IFRS 9 Financial Instruments Project Summary July 2014 2 | IFRS 9 Financial Instruments | July 2014 The IASB published the final version of IFRS 9 Financial Instruments in July 2014. This document provides a brief overview of IFRS 9, with an emphasis on the most recent additions and changes made in finalising the Standard. At a glance IFRS 9 is built on a logical, single classification and measurement approach for financial assets that reflects the business model in which they are managed and their cash flow characteristics. The final version of IFRS 9 brings together the classification and measurement, impairment and hedge accounting phases of the IASB’s project to replace IAS 39 Financial Instruments: Recognition and Measurement. A single and integrated Standard The Standard also includes an improved hedge accounting model to better link the economics of risk management with its accounting treatment. In addition, IFRS 9 addresses the so-called ‘own credit’ issue, whereby banks and others book gains through profit or loss as a result of the value of their own debt falling due to a decrease in credit worthiness when they have elected to measure that debt at fair value. Built upon this is a forward-looking expected credit loss model that will result in more timely recognition of loan losses and is a single model that is applicable to all financial instruments subject to impairment accounting. IFRS 9 is effective for annual periods beginning on or after 1 January 2018. IFRS 9 is now complete. The IASB has an active project on accounting However, the Standard is available for early for dynamic risk management. This is application. In addition, the own credit separate from IFRS 9. changes can be early applied in isolation without otherwise changing the accounting for financial instruments. Mandatory effective date What remains to be completed? IFRS 9 Financial Instruments | July 2014 | 3 4 | IFRS 9 Financial Instruments | July 2014 The reform of financial instruments accounting was one of the areas identified in the Norwalk Agreement of 2002 between the IASB and US Financial Accounting Standards Board (FASB). As a result of this agreement, a number of projects were undertaken to eliminate a variety of differences between International Financial Reporting Standards and US GAAP. Many preparers of financial statements, their auditors and users of financial statements find the requirements for reporting financial instruments complex. IFRS 9 replaces IAS 39, one of the Standards inherited by the IASB when it began its work in 2001. Throughout the lifecycle of the project the IASB has consulted widely with constituents and stakeholders on the development of the new standard. The IASB has received over a thousand comment letters from stakeholders and has published six Exposure Drafts, one Supplementary Document and a Discussion Paper during this process. The IASB has worked closely with the FASB throughout the development of IFRS 9. Although every effort has been made to come to a converged solution, ultimately these efforts have been unsuccessful. Work on IFRS 9 was accelerated in response to the financial crisis. In particular, interested parties including the G20, the Financial Crisis Advisory Group and others highlighted the timeliness of recognition of expected credit losses, the complexity of multiple impairment models and own credit as areas in need of consideration. Project background The IASB has previously published versions of IFRS 9 that introduced new classification and measurement requirements (in 2009 and 2010) and a new hedge accounting model (in 2013). The July 2014 publication represents the final version of the Standard, replaces earlier versions of IFRS 9 and completes the IASB’s project to replace IAS 39. The IASB has also conducted an extensive programme of outreach, including hundreds of meetings with users, preparers of financial statements and others. Classification and measurement 6 | IFRS 9 Financial Instruments | July 2014 Based on feedback received, the IASB decided that the most effective way to address such issues and improve the ability of users of financial statements to better understand the information about the amounts, timing and uncertainty of future cash flows is to replace the existing classification and measurement categories for financial assets. IAS 39 contained many different classification categories and associated impairment models. Many of the application issues that arose with IAS 39 were related to the classification and measurement of financial assets. The requirements for impairment and hedge accounting are based on that classification. Requirements for classification and measurement are the foundation of the accounting for financial instruments. Classification determines how financial assets are accounted for in financial statements and, in particular, how they are measured on an ongoing basis. • Business model-driven reclassification • Own credit gains and losses presented in OCI for FVO liabilities • One impairment model • Classification based on business model and nature of cash flows • Principle-based IFRS 9 Classification • Complicated reclassification rules • Own credit gains and losses recognised in profit or loss for fair value option (FVO) liabilities • Multiple impairment models • Complex and difficult to apply • Rule-based IAS 39 Classification A logical approach to classification and measurement Classification and measurement (b) the contractual cash flow characteristics of the financial asset. (a) the entity’s business model for managing the financial assets; and Two criteria are used to determine how financial assets should be classified and measured: IFRS 9 applies one classification approach for all types of financial assets, including those that contain embedded derivative features. Financial assets are therefore classified in their entirety rather than being subject to complex bifurcation requirements. Fair value through profit or loss* Yes No No * Presentation option for equity investments to present fair value changes in OCI Amortised cost No Fair value option? Yes Held to collect contractual cash flows only? Yes Contractual cash flows are solely principal and interest? Instruments within the scope of IFRS 9 Yes No IFRS 