Background
IFRS
9 financial Instruments is that the IASB’s replacement of IAS 39 (Financial
Instruments: Recognition and Measurement). This standard shall be applied by
all entities to all or any forms of financial instruments except the exceptions
dominated by different accounting standards (refer 'Scope of IFRS 9' for more details).
It’s
effective from annual periods starting on or after 1 Jan 2018 with early
application allowable.
Coverage
The
following areas are considered by IFRS 9:-
1. Recognition and measurement of financial instrument: Initial recognition,
classification and measurement of financial assets,
financial liabilities, and some contracts to buy or sell non-financial items.
2. Derecognition- The derecognition model in IFRS 9 is carried over unchanged from
IAS 39
3.
Impairment
4.
Hedge
accounting
##Recognition
and measurement of financial instrument-
Initial
recognition:
An entity shall recognize a financial asset or a financial
liability in the statement of financial position when the entity becomes a
party to the contractual provisions of the instrument. A regular way
purchase or sale of financial assets (trade receivable/payable) shall be
recognized either on trade date or on settlement date.
Classification:
IFRS 9 classifies financial instruments as below:
Financial
asset: - Entity
recognizes a financial asset based on the entity’s business
model for
managing the asset and the asset’s contractual
cash flow (SPPI
test) characteristics, as follows
- Amortised cost—Any financial
asset can be measured at amortised cost if the following both conditions
are met:
- Business model
test - Asset is being
hold within a business model whose objective is to hold assets in to receive
contractual cash flows; and
- Contractual
cash flow test – When contractual
terms of the financial asset give rise on specified dates to cash flows
that are solely payments of principal and interest on the remaining principal
amount.
In simple words, if asset is held to maturity {held to collect)
then that will fall under Amortised cost. For example:- Trade receivable, bonds
held at maturity, simple loan etc.
- Fair value through
other comprehensive income (FVOCI)—financial assets should be classified and
recognised at fair value through other comprehensive income when the asset
will be hold in a business model whose purpose is to achieve both = collecting
contractual cash flows + selling
financial assets.
In simple words, if asset is available for sale then will fall
under FVOCI. For example:- Debt, equity classified as FVOCI etc.
- Fair value through
profit or loss (FVTPL)—any residual financial assets will be measured at
fair value through profit or loss.
In
simple words, if any asset doesn’t fall under above two then will consider as
FVTPL. For example- equity classified as FVTPL etc.
Refer below diagram for quick glimpse:
ð Reclassification: It will happen only when the entity changes its business
model for handling the financial assets. Then, it should be reclassifying all affected financial
assets.
Financial liability:- It can be allocated in below
categories-
# Amortised Cost- All financial liabilities are measured at
amortised cost, except for financial liabilities at fair value through profit
or loss.
#Fair value through profit or loss(FVTPL)- The term liability includes derivatives
(other than derivatives that are financial guarantee contracts or are
designated and effective hedging instruments), other liabilities held for
trading, and liabilities that an entity considerd to be recognized at fair value
through profit or loss (see ‘fair value option’ below).
ð
Reclassification: Post initial recognition, company cannot
reclassify any of its financial liability.
Measurement:
Initial measurement:
Financial asset or financial liability shall be first measured at:
- Fair value: all financial instruments should be measured at fair value through profit or loss;
- Fair value plus or minus transaction cost: all other financial instruments (at amortized cost or fair value through other comprehensive income).
Subsequent
Measurement:
Subsequent measurement based on the classification of financial instrument:-
- Financial
assets will be further recognised either at fair value or at amortized
cost;
- Financial
liabilities will be recognised at amortized cost unless until the fair value option is considered.
Refer
below diagram for quick glimpse:
# NOTES TO TAKE #
1.
Fair value option: IFRS
9 contains an option to designate FVTPL. An entity may, at initial recognition,
irrevocably designate any financial asset or liability to be measured at fair
value through profit or loss (FVTPL) if doing so would eliminate or
significantly reduce an inconsistency in measurement or recognition (sometimes referred
to as "mismatch" accounting "') or otherwise results in more
relevant information.
2.
Equity instrument: all
equity investments in the scope of IFRS 9 must be measured at fair value in the
statement of financial position, with changes in value recognized in profit or
loss, except those equity investments for which the entity has chosen the
present value changes in 'other comprehensive income'. There is no "cost
exception" for unlisted shares.
3.
The FVTOCI
classification is mandatory for certain debt instrument assets unless the FVTPL
option is taken ("the fair value option"). While for equity
investments, the FVTOCI rating is a choice
4.
The requirements to
reclassify the gains or losses recognized in other comprehensive income (OCI)
are different for debt and equity investments (see the diagram mentioned
above). For debt instruments measured in FVTOCI, interest income (calculated
using the effective interest rate method), foreign currency gains or losses and
impairment gains or losses are recognized directly in profit or loss. The
difference between the cumulative gains or losses of fair value and the
accumulated amounts recognized in results is recognized in OCI until the
derecognition, when the amounts in OCI are reclassified to results. In contrast
to the accounting treatment for investments in equity instruments designated in
FVTOCI under which only dividend income is recognized in results with all other
gains and losses recognized in OCI and there is no reclassification in
derecognition.
