments are recognised when the group becomes a party to the contractual provisions of the instrument.
Financial instruments are recognised initially at fair value plus transactions costs that are directly attributable to the acquisition or issue of the financial instrument, except for financial assets at fair value through profit or loss, which are initially measured at fair value, excluding transaction costs (which are recognised in profit or loss).
Financial assets are derecognised when the rights to receive cash flows from the investments have expired or have been transferred and the group has transferred substantially all risk and rewards of ownership.
Financial assets are classified for measurement purposes into one of the following three categories:
Financial assets are measured at amortised cost where they are held within a business model whose objective is to hold the assets to collect contractual cash flows and the contractual cash flows are solely payments of principal and interest.
Such financial assets include trade receivables and cash and cash equivalents.
Trade receivables are measured at initial recognition at fair value, and are subsequently measured at amortised cost using the effective interest rate method, less provision for impairment. Trade receivables are reduced by appropriate allowances for estimated irrecoverable amounts. Interest on overdue trade receivables is recognised as it accrues.
Cash equivalents comprise short-term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value. An investment with a maturity of three months or less is normally classified as being short term. Bank overdrafts are shown within borrowing in current liabilities.
Financial assets are classified as fair value through other comprehensive income where the asset is held in a business model whose objective is a combination of holding assets to collect contractual cash flows and also selling financial assets and where the contractual cash flows comprise solely of payments of principal and interest. Equity investments that are not held for trading purposes are also classified as fair value through other comprehensive income under specific elections made by the company.
Subsequent to initial recognition, fair value through other comprehensive income financial assets is stated at fair value with fair value changes recognised through other comprehensive income. Fair values are based on prices quoted in an active market if such a market is available. If an active market is not available, the group establishes the fair value of financial instruments by using a valuation technique, usually discounted cash flow analysis. Dividends are recognised in profit or loss when the right to receive payments is established.
All financial assets other than those classified as amortised cost or fair value through other comprehensive income are classified as fair value through profit or loss. Fair value through profit or loss assets also include financial assets which may meet the business model tests above but which are designated upon initial recognition at fair value through profit or loss. Financial assets at fair value through profit or loss comprise derivative financial instruments, namely interest rate swaps and forward exchange contracts. After initial recognition, financial assets at fair value through profit and loss are stated at fair value. Movements in fair values are recognised in profit or loss, unless they relate to financial assets designated and effective as hedging instruments, in which event the timing of the recognition in profit or loss depends on the nature of the hedging relationship. The group designates certain derivatives as hedging instruments in fair value hedges of recognised assets and liabilities and firm commitments, and in cash flow hedges of highly probable forecast transactions and foreign currency risks relating to firm commitments.
The effective portion of fluctuations in the fair value of interest rate swaps used to hedge interest rate risk and that qualify as fair value hedges are recognised together with finance costs. The ineffective portion of the gain or loss is recognised in other expenses or other income.
Fluctuations in the fair value of forward exchange contracts used to hedge currency risk of future cash flows, and the fair value of foreign currency monetary items on the statement of financial position, are recognised directly in other expenses or other income. This policy has been adopted as the relationship between the forward exchange contracts and the item being hedged does not meet certain conditions in order to qualify as a hedging relationship.
Financial liabilities are classified as measured at amortised cost.
Trade payables are initially measured at fair value, and subsequently measured at amortised cost using the effective interest rate method.
Bank overdrafts and interest-bearing borrowings are recognised initially at fair value, net of transaction costs incurred and subsequently measured at amortised cost using the effective interest method.
At the issue date, the fair value of the liability component of a compound instrument is estimated using the market interest rate for a similar non-convertible instrument. This amount is recorded as a liability at amortised cost using the effective interest method until extinguished upon conversion or at the instrument redemption date. The equity component is determined as the difference of the amount of the liability component from the fair value of the instrument. This is recognised in equity, net of income tax effects, and is not subsequently remeasured.
The effective interest method is a method of calculating the amortised cost of a financial liability and of allocating interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments through the expected life of the financial liability.
The effective portion of fluctuations in the fair value of the hedging instrument used to hedge currency risk of net investments in foreign companies is recognised directly in equity. The ineffective portion of the gain or loss is recognised in profit or loss. The gain or loss deferred in equity, or part thereof, for hedges of net investments in foreign companies is recycled through profit or loss when the interest in, or part of the interest in, the foreign company is disposed of.
