|Annual periods beginning on or after 1 January 2018. Early adoption is permitted (see detail below).
|EU adoption status
|Not adopted at the time of going to print.
IFRS 9, ‘Financial instruments’, replaces IAS 39, ‘Financial instruments: Recognition and measurement’.
If an entity early adopts IFRS 9, it will not
be required to early adopt subsequent
stages in the IAS 39 replacement project –
that is, impairment and hedging. This is to
facilitate early adoption of IFRS 9.
However, if an entity chooses to early
adopt any of the subsequent stages, it will
be required to early adopt all preceding
stages from the same date.
Classification and measurement of financial assets
How are financial assets to be measured?
IFRS 9 requires all financial assets to be measured at either amortised cost or full fair value. Amortised cost provides decision-useful information for financial assets that are held primarily to collect cash flows that represent the payment of principal and interest. For all other financial assets, including those held for trading, fair value is the most relevant measurement basis.
What determines classification?
IFRS 9 introduces a two-step classification approach. First, an entity considers its business model − that is, whether it holds the financial asset to collect contractual cash flows rather than to sell it prior to maturity to realise fair value changes. If the latter, the instrument is measured at fair value through profit or loss (FVTPL). If the former, an entity further considers the contractual cash flow characteristics of the instrument.
What is a contractual cash flow characteristics test?
A financial asset within a qualifying business model will be eligible for amortised cost accounting if 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. Interest is defined as consideration for the time value of money and for the credit risk associated with the principal amount outstanding during a particular period of time.
Any leverage feature increases the variability of the contractual cash flows with the result that they do not have the economic characteristics of interest. If a contractual cash flow characteristic is not genuine, it does not affect the classification of a financial asset. A cash flow characteristic is not genuine if it affects the instrument’s contractual cash flows only on the occurrence of an event that is extremely rare, highly abnormal and very unlikely to occur.
What are common features that would generally pass the cash flow characteristics test?
unleveraged linkage to an inflation index in the currency in which the financial asset is denominated;
- multiple extension options (for example, a perpetual bond);
- call and put options if they are not contingent on future events, and the pre-payment amount substantially represents unpaid amounts of principal and interest on the principal amount outstanding, which may include reasonable additional compensation for the early termination of the contract;
- interest rate caps, floors and collars that effectively switch the interest rate from fixed to variable and vice versa; and
- in a variable rate financial asset, a borrower option to choose a rate at each interest rate reset day as long as the rate compensates the lender for the time value of money (for example, an option to pay three-month LIBOR for a three-month term or one-month LIBOR for a one-month term).
What are common features that would generally fail the cash flow characteristics test?
linkage to equity index, borrower’s net income or other variables;
- inverse floating rate;
- call option at an amount not reflective of outstanding principal and interest;
- issuer is required or can choose to defer interest payments and additional interest does not accrue on those deferred amounts;
- in a variable rate financial asset, a borrower option to choose a rate at each interest rate reset day such that the rate does not compensate the lender for the time value of money (for example, an option to pay one-month LIBOR for a three-month term and one-month LIBOR is not reset each month);
- a variable rate that is reset periodically but always reflects a five-year maturity in a five-year constant maturity bond (that is, the rate is disconnected with the term of the instrument except at origination); and
- an equity conversion option in a debt host (from a holder perspective).
Are reclassifications permitted?
Classification of financial assets is determined on initial recognition. Subsequent reclassification is permitted only in those rare circumstances when there is a change to the business model within which the financial asset is held. In such cases, all affected financial assets are reclassified.
IFRS 9 specifies that changes in business model are expected to be very infrequent, should be determined by the entity’s senior management as a result of external or internal changes, should be significant to the entity’s operations and demonstrable to external parties. For example, an entity has a portfolio of commercial loans that it holds to sell in the short term. The entity acquires a company that manages commercial loans and has a business model that holds the loans in order to collect the contractual cash flows. The portfolio of commercial loans is no longer for sale, and the portfolio is now managed together with the acquired commercial loans; all are held to collect the contractual cash flows.
Another example of a change in the business model is where an entity decides to shut down a line of service (for example, a retail mortgage business). The line of service does not accept new business, and the affected portfolio is being actively marketed for sale.