5.
Derivatives: All
derivatives within the scope of IFRS 9, including those linked to unlisted
equity investments, are measured at fair value. Changes in fair value are
recognized in profit or loss, unless the entity has chosen to apply hedge
accounting by designating the derivative as a hedging instrument in an eligible
hedging relationship in which some or all gains or losses may be recognized in
other comprehensive income.
6.
Embedded derivatives:
Implicit derivatives are not separated for accounting purposes if the
non-derivative host is a financial asset within the scope of IFRS 9, that is,
the classification criteria in IFRS 9 apply to the financial asset as a whole.
An embedded derivative is separated from the host contract if, and only if, all
of the following criteria are met:
·
The economic
characteristics and risks of the embedded derivative are not closely related to
the economic characteristics and risks of the host;
·
A separate instrument
with the same terms as the embedded derivative would meet the definition of a
derivative; and
·
The hybrid contract is
not measured at fair value with changes in fair value recognized in results
(that is, a derivative that is incorporated in a financial liability at fair
value through results is not separated).
A derivative that is
attached to a financial instrument but is contractually transferable
independently of that instrument, or has a different counterparty, is not an
embedded derivative, but a separate financial instrument.
##Derecognition
Derecognition of financial assets
The basic premise for the derecognition model in IFRS 9 (transferred from IAS 39) is to determine whether the asset under consideration for derecognition is an asset in its entirety. Once the asset has been determined, an assessment is made of whether the asset has been transferred and, if so, whether the transfer of that asset is subsequently eligible for derecognition.
If the entity has not retained or transferred substantially all of the risks and rewards of the asset, then the entity should assess whether or not it has relinquished control of the asset. If the entity does not control the asset, then derecognition is appropriate; however, if the entity has retained control of the asset, then the entity continues to recognize the asset to the extent that it has a continuing interest in the asset. These various derecognition steps are summarized in the decision tree below:
Derecognition of financial liabilities
A financial liability should be removed from the balance sheet when, and only when, it is extinguished, that is, when the obligation specified in the contract is discharged or canceled or expires. When there has been an exchange between an existing borrower and lender of debt instruments with substantially different terms, or there has been a substantial modification of the terms of an existing financial liability, this transaction is accounted for as a termination of the original financial liability and the recognition of a new financial liability. A gain or loss on termination of the original financial liability is recognized in results.
##Impairment
IFRS 9 introduces a new impairment model based on expected losses (rather than the loss incurred under IAS 39) that has a broader scope than IAS 39. Impairment of financial assets is recognized in stages:
Stage 1: As soon as a financial instrument is originated or purchased, the expected 12-month credit losses are recognized in results and a reserve for losses is established. This serves as a proxy for initial expectations of credit losses. For financial assets, interest income is calculated on the gross carrying amount (that is, without deduction for expected credit losses).
Stage 2: if the credit risk increases significantly and is not considered low, the expected credit losses for life are recognized in results. The calculation of interest income is the same as for Stage 1.
Stage 3: If the credit risk of a financial asset increases to the point where it is considered to be impaired, interest income is calculated based on the amortized cost (that is, the gross carrying amount less the loss reserve) . Financial assets at this stage will generally be evaluated individually. The expected lifetime credit losses are recognized in these financial assets.
##Hedge accounting
The objective of hedge accounting is to represent, in financial statements, the effect of an entity's risk management activities that use financial instruments to manage exposures arising from particular risks that could affect profit or loss or other result. integral.
Hedge accounting is optional. An entity that applies hedge accounting designates a hedging relationship between a hedging instrument and a hedged item. For hedging relationships that meet the qualification criteria in IFRS 9, an entity accounts for the gain or loss in the hedging instrument and the hedged item in accordance with the special hedge accounting provisions of IFRS 9.
IFRS 9 identifies three types of hedging relationships and prescribes special accounting provisions for each:
fair value hedge: a hedge of exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, or a component of any item, that is attributable to a particular risk and could affect profit or loss .
cash flow hedge: a hedge of exposure to variability in cash flows that is attributable to a particular risk associated with all, or a component of, a recognized asset or liability (such as all or some future interest payments on variable rate debt) or a highly probable forecasted transaction, and could affect profit or loss.
hedge of a net investment in a foreign business as defined in IAS 21.
When an entity first applies IFRS 9, it may choose to continue to apply the hedge accounting requirements in IAS 39, rather than the requirements in IFRS 9, to all its hedging relationships.
Disclosure
IFRS 9 modifies some of the requirements of IFRS 7 Financial Instruments: disclosures that include adding disclosures about investments in equity instruments designated as FVTOCI, disclosures about risk management activities and hedge accounting, and disclosures about risk management and impairment of credit.
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