Update 2017: This is an article from 2012 and I wrote the totally updated article in 2017 here.

However, there’s a valuable discussion in the comments to this article, and that’s why I did not delete it, but left it here.

Please, if you have some questions, read the new article and post your comments there. I will not respond to any new comments here. Thank you!

The new financial instruments’ standard – IFRS 9 was under development for a long time and in July 2014, it was finally completed. 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.

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I wrote this summary at the time when Phase 1 was completed and Phases 2 and 3 were still to go. However, by the end of July 2014, IFRS 9 is complete. As the process of updating my videos and articles requires some time, I’ll update these free materials fully within a few weeks. However, I’ll make note here about outdated issues, so don’t worry, I’ll not fool you with the old things.

After all these amendments, mandatory effective date of IFRS 9 was set to 1 January 2018.

In this summary, I will focus just on IFRS 9. For summary of IAS 39, please refer here.

And if you’d like to learn more about differences between IFRS 9 and IAS 39, please read more in the article IAS 39 vs. IFRS 9: Clarifying the Confusion.

Objective 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.

Scope of IFRS 9

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.

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.

Initial recognition

IFRS 9 requires recognizing a financial asset or a financial liability in the statement of financial position when the entity becomes a party to the contractual provisions of the instrument.

Derecognition of financial assets

Standard IFRS 9 provides extensive guidance on derecognition of a financial asset. Before deciding on derecognition, an entity must determine whether derecognition is related to:

  • a financial asset (or a group of similar financial assets) in its entirety, or
  • a part of a financial asset (or a part of a group of similar financial assets)

The part must fulfill the following conditions (if not, then asset is derecognized in its entirety):

  • the part comprises only specifically defined cash flows from a financial asset (or group)
  • the part comprises only a fully proportionate (pro rata) share of the cash flows from a financial asset (or group)
  • the part comprises only a fully proportionate (pro rata) share of specifically identified cash flows from a financial asset (or group).

An entity shall derecognize the financial asset when:

  • the contractual rights to the cash flows from the financial asset expire, or
  • an entity transfers the financial asset and the transfer qualifies for the derecognition.

Transfers of financial assets are discussed in more details. First of all, an entity must decide whether the asset was transferred or not. Then, if the financial asset was transferred, the entity must determine whether also risks and rewards from the financial asset were transferred.

Was the financial asset transferred?

An entity transfers a financial asset if either the entity transfers the contractual rights to receive the cash flows from a financial asset, or the entity retains the contractual rights to receive the cash flows from the asset, but assumes a contractual obligation to pay these cash flows to one or more recipients under an arrangement that meets the following conditions:

  • the entity has no obligation to pay amounts to the eventual recipient unless it collects equivalent amounts on the original asset
  • the entity is prohibited from selling or pledging the original asset (other than as security to the eventual recipient),
  • the entity has an obligation to remit any cash flows it collects on behalf of eventual recipients without material delay

Were the risks and rewards from the financial assets transferred?

If substantially all the risks and rewards have been transferred, the asset is derecognized. If substantially all the risks and rewards have been retained, the entity must continue recognizing the asset in its financial statements.

If the entity has neither retained nor transferred substantially all of the risks and rewards of the asset, then the entity must assess whether it has retained control of the asset or not.

If the entity does not control the asset then it must derecognize the asset. But if the entity has retained control of the asset, then the entity continues to recognize the asset to the extent of its continuing involvement in the asset.

Transfers of financial assets are then discussed in much greater detail in IFRS 9 and also, application guidance in paragraph 36 summarizes derecognition steps in a simple decision tree. You can familiarize yourself with the decision tree in the video below this summary.

Derecognition of a financial liability

An entity shall derecognize a financial liability when it is extinguished. It is when the obligation specified in the contract is discharged, cancelled or expires.

 

Classification of financial instruments

Classification of financial assets

IFRS 9 classifies financial assets into 2 main categories:

  1. 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.
  2. 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:

  1. Financial liabilities at fair value through profit or loss: these financial liabilities are subsequently measured at fair value and here, all derivatives belong
  2. 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.

Impairment of financial assets

New rules about the impairment of financial assets were added only in July 2014.

IFRS 9 requires entities to estimate and account for expected credit losses for all relevant financial assets, starting from when they first acquire a financial instrument.

When measuring expected credit losses, entities will be required to use all relevant information that is available to them (without undue cost or effort).

Please, read more about the new IFRS 9 impairment model here.

Embedded derivatives

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.

Measurement of financial instruments

Initial measurement

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.

Subsequent 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.

Hedge accounting

Hedge accounting requirements were 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.

In July 2014, IFRS 9 introduced a substantially-reformed model for hedge accounting, with improved disclosures about risk management activity.

Effective date and transition

Mandatory effective date for IFRS 9 application is 1 January 2018 with earlier application permitted.

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 (however, updated video about IFRS 9 will be issued within a few weeks):

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