IFRS 9: Financial Instrumentsby
This standard was released in November 2009 and is intended to completely replace IAS 39 Financial Instruments: Recognition and Measurement by the end of 2010.
IFRS 9 only deals with the classification and measurement of financial assets. A consistent theme of IFRS 9 is that it requires financial assets to be classified on initial recognition at amortised cost or fair value.
Financial assets are measured at amortised cost dependant on how the entity manages its financial instruments in its business model (see below). If the entity’s business model is to hold financial assets in order to collect contractual cash flows, the financial asset can be measured at amortised cost.
However, the contractual terms must give rise (on specified dates) to cash flows that are solely payments of capital and interest on the capital amount outstanding. The financial asset concerned cannot be recognised at amortised cost if the entity intends to sell it to realise its fair value changes. IFRS 9 does contain several examples to illustrate this condition.
Any other financial asset that does not meet this criteria is measured at fair value.
Management and key personnel are responsible for the entity’s business model in relation to how it manages its financial instruments. Management and key personnel are dealt with, and defined, in IAS 24 Related Party Disclosures. This approach was considered appropriate by the IASB because it aligns the accounting for financial assets with the same way the entity deploys the assets in the business.
Categories of Financial Assets
IFRS 9 does not consider held-to-maturity assets and available-for-sale assets.
Under IFRS 9, embedded derivatives are no longer separated from hybrid contracts that have a financial asset host. Instead, the entire hybrid contract is assessed for classification using the principles above.
Fair Value Option
IFRS 9 allows entities to designate a financial instrument on initial recognition at fair value through profit or loss, even if it meets the criteria for recognition at amortised cost. Care must be taken to apply the option when appropriate because the option to measure at fair value should only be exercised where it eliminates, or significantly reduces, a measurement or recognition inconsistency, often referred to as an ‘accounting mismatch’.
Where an entity changes its business model and the change is significant to the entity’s operations and demonstrable to third parties, reclassification of the financial asset from fair value through profit or loss to amortised cost or vice versa should take place. Such situations are considered rare but if it is done, it should be done prospectively from the date of reclassification. Any gains, losses or interest are not restated.
Investments in Equity Instruments
Under IFRS, an entity will prepare the statement of comprehensive income which comprises the income statement but with an added statement being the ‘statement of comprehensive income’. Other comprehensive income contains any gains or losses which have been taken in the statement of financial position (balance sheet) which would traditionally be reported in the statement of recognised income and expenses (SoRIE) such as gains on property revaluations and actuarial gains and losses on defined benefit pension schemes.
Where an entity has shares in other entities (investments in equity instruments), these should be measured at fair value. Where investments in equity instruments are subsequently remeasured, any gains or losses on remeasurement are recognised in profit or loss. Dividends on investments in equity instruments which are not held-for-trading are recognised in profit or loss as opposed to other comprehensive income. This is consistent with the approach in IAS 18 Revenue provided that none of the dividend represents recovery of the investment.
IFRS 9 stipulates that all investments in unquoted equity instruments are measured at fair value.
One single method of impairment is considered in IFRS 9. Several methods are considered in IAS 39.
Changes in Fair Value
Any changes in the fair value of financial assets are recognised in profit or loss. Equity investments which exercise the option to recognise such changes in other comprehensive income should not be measured in profit or loss. This also applies to any gains or losses relating to financial assets that are also part of a hedging relationship.
About the author:
Steve Collings FMAAT ACCA DipIFRS is Audit Manager at Leavitt Walmsley Associates www.lwaltd.com. Read all of Collings's analyses of the International Financial Reporting Standards.