All financial assets measured at amortised cost and at fair value where changes in fair value are reported through other comprehensive income are subject to impairment provisions of IFRS 9. The company applies the simplified approach under IFRS 9 under which lifetime expected credit losses are recognised for its trade receivables. In respect of loans to related parties and other receivables, the company initially recognises 12 month expected credit losses and at each reporting date assesses whether there has been a significant increase in credit risk for such assets since initial recognition, and if so, recognises impairment provisions based on the lifetime expected credit loss model.
Financial assets and liabilities are offset and the net amount reported in the statement of financial position when there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis or to realise the asset and settle the liability simultaneously.
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:
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.
The disclosures provided will seek to explain the entity's risk management strategy to provide users with details on how each risk arises, how such risks are managed, including whether the entity hedges an item in entirety for all risks or only a component, and the extent of risk exposures that an entity manages.
The information provided above should include details of hedging instruments used, the way in which the entity determines the economic relationship between the hedged item and the hedging instrument for purposes of assessing hedge effectiveness and how the entity establishes the hedge ratio and what the sources of hedge ineffectiveness are.
IFRS 7 requires an entity to disclose by risk category quantitative information to allow users of its financial statements to evaluate the terms and conditions of hedging instruments and how they affect the amount, timing and uncertainty of future cash flows of the entity.
To meet the requirement an entity is required to provide a breakdown that discloses:
In situations in which an entity frequently resets (i.e., discontinues and restarts) hedging relationships because both the hedging instrument and the hedged item frequently change (i.e., the entity uses a dynamic process in which both the exposure and the hedging instruments used to manage that exposure do not remain the same for long), IFRS 7 provides relief from detailed instrument based disclosures and instead required disclosure of:
IFRS 7 also requires disclosure of any sources of hedge ineffectiveness that are expected to affect the hedging relationship over its term. For cash flow hedges, an entity shall disclose a description of any forecast transaction for which hedge accounting had been used in the previous period, but which is no longer expected to occur.
IFRS 7 requires the following disclosures for each type of hedging instrument (i.e., cash flow hedge, fair value hedge and net investment hedge):
The following disclosure is required for each type of hedged item:
For fair value hedges:
For cash flow hedges and hedges of a net investment in a foreign operation:
The following disclosure is required in respect of hedge ineffectiveness:
For fair value hedges:
For cash flow hedges and hedges of a net investment in a foreign operation:
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:
Disclosures of fair value are not required in these circumstances:
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:
Below is a comparison of the carrying value and the fair value of the group's financial instruments, other than those with a carrying value that approximates its fair value.
20XX | 20XX-1 | |||
Carrying value | Fair value | Carrying value | Fair value | |
Financial assets | ||||
Equity investments | X | X | X | X |
Other current assets | X | X | X | X |
Other current assets at fair value through profit or loss | X | X | X | X |
Cash and cash equivalents | X | X | X | X |
Total | X | X | X | X |
Financial liabilities | ||||
Non-current borrowings | X | X | X | X |
Current borrowings/Trade payables | X | X | X | X |
Current portion of non-current borrowings | X | X | X | X |
Finance lease liability | X | X | X | X |
Total | X | X | X | X |
It is the directors' opinion that the carrying value of trade receivables and trade payables approximates their fair value due to the short-term maturities of these instruments.
Fair value measurement as at 31 December 20XX | ||||
Level 1 | Level 2 | Level 3 | Total | |
Financial assets | ||||
Financial assets at fair value through profit or loss | ||||
Trading derivatives | X | X | X | X |
Trading securities | X | X | X | X |
Derivatives used for hedging | ||||
Interest rate contracts | X | X | X | X |
Financial assets at fair value through other comprehensive income | ||||
Equity investments | X | X | X | X |
Fair value measurement as at 31 December 20XX-1 | ||||
Level 1 | Level 2 | Level 3 | Total | |
Financial assets | ||||
Financial assets at fair value through profit or loss | ||||
Trading derivatives | X | X | X | X |
Trading securities | X | X | X | X |
Derivatives used for hedging | ||||
Interest rate contracts | X | X | X | X |
Financial assets at fair value through other comprehensive income | ||||
Equity investments | X | X | X | X |
The fair value of financial instruments traded in an active market is based on quoted market prices at the reporting date. The quoted market price used for financial assets held by the group is the quoted bid price.
