Part 5c:
IFRS 9
Financial Instruments
IFRS 9: Financial instruments
 Designated to replace IAS 32 and IAS 39
 Response to the financial crisis:
 Beginning of crisis in August 2008, decrease of market
values of securitized financial instruments (e.g. ABS),
increasing consumption of Equity Capital
 Request by G20 to contribute to limit impact of crisis
through change of accounting procedures
 Amendment to IAS 39: If FV Instruments are not intended
to be traded on short view, reclassification may be
allowed, values “frozen” on 01.10.2008
 Decision taken to “reconstruct” regulation on Financial
Instruments and to summarize in one standard: IFRS 9
Dr. Th. Goswin
International Accounting Standards
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1
IFRS 9: Financial instruments
 Situation at the peak of the crisis (I):
Asset
Liability
Credit Derivative:
100
Equity:
Cash:
50
Liabilities:
Dr. Th. Goswin
50
100
International Accounting Standards
3
IFRS 9: Financial instruments
 Situation at the peak of the crisis (II):
Asset
Liability
Credit Derivative:
Loss on M.V.:
New M.V.:
100
-20
80
Equity:
Retained earnings
Total Equity:
Cash:
50
Liabilities:
Dr. Th. Goswin
International Accounting Standards
50
-20
30
100
4
2
IFRS 9: Financial instruments
 Solution to “solve” the crisis (III):
Asset
„Frozen“ value of CD
Cash:
Dr. Th. Goswin
Liability
80
50
„Frozen“ Equity:
Liabilities:
30
100
International Accounting Standards
5
IFRS 9: Financial instruments
 IFRS 9 originally issued in November 2009, reissued in
October 2010, intended to be applicable originally from
01.01.2013 onwards, new date of application now 01.01.2018
 IFRS 9 consisting of 3 parts (improvements):
 Classification and Measurement
 Amortized cost and impairment
 Hedge Accounting
 Greatest improvement is, that “expected loss model” now
acceptable
 Clear procedure defined with steps of implementation
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International Accounting Standards
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3
IFRS 9: Financial instruments
 New regulation on classification:
 Classification according to IAS 39:
 Rule based
 Complex and difficult to apply
 Multiple impairment models
 Own credit gains and losses recognized in profit or loss for
fair value option liabilities (not applicable in the EU)
 Complicated reclassification rules
 Classification according to IFRS 9:
 Principle based
 Based on business model and nature of cash flow
 One impairment model
 Own credit gains and losses presented in OCI for FVO
liabilities
 Business model driven reclassification
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International Accounting Standards
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IFRS 9: Financial instruments
 New regulation on classification:
 Consecutive measurement depends on the intended use of
the financial instrument: The business model
 Target of the investment is to keep the asset in order to
generate consecutive and regular cash-flow
 Contract details of the asset lead to payment flows at fixed
moments in time, these flows consist of coupon payment
and repayment of principals only.
 Both conditions have to be fulfilled simultaneously
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International Accounting Standards
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4
IFRS 9: Financial instruments
Financial Assets
Business Model
Test
Measurement
according to
amortized cost
Measurement
according to
Fair Value
Recognition of
coupon in I.S.
Recognition of F.V.
change in I.S.
International Accounting Standards
Dr. Th. Goswin
9
IFRS 9: Financial instruments
Instrument within the
scope of IFRS 9
other standard
no
yes
Contractual cash flows are
solely principal and interest?
no
yes
Held to collect contractual
cash flows only?
yes
Held to collect contractual
cash flows and for sale?
no
Fair value Option?
no
Amortized cost
Fair value Option?
yes
Fair value through profit and loss
(Presentation option for equity investments to
present fair value changes in OCI)
Dr. Th. Goswin
yes
no
International Accounting Standards
yes
no
Fair value through
OCI
10
5
IFRS 9: Financial instruments
 In detail: DEBT INSTRUMENTS
 Classification is made at the time, when financial
instrument is recognized the first time
 Financial instrument can be measured at amortized cost
(net of any write-down for impairment), if the two following
conditions are met:
 Business model test: Objective of entity’s business
model is to collect contractual cash-flow rather than to
sell the instrument prior to its contractual maturity to
realize fair value changes
 Cash-flow characteristics test: Contractual terms of
asset give rise on specified dates to cash-flows that
consist of repayment of principal and interest on
amount outstanding
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International Accounting Standards
11
IFRS 9: Financial instruments
 In detail: DEBT INSTRUMENTS
 What is a business model?
 Refers to how an entity manages its financial assets in
order to generate cash-flows, selling financial assets or
both
 Business model should be determined on a level that
reflects how financial assets are managed to achieve a
particular business objective (i.e. what do we want to
achieve?)
 Business model can be observed through activities, that
an entity undertakes to achieve business objective. So
no evaluation on individual level (no assertion) but
objective facts to be considered
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International Accounting Standards
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IFRS 9: Financial instruments
 In detail: DEBT INSTRUMENTS
 What is a business model?
 Objective facts:

Business plans

Compensation for managers (i.e. bonus plans)

Amount and frequency of general sales activities

Past sales activities and expectations about future sales
activity

Having some sale activity is not necessarily inconsistent
with the business model

