for Accounting Professionals
IFRS 9 FINANCIAL INSTRUMENTS
2011
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IFRS WORKBOOKS
(1 million downloaded)
Welcome to IFRS Workbooks! These are the latest versions of the legendary workbooks in Russian and English produced by 3 TACIS projects, sponsored by
the European Union (2003-2009) and led by PricewaterhouseCoopers. They have also appeared on the website of the Ministry of Finance of the Russian
Federation.
The workbooks cover various concepts of IFRS based accounting. They are intended to be practical self-instruction aids that professional accountants can use to
upgrade their knowledge, understanding and skills.
Each workbook is a self-standing short course designed for approximately of three hours of study. Although the workbooks are part of a series, each one is
independent of the others. Each workbook is a combination of Information, Examples, Self-Test Questions and Answers. A basic knowledge of accounting is
assumed, but if any additional knowledge is required this is mentioned at the beginning of the section.
Having written the first three editions, we want to update them and provide them to you to download. Please tell your friends and colleagues. Relating to the
first three editions and updated texts, the copyright of the material contained in each workbook belongs to the European Union and according to its policy may be
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as that of the European Union.
We wish to especially thank Elizabeth Appraxine (European Union) who administered these TACIS projects, Richard J. Gregson (Partner,
PricewaterhouseCoopers) who led the projects and all friends at Bankir.Ru for hosting the books.
TACIS project partners included Rosexpertiza (Russia), ACCA (UK), Agriconsulting (Italy), FBK (Russia), and European Savings Bank Group (Brussels). The help of
Philip W. Smith (editor of the third edition) and Allan Gamborg, project managers and Ekaterina Nekrasova, Director of PricewaterhouseCoopers, who managed
the production of the Russian version (2008-9) is gratefully acknowledged. Glyn R. Phillips, manager of the first two projects conceived the idea, designed the
workbooks and edited the first two versions. We are proud to realise his vision.
Robin Joyce
Professor of the Chair of
International Banking and Finance
Financial University
under the Government of the Russian Federation
Visiting Professor of the Siberian Academy of Finance and Banking
Moscow, Russia
2
2011
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CONTENTS
Introduction ................................................................................................................................................................... 5
Definitions ..................................................................................................................................................................... 6
Initial recognition and measurement of financial assets ................................................................................................ 7
Classification ................................................................................................................................................................ 8
Amortised Cost ............................................................................................................................................................. 9
Measurement.............................................................................................................................................................. 10
Investments in equity instruments (Special exception) ................................................................................................ 11
Classification of the undertaking’s business model for managing financial assets ...................................................... 12
Liquidation before maturity – put options .................................................................................................................... 14
Liquidation after maturity- extension option................................................................................................................. 15
Changes of timing or amounts of payment amounts ................................................................................................... 15
Measurement - Initial measurement of financial assets .............................................................................................. 16
Subsequent measurement of financial assets ............................................................................................................. 16
Investments in unquoted equity instruments ............................................................................................................... 17
Reclassification........................................................................................................................................................... 17
Gains and losses on foreign exchange ....................................................................................................................... 19
Collateral (including REPO’s) ..................................................................................................................................... 19
Fair value measurement (see IFRS 13) ...................................................................................................................... 20
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Financial Liabilities...................................................................................................................................................... 20
Credit-value adjustments ............................................................................................................................................ 23
Derecognition of financial assets and liabilities ........................................................................................................... 24
Bookkeeping for Financial Instruments ....................................................................................................................... 26
Securitisation .............................................................................................................................................................. 34
Embedded derivatives ................................................................................................................................................ 35
Separate financial instruments .................................................................................................................................... 35
Multiple Choice Questions .......................................................................................................................................... 37
Answers ...................................................................................................................................................................... 37
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IFRS 9 Financial Instruments
Introduction
IFRS 9 is replacing IAS 39
IFRS 9 will ultimately replace IAS 39 completely. As the IASB completes each phase, it will delete the relevant portions of IAS 39 and
create replacement chapters in IFRS 9.
Its effective date is 1 January 2013 (earlier application permitted).
Here are the chapters of IFRS 9 relating to the classification and measurement of financial assets and liabilities.
Main features of IFRS 9
IFRS 9 specifies how an undertaking should classify and measure financial assets, including some hybrid contracts. They require all
financial assets to be:
(i) classified on the basis of the undertaking’s business model for managing the financial assets and the contractual cash flow
characteristics of the financial asset.
(ii) initially measured at fair value plus particular transaction costs, except in the case of a financial asset at fair value through profit or
loss, when the transaction costs are expensed.
(iii) subsequently measured at fair value, or amortised cost.
The accounting for financial liabilities is unchanged from IAS 39, except that credit-value adjustments (see below) are generally
recorded through Other Comprehensive Income.
Objective and Scope
The objective of IFRS 9 is to establish principals for the reporting of financial assets and liabilities that will present relevant and useful
information to users of financial statements for their assessment of the amounts, timing and uncertainty of the undertaking’s future cash
flows.
An undertaking shall apply IFRS 9 to all assets and liabilities within the scope of IAS 39.
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Definitions
derecognition
derivative
fair value
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 (see
IFRS 13).
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.
The removal of a previously recorded
financial asset or financial liability from an
undertaking's statement of financial position.
A financial instrument, or other contract,
within the scope of IFRS 9 with all three of
the following characteristics.
financial liability A financial liability that meets either of the
at fair value
following conditions:
through profit or
loss
(i) It meets the definition of held for trading.
(i) Its value changes in response to the
change in a specified interest rate,
financial instrument price, commodity
price, foreign exchange rate, index of
prices or rates, credit rating or credit
index, or other variable, provided in
the case of a non-financial variable
that the variable is not specific to a
party to the contract (sometimes
called the 'underlying').
(ii) Upon initial recognition, it is designated
by the undertaking as at fair value through
profit or loss.
held for trading A financial asset or financial liability that:
(ii) It requires no initial net investment or
an initial net investment that is
smaller than would be required for
other types of contracts that would
be expected to have a similar
response to changes in market
factors.
