IFRS 9: Financial Instruments
IFRS 9 now classifies financial assets under three
headings as follows:
(1) Financial assets at fair value through profit or
loss (FVTPL)
This classification includes any financial assets held for trading purposes and also derivatives, unless they are part of a properly designated hedging arrangement. Debt instruments will be classified to be measured and accounted for at FVTPL unless they have been correctly designated to be measured at amortised cost. Initial recognition at fair value is normally cost incurred and this will exclude transactions costs, which are charged to profit or loss as incurred. Remeasurement to fair value takes place at each reporting date, with any movement in fair value taken to profit or loss for the year, which effectively incorporates an annual impairment review.
(2) Financial assets at fair value through other comprehensive income (FVTOCI)
This classification applies to equity instruments and simple debt instruments and must be designated upon initial recognition. It will be applicable to financial assets that an entity holds within a business model whose objective is achieved by both collecting the contractual cash flows and selling the financial assets. The contractual cash flows will usually be collected on a specific date will consist of payments of principle and interest. Initial recognition at fair value would normally include the associated transaction costs of purchase. The accounting treatment automatically incorporates an impairment review, with any change in fair value taken to other comprehensive income in the year.Upon derecognition, any gain or loss is based upon the carrying amount at the date of disposal.
This classification applies to equity instruments and simple debt instruments and must be designated upon initial recognition. It will be applicable to financial assets that an entity holds within a business model whose objective is achieved by both collecting the contractual cash flows and selling the financial assets. The contractual cash flows will usually be collected on a specific date will consist of payments of principle and interest. Initial recognition at fair value would normally include the associated transaction costs of purchase. The accounting treatment automatically incorporates an impairment review, with any change in fair value taken to other comprehensive income in the year.Upon derecognition, any gain or loss is based upon the carrying amount at the date of disposal.
(3) Financial assets measured at amortised cost
This classification can apply only to debt instruments and must be designated upon initial recognition. For the designation to be effective, the financial asset must pass two tests as follows:
- The business model test - to pass this test, the entity must be holding the financial asset to collect in the contractual cash flows associated with that financial asset. If this is not the case, such as the financial asset being held and then traded to take advantage of changes in fair value, then the test is failed and the financial asset reverts to the default classification to be measured at FVTPL.
- The cash flow characteristics test - to pass this test, the contractual cash flows collected must consist solely of payment of interest and capital. If this is not the case, the test is failed and the financial asset reverts to the default classification to be measured at FVTPL.
IFRS 9 requires an entity to account for expected credit losses - ie a credit event does not need to have occurred for a credit loss to be recognised. An impairment review is required for financial assets that are measured at fair value and any fall in fair value is taken to profit or loss or other comprehensive income for the year, depending upon the classification of the financial asset
For financial assets designated to be measured at amortised cost, an entity must make an assessment at each reporting date whether there is evidence of possible impairment; if there is, then an impairment review should be performed. If impairment is identified, it is charged to profit or loss immediately. Quantification of the recoverable amount would normally be based upon the present value of the expected future cash flows estimated at the date of the impairment review and discounted to their present value based on the original effective rate of return at the date the financial asset was issued.
Classification of financial liabilities
Financial liabilities should be accounted for as follows:
- Financial liabilities at fair value through profit or loss (FVTPL): like the equivalent classification for financial assets, this will include financial liabilities incurred for trading purposes and also derivatives that are not part of a hedging arrangement.
- Other financial liabilities measured at amortised cost: if financial liabilities are not measured at FVTPL, they are measured at amortised cost.