Same with sales as a result of (e.g.) an increase of credit
risk

If sales are more than insignificant, entity, must assess,
how these sales are in consistency with business model.
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International Accounting Standards
13
IFRS 9: Financial instruments
 In detail: DEBT INSTRUMENTS
 What business model qualifies for fair value through other
comprehensive income (FVOCI)?
 Here, business objective is both to collect contractual
cash flows and selling financial assets
 In comparison to model, based on contractual cashflows (etc.), this model typically has greater frequency
and volume of sales
 Typical objectives:

Manage liquidity

Maintain particular interest yield profile

Match duration of financial liabilities to duration of assets
they are funding
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International Accounting Standards
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7
IFRS 9: Financial instruments
 In detail: DEBT INSTRUMENTS
 What are the characteristics of a contractual cash flow?

In general, contractual cash flows are solely payments of
principal and interest (SPPI)

Only financial assets with such cash flows are eligible for
amortized cost or FVOCI)

Clarification: interest can comprise not only for time value of
many and credit risk
But

Return for liquidity risk, amounts to cover expenses, profit
margin

As long as consistency with a basic lending arrangement is
given (for instance: if contractual cash flows include a return
for equity price risk, this is not in accordance with SPPI)
Dr. Th. Goswin
International Accounting Standards
15
IFRS 9: Financial instruments
 In detail: DEBT INSTRUMENTS
 What are the characteristics of a contractual cash flow?
 Basic element of identifying SPPI is „Time Value of
Money“, which determines the contractual payment of
interest (and alike elements)
 Example: Fixed interest rate (i.e. 10% p.a.) or variable
interest rate (i.e. index, 3 month Libor). In that case time
value of money is calculated on that time. However,
tenors may be concluded, where determination of
interest rate (i.e. coupon) differs from usual
preconditions of interest rate fixing (e.g. 3 month Libor,
re-fixed every week)
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International Accounting Standards
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8
IFRS 9: Financial instruments
 In detail: DEBT INSTRUMENTS
 What are the characteristics of a contractual cash flow?
 In this case, individual assessment, if FI fulfill the cash
flow characteristics and if the cash flow represents
SPPI.
 Objective is to determine, if cash flow differs
significantly from cash flow with unmodified time value
of money element
 In cases of doubt: Precondition of contractual cash flow
is not given, valuation according to amortized cost not
possible
Dr. Th. Goswin
International Accounting Standards
17
IFRS 9: Financial instruments
 In detail: DEBT INSTRUMENTS
 What are the characteristics of a contractual cash flow?
 Example:

Pre-payable financial asset to have contractual cash flows
that are SPPI (FX bond, bond with an add on). Testing of
contractual lending arrangement is given

Regulated interest rates, set by government, not
representing time value of money, acceptable as SPPI as
long they do not introduce risk or volatility, that is
inconsistent with a basic lending arrangement
Dr. Th. Goswin
International Accounting Standards
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9
IFRS 9: Financial instruments
 In detail: DEBT INSTRUMENTS
 All other debt instruments, which do not pass the two tests
have to be measured by Fair Value through profit and loss
 Transaction costs are part of the Fair Value at first time
recognition
 Amortization of transaction costs until maturity via effective
interest method
 Fair Value option:
 An entity can voluntarily measure a debt instrument by Fair
Value, if otherwise an “accounting mismatch” would occur
 In this case, transaction costs are to be expensed
immediately via profit and loss
Dr. Th. Goswin
International Accounting Standards
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IFRS 9: Financial instruments
 In detail: EQUITY INSTRUMENTS
 All Equity instruments to be measured at fair value though
profit and loss
 Transaction costs to be expensed immediately via profit and
loss
 No “cost exception” for unquoted equities:
 IAS 39 has an exception for investments in unquoted equity
instruments (and some related derivatives). The exception
requires that these instruments be measured at cost (less
impairment) if fair value cannot be determined reliably.
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International Accounting Standards
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IFRS 9: Financial instruments
 In detail: EQUITY INSTRUMENTS
 “Other comprehensive income option”: If equity investment is
not held for trading, entity can make irrevocable decision at
initial recognition to measure it at “fair value through other
comprehensive income”
 Dividend income recognized in profit and loss
 FV changes recognized in Equity via “other comprehensive
income”
Dr. Th. Goswin
International Accounting Standards
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IFRS 9: Financial instruments
 Treatment of Financial Liabilities according to IFRS 9
 Similar to IAS 39, two categories of liabilities exist:

Fair value through profit or loss (FVTPL): Liabilities held with
the intention (and possibility) of trading (i.e. callable bond)

