IFRS 9 Financial Instruments
Overview of IFRS 9
Initial measurement of financial assets
All financial assets are initially measured at fair value plus, in the case of a financial asset not at fair value through profit or loss, transaction costs.
Subsequent measurement of financial assets
IFRS 9 divides all financial assets that are currently in the scope of IAS 39 into two classifications – those measured at amortised cost and those measured at fair value. Classification is made at the time the financial asset is initially recognised, namely when the entity becomes a party to the contractual provisions of the instrument.
A debt instrument that meets the following two conditions can be measured at amortised cost (net of any writedown for impairment):
- Business model test. The objective of the entity’s business model is to hold the financial asset to collect the contractual cash flows (rather than to sell the instrument prior to its contractual maturity to realise its fair value changes).
- Cash flow characteristics test: 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 outstanding.
All other debt instruments must be measured at fair value through profit or loss (FVTPL).
Fair value option
Even if an instrument meets the two amortised cost tests, IFRS 9 contains an option to designate a financial asset as measured at FVTPL if doing so eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an ‘accounting mismatch’) that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases.
IAS 39’s AFS and HTM categories are eliminated
The available-for-sale and held-to-maturity categories currently in IAS 39 are not included in IFRS 9.
All equity investments in scope of IFRS 9 are to be measured at fair value in the balance sheet, with value changes recognised in profit or loss, except for those equity investments for which the entity has elected to report value changes in ‘other comprehensive income’. There is no ‘cost exception’ for unquoted equities.
‘Other comprehensive income’ option
If an equity investment is not held for trading, an entity can make an irrevocable election at initial recognition to measure it at fair value through other comprehensive income (FVTOCI) with only dividend income recognised in profit or loss.
Despite the fair value requirement for all equity investments, IFRS 9 contains guidance on when cost may be the best estimate of fair value and also when it might not be representative of fair value.
All derivatives, including those linked to unquoted equity investments, are measured at fair value. Value changes are recognised in profit or loss unless the entity has elected to treat the derivative as a hedging instrument in accordance with IAS 39, in which case the requirements of IAS 39 apply.
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. 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.
The embedded derivative concept of IAS 39 is not included in IFRS 9. Consequently, embedded derivatives that under IAS 39 would have been separately accounted for at FVTPL because they were not closely related to the financial host asset will no longer be separated. Instead, the contractual cash flows of the financial asset are assessed in their entirety, and the asset as a whole is measured at FVTPL if any of its cash flows do not represent payments of principal and interest.
For debt instruments, reclassification is required between FVTPL and amortised cost, or vice versa, if and only if the entity’s business model objective for its financial assets changes so its previous model assessment would no longer apply.
If reclassification is appropriate, it must be done prospectively from the reclassification date. An entity does not restate any previously recognised gains, losses, or interest.
IFRS 9 amends some of the requirements of IFRS 7 Financial Instruments: Disclosures including added disclosures about investments in equity instruments designated as at FVTOCI.
IFRS 9 (2009) does not address financial liabilities. The IASB has begun the process of giving further consideration to the classification and measurement of financial liabilities in its project on Credit Risk in Liability Measurement, and it expects to issue final requirements for financial liabilities in 2010.