Introduction to financial instruments – objectives, definitions and scope (IFRS 9)

Publication date: 06 Aug 2018

Resources (This includes links to the latest standards, drafts, PwC interpretations, tools and practice aids for this topic)

Latest developments

In July 2014, the IASB published IFRS 9, 'Financial instruments', the complete version of IFRS 9, 'Financial Instruments', which replaces the guidance in IAS 39. This final version includes requirements on the classification and measurement of financial assets and liabilities; it also includes an expected credit losses model that replaces the incurred loss impairment model used today. This version includes the hedge accounting amendments released in November 2013. The new standard is effective 1 January 2018, and was endorsed by the EU in November 2016, with early application permitted. In September 2016, the IASB issued Applying IFRS 9 'Financial Instruments' with IFRS 4 'Insurance Contracts' (Amendments to IFRS 4) to address concerns by preparers on implementing IFRS 9 before the new insurance standard, IFRS 17, is effective. The amended IFRS 4 will provide all companies that issue insurance contracts the option to recognise in other comprehensive income, rather than profit or loss, the volatility that could arise when IFRS 9 is applied before IFRS 17 is issued (known as the overlay approach), and also give companies whose activities are predominantly connected with insurance an optional temporary exemption from applying IFRS 9 until 2021 (known as the deferral approach). Entities deferring application of IFRS 9 will continue to apply IAS 39.

In October 2017, the IASB issued a narrow-scope amendment to IFRS 9 for Prepayment Features with Negative Compensation. The amendment clarifies that it is possible for an instrument to pass the ‘Solely Payments of Principle and Interest’ (SPPI) test, even where on early repayment compensation could be paid by either the lender or the borrower to the other party, sometimes referred to a symmetric or ‘two-way’ prepayment clause. The amendment also provided an indication of the Board’s view of prepayment at fair value, and what constitutes ‘reasonable compensation’ in the case of early repayment under paragraph B4.1.11(b) of IFRS 9. The effective date is for annual periods beginning on or after 1 January 2019, with early application permitted. As part of the same amendment, the Board clarified (through the basis for conclusions) that under IFRS 9 the accounting for a modification that does not result in derecognition of a financial liability should be consistent with the accounting for a modification of a financial asset that does not result in derecognition.

The IASB has started other financial instrument-related projects that have not yet been finalised. These include:

  • A discussion paper on dynamic macro portfolio hedging was issued in 2014. While further analysis is being carried out on this topic, to date no consensus has been reached on a consistent set of principles that would support macro hedge accounting.
  • Reconsideration of the accounting treatment of financial instruments with the characteristics of equity.

Overview

For periods beginning on or after 1 January 2018, IFRS 9 is required to be applied in full. But, when an entity first applies IFRS 9, as an accounting policy choice, it can apply the hedge accounting requirements of IAS 39 instead of the hedge accounting requirements included in IFRS 9.

The objective of the four financial instruments standards is to establish requirements for all aspects of accounting for financial instruments, including distinguishing debt from equity, netting, recognition, derecognition, measurement, hedge accounting and disclosure.

The standards’ scope is broad. The standards cover all types of financial instruments, including receivables, payables, investments in bonds and shares, borrowings and derivatives. They also apply to certain contracts to buy or sell non-financial assets (such as commodities) that can be net-settled in cash or another financial instrument. Financial instruments are recognised and measured according to IAS 39/IFRS 9's requirements and are disclosed in accordance with IFRS 7.

In addition, requirements for fair value measurement and disclosures are covered by IFRS 13, ‘Fair value measurement’.

IAS 32 establishes principles for presenting financial instruments as financial liabilities or equity, and for offsetting financial assets and financial liabilities.

Financial instruments represent contractual rights or obligations to receive or pay cash or other financial assets.

A financial asset is cash; a contractual right to receive cash or another financial asset; a contractual right to exchange financial assets or liabilities with another entity under conditions that are potentially favourable; or an equity instrument of another entity.

A financial liability is a contractual obligation to deliver cash or another financial asset; or to exchange financial instruments with another entity under conditions that are potentially unfavourable.

An equity instrument is any contract that evidences a residual interest in the entity's assets after deducting all of its liabilities.

A derivative is a financial instrument that derives its value from an underlying price or index; requires little or no initial net investment; and is settled at a future date.
 
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