(i) is acquired, or incurred, principally for
the purpose of selling, or settling, it in the
near term;
(ii) on initial recognition, is part of a
portfolio of identified financial instruments
that are managed together and for which
there is evidence of a recent actual pattern of
short-term profit-taking; or
(iii) It is settled at a future date.
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(iii) is a derivative (except for a financial
guarantee contract or a hedging instrument).
reclassification The first day of the first reporting period
date
following the change in business model that
results in an undertaking reclassifying
financial assets.
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 time frame
established generally by regulation, or
convention, in the marketplace concerned.
amortised cost of a financial asset or financial liability
(ii)
credit risk
(iii)
effective interest method
(iv)
equity instrument
(v)
financial asset
financial instrument
(vii)
financial liability
(viii)
hedged item
(ix)
hedging instrument
(x)
transaction costs.
Initial recognition and measurement of
financial assets
An undertaking shall record a financial asset in its statement of
financial position (balance sheet) only when the undertaking
becomes party to the contractual provisions of the instrument.
The following terms are defined in IAS 32, IAS 39 or IFRS 7:
(i)
(vi)
A financial asset shall be measured at fair value (the
standard situation) unless it is measured at amortised cost
(the exceptional situation).
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Classification
There are two basic aims of holding financial assets:
1. An undertaking can buy a financial asset that it plans to sell at a profit. To do so, there must be a future buyer and probably a market of
buyers. Such financial instruments will normally be valued at fair value, if the business model reflects this type of transaction. Most of its
profit comes from the resale, though some income may accrue from interest, or dividends, while it is held.
2. An undertaking can provide a loan to another party, hold it to maturity, collect the interest and principal repayments. Its profit is derived
from the client. It will normally be measured at amortised cost, but only if the business model reflects this type of transaction.
An undertaking will designate a financial asset as measured at fair value through profit or loss (‘FVTPL’), if this reflects the business
model. An undertaking may have more than one business model (different portfolios of financial instruments).
Also, it uses FVTPL if it eliminates, or significantly reduces, a measurement or recognition inconsistency (an ‘accounting mismatch’),
that would otherwise arise from measuring assets or liabilities, or recording the gains and losses on them, on different bases.
EXAMPLE: ACCOUNTING MISMATCH
Razilya’s bank provides mortgage loans to home owners, but finances them with
back-to-back loans. Both assets and liabilities are at variable interest rates. In order to match the assets, liabilities and their transaction
costs accurately, FVTPL may be a better method of accounting than amortised cost.
An undertaking shall classify financial assets as subsequently measured at either fair value or amortised cost on the basis of both:
(i) the undertaking’s business model for managing the financial assets; and
(ii) the contractual cash flow characteristics of the financial asset.
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Amortised Cost
Summary
Amortised cost can only be used if:
-the assets are debt instruments (not equity instruments) and
-the business model’s objective is to hold assets in order to collect contractual cash flows, and
-the cash flows that are solely payments of principal and interest, and
-there must not be an accounting mismatch that could be remedied by FVTPL.
Otherwise, Fair Value must be used.
Amortised cost is a misnomer. If the asset has a discount, or a premium, at the time of purchase, the discount or premium is amortised
over the asset life, using the effective interest rate.
The cost is never amortised.
No discount, no premium = no amortisation.
The discount (or premium) are included in the cost of the asset on purchase, then are progressively diminished by the amortisation until
they disappear at the maturity date.
Transaction costs will be included in the discount or premium, if they are material.
If there is no premium, nor discount, bookkeeping reflects giving of the loan, then the accruals of receipts of interest and principal.
A financial asset shall be measured at amortised cost if both of the following
conditions are met:
(i) the asset is held within a business model whose objective is to hold assets in
order to collect contractual cash flows.
(ii) the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and
interest on the principal amount outstanding. Also, there must not be an accounting mismatch that could be remedied by FVTPL.
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Interest is charge for the time value of money and for the credit risk.
Measurement
Initial measurement of financial assets:
At initial recognition, an undertaking shall measure a financial asset at its fair value. Transaction costs relating to the acquisition of the
financial asset will be added to this value ONLY if it will be measured at amortised cost. Otherwise, they are immediately expensed.
Subsequent measurement of financial assets
After initial recognition, an undertaking shall measure a financial asset at fair value, or amortised cost.
An undertaking shall apply the impairment requirements of IAS 39 to financial assets measured at amortised cost. Impairment charges
(and reversals) always go to profit or loss. (Fair value changes include any impairment, so no further work is necessary for fair value
bookkeeping.)
An undertaking shall apply the hedge accounting requirements in IAS 39 to a financial asset that is designated as a hedged item.
Gains and losses
A gain, or loss, on a financial asset that is measured at fair value shall be recorded in profit or loss.
A gain, or loss, on a financial asset that is measured at amortised cost shall be recorded in profit or loss when the financial asset is
derecognised, impaired or reclassified, and through the amortisation process.
A gain or loss on financial assets that are
(i) hedged items, or
(ii) accounted for, using settlement date accounting,
shall be recorded in accordance with IAS 39.
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Investments in equity instruments (Special exception)
At initial recognition, an undertaking may make an irrevocable election to present in other comprehensive income subsequent changes
in the fair value of an investment in an equity instrument within the scope of IFRS 9 that is not held for trading.
The gain, or loss, from changes in fair value that is presented in other comprehensive income includes any related foreign exchange
component.
(The bookkeeping transfers the gain, or loss, to a reserve in equity. The changes are reflected in other comprehensive income in the
financial statements.)
This election is made on an instrument-by-instrument (share-by-share) basis.
Investments in equity instruments not held for trading could be strategic holdings of shares in other companies, either with a view to a
future purchase of the entire undertaking, or held as part of a trading relationship, or a political requirement. Any changes in fair value
would be recorded in other comprehensive income until final disposal of the asset.
EXAMPLE: BP and ROSNEFT (Russia)
In 2011, oil companies BP and Rosneft proposed a joint venture which would have involved Rosneft owning 5% of BP’s shares and BP
owning 9.5% of Rosneft’s shares.