Amortized cost (AC): Liabilities, which are paid back at
maturity (other liabilities)
 Fair Value Option: Entity can voluntarily measure according
to Fair Value, if
 By doing so an “accounting mismatch” is avoided (or)
 The liability is part of a group of liabilities and/or assets,
which are (risk-) managed as an appropriate investment
strategy and supervised by key management personnel.
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International Accounting Standards
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11
IFRS 9: Financial instruments
Financial
Liabilities
Other Liabilities
Trading Liabilities
Measurement
according to
amortized cost
Measurement
according to
Fair Value
No impact on P&L
Impact on P&L
Dr. Th. Goswin
International Accounting Standards
23
IFRS 9: Financial instruments
 In principle, the approach of IAS 39 remains unchanged.
 Problem:
 Approach criticized due to “artificial” creation of profits as
a consequence of deterioration of own credit standing.
 Therefore this approach still not applicable within EU
 IFRS 9 offers improvement of treatment of liabilities:
 Amount of profit, which is attributable to
movements to be recognized in Income Statement
market
 Amount of profit, which is attributable to deterioration of
own credit standing to be recognized as “other
comprehensive income”
Dr. Th. Goswin
International Accounting Standards
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12
IFRS 9: Financial instruments
 Reclassification:
 For Financial Assets reclassification is required between
FVTPL and AC (and vice versa), if and only if the entity’s
business model objective for its financial assets changes
 In this case the previous model does not apply any more
 If reclassification is decided (appropriate), it must be done
from reclassification date. No restating of previous gains,
losses or interest
 No limitation of reclassifications considered
 However: Reclassification is a significant event and
expected to be uncommon
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International Accounting Standards
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IFRS 9: Financial instruments
Financial Assets
Business Model
Test
Measurement
according to
Fair Value
Measurement
according to
amortized cost
Reclassification
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International Accounting Standards
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13
IFRS 9: Financial instruments
 Reclassification:
 Users of financial statement must be provided with
sufficient information to understand and evaluate the
reclassification
 Especially how the cash flows on financial assets are
expected to be realized
 IFRS 7 requires disclosures about reclassifications:

Amount of financial assets moved out and into different
categories

Detailed explanation of the change in business model and its
effect on income statement(s)
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International Accounting Standards
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IFRS 9: Financial instruments
 De-recognition: ASSETS
 1st step: Determine whether asset under consideration is an

Entire asset

Specially identified cash-flows from an asset (e.g. pre-mature
repayment of a loan)

Fully proportionate share of a cash-flow (pro rata, e.g. regular
repayment of proportion of loan, mortgage, etc)
 2nd step: Determine, whether the asset has been transferred
and if so, whether the asset is subsequently eligible for derecognition:
 Entity has transferred the contractual rights to receive
cash-flows
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International Accounting Standards
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14
IFRS 9: Financial instruments
 De-recognition: ASSETS
 2nd step:
 Entity has retained the contractual rights to receive cashflows, but has assumed a contractual obligation to pass
these cash-flows to someone else under an arrangement
that meets the following conditions:

Entity has no obligation to pay amounts unless it collects
equivalent amounts on original asset (e.g. sale of an option on
secondary market)

Entity is prohibited from selling or pledging the original asset
(e.g. a loan/mortgage)

The entity has obligation to remit those cash-flows without
material delay (e.g. factoring)
Dr. Th. Goswin
International Accounting Standards
29
IFRS 9: Financial instruments
 De-recognition: ASSETS
 3rd step: Determination whether risk out of investment are
transferred as well.
 Substantial transfer of risks: Full de-recognition of asset
 Retaining of risks: De-recognition of asset precluded
 No full retaining and no full transfer of risks (“in-betweencase”): Determination of control of risks

Entity does not control: De-recognition may be appropriate
(IAS 39 requires provision, IFRS 9 does not mention)

Entity still controls risk: Recognition of the asset to the extent
of ongoing involvement in the asset
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International Accounting Standards
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15
IFRS 9: Financial instruments