Changes in intentions with respect to individual instruments, temporary disappearance of a particular market or transfers of instrument between business models do not represent a change in business model.
What does this mean for equity investments?
Equity investments do not demonstrate contractual cash flow characteristics of principal and interest; they are therefore accounted for at fair value. However, IFRS 9 provides an option to designate a non-trading equity investment at FVTPL or at fair value through other comprehensive income. The designation is available on an instrument-by-instrument basis and only on initial recognition. Once made, the designation is irrevocable.
All realised and unrealised fair value gains and losses follow the initial designation, and there is no recycling of fair value gains and losses recognised in other comprehensive income to profit or loss. Dividends that represent a return on investment from equity investments continue to be recognised in profit or loss regardless of the designation.
Can an equity investment be measured at cost where no reliable fair value measure is available?
IFRS 9 removes the cost exemption for unquoted equities and derivatives on unquoted equities but stipulates that, in certain circumstances, cost may be an appropriate estimate of fair value. This may be the case where insufficient recent information is available or where there is a wide range of possible fair value measurements. Cost will not be an appropriate estimate of fair value if there are changes in investee circumstances, markets or wider economy, or if there is evidence from external transactions or for investments in quoted equity instruments. To the extent factors exist that indicate cost might not be representative of fair value, the entity should estimate fair value.
What does this mean for hybrid contracts?
IFRS 9 requires financial assets to be
classified in their entirety. Hybrid
contracts are those instruments that
contain a financial or non-financial host
and an embedded derivative.
Hybrid contracts with financial asset hosts
are assessed in their entirety against the
two classification criteria. The accounting
for embedded derivatives in non-financial
host contracts and financial liabilities
remains unchanged. Hybrid contracts
outside the scope of IFRS 9 are assessed
for bifurcation under IAS 39. In many
cases, hybrid contracts may fail the
contractual cash flow characteristic test
and should therefore be measured at
Is a fair value option available?
Two of the existing three fair value option criteria currently in IAS 39 become obsolete under IFRS 9, as a fair-value driven business model requires fair value accounting, and hybrid contracts are classified in their entirety. The remaining fair value option condition in IAS 39 is carried forward to the new standard – that is, management may still designate a financial asset as at FVTPL on initial recognition if this significantly reduces recognition or measurement inconsistency, commonly referred to as ‘an accounting mismatch’. The designation at FVTPL continues to be irrevocable.
Classification and measurement of financial liabilities
How are financial liabilities to be measured?
Financial liabilities are measured at amortised cost unless they are required to be measured at fair value through profit or loss or an entity has chosen to measure a liability at fair value through profit or loss.
What determines classification?
The classification and measurement of financial liabilities under IFRS 9 remains unchanged from the guidance in IAS 39 except where an entity has chosen to measure a liability at fair value through profit or loss. There continue to be two measurement categories for financial liabilities: fair value and amortised cost. Certain liabilities are required to be at fair value through profit or loss, such as liabilities held for trading and derivatives. Other liabilities are measured at amortised cost unless the entity elects the fair value option; however, if the liability contains embedded derivatives, the embedded derivatives might be required to be separated and measured at fair value through profit or loss.
What is the accounting for financial liabilities that are required to be at fair value through profit and loss?
Financial liabilities that are required to be measured at fair value through profit or loss (as distinct from those that the entity has chosen to measure at fair value through profit or loss) continue to have all fair value movements recognised in profit or loss, with none of the fair value movement recognised in ‘other comprehensive income’ (OCI). This includes all derivatives (such as foreign currency forwards or interest rate swaps), or an entity’s own liabilities that are ‘held for trading’. Similarly, financial guarantees and loan commitments that entities choose to measure at fair value through profit or loss will have all fair value movements in profit or loss.
What is the accounting for financial liabilities that an entity chooses to account for at fair value?
IFRS 9 changes the accounting for financial liabilities that an entity chooses to account for at fair value through profit or loss, using the fair value option. For such liabilities, changes in fair value related to changes in own credit risk are presented separately in OCI.
However, if presenting the changes in own credit of a financial liability in OCI would create an accounting mismatch in profit or loss, all fair value movements are recognised in profit or loss.
The accounting mismatch must arise due to an economic relationship between the financial liability and a financial asset that results in the liability’s credit risk being offset by a change in the fair value of the asset.