These strategic holdings (which would have been held for a number of years) would be suitable for this treatment. Both are listed
companies and their share prices change frequently, so gains and losses (including exchange gains and losses) would be recorded in
each period by both companies in other comprehensive income.
If an undertaking makes the election, it shall record dividends in profit or loss from that investment on an accruals basis, unless the
dividend clearly represents a recovery of part of the cost of the investment. (In such a case, the dividend would reduce the fair value
of the investment.)
Any impairment would also go to profit and loss.
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Amounts presented in other comprehensive income shall not be subsequently transferred to profit or loss. However, the undertaking may
transfer the cumulative gain, or loss, within equity to retained earnings.
Classification of the undertaking’s business model for managing financial assets
Based on the undertaking’s business model, IFRS 9 requires an undertaking to classify the financial assets as subsequently measured at
fair value, or amortised cost. The business model is determined by the undertaking’s key management.
There are two options: fair value or amortised cost models.
Amortised cost can only apply to debt instruments, not to equity portfolios. Fair value can apply to either debt or equity instruments, or to
a portfolio of both.
The business model overrides management’s intentions for an individual instrument. A single undertaking may have more than one
business model for managing its financial instruments.
EXAMPLE: TWO PORTFOLIOS
An undertaking 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 speculate. It will account for the two portfolios separately.
Although the objective of an undertaking’s business model may be to hold financial
assets in order to collect contractual cash flows, the undertaking need not hold all of
those instruments until maturity.
Thus an undertaking’s business model can be to hold financial assets to collect contractual cash flows even when sales of financial
assets occur.
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EXAMPLES: REASONS FOR ASSET SALES (holding financial assets to collect contractual cash flows)
The undertaking may sell a financial asset if:
(i) the financial asset no longer meets the undertaking’s investment policy (the
credit rating of the asset declines);
(ii) an investor adjusts its investment portfolio to reflect a change in the expected timing of payouts; or
(iii) an undertaking needs cash.
However, if frequent sales are made out of a portfolio, the undertaking needs to assess whether, and how, such sales are consistent with
an objective of collecting contractual cash flows.
Managing a portfolio of assets to realise fair value changes
If an undertaking actively manages (and/or measures) a portfolio of assets in order to realise fair value changes, its business model
would be considered a fair value model. The undertaking’s objective results in active buying and selling to realise fair value gains rather
than to collect the contractual cash flows.
Also, a portfolio of financial assets that are held for trading would be considered a fair value model.
Contractual cash flows that are solely payments of principal and interest on the principal
amount outstanding
An undertaking shall assess whether contractual cash flows are solely payments of
principal and interest on the principal amount.
Leverage (gearing) is a contractual cash flow characteristic of some financial assets. Leverage increases the variability of the contractual
cash flows with the result that they do not have the economic characteristics of interest.
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Options, forward and swap contracts are examples of financial assets that include leverage. Thus such contracts cannot be
(subsequently) measured at amortised cost.
Liquidation before maturity – put options
Contractual provisions that permit the issuer (the debtor) to prepay a debt instrument (such as a loan or a bond), or permit the holder (the
creditor) to put (resell) a debt instrument back to the issuer before maturity, result in contractual cash flows that are solely payments
of principal and interest on the principal amount outstanding only if:
(1) the provision is not contingent on future events, other than to protect:
(i) the holder against the credit deterioration of the issuer (such as defaults, credit downgrades or loan covenant violations), or a change
in control of the issuer; or
(ii) the holder, or issuer, against changes in relevant taxation or law; and
(2) the prepayment amount substantially represents unpaid amounts of principal and interest, which may include reasonable additional
compensation for the early termination of the contract.
EXAMPLE: PUT OPTION
Gulnara has a 10 year mortgage loan to buy a home. If she repays it early, she will have to pay the full amount outstanding, plus a
penalty. The penalty is based on the additional costs the lender to reorganise its finances as a result of the early repayment.
This loan would qualify as ‘solely payments of principal and interest’.
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Liquidation after maturity- extension option
Contractual provisions that permit the issuer, or holder, to extend the contractual term of a debt instrument (an extension option) result
in contractual cash flows that are solely payments of principal and interest on the principal amount outstanding only if:
(1) the provision is not contingent on future events, other than to protect:
(i) the holder against the credit deterioration of the issuer (eg defaults, credit downgrades or loan covenant violations) or a change in
control of the issuer; or
(ii) the holder or issuer against changes in relevant taxation or law; and
(2) the terms of the extension option result in contractual cash flows during the extension period that are solely payments of principal and
interest.
EXAMPLE: EXTENSION OPTION
Gulnara has a 10 year mortgage loan to buy a home. There is an extension option, for which she must pay a higher interest rate (if she
needs the extension). The higher rate reflects ‘the credit deterioration of the issuer’ – Gulnara would be a higher risk due to failing to
repay the loan in full, on time. The lender may also have additional costs to reorganise its finances as a result of the delay in repayment.
This loan would qualify as ‘solely payments of principal and interest’.
Changes of timing or amounts of payment amounts
A contractual term that changes the timing, or amount, of payments of principal
or interest does not result in contractual cash flows that are solely principal and
interest on the principal amount outstanding unless it:
(i) is a variable interest rate that is consideration for the time value of money
and the credit risk (which may be determined at initial recognition only); and
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(ii) if the contractual term is a prepayment option and meets the conditions above; or
(iii) if the contractual term is an extension option and meets the conditions above.
Measurement - Initial measurement of financial assets
The fair value of a financial asset at initial recognition is normally the transaction price.
However, if part of the price is for something other than the financial instrument, the fair value of the financial instrument is estimated
using a valuation technique.
EXAMPLE: VALUATION TECHNIQUE
The fair value of a long-term loan, or receivable, that carries no interest can be estimated as the present value of all future cash receipts,
discounted using the prevailing market rate(s) of interest for a similar instrument 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.