De-recognition of Fundamental Financial Assets
Transfer
of rights
no
yes
yes
Transfer
of risks
no
Transfer
of control
no
De-recognition
Dr. Th. Goswin
Recognition
insofar further
involvement
yes
De-recognition,
maybe provision
to be created
International Accounting Standards
Recognition
31
IFRS 9: Financial instruments
 De-recognition: LIABILITIES:
 Financial liability to be removed from balance sheet, when
and only when it is extinguished
 Obligation specified in the contract is either discharged or
cancelled or expires (e.g. Option)
 If there was an exchange between existing borrower and
lender of debt instrument with substantially different terms,
or if there was a substantial modification of the terms of
existing liability, the previous liability is de-recognized and a
new liability is recognized
 Gain and loss of the exchange to be considered directly and
immediately in the income statement.
Dr. Th. Goswin
International Accounting Standards
32
16
IFRS 9: Financial instruments
 Derivatives:
 All derivatives, including those unquoted, are measured a
fair value
 Fair Value changes are recognized in profit and loss,
unless the entity has decided to classify the derivative as a
hedging instrument, Requirements of IAS 39 to apply
 If fair value not available, best estimates to be applied (i.e.
certified valuers, Option price models)
 Transaction costs to be expensed immediately via income
statement
Dr. Th. Goswin
International Accounting Standards
33
IFRS 9: Financial instruments
 Embedded Derivatives:
 Hybrid contract, which is a combination of derivative
element with non-derivative host
 Consequence: Cash-flow not entirely applicable to
business model and cash-flow characteristics test, having
strong elements of “stand-alone-derivative”.
 Derivative, which is attached to an other financial
instrument and is contractually transferable independently
to third party is not an embedded derivative, but a separate
financial instrument, to be accounted separately
 No risk attachment/risk separation testing required (as in
IAS 39)
Dr. Th. Goswin
International Accounting Standards
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17
IFRS 9: Financial instruments
 Embedded Derivatives:
 Embedded derivatives, that under IAS 39 would be
accounted separately, due to different risk structure (not
closely related), will not be separated any more
 Categorization into FVTPL of the entire instrument, even if
only a part of contractual cash-flow do not represent
payment of interest and repayment of principal (e.g.
convertible bond)
Dr. Th. Goswin
International Accounting Standards
Insurance Contract
Financial asset
Fundamental
Financial asset
Derivatives
Financial Instrument
Financial liability
Amortized Cost
Fair Value
Plain Derivatives
Plain
Equity
Capital
Other liabilities
Compound
Equity
Instrument
Fair Value Hedge
Cash-flow Hedge
Hedge of a net investment
in a foreign operation
Macro Hedge
Dr. Th. Goswin
Equity instrument
Liabilities Held
for Trading
Embedded
Derivatives
Hedging
Instruments
35
International Accounting Standards
Synthetic
Equity
Instrument
36
18
IAS 32/39: Financial instruments
(Excursion: Overview on Financial Instruments)
Financial assets
Traded at spot market
Traded at forward market
Conclusion and settlement of
contract at the same time
Conclusion and settlement of contract
at different times
Interest
Instruments
conditional
forwards
unconditional
forwards
Buyer acquires right,
seller accepts
commitment
Buyer and seller
accept commitment
- Options
- Forwards
-Instruments similar to
Options (Caps, Floors
etc.)
- Futures
Shares (Equity
Instruments)
- Money Market
instruments
- Common
shares
- Capital Market
instruments
-Preferred Stock
(Premium sh.)
Dr. Th. Goswin
-Swaps
International Accounting Standards
37
IFRS 9: Financial instruments
 Summary: Treatment of the different financial instruments
 First time recognition in every case by Fair Value
 Interest instruments: Testing of Business Model and CashFlow Characteristics, categorization to AC and FVTPL,
application of Fair Value Option
 Shares: Application of FVTPL, “Other Comprehensive
Income Option, no “Cost Exemption” in case of absence of
price quotation
 Derivatives: Application of FVTPL, no accounting options
 Hedging instruments: According to IAS 39, changes and
simplifications promised, but not disclosed so far
Dr. Th. Goswin
International Accounting Standards
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19
IFRS 9: Financial instruments
 Summary: Treatment of the different financial instruments
 Embedded Derivatives: in general accounting procedure as
a whole (as one Financial Instrument, no separation
foreseen), application of FVTPL, no “cost exemption”
applicable, simplification of procedures in comparison to
IAS 39
 Own Equity: No changes so far, IAS 39 applicable
 Own liabilities: categorization into “Trading Liabilities” and
“Other Liabilities”, treatment according to EFRAG
proposal:

Profit, out of market movements to be recognized in Income
Statement

Profit, attributable to deterioration of own credit standing to be
recognized as “other comprehensive income”
Dr. Th. Goswin
International Accounting Standards
39
IFRS 9: Financial instruments
 Open issue:
 Asset and Liability offsetting: US-GAAP allows the
offsetting of assets and liabilities, if there is a masternetting-agreement available: In case of default of
bankruptcy all and asset and liability contracts are netted
into a single payable or receivable amount. IFRS does not
allow this procedure
IASB and FASB were unable to agree on a compromise, as
a result an amendment to IAS 32 was agreed on special
disclosures, which allow analysts to more easily compare
credit exposure
The said amendment is still under preparation
Dr. Th. Goswin
International Accounting Standards
40
20
IFRS 9: Financial instruments
 Impairment
 IAS 32 required an impairment model, based on “incurred
losses”.
Incurred loss model assumes that all loans will be repaid,
until evidence to the contrary (Loss trigger event). Only at
that point, an impaired loan (or portfolio) is written down
Basel II requires a proactive approach, creation of
provisions and reserves for credit event.
IFRS 9 accepts now “expected loss approaches” whereby
expected losses are recognized throughout the life of a
loan/financial asset, even if it is measured at amortized
cost, recognition of a potential loss at an “earlier level”
International Accounting Standards
Dr. Th. Goswin
41
IFRS 9: Financial instruments
Three stages of impairment:
Stage 1:
Stage 2:
As soon as a financial instrument
If the credit risk increases
If the credit risk of a financial
is originated of purchased, 12
significantly
the
asset increases to the point,
month expected credit losses are
resulting credit quality is not
that it is considered credit-
recognized in profit or loss and a
considered to be low credit
impaired, interest revenue is
loss allowance is established.
risk, full lifetime expected
calculated
credit losses are recognized.
amortized cost (i.e. the gross
Stage 3:
and
This serves as a proxy for the
initial
expectations
of
credit
losses.
expected
credit
losses are only recognized,
financial
assets,
interest
revenue is calculated on the gross
carrying
amount
(i.e.
without
adjustment for expected credit
significantly from when the
entity
originates
the
purchases
the
the loss allowance). Financial
assets
in
generally
this
stage
be
individually
will
assessed.
or
financial
instrument.
losses.
Dr. Th. Goswin
on
carrying amount adjusted for
Lifetime
if the credit risk increases
For
based
International Accounting Standards
Lifetime
expected
credit
losses are still recognized on
these financial assets.
42
21
IFRS 9: Financial instruments
 12-month expected credit losses:
 Portion of lifetime expected credit losses, that represent
the EXPECTED credit losses, which result from default
events on a FINANCIAL INSTRUMENT (in general), which
are possible within the 12month after the reporting date
 It is not the expected CASH shortfall over the next twelve
month, however, it is the effect of the entire credit loss on
an asset weighted by the probability that this loss will
occur in the next 12 month.
 It is also not the credit losses on assets, that are forecasted
to actually default in the next 12 month
 If an entity can identify such assets (or a portfolio), these
are recognized in LIFETIME EXCPECTEDCREDIT LOSS
Dr. Th. Goswin
International Accounting Standards
43
IFRS 9: Financial instruments

