The new financial instruments’ standard – IFRS 9 is currently under development and its aim is to replace IAS 39—older standard dealing with financial instruments.
International Accounting Standards Board (IASB) decided to replace IAS 39 gradually in the process consisting of 3 phases: Phase 1—Classification and measurement of financial assets and financial liabilities, Phase 2—Impairment Methodology and Phase 3—Hedge Accounting.
At the time of writing this article, Phase 1 is completed and IFRS 9 contains new rules for classification and measurement of financial assets and financial liabilities. These will be discussed below. Phase 2 and Phase 3 are still in progress, so old IAS 39 applies.
On 19 November 2013 IASB issued significant amendment of IFRS 9 in which the mandatory effective date (1 January 2015) was cancelled. Currently, there’s no mandatory effective date and every IFRS preparer has the choice to apply old 39 in full, or to decide on application of IFRS 9. Please read more in the article IAS 39 vs. IFRS 9: Clarifying the Confusion.
In this summary, I will focus just on IFRS 9. For summary of IAS 39, please refer here.
IFRS 9 contains 7 chapters and 3 appendices (defined terms, application guidance and amendments to other IFRS) that are integral part of IFRS 9.
IFRS 9 establishes principles for the financial reporting of financial assets and financial liabilities. Here, the principal aim is to 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.
Here, IFRS 9 makes reference to IAS 39, because it says that IFRS 9 shall be applied to all items within the scope of IAS 39.
Chapter 3—Recognition and Derecognition
This chapter prescribes WHEN the financial asset and financial liability shall be recognized or derecognized in the financial statements.
Paragraphs related to recognition and derecognition of financial assets and financial liabilities in IFRS 9 are to the great extent carried over from IAS 39. Therefore, I carry over the relevant summary from the previous article about IAS 39 for your convenience. All information carried over from IAS 39 summary is put to the frame.
Classification of financial assets
IFRS 9 classifies financial assets into 2 main categories:
- Financial asset subsequently measured at amortized cost: a financial asset falls into this category if BOTHof the following conditions are met:
- the asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows, and
- the only contractual cash flows are payments of principal and related interest on specified dates.
- Financial assets subsequently measured at fair value: all financial assets not falling to the above category.
Here, we can see significant reduction of rules, because if you remember IAS 39 classified financial assets into 4 categories. In this case, IFRS 9 brings certain simplification.
Moreover, regardless above 2 categories, a reporting entity may decide to designate the financial asset at fair value through profit or loss at its initial recognition. It effectively means that under IFRS 9 all financial assets can be measured at fair value with no need to split them into categories. Well, whether that’s practical and doable or not, that’s another question.
Classification of financial liabilities
IFRS 9 classifies financial liabilities as follows:
- Financial liabilities at fair value through profit or loss: these financial liabilities are subsequently measured at fair value and here, all derivatives belong
- Other financial liabilities measured at amortized cost using the effective interest method
IFRS 9 mentions separately some other types of financial liabilities measured in a different way, such as financial guarantee contracts and commitments to provide a loan at a below market interest rate, but here, we will deal with 2 main categories.
As you can see, not much change in comparison to IAS 39. An entity can designate the financial liability at fair value through profit or loss at its initial recognition, too—regardless of the category.
Much of the concept of embedded derivatives was taken from IAS 39 to IFRS 9, however, there is a change.
To refresh your knowledge from IAS 39: Embedded derivative is simply a component of a hybrid instrument that also includes a non-derivative host contract. Careful here, because IFRS 9 says that a derivative that is attached to the financial instrument, but is contractually transferable independently of that instrument or has a different counterparty, is not embedded derivative. Instead, it is a separate financial instrument.
Now, according to IFRS 9, you should look whether the host contract is a financial asset within the scope of IFRS 9 or not.
If the host is within the scope of IFRS 9, then the whole hybrid contract shall be measured as one and not be separated. This is quite different from IAS 39. Under IAS 39, if you have a host contract that is a financial asset with some embedded derivative whose economic characteristics are not closely related, these 2 would have been separated. But not under IFRS 9, because when a host is a financial asset, then no separation is required.
If the host contract is outside the scope of IFRS 9 (some non-financial asset), then IFRS 9 requires separation of embedded derivative from the host contract when the following conditions are fulfilled (and yes, again I carry forward from IAS 39):
- the economic risks and characteristics of the embedded derivative are not closely related to the economic risks and characteristics of the host contract
- a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative
- the hybrid instrument is not measured at fair value with changes in fair value recognized in the profit or loss.
Separation means that you account for embedded derivative separately in line with IFRS 9 and the host contract in line with other appropriate standard. If an entity is not able to do this, then the whole contract must be accounted for as a financial asset at fair value through profit or loss.
Financial asset or financial liability shall be initially measured at its fair value. When financial asset or financial liability are NOT measured at fair value through profit or loss, then directly attributable transaction costs shall be included in the initial measurement.
Due to the fact that IFRS 9 reduced the number of categories of financial assets and simplified the matter, also their subsequent measurement is simple. Just look to the titles of the categories and it will become clear.
Thus, financial assets shall be subsequently measured either at fair value or at amortized cost.
Subsequent measurement of financial liabilities is carried over from IAS 39. Financial liabilities held for trading are measured at fair value through profit or loss, and all other financial liabilities are measured at amortised cost unless the fair value option is applied.
With regard to recognizing gains and losses from subsequent measurement, IFRS 9 requires to put them to profit or loss with the following exceptions:
- when there is a hedging relationship and hedge accounting applies – please, refer to IAS 39 summary
- when a financial asset is an equity instrument not held for trading, then an entity can irrevocably at initial recognition to choose to present changes in fair value of that instrument in other comprehensive income
- when a financial liability is designated at fair value through profit or loss, then the change in fair value attributable to changes in the credit risk shall be presented in other comprehensive income and the remaining change in profit or loss.
Chapter 6—Hedge accounting
Chapter about hedge accounting was completed on 19 November 2013. Basic rules for hedge accounting, types of hedges and mechanics of accounting for each type of hedge remain the same as in IAS 39. However, IFRS 9 widens the situations in which the hedge accounting can be applied. For more details please read an article about differences in hedge accounting between IAS 39 and IFRS 9.
Chapter 7—Effective date and transition
Mandatory effective date for IFRS 9 application of 1 January 2015 was cancelled and no new date is set now.
As well as IAS 39, also standard IFRS 9 addresses all issues in a greater detail and contains application guidance. I have summarized it also in the following video:
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