EXAMPLE: OFF-MARKET INTEREST RATE
If an undertaking originates a loan that bears an off-market interest rate (for example, 7 per cent when the market rate for similar loans is
10 per cent), and receives an upfront fee as compensation, the undertaking records the loan at its fair value (discounted at 10 per cent),
net of the fee it receives.
Subsequent measurement of financial assets
If a financial asset is measured at fair value and its fair value decreases below zero, it is a financial liability.
EXAMPLE: VALUE FALLS BELOW ZERO
Nadia has a swap contract. She will receive Yen in exchange for paying Roubles. The Rouble rises against the Yen, so she has to pay
on the contract. It becomes a financial liability.
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Investments in unquoted equity instruments (and contracts on those investments that must be
settled by delivery of the unquoted equity instruments)
In limited circumstances, cost may be an appropriate estimate of fair value. That may be the case if more recent information is lacking to
determine fair value.
An undertaking shall use all information about the performance and operations of the investee that becomes available after the date of
initial recognition. To the extent that any such relevant factors exist, they may indicate that cost might not (or may no longer be) be
representative of fair value.
In such cases, the undertaking must estimate fair value.
EXAMPLE: UNQUOTED EQUITY INSTRUMENTS
Marina’s bank buys some shares in a client company for 100 to secure some business. This is a rare purchase as the shares have
limited liquidity, causing adverse impacts on the bank’s liquidity ratios.
Fair value is taken as cost (100). Later, the company has problems and is restructured.
The shares are revalued at 60, using valuations based on anticipated discounted cash flows, and Marina’s bank records an impairment
charge of 40.
Cost is never the best estimate of fair value for investments in quoted equity instruments (or contracts on quoted equity instruments, such
as derivatives).
Reclassification
IFRS 9 requires an undertaking to reclassify financial assets if the undertaking’s business model for managing those financial assets
changes. Such changes are expected to be very infrequent.
Such changes must be determined as a result of external, or internal, changes significant to the undertaking’s operations and
demonstrable to external parties.
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If an undertaking reclassifies financial assets, it shall apply the reclassification prospectively from the reclassification date (onwards). The
undertaking shall not restate any previously recorded gains, losses or interest.
If an undertaking reclassifies a financial asset to be measured at fair value, its fair value is determined at the reclassification date. Any
gain, or loss, arising from a difference between the previous carrying amount and fair value is recorded in profit or loss.
If an undertaking reclassifies a financial asset to be measured at amortised cost, its fair value at the reclassification date becomes its new
carrying amount.
EXAMPLES: RECLASSIFICATION
Such changes could include the closure of a portfolio, or part of the business, and the transfer of assets from collecting contractual cash
flows to being held for sale.
A change in the objective of the undertaking’s business model must be effected (no new business written between the decision and the
reclassification date.)
EXAMPLE: RECLASSIFICATION AND CEASING TO WRITE NEW BUSINESS
A firm decides on 15 December to shut down its retail mortgage business and hence must reclassify all affected financial assets on 1
January (the first day of the undertaking’s next reporting period), the undertaking must not accept new retail mortgage business after 15
December.
The following are not changes in business model:
(i) a change in intention related to particular financial assets (even in
circumstances of significant changes in market conditions);
(ii) a temporary disappearance of a particular market for financial assets;
(iii) a transfer of financial assets between parts of the undertaking with different
business models.
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Gains and losses on foreign exchange
IAS 21 requires any foreign exchange gains, and losses, on monetary assets to be recorded in profit or loss. (An exception is a monetary
item that is designated as a hedging instrument in either a cash flow hedge, or a hedge of a net investment.)
If an undertaking recognises financial assets using settlement date accounting, any change in the fair value of the asset to be received
during the period between the trade date and the settlement date is not recognised for assets measured at amortised cost (other than
impairment losses).
For assets measured at fair value, however, the change in fair value shall be recognised in profit or loss, or in other comprehensive
income.
Collateral (including REPO’s)
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 (borrower) and transferee (lender) shall account for the collateral as follows:
(i) If the transferee has the right to sell, or repledge, the collateral, then the transferor shall reclassify that asset in its statement of
financial position (for example, as a loaned asset, pledged equity instruments or repurchase receivable) separately from other assets. It
will be matched by a liability in favour of the transferor.
(ii) If the transferee sells collateral pledged to it, it shall recognise the proceeds from the sale, and a liability measured at fair value,
for its obligation to return the collateral.
(iii) If the transferor defaults under the terms of the contract and is no longer entitled to redeem the collateral, it shall derecognise the
collateral, and the transferee shall recognise the collateral as its asset initially measured at fair value or, if it has already sold the
collateral, derecognise its obligation to return the collateral.
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(iv) Except as provided in (iii), the transferor (borrower) shall continue to carry the collateral as its asset, and the transferee (lender)
shall not recognise the collateral as an asset.
Fair value measurement (see IFRS 13)
In determining the fair value of a financial asset or a financial liability, an undertaking shall apply IFRS 13:
Fair value hierarchy
The hierarchy categorises the inputs used in valuation techniques into three levels.
The hierarchy gives the highest priority to (unadjusted) quoted prices in active markets for identical assets or liabilities and the
lowest priority to unobservable inputs.
If the inputs are categorised into different levels of the fair value hierarchy, the fair value measurement is categorised in its entirety in
the level of the lowest level input that is significant to the entire measurement (based on the application of judgement).
Financial Liabilities
Classification of financial liabilities
An undertaking shall classify all financial liabilities as subsequently measured at amortised cost using the effective interest method,
except for:
(1) financial liabilities at fair value through profit or loss. Such liabilities, including derivatives that are liabilities, shall be subsequently
measured at fair value.
(2) financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition, or when the continuing
involvement approach applies.
(3)
financial guarantee contracts. After initial recognition, an issuer of such a contract shall subsequently measure it at the higher of:
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(i)
the amount determined in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets and
(ii)
the amount initially recognised less, when appropriate, cumulative amortisation recognised in accordance with IAS 18 Revenue.