12 month expected credit loss:


Expected risk, “acceptable”
damage calculated statistically
out of past events
Example: about 600 credit
events with different rate of
repayment/default
50 enterprises created 0% default
70 enterprises created 0.25% default
95 enterprises created 0.5% default
…..
1 enterprise created 4.75% default
0 enterprise created 5% default and
more


Average loss of credit: 1%
i.e. 1% of all credits default
1% expected risk, part of
calculation of credit cost
Dr. Th. Goswin
Lossrate
Number of cases
creating loss
0,00%
0,25%
0,50%
0,75%
1,00%
1,25%
1,50%
1,75%
2,00%
2,25%
2,50%
2,75%
3,00%
3,25%
3,50%
3,75%
4,00%
4,25%
4,50%
4,75%
5,00%
Over 5%
50
70
95
100
90
80
70
50
30
20
10
5
3
2
1
1
1
1
1
1
0
0
rel. Freqeuncy weighted loss
of cases
0,0%
11,2%
15,2%
16,1%
14,4%
12,8%
11,2%
8,0%
4,8%
3,2%
1,6%
0,8%
0,5%
0,3%
0,2%
0,2%
0,2%
0,2%
0,2%
0,2%
0,0%
0,0%
0,0%
0,0%
0,1%
0,1%
0,1%
0,2%
0,2%
0,1%
0,1%
0,1%
0,0%
0,0%
0,0%
0,0%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
Expected loss = Σ (loss * frequency of loss)
= Σ weighted loss
International Accounting Standards
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22
IFRS 9: Financial instruments

potential exposures
Period
0
1
2
3
4
5
6
7
8
9
10
explanation
Summ
12 month expected credit loss:
 Example: Investment in
interest rate swap
 Consideration of counterparty
risk
 Calculation of credit value
adjustment at the beginning of
swap arrangement
EPE
0
9
16
21
24
25
24
21
16
9
0
ENE
0
-9
-16
-21
-24
-25
-24
-21
-16
-9
0
from yield curve
from yield curve
Dr. Th. Goswin
30
25
24
21
20
EPE
24
ENE
21
16
10
16
9
0
9
0
0
0
1
2
3
4
5
6
7
8
9
‐9
‐10
10
‐9
‐16
‐20
‐16
‐21
‐24
‐25
‐24
‐21
‐30
Credit Spread
credit charges with 50% probability
counterparty
0,80%
0,90%
1,00%
1,00%
1,00%
1,00%
1,00%
1,00%
1,00%
1,00%
1,00%
own
0,40%
0,45%
0,50%
0,50%
0,50%
0,50%
0,50%
0,50%
0,50%
0,50%
0,50%
counterparty
0,000
0,041
0,080
0,105
0,120
0,125
0,120
0,105
0,080
0,045
0,000
given
given
EPE*Cr.Sp*50%
own
0,000
-0,020
-0,040
-0,053
-0,060
-0,063
-0,060
-0,053
-0,040
-0,023
0,000
difference
0,000
0,020
0,040
0,053
0,060
0,063
0,060
0,053
0,040
0,023
0,000
Discount Factor
4,00%
1,000
0,962
0,925
0,889
0,855
0,822
0,790
0,760
0,731
0,703
0,676
Cash value
0,000
0,019
0,037
0,047
0,051
0,051
0,047
0,040
0,029
0,016
0,000
ENE*Cr.Sp*50%
International Accounting Standards
45
0,338
credit value
adjustment
IFRS 9: Financial instruments
 Lifetime expected credit losses:
 Expected present value measure of losses, that arise, if a
borrower defaults on his obligation throughout the life of
the financial instrument. They are the weighted average
credit losses, with the probability of default as the weight.
 Difference to 12-month expected credit losses:

12-month expected losses are proportion of lifetime expected
losses, limited to an expectation within 12month.

Lifetime expected credit losses consider both amount and
timing of payments, this means, that a credit loss has to be
recognized eve, when the entity expects to be paid in full but at
a later moment.
Dr. Th. Goswin
International Accounting Standards
46
23
IFRS 9: Financial instruments

Lifetime expected credit losses:

Example: Portfolio of home loans originated in a country:

Stage 1: 12-month expected credit losses are recognized for all
loans on initial recognition

Stage 2: information emerges, that one region in the country is
experiencing tough economic conditions. Therefore it is
expected, that the loans in that region may be more exposed to
default. Lifetime expected credit losses are recognized for
those loans within that region additionally to the 1-month
expected credit losses.