The accounting mismatch:
- is required to be determined when the liability is first recognised;
- is not reassessed subsequently; and
- must not be caused solely by the measurement method that an entity uses to determine the changes in a liability’s credit risk.
Use of this exemption from the requirement to present movements in the own credit risk of a liability in OCI is expected to be rare.
What are the eligibility criteria for the fair value option?
The eligibility criteria for the fair value option remain the same; they are based on whether:
- the liability is managed on a fair value basis;
- electing fair value will eliminate or reduce an accounting mismatch; or
- the instrument is a hybrid contract (that is, it contains a host contract and an embedded derivative) for which separation of an embedded derivative would be required.
What might be a common reason for electing the fair value option?
A common reason is where entities have embedded derivatives that they do not wish to separate from the host liability. In addition, entities may elect the fair value option for liabilities that give rise to an accounting mismatch with assets that are required to be held at fair value through profit or loss.
Have there been any changes in the accounting for embedded derivatives?
The existing guidance in IAS 39 for
embedded derivatives has been retained in
IFRS 9. Entities are still required to separate
derivatives embedded in financial liabilities
where they are not closely related to the host
contract – for example, a structured note
where the interest is linked to an equity
index. The separated embedded derivative
continues to be measured at fair value
through profit or loss, and the residual debt
host is measured at amortised cost. The
accounting for embedded derivatives in
non-financial host contracts also remains
Is the treatment of derivatives embedded in financial liabilities symmetrical to the treatment of derivatives embedded in financial assets?
No. The existing embedded derivative guidance in IAS 39 is retained in IFRS 9 for financial liabilities and non-financial instruments. This results in some embedded derivatives still being separately accounted for at fair value through profit or loss. However, embedded derivatives are no longer separated from financial assets. Instead, they are part of the contractual terms that are considered in determining whether the entire financial asset meets the contractual cash flow test (that is, the instrument has solely payments of principal and interest) to be measured at amortised cost or whether it should be measured at fair value through profit or loss.
How are financial liabilities at fair value to be measured?
Entities will need to calculate the amount of the fair value movement that relates to the credit risk of the liability. IFRS 7 already requires disclosure of the amount of fair value changes that are attributable to own credit risk for liabilities designated at fair value through profit or loss. The existing guidance on how to calculate own credit risk in IFRS 7 is retained but has been relocated to IFRS 9, and some aspects have been clarified.
How can own credit risk be determined?
This can be determined as either:
- the amount of fair value change not attributable to changes in market risk (for example, benchmark interest rates) – this is often referred to as the default method; or
- an alternative method that the entity believes more faithfully represents the changes in fair value due to ‘own credit’ (for example, a method that calculates credit risk based on credit default swap rates).
IFRS 9 clarifies that if the changes in fair value arising from factors other than changes in the liability’s credit risk or changes in observed interest rates (that is, benchmark rates such as LIBOR) are significant, an entity is required to use an alternative method and may not use the default method. For example, changes in the fair value of a liability might arise due to changes in value of a derivative embedded in that liability rather than changes in benchmark interest rates. In that situation, changes in the value of the embedded derivative should be excluded in determining the amount of own credit risk that is presented in OCI.
The expanded guidance in IFRS 9 confirms that the credit risk of a liability with collateral is likely to be different from the credit risk of an equivalent liability without collateral issued by the same entity.
It also clarifies that unit-linking features usually give rise to asset performance risk rather than credit risk − that is, the value of the liability changes due to changes in value of the linked asset(s) and not because of changes in the own credit risk of the liability. This means that changes in the fair value of a unit-linked liability due to changes in the fair value of the linked asset will continue to be recognised in the income statement: they are not regarded as being part of the own credit risk of the liability that is recognised in OCI.
What is the impact of the changes on the presentation of financial liabilities?
Elements of the fair value movement of the liability are presented in different parts of the performance statement; changes in own credit risk are presented in OCI, and all other fair value changes are presented in profit or loss. This means that the amount of the overall fair value movement does not change, but it is presented in separate sections of the statement of comprehensive income.
Amounts in OCI relating to own credit are not recycled to the income statement even when the liability is derecognised and the amounts are realised. However, the standard does allow transfers within equity.