(4) commitments to provide a loan at a below-market interest rate (often to related parties). After initial recognition, an issuer of such
a commitment shall subsequently measure it at the higher of:
(i)
the amount determined in accordance with IAS 37 and
(ii)
the amount initially recognised less, when appropriate, cumulative amortisation recognised in accordance with IAS 18.
Option to designate a financial liability at fair value through profit or loss
An undertaking may, at initial recognition, irrevocably designate a financial liability as measured at fair value through profit or loss when
doing so results in more relevant information, because either:
(i) it 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; or
(ii) a group of financial liabilities, or financial assets and financial liabilities is managed and its performance is evaluated on a fair
value basis, in accordance with a documented risk management or investment strategy, and information about the group is provided
internally on that basis to the undertaking's key management.
An undertaking shall not reclassify any financial liability.
The following changes in circumstances are not reclassifications:
(i)
A derivative that was previously a designated and effective hedging instrument in a cash flow hedge, or net investment, hedge no
longer qualifies as such.
(ii)
A derivative becomes a designated and effective hedging instrument in a cash flow hedge, or net investment, hedge.
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The fair value of a financial liability with a demand feature (such as a demand deposit) is not less than the amount payable on demand,
discounted from the first date that the amount could be required to be paid.
Liabilities designated as at fair value through profit or loss
An undertaking shall present a gain, or loss, on a financial liability designated as at fair value through profit or loss as follows:
(i)
The amount of change in the fair value of the financial liability that is attributable to changes in the credit risk of that liability shall be
presented in other comprehensive income, and
(ii)
the remaining amount of change in the fair value of the liability shall be presented in profit or loss
unless the treatment of the effects of changes in the liability's credit risk described in (i) would create, or enlarge, an accounting
mismatch in profit or loss.
EXAMPLES: LIABILITIES CHANGING IN VALUE
The idea that liabilities would fluctuate in value may not be immediately apparent.
They may change if they are denominated in a foreign currency and that currency moves in relation to the reporting currency. There
may be a liability for a commodity, or a derivative of a commodity. Also, a trader may have sold a security that he/she does not yet own
(a ‘short sale’) and plans to buy one at a lower price to fulfil the sale.
In such cases, these changes in value would be recorded in profit and loss.
Credit-value adjustments (see below) relate to the credit risk, and are recorded in other comprehensive income.
If the requirements would create, or enlarge, an accounting mismatch in profit or loss, an undertaking shall present all gains or losses
on that liability (including the effects of changes in the credit risk of that liability) in profit or loss.
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An undertaking shall present in profit or loss all gains, and losses, on loan commitments and financial guarantee contracts that are
designated as at fair value through profit or loss.
Credit-value adjustments
Credit-value adjustments have been used by many banks, though can be used by any company with financial liabilities, turning credit
rating downgrades into profits. The issue relates to bonds that they have issued which have a market price.
The idea is that if you have a liability of 100 and can settle it for 80, then you have made a realised profit of 20. (Realised profit is fine; it is
the next step which lacks integrity.)
This is then extended to the situation when you have not settled the liability, but the market price is 80 (maybe due to foreign exchange
fluctuations, or perceived increased risk of your company). In this case, IFRS enables you to mark the liability to the market price and
recognise a gain.
Credit-value adjustments relate to the special case of bonds (liabilities) issued by the banks themselves. If our bank has issued a bond
worth 100 with a 10% coupon, then a rise in market interest rates to (say) 15% will make the bond less attractive to investors and it will
probably be priced at a discount. The bank has a choice to buy it in the market (if it has the cash available) and make a profit, or wait until
the bond matures and pay 100 to the investor.
Credit-value adjustments - gains are a fallacy
Such a gain is a fallacy. If a rise in market rates to 15% had caused the fall in the price of bonds, the bank would have to borrow money
at 15% to redeem the 10% bond. Thus, an immediate profit would have to be matched with increased interest payments of 15%,
contrasted with the current cost of 10%.
If the bond is trading at a discount because the bank’s reputation is damaged and there is a perceived risk of default of the bond, the
bank could only raise finance at (say) 18-20% to buy back the bond, and would be saddled with future interest payments of 18-20%,
instead of 10%.
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Derecognition of financial assets and liabilities
A financial asset is derecognised when it is sold, cancelled or expires.
An undertaking shall remove a financial liability (or a part of a financial liability) from its statement of financial position only when it is
extinguished - when the obligation specified in the contract is discharged, or cancelled or expires.
In general, derecognition of a financial asset, or a liability, is achieved when the asset is sold, or the liability is settled.
If an asset is sold with some ongoing commitment (risk and/or reward), such as a guarantee, or a commitment to repurchase (a ‘REPO’)
derecognition in full may not be permitted. A REPO should be treated as a loan with collateral, not a sale and repurchase.
If the seller of the financial asset sells it and then collects cash relating to the asset, as an agent for the new owner, derecognition is
allowed. The agent must promptly pass cash to the new owner and must not be liable to the new owner for any amounts that the agent
has not received relating to the asset. There must not be any further risk in relation to the asset.
Problems arise if a liability is only partially settled, is transferred with recourse – if the transferee does not pay, you will have to do soand where some risks and rewards relating to the liability remain. The continuing commitments must be recorded.
Such problems were prevalent in the 2008 financial crisis. Financial institutions found that assets and liabilities that they had
derecognised, sometimes to off-balance-sheet
vehicles, presented them with further, unforeseen risks (and a few rewards).
The second IAS 32/39 workbook (on our website) looks in depth at Derecognition.
An exchange between an existing borrower and lender of debt instruments with substantially different terms shall be accounted for as
an extinguishment of the original financial liability and the recognition of a new financial liability.
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EXAMPLE: DEBT INSTRUMENTS WITH SUBSTANTIALLY DIFFERENT TERMS
A member country of the Euro group is unable to pay the principal of its (3,5%) 5 year bond and replaces it with a 30 year bond paying
6%. The new bond should be considered as a new financial liability and the original bond derecognised when all holders have agreed to
the changes.