Stage 3: more information emerges and the entity is able to
identify some particular loans which have already defaulted or
will imminently default. Lifetime expected cedit losses continue
to be recognized, but interest revenue switches to a net
interest basis.
International Accounting Standards
Dr. Th. Goswin
47
IFRS 9: Financial instruments

Lifetime expected credit loss:
 Example: Investment in interest
rate swap
 Consideration of change of risk
if an (even remote) event is
triggered (e.g. change of interest
rate
 Calculation of credit value
adjustment in course of time.
Beginning of contract
30
EPE
24
ENE
21
16
10
16
9
0
9
0
0
0
1
2
3
4
5
6
7
8
9
‐9
‐10
10
‐9
‐16
‐20
‐16
‐21
‐24
‐25
‐24
‐21
‐30
30
EPE
25
25
24
24
21
20
ENE
21
16
15
10
Change of interest rate after
one year
16
9
9
5
0
-5
25
24
21
20
0
0
-10
-15
Dr. Th.
-20 Goswin
1
0
2
3
4
5
6
7
8
-7
9
-7
-12
-12
-15
-16
-15
International Accounting Standards
48
24
IFRS 9: Financial instruments
potential exposures
Period
EPE
0
9
16
21
24
25
24
21
16
9
0
0
1
2
3
4
5
6
7
8
9
10
explanation
Credit Spread
ENE
0
-9
-16
-21
-24
-25
-24
-21
-16
-9
0
from yield curve
credit charges with 50% probability
counterparty
0,80%
0,90%
1,00%
1,00%
1,00%
1,00%
1,00%
1,00%
1,00%
1,00%
1,00%
own
0,40%
0,45%
0,50%
0,50%
0,50%
0,50%
0,50%
0,50%
0,50%
0,50%
0,50%
counterparty
0,000
0,041
0,080
0,105
0,120
0,125
0,120
0,105
0,080
0,045
0,000
given
given
EPE*Cr.Sp*50%
from yield curve
own
0,000
-0,020
-0,040
-0,053
-0,060
-0,063
-0,060
-0,053
-0,040
-0,023
0,000
Discount Factor
4,00%
1,000
0,962
0,925
0,889
0,855
0,822
0,790
0,760
0,731
0,703
0,676
difference
0,000
0,020
0,040
0,053
0,060
0,063
0,060
0,053
0,040
0,023
0,000
Cash value
0,000
0,019
0,037
0,047
0,051
0,051
0,047
0,040
0,029
0,016
0,000
ENE*Cr.Sp*50%
Summ
0,338
credit value
adjustment
potential exposures
Period
0
1
2
3
4
5
6
7
8
9
explanation
EPE
9
16
21
24
25
24
21
16
9
0
from yield curve
ENE
9
0
-7
-12
-15
-16
-15
-12
-7
0
from yield curve
Credit Spread
counterparty
18
16
21
24
25
24
21
16
9
0
from yield curve
own
0
0
-7
-12
-15
-16
-15
-12
-7
0
credit charges with 50% probability
counterparty
0,80%
0,90%
1,00%
1,00%
1,00%
1,00%
1,00%
1,00%
1,00%
1,00%
own
0,40%
0,45%
0,50%
0,50%
0,50%
0,50%
0,50%
0,50%
0,50%
0,50%
counterparty
0,072
0,072
0,105
0,120
0,125
0,120
0,105
0,080
0,045
0,000
given
given
EPE*Cr.Sp*50%
from yield curve
own
0,000
0,000
-0,018
-0,030
-0,038
-0,040
-0,038
-0,030
-0,018
0,000
difference
0,072
0,072
0,088
0,090
0,088
0,080
0,068
0,050
0,028
0,000
Discount Factor
4,00%
1,000
0,962
0,925
0,889
0,855
0,822
0,790
0,760
0,731
0,703
Cash value
0,072
0,069
0,081
0,080
0,075
0,066
0,053
0,038
0,020
0,000
ENE*Cr.Sp*50%
Summ
0,554
credit value
adjustment
International Accounting Standards
Dr. Th. Goswin
49
IFRS 9: Financial instruments
Increase in credit risk since initial recognition
Stage 1
Stage 2
Stage 3
 Impairment recognition
12-month expected
credit losses
Lifetime expected
credit losses
Lifetime expected
credit losses
Effective interest
on gross carrying
amount
Effective interest
on amortized cost
 Interest revenue
Effective interest on
gross carrying
amount
Dr. Th. Goswin
International Accounting Standards
50
25
IFRS 9: Financial instruments

Measuring expected credit losses:

Expected credit losses (in general) are an estimate of credit
losses over the life of the financial instrument

Factors to be considered:

Probability weighted outcome. Neither best case nor worst
case scenario

Estimate should reflect the possibility that credit lost occurs
and that no credit loss occurs

Time value of money. Expected credit loss to be discounted to
reporting date

Based on reasonable and supportable information that is
available without undue cost or effort (i.e not necessary to
obtain external rating for all credit exposures)
Dr. Th. Goswin
International Accounting Standards
51
IFRS 9: Financial instruments

Measuring expected credit losses:

Examples:

Discriminant analysis

Value at Risk (VAR)

Option pricing theory
Dr. Th. Goswin
µ bankrupt
International Accounting Standards
µ stable
52
26
IFRS 9: Financial instruments

Measuring expected credit losses:

Entity required to use reasonable and supportable information
that is available at reporting date and that includes information
about past events, current conditions and forecasts of future
conditions

No need to use a „crystal ball“ to predict future, everything
depends on the availability of the information. As forecast horizon
increases, quality of information decreases.