The fair value of financial instruments not traded in an active market is determined by using valuation techniques. Specific valuation techniques used to value the above financial instruments include:
If all significant inputs in the valuation technique used are observable, the instrument is included in level 2, if not the instrument is included in level 3.
Included in level 3 are holdings in unlisted shares which are measured at fair value, using the price earnings multiple model. The key assumption used by management is a price earnings multiple of X (20XX-1: X) which is not observable from market or related data. Management consider a reasonable possible alternative assumption would result in a decrease/increase of X (20XX-1: decrease/increase of Y) in the value of unlisted investments. This sensitivity represents a change in the price earnings multiple of 10%.
The following table presents the changes in level 3 instruments.
Financial assets at fair value through profit or loss | Derivatives used for hedging | Financial assets at fair value through other comprehensive income | Total | |
Opening balance 1 January 20XX | X | X | X | X |
Total gains or losses | ||||
In profit or loss | X | X | X | X |
In other comprehensive income | X | X | X | X |
Purchases | X | X | X | X |
Issues | X | X | X | X |
Settlements | X | X | X | X |
Transfers out of level 3 | X | X | X | X |
Closing balance 31 December 20XX | X | X | X | X |
Total gains or losses for the period included in profit or loss for assets held at the end of the reporting period | X | X | X | X |
Change in unrealised gains or losses for the period included in profit or loss for assets held at the end of the reporting period | X | X | X | X |
Financial assets at fair value through profit or loss | Derivatives used for hedging | Financial assets at fair value through other comprehensive income | Total | |
Opening balance 1 January 20XX-1 | X | X | X | X |
Total gains or losses | ||||
In profit or loss | X | X | X | X |
In other comprehensive income | X | X | X | X |
Purchases | X | X | X | X |
Issues | X | X | X | X |
Settlements | X | X | X | X |
Transfers out of level 3 | X | X | X | X |
Closing balance 31 December 20XX-1 | X | X | X | X |
Total gains or losses for the period included in profit or loss for assets held at the end of the reporting period | X | X | X | X |
Change in unrealised gains or losses for the period included in profit or loss for assets held at the end of the reporting period | X | X | X | X |
Fair value measurement as at 31 December 20XX | ||||
Level 1 | Level 2 | Level 3 | Total | |
Financial assets held at amortised cost | ||||
Loans and receivables | ||||
Trade and other receivables | – | X | – | X |
Cash and cash equivalents | X | – | – | X |
Financial liabilities held at amortised cost | ||||
Bank loans | – | – | X | X |
Loans from other entities | – | – | X | X |
Trade and other payables | – | X | – | X |
Finance lease payables | – | X | – | X |
Fair value measurement as at 31 December 20XX-1 | ||||
Level 1 | Level 2 | Level 3 | Total | |
Financial assets held at amortised cost | ||||
Loans and receivables | ||||
Trade and other receivables | – | X | – | X |
Cash and cash equivalents | X | – | – | X |
Financial liabilities held at amortised cost | ||||
Bank loans | – | – | X | X |
Loans from other entities | – | – | X | X |
Trade and other payables | – | X | – | X |
Finance lease payables | – | X | – | X |
The fair values of the financial assets and liabilities disclosed under levels 2 and 3 above have been determined in accordance with generally accepted pricing models based on a discounted cash flow analysis, with the most significant input being the discount rate.
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.
For each type of risk arising from financial instruments, the reporting entity is expected to disclose:
For each type of risk arising from financial instruments, the entity must present:
If the quantitative data disclosed as of the date of the statement of financial position are not representative of the reporting entity's exposure to risk during the period, it must provide further information that is representative.
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:
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.