Similarly, a substantial modification of the terms of an existing financial liability, or a part of it (whether or not attributable to the financial
difficulty of the debtor) shall be accounted for as an extinguishment of the original financial liability and the recognition of a new financial
liability.
The difference between the carrying amount of a financial liability (or part of a financial liability) extinguished, or transferred to another
party, and the consideration paid, including any non-cash assets transferred, or liabilities assumed, shall be recognised in profit or loss.
If an undertaking repurchases a part of a financial liability, the undertaking shall allocate the previous carrying amount of the financial
liability between the part that continues to be recognised and the part that is derecognised, based on the relative fair values of those
parts on the date of the repurchase.
The difference between (i) the carrying amount allocated to the part derecognised and (ii) the consideration paid, including any noncash assets transferred or liabilities assumed, for the part derecognised shall be recognised in profit or loss.
A gain, or loss, on a financial liability that is measured at amortised cost (and is not part of a hedging relationship) shall be recognised
through the amortisation process and when the financial liability is derecognised in profit or loss.
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Bookkeeping for Financial Instruments
(These comparisons only apply to bookkeeping: several classifications have changed.)
Summary (IFRS 9 comparisons with IAS 39)
1. Bookkeeping Unchanged from IAS 39
-FVTPL Assets
-FVTPL Liabilities (except Credit-value adjustments which are generally recorded through Other Comprehensive Income)
-Other Liabilities
2. Amortised cost (amortisation of discount and premium)
Identical to IAS 39 Loans and Receivables and Held to Maturity
3. Fair Value through Other Comprehensive Income
Identical to IAS 39 Available for Sale (debt instruments– impairments can be reversed), except that transaction costs are expensed.
Notes:
1. Available for Sale, Loans and Receivables and Held to Maturity classifications from IAS 39 have all disappeared in IFRS 9.
2. The cost model of IAS 39 is now accounted for under FVTPL.
Transaction costs are expensed.
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DETAILED BOOKKEEPING EXAMPLES
4. Interest received 4
In the following examples,
I/B refers to Income Statement and Balance Sheet (Statement of Financial
Position).
EXAMPLE - Financial assets at fair value through profit and loss
1. Financial assets at fair value through profit and loss
Cash
Interest received
1. Buy asset for 60 + 5 transaction costs
5. Asset revalued to 70
Asset
Transaction costs
Cash
DR
CR
Asset
Revaluation income
60
5
4
I/B
B
I
DR
CR
37
37
6. Asset sold for 79
EXAMPLE - Financial assets at fair value through profit and loss
EXAMPLE - Financial assets at fair value through profit and loss
I/B
B
I
DR
CR
Cash
Profit on sale of asset
3
3
Asset
3. Impairment reduces value to 33
I/B
I
B
DR
I/B
B
I
DR
CR
79
B
Note: Financial assets at fair value through profit and loss:
No change from IAS 39
EXAMPLE - Financial assets at fair value through profit and loss
Revaluation expense
Asset
CR
4
65
2. Revalue to 63
Asset
Revaluation income
DR
EXAMPLE - Financial assets at fair value through profit and loss
EXAMPLE - Financial assets at fair value through profit and loss
I/B
B
I
B
I/B
B
I
CR
30
30
27
9
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2. Equity instrument not held for trading
4. Dividend received 4
1. Buy asset for 60 + 5 transaction costs
EXAMPLE - Equity instrument not held for trading
EXAMPLE - Equity instrument not held for trading
Cash
Dividend received
Asset
Transaction costs
Cash
I/B
B
I
B
DR
60
5
CR
4
4
5. Asset revalued to 70
65
EXAMPLE - Equity instrument not held for trading
Asset
Reversal of Impairment of equity instrument
Revaluation gain -equity
EXAMPLE - Equity instrument not held for trading
I/B
B
B
DR
CR
2. Revalue to 63
Asset
Revaluation gain -equity
I/B
B
I
DR
I/B
B
I
B
DR
CR
37
30
7
CR
3
3
6. Asset sold for 79
EXAMPLE - Equity instrument not held for trading
3. Impairment reduces value to 33
EXAMPLE - Equity instrument not held for trading
Impairment of equity instrument
Asset
I/B
I
B
DR
Asset
Revaluation gain –equity
Cash
Asset
Revaluation gain –equity - transfer
Retained earnings (NOT profit and loss)
CR
30
30
(Note: 3 might be charged against the revaluation gain,
27 to the Income Statement as an alternative.)
I/B
B
B
B
B
B
B
DR
CR
9
9
79
79
10
Note: Equity instrument not held for trading:
The bookkeeping is the same as an available for sale debt instrument
under IAS 39,
though the classification is different. However, transaction costs are
expensed.
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3. Amortised Cost – Amortisation of Discount – Loan
Year
1
2
3
4
5
Opening
Value
93400
94533
95753
97066
98479
Cash
Interest
6000
6000
6000
6000
6000
Amortisation
of discount
1133
1220
1313
1413
1521
Effective
Interest
7133
7220
7313
7413
7521
Deferred commission
Commission
Closing
Value
94533
95753
97066
98479
100000
Effective
Interest
Rate
7,64%
7,64%
7,64%
7,64%
7,64%
EXAMPLE - Amortised Cost – Amortisation of Discount
I/B
DR
Cash
B
6.000
Interest receivable
I
Deferred commission
B
1.220
Commission
I
1.133
CR
6.000
1.220
End of year 3
EXAMPLE - Amortised Cost – Amortisation of Discount
I/B
DR
Cash
B
6.000
Interest receivable
I
Deferred commission
B
1.313
Commission
I
Galina, the client, pays commission of 6.600 on day 1 for the loan.
She therefore receives only 93.400 in cash, a discount of 6.600.
This commission forms part of the effective interest rate – an effective rate of
7,64%.
CR
6.000
1.313
End of year 4
The discount is amortised in Elena’s books over the period of the loan, using
the effective interest rate (7.64%).