Although model should be forward looking, historical data is an
anchor. Adjustment of historical data to current economic trends
is may be necessary.

IFRS 9 does not prescribe any model or method. As long as
findings and observations are justifiable, preconditions of IFRS 9
fulfilled.
Dr. Th. Goswin
International Accounting Standards
53
IFRS 9: Financial instruments

Assessing significant increases in credit risk:

IFRS 9 requires life expected credit losses to be recognized, when
there are significant increases in credit risk since initial
recognition

At beginning of lifetime of credit entity assesses initial
creditworthiness of the borrower. Initial creditworthiness is taken
evaluated.

If in course of time a re-valued creditworthiness shows difference
to initial expectations (i.e. if when lender is not receiving
compensation for the level of credit risk to which he is now
exposed), readjustment of expectation has to be done.

This is reflected in the income statement as a financial loss

Important: there is a significant increase of credit risk before a
financial asset becomes impaired. And this risk is already
reflected in the financial statement.
Dr. Th. Goswin
International Accounting Standards
54
27
IFRS 9: Financial instruments

Disclosure:

Explain basis for expected credit loss calculations

How credit losses and changes in credit risk are assessed

Reconciliation from opening to closing of allowance balance for
12-month losses, separately from lifetime losses allowances
balance

Balances of carrying amount from opening to closing for financial
instruments, subject to impairment

Users of financial statements must be able to understand the
reasons for changes in the allowance balances (i.e. if it is caused
by changes in credit risk or increased lending).

Additionally: Information on rating grades and modification of
contractual cash flows.
Dr. Th. Goswin
International Accounting Standards
55
IFRS 9: Financial instruments
 Hedge accounting:
Clarification on the eligibility of financial instruments
managed on a contractual cash flow basis in a fair value
hedge
Target:
 Simplification of hedge accounting procedures for
fair value hedges
 Aligning hedge accounting more with Risk
Management and provide more useful information for
analysis
 Establish a more objective-based approach to hedge
accounting
 address inconsistencies and weaknesses in existing
Dr. Th. Goswin
model
International Accounting Standards
56
28
IFRS 9: Financial instruments
 Hedge accounting:
Aspects considered
Objective
Alternatives to
hedge
accounting
Presentation
and
disclosure
Hedged
items
Hedge
accounting
Hedging
instruments
Effectiveness
assessment
Groups and
net positions
Discontinuation
and
rebalancing
Dr. Th. Goswin
International Accounting Standards
57
IFRS 9: Financial instruments
 Hedge accounting: Main questions solved in IFRS 9
(1) Definition of what financial instrument qualify for
designation as hedging instrument
(2) Definition of what items (existing or expected)
qualify as hedged items
(3) How should an entity account a hedging relationship
(4) Hedge accounting presentation and disclosures
Dr. Th. Goswin
International Accounting Standards
58
29
IFRS 9: Financial instruments
 Hedge accounting:
(1) and (2)
Non-derivative financial assets or liabilities,
measured by fair value through profit and loss
(FVTPL) may be eligible as a hedging instrument (for
derivatives and non-derivatives)
Non-derivative financial assets and liabilities
measured not by FVTPL may lead to operational
problems and therefore do not qualify as hedging
instruments
Non-derivative financial assets or liabilities,
measured by fair value through profit and loss
(FVTPL) may be eligible as a hedged item
Dr. Th. Goswin
International Accounting Standards
59
IFRS 9: Financial instruments
 Hedge accounting:
(1) and (2)
Derivatives qualify as a hedged item
Derivatives may qualify as hedging Instrument as
well, especially in case of covering interest rate risk
and foreign currency risk
Although the two risks can be hedged with one
instrument altogether, the board acknowledges the
fact that entities often hedge these risks with
different instruments
However, derivatives need to be identified formally
as a hedging instrument
Dr. Th. Goswin
International Accounting Standards
60
30
IFRS 9: Financial instruments
 Hedge accounting:
(3) Accounting procedures:
Fair value hedge: Gain and loss from re-measuring
hedging instrument to be recognized as other
comprehensive income
Hedged gain or loss of hedged item to be recognized
separately in income statement (next to gain/loss of
the entire asset/liability, that was hedged), and
afterwards recognized in other comprehensive
income
Ineffective portion of hedging operation to be shown
in income statement
Dr. Th. Goswin
International Accounting Standards
61
IFRS 9: Financial instruments
 Hedge accounting:
(3) Accounting procedures:
Cash flow hedge: Eligible only, if close relation
between hedge instrument and hedged item, formal
designation, hedge effectiveness given an more than
accidental
Gains and losses of hedged itemto show in equity
(cash flow hedge reserve), gains and losses of
hedging instrument to be shown in other
comprehensive income, if ineffective part existing, to
be shown in income statement
Dr. Th. Goswin
International Accounting Standards
62
31
IFRS 9: Financial instruments
 Hedge accounting:
(3) Accounting procedures:
Hedge of a net investment in a foreign operation:
Gain or losses on the hedging instrument shall be
recognized in other comprehensive income if
effective, in-effective part to be shown in income
statement
For hedging operations prior to first time application
of IFRS 9, Cash flow hedge reserve shall be
transferred to profit and loss
Dr. Th. Goswin
International Accounting Standards
63
IFRS 9: Financial instruments
 Hedge accounting:
(4) Disclose information about:
 an entity’s risk management and how it is applied
to current risk problems
 how the entity’s hedging activities may affect the
amount, timing and uncertainty of its future cash
flows
 the effect of the hedge accounting has on the
entity’s statement of financial positions (balance
sheet), statement of comprehensive income
(income statement) and statement of changes in
equity
Dr. Th. Goswin
International Accounting Standards
64
32
IFRS 9: Financial instruments
 Hedge accounting:
(4) Disclose information on Risk Management strategy,
explain