In disclosing the credit risk management process, IFRS 7 requires specific disclosure of:
Where an entity uses a model, whether simple or complex, to comply with the impairment requirements of IFRS 9, it is required to explain the inputs, assumptions and estimation techniques used therein. Specifically, disclosure is required of:
To explain the changes in the loss allowance and the reasons for those changes, an entity shall provide, by class of financial instrument, a reconciliation from the opening balance to the closing balance of the loss allowance, in a table, showing separately the changes during the period for:
To enable users of financial statements to understand the changes in the loss allowance disclosed, an entity shall provide an explanation of how significant changes in the gross carrying number of financial instruments during the period contributed to changes in the loss allowance. The information shall be provided separately for financial instruments that represent the loss allowance and shall include relevant qualitative and quantitative information. Examples of changes in the gross carrying number of financial instruments that contributed to the changes in the loss allowance may include:
To enable users of financial statements to understand the nature and effect of modifications of contractual cash flows on financial assets that have not resulted in derecognition and the effect of such modifications on the measurement of expected credit losses, an entity shall disclose:
To enable users of financial statements to understand the effect of collateral and other credit enhancements on the amounts arising from expected credit losses, an entity shall disclose by class of financial instrument:
An entity shall disclose the contractual amount outstanding on financial assets that were written off during the reporting period and are still subject to enforcement activity.
To enable users of financial statements to assess an entity's credit risk exposure and understand its significant credit risk concentrations, an entity shall disclose, by credit risk rating grades, the gross carrying amount of financial assets and the exposure to credit risk on loan commitments and financial guarantee contracts. This information shall be provided separately for financial instruments:
When an entity obtains financial or non-financial assets during the period by taking possession of collateral it holds as security or calling on other credit enhancements (e.g., guarantees), and such assets meet the recognition criteria in other IFRS, an entity shall disclose for such assets held at the reporting date:
The following illustrative disclosures, as derived from the Implementation Guidance to IFRS 7, illustrates one way of providing information about the changes in the loss allowance and the significant changes in the gross carrying amount of financial assets during the period that contributed to changes in the loss allowance. This example does not illustrate the requirements for financial assets that are purchased or originated credit impaired.
Mortgage loans—loss allowance | 12-month expected credit losses | Lifetime expected credit losses (collectively assessed) | Lifetime expected credit losses (individually assessed) | Credit-impaired financial assets (lifetime expected credit losses) |
€'000 | ||||
Loss allowance as at 1 January | X | X | X | X |
Changes due to financial instruments recognised as at 1 January: | ||||
(Transfer to lifetime expected credit losses) | (X) | X | X | – |
(Transfer to credit-impaired financial assets) | (X) | – | (X) | X |
(Transfer to 12-month expected credit losses) | X | (X) | (X) | – |
(Financial assets that have been derecognised during the period) | (X) | (X) | (X) | (X) |
New financial assets originated or purchased | X | – | – | – |
Write-offs | – | – | (X) | (X) |
Changes in models/risk parameters | X | X | X | X |
Foreign exchange and other movements | X | X | X | X |
Loss allowance as at 31 December | X | X | X | X |
Significant changes in the gross carrying amount of mortgage loans that contributed to changes in the loss allowance were:
The significant changes in the gross carrying amount of mortgage loans is further explained below:
Mortgage loans—gross carrying amount | 12-month expected credit losses | Lifetime expected credit losses (collectively assessed) | Lifetime expected credit losses (individually assessed) | Credit-impaired financial assets (lifetime expected credit losses) |
€'000 | ||||
Gross carrying amount as at 1 January | X | X | X | X |
Individual financial assets transferred to lifetime expected credit losses | (X) | – | X | – |
Individual financial assets transferred to credit-impaired financial assets | (X) | – | (X) | X |
Individual financial assets transferred from credit-impaired financial assets | X | – | X | (X) |
Financial assets assessed on collective basis | (X) | X | – | – |
New financial assets originated or purchased | X | – | – | – |
Write-offs | – | – | (X) | (X) |
Financial assets that have been derecognised | (X) | (X) | (X) | (X) |
Changes due to modifications that did not result in derecognition | (X) | – | (X) | (X) |
Other changes | X | X | X | X |
Gross carrying amount as at 31 December | X | X | X | X |
IFRS 7 requires disclosures about credit risk grades used (both internal and external). However, if information about credit risk rating grades is not available without undue cost or effort and an entity uses past due information to assess whether credit risk has increased significantly since initial recognition, the entity shall provide an analysis by past due status for those financial assets. This is illustrated below using an example also derived from the Implementation Guidance to IFRS 7.
The entity is required to disclose:
A number of informative disclosures are mandated, as described in the following paragraphs.
Sensitivity analysis:
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:
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.
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:
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:
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:
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:
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:
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:
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.