EXAMPLE - Amortised Cost – Amortisation of Discount
I/B
DR
Cash
B
6.000
Interest receivable
I
Deferred commission
B
1.413
Commission
I
CR
93.400
6.600
End of year 1
EXAMPLE - Amortised Cost – Amortisation of Discount
I/B
DR
Cash
B
6.000
Interest receivable
I
1.133
End of year 2
Elena issues a 5-year loan at 6% interest. Interest is paid at the end of each
year.
Accounting on Day 1
EXAMPLE - Amortised Cost – Amortisation of Discount
I/B
DR
Loan - Galina
B
100.000
Cash
B
Deferred commission
B
B
I
CR
6.000
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CR
6.000
1.413
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End of year 5
EXAMPLE - Amortised Cost – Amortisation of Discount
I/B
DR
Cash
B
106.000
Interest receivable
I
Loan - Tamara
B
Deferred commission
B
1.521
Commission
I
Accounting on Day 1
EXAMPLE - Amortised Cost – Amortisation of Premium
I/B
DR
Bond
B
100.000
Bond premium
B
6.600
Cash
B
CR
6.000
100.000
CR
106.600
End of year 1
1.521
EXAMPLE - Amortised Cost – Amortisation of Premium
I/B
DR
Cash
B
6.000
Interest receivable
I
Interest expense
I
1.203
Bond premium
B
Note: Amortised Cost – Amortisation of Discount –
The bookkeeping is the same as either Loans and Receivables or
Held to Maturity under IAS 39
4. Amortised Cost – Amortisation of Premium – Bond
CR
6.000
1.203
End of year 2
Yea
r
1
2
3
4
5
Openin
g Value
106600
105397
104140
102826
101453
Cash
Interest
6000
6000
6000
6000
6000
Amortisation
of premium
-1203
-1257
-1314
-1373
-1454
Effective
Interest
4797
4743
4686
4627
4546
Closing
Value
105397
104140
102826
101453
100000
Effectiv
e
Interest
Rate
4,5%
4,5%
4,5%
4,5%
4,5%
EXAMPLE - Amortised Cost – Amortisation of Premium
I/B
DR
Cash
B
6.000
Interest receivable
I
Interest expense
I
1.257
Bond premium
B
CR
6.000
1.257
End of year 3
EXAMPLE - Amortised Cost – Amortisation of Premium
I/B
DR
Cash
B
6.000
Interest receivable
I
Interest expense
I
1.314
Bond premium
B
Anna buys a 5-year listed bond for 106.600, paying a premium of 6.600 as it
has a face value of 100.000.
The bond pays 6% interest at the end of each year. Anna paid the premium as
6% is an attractive rate of interest compared to other similar investments.
Anna will hold the bond to maturity. She will amortise the premium over the
life of the bond. Her effective interest rate is 4,5% after adjusting for the
premium.
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CR
6.000
1.314
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End of year 4
EXAMPLE - Financial liability at fair value through profit and loss
EXAMPLE - Amortised Cost – Amortisation of Premium
I/B
DR
Cash
B
6.000
Interest receivable
I
Interest expense
I
1.373
Bond premium
B
CR
Commodity liability
Revaluation income
I/B
B
I
DR
CR
2
2
6.000
3. Commodity liability revalued to 33
1.373
EXAMPLE - Financial liability at fair value through profit and loss
End of year 5
EXAMPLE - Amortised Cost – Amortisation of Premium
I/B
DR
Cash
B
106.000
Interest receivable
I
Bond
B
Interest expense
I
1.454
Bond premium
B
Commodity liability
Revaluation income
CR
I/B
B
I
DR
CR
30
30
6.000
100.000
4. Commodity liability revalued to 70
1.454
EXAMPLE - Financial liability at fair value through profit and loss
Note: Amortised Cost – Amortisation of Premium –
The bookkeeping is the same as either Loans and Receivables or
Held to Maturity under IAS 39
Revaluation expense
Commodity liability
5. Financial liability at fair value through profit and loss
Olga’s bank has a (forward position) liability for a commodity contract. The
commodity is listed on a commodity exchange.
I/B
I
B
DR
CR
37
37
5. Commodity liability settled for 79
EXAMPLE - Financial liability at fair value through profit and loss
1. Client pays Olga 65 to take on the liability
EXAMPLE - Financial liability at fair value through profit and loss
Cash
Commodity liability
I/B
B
B
DR
Commodity liability
Loss on settlement of liability
I/B
B
I
DR
CR
70
9
CR
65
Cash
B
65
Note: Financial liability at fair value through profit and loss –
Same bookkeeping as under IAS 39
2. Revalue to 63
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6. Other Financial liability - Amortisation of Discount – Amortised Cost
Effectiv
e
Amortisation
Yea
Openin
Cash
Effective
Closing Interest
of discount
r
g Value Interest
Interest
Value
Rate
1133
1
93400
6000
7133
94533
7,64%
1220
2
94533
6000
7220
95753
7,64%
1313
3
95753
6000
7313
97066
7,64%
1413
4
97066
6000
7413
98479
7,64%
1521
5
98479
6000
7521 100000
7,64%
End of year 2
Katya’s bank issues a 5-year bond that will pay interest of 6% at the end of
each year.
On the date of issue, interest rates for similar instruments rise and she issues
the bond at a discount of 6.600. This lifts the effective interest rate to 7,64%.
Katya will amortise the premium over the life of the bond using the effective
interest rate of 7,64%.