how risks arise

how the entity manages each risk (separately
for individual risks or the entirety of risks)

the extent of risk exposure the entity manages
Dr. Th. Goswin
International Accounting Standards
65
IFRS 9: Financial instruments
 Hedge accounting:
(4) Disclose information on the amount, timing and
uncertainty of future cash flow
For each category of risk exposure
quantitative information to analyze
disclose
- type of risk exposure, which is managed
- extend of hedging to every risk exposure
- effect of hedging to every risk exposure
Dr. Th. Goswin
International Accounting Standards
66
33
IFRS 9: Financial instruments
 Hedge accounting:
(4) Disclose information on the amount, timing and
uncertainty of future cash flow, in particular:
 amount or quantity (tons etc.) of risk to which
entity is exposed
 amount or quantity of risk, which is hedged
 how hedging changes the exposure to risk
 for each category a description of sources of
hedge ineffectiveness (currently and as a future
expectation)
Dr. Th. Goswin
International Accounting Standards
67
IFRS 9: Financial instruments
 Hedge accounting:
(4) Disclose of effects of hedge accounting on primary
financial statement, in tabular form, for fair value
hedge, cash-flow hedge and hedge of a net
investment (…)
- carrying amount of the hedging instruments, and
- notional amounts or other quantities (tons etc.)
related to hedging instrument
Dr. Th. Goswin
International Accounting Standards
68
34
IFRS 9: Financial instruments
 Hedge accounting:
(4) Disclose of effects of hedge accounting on primary
financial statement, in tabular form, for hedged items
•
For fair value hedges
•
Carrying amount of accumulated gains and losses
on the hedged items, presented in separate line in
balance sheet (statement of financial positions),
separating assets from liabilities
•
Balance remaining in balance sheet for hedges,
where hedging has been discontinued
Dr. Th. Goswin
International Accounting Standards
69
IFRS 9: Financial instruments
 Hedge accounting:
(4) Disclose of effects of hedge accounting on
primary financial statement, in tabular form, for
hedged items
•
For cash flow hedges
•
Balance in the cash flow hedge reserve (i.e.
Equity) for continuing hedges, when there was an
effect on income statement
•
Balance remaining in balance sheet for hedges,
where hedging has been discontinued
Dr. Th. Goswin
International Accounting Standards
70
35
IFRS 9: Financial instruments
 Hedge accounting:
(4) Disclose of effects of hedge accounting on primary
financial statement, in tabular form, for each
category of risk

For fair value-, cash flow-, and hedges of a net
investment (...)

Changes in the value of the hedging instrument
recognised in other comprehensisve income

Hedge ineffectiveness recognized in profit and
loss

A description of the items,
ineffectiveness is included
Dr. Th. Goswin
where
International Accounting Standards
hedge
71
IFRS 9: Financial instruments
 Hedge accounting:
(4) Disclose of effects of hedge accounting on primary
financial statement, in tabular form, for each
category of risk
•
For fair value hedges
•
Change of the value of the hedged item
Dr. Th. Goswin
International Accounting Standards
72
36
IFRS 9: Financial instruments
 Hedge accounting:
(4) Disclose of effects of hedge accounting on primary
financial statement, in tabular form, for each
category of risk

For cash flow-, and hedges of a net investment (...)

For hedges of net positions the hedging gains or
losses recognized in a separate line in the income
statement

Amount reclassified from cash flow hedge reserve
to profit and loss as a reclassification adjustment

Description of the line item in the income
statement, affected by reclassification
Dr. Th. Goswin
International Accounting Standards
73
IFRS 9: Financial instruments
 Hedge accounting:
(4) Disclose of effects of hedge accounting on primary
financial statement

A reconciliation calculation shall be given, that

Allows users to identify the different adjustments,
classifications and operations, which have an
effect on balance sheet, income statement,
statement of profit and loss, statement of other
comprehensive income and statement of changes
of equity
Dr. Th. Goswin
International Accounting Standards
74
37
Thank you for your attention
Thomas.Goswin@Bundesbank.de
Dr. Th. Goswin
International Accounting Standards
75
38