End of year 3
EXAMPLE - Other Financial liability – Amortisation of Discount –
Amortised Cost
Interest paid
Cash
Interest paid
Bond discount
I/B
I
B
I
B
DR
6.000
CR
6.000
1.220
1.220
EXAMPLE - Other Financial liability – Amortisation of Discount –
Amortised Cost
Interest paid
Cash
Interest paid
Bond discount
Accounting on Day 1
EXAMPLE - Other Financial liability – Amortisation of Discount –
Amortised Cost
I/B
I
B
I
B
DR
6.000
CR
6.000
1.313
1.313
End of year 4
Cash
Bond discount
Bond
I/B
B
B
B
DR
93.400
6.600
CR
EXAMPLE - Other Financial liability – Amortisation of Discount –
Amortised Cost
100.000
Interest paid
Cash
Interest paid
Bond discount
End of year 1
EXAMPLE - Other Financial liability – Amortisation of Discount –
Amortised Cost
Interest paid
Cash
Interest paid
Bond discount
I/B
I
B
I
B
DR
6.000
CR
6.000
1.133
1.133
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I/B
I
B
I
B
DR
6.000
CR
6.000
1.413
1.413
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End of year 5
Interest paid
Cash
Interest paid
Bond discount
EXAMPLE - Other Financial liability – Amortisation of Discount –
Amortised Cost
Bond
I/B
B
DR
100.000
CR
I
B
I
B
6.000
106.000
1.521
1.521
Note: - Other Financial liability – Bookkeeping the same as under IAS 39
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Securitisation
An undertaking has a business model with the objective of originating loans to
clients and subsequently selling those loans to a securitisation vehicle (a separate legal undertaking that may, or may not, be controlled
by the undertaking) .
Securitisation is a lenders’ method of selling loans (and other future cash flows) to third parties, in order to receive immediate cash. For
financial institutions with legislated minimum capital requirements, it enables them to recycle the capital, dedicated to the original loans,
to make new loans.
The securitisation vehicle issues instruments to investors, who buy them in exchange for future cash flows.
The undertaking originated the loans with the objective of selling them: it would be considered a fair value model.
Securitisation - Contractually linked instruments
In some types of transactions (especially in securitisations), an undertaking may prioritise payments to the holders of financial assets
using multiple, contractually-linked instruments that create concentrations of credit risk (tranches). Each tranche has a ranking that
specifies the order in which any cash flows generated by the issuer are allocated to the tranche.
In such situations, the holders of a tranche have the right to payments of principal and interest on the principal amount outstanding only if
the issuer generates sufficient cash flows to satisfy higher-ranking tranches.
In such transactions, a tranche has cash flow characteristics that are payments of
principal and interest on the principal amount outstanding only if:
(i) the contractual terms of the tranche being assessed for classification give rise to cash flows that are solely payments of principal and
interest on the principal amount outstanding (eg the interest rate on the tranche is not linked to a commodity index);
and
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(ii) the exposure to credit risk in the underlying pool of financial instruments inherent in the tranche is equal to, or lower than, the
exposure to credit risk of the underlying pool of financial instruments (for example, this condition would be met if the underlying pool of
instruments were to lose 50 per cent as a result of credit losses and, under all circumstances, the tranche would lose 50 per cent or less).
An undertaking must look through until it can identify the underlying pool of instruments that are creating (rather than passing through)
the cash flows. This is the underlying pool of financial instruments.
The underlying pool must contain one, or more, instruments that have contractual cash flows that are solely payments of principal and
interest on the principal amount outstanding.
Embedded derivatives
An embedded derivative is 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 causes some, or all, of the cash flows of the contract to be modified. This may be according to a specified
interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or
other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract.
If a hybrid contract contains a host that is within the scope of IFRS 9, IFRS 9 applies to the entire hybrid contract.
Separate financial instruments
If 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 under IFRS 9 only if:
(i)
the characteristics and risks of the embedded derivative are not closely related to the characteristics and risks of the host;
(ii)
a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and
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(iii) the hybrid contract is not measured at fair value with changes in fair value recognised in profit or loss (a derivative that is
embedded in a financial liability at fair value through profit or loss is not separated).
If an embedded derivative is separated, the host contract shall be accounted for in accordance with the appropriate IFRSs.
However, if a contract contains one, or more, embedded derivatives and the host is not an asset within the scope of IFRS 9, an
undertaking may designate the entire hybrid contract as at fair value through profit or loss unless:
(i)
the embedded derivative(s) do(es) not significantly modify the cash flows that otherwise would be required by the contract; or
(ii) it is clear with little, or no, analysis when a similar hybrid instrument is first considered that separation of the embedded
derivative(s) is prohibited, such as a prepayment option embedded in a loan that permits the holder to prepay the loan for approximately
its amortised cost.
If an undertaking is required by IFRS 9 to separate an embedded derivative from its host, but is unable to measure the embedded
derivative separately, either at acquisition, or at the end of a subsequent financial reporting period, it shall designate the entire hybrid
contract as at fair value through profit or loss.
If an undertaking is unable to determine reliably the fair value of an embedded derivative on the basis of its terms and conditions,
the fair value of the embedded derivative is the difference between the fair value of the hybrid contract and the fair value of the host,
if those can be determined under IFRS 9. If the undertaking is unable to determine the fair value of the embedded derivative using this
method, the hybrid contract is designated as at fair value through profit or loss.
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(ii) Must show gains and losses in Other Comprehensive
Income.
(iii) May show gains and losses in Other Comprehensive
Income
if the instrument is not held for trading.
Multiple Choice Questions
1. Amortised cost relates to:
(i) Equity instruments
(ii) Debt instruments
(iii) Equity and debt instruments
8. Cost can be used as the basis for fair value for unquoted
instruments:
(i) True
(ii) False
2. Under amortised cost, what is amortised:
(i) Cost
(ii) Any discount or premium.
9. A busines may have
(i) Only one portfolio of financial instruments
(ii) One or more portfolios of financial instruments
3. To avoid accounting mismatches, which system should be
used:
(i) Fair value
(ii) Amortised cost
10. Most derivatives are accounted for under:
(i)
FVTPL
(ii)
Amortised cost
4. In determining classification, which is more important:
(i) Character of cash flows
(ii) Business model
Answers
5. Transaction costs for Fair Value are:
(i) Expensed
(ii) Added to the value of the instrument
1. ii
2. ii
3. i
4. ii
5. i
6. ii
7. iii
8. i
9. ii
10. i
6. Transaction costs for Amortised Cost are:
(i) Expensed
(ii) Added to the value of the instrument
7. Investments in equity instruments:
(i) Must show gains and losses in profit and loss
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