9 Financial Instruments | July 2014 Fair value through other comprehensive income No Fair value option? Yes Held to collect contractual cash flows and for sale? Process for determining the classification and measurement of financial assets The classification and measurement approach Classification and measurement | 7 8 | IFRS 9 Financial Instruments | July 2014 A business model can typically be observed through the activities that an entity undertakes to achieve its business objective. As such, a business model is a matter of fact rather than an assertion. Objective information, such as business plans, how managers of the business are compensated and the amount and frequency of sales activity should be considered. Judgement needs to be used when assessing a business model and that assessment should consider all relevant available evidence. The business model should be determined on a level that reflects how financial assets are managed to achieve a particular business objective. However, the determination is not dependent on management’s intentions for an individual instrument, and should be made on a higher level of aggregation. A business model refers to how an entity manages its financial assets in order to generate cash flows—by collecting contractual cash flows, selling financial assets or both. What is a business model? Sales information in isolation doesn’t determine the business model; however, it does provide evidence about how the business objective is achieved and how cash flows are realised. When determining whether this business model is applicable, an entity should consider past sales information and expectations about future sales activity. The objective of this business model is unchanged in the July 2014 version of IFRS 9. To assist in application, additional guidance has however been provided. Financial assets at amortised cost are held in a business model whose objective is to hold assets in order to collect contractual cash flows. What business model qualifies for amortised cost? Financial assets classified and measured at fair value through other comprehensive income are held in a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets. What business model qualifies for fair value through other comprehensive income (FVOCI)? Having some sales activity is not necessarily inconsistent with this business model. For example, sales that are infrequent or insignificant in value may be consistent with this business model, as are sales that occur as a result of an increase in credit risk. However, if more than an infrequent number of sales occur and those sales are more than insignificant in value, an entity needs to assess whether and how such sales are consistent with an objective of collecting contractual cash flows. Business model for managing financial assets Classification and measurement Any financial assets that are not held in one of the two business models mentioned above are measured at fair value through profit or loss. As such, fair value through profit or loss represents a ‘residual’ category. Financial assets that are held for trading and those managed on a fair value basis are also included in this category. Other business models This business model was added in the July 2014 version of IFRS 9. This measurement category results in amortised cost information being provided in profit or loss and fair value information in the balance sheet. Various objectives may be consistent with this business model, for example to manage liquidity, maintain a particular interest yield profile or to match the duration of financial liabilities to the duration of the assets they are funding. Compared to a business model whose objective is to hold financial assets to collect contractual cash flows, this business model will typically involve greater frequency and volume of sales. Classification and measurement When reclassification is required, IFRS 7 Financial Instruments: Disclosures requires disclosures about such reclassifications (including the amount of financial assets moved out of and into different measurement categories and a detailed explanation of the change in business model and its effect) to ensure that users of financial statements can see clearly what has occurred. IFRS 9 requires financial assets to be reclassified between measurement categories when, and only when, the entity’s business model for managing them changes. This is a significant event and thus is expected to be uncommon. This ensures that users of financial statements are always provided with information reflecting how the cash flows on financial assets are expected to be realised. Reclassification IFRS 9 Financial Instruments | July 2014 | 9 If the business model is neither of these, then fair value information is increasingly important so it is provided both in profit or loss and in the balance sheet. In contrast, if that asset is held in a business model the objective of which is achieved by both collecting contractual cash flows and selling financial assets, then the financial asset is measured at fair value in the balance sheet, and amortised cost information is provided through profit or loss. In essence, if a financial asset is a simple debt instrument and the objective of the entity’s business model within which it is held is to collect its contractual cash flows, the financial asset is measured at amortised cost. 10 | IFRS 9 Financial Instruments | July 2014 Often it will be readily apparent whether contractual cash flows meet the SPPI criteria but sometimes closer analysis is required. IFRS 9 now provides more extensive guidance on SPPI. Importantly, it has been clarified that interest can comprise a return not only for the time value of money and credit risk but also for other components such as a return for liquidity risk, amounts to cover expenses and a profit margin. One of the criteria for determining the classification of a financial asset is whether the contractual cash flows are solely payments of principal and interest (SPPI). Only financial assets with such cash flows are eligible for amortised cost or fair value through other comprehensive income measurement dependent on the business model in which the asset is held. Usually there is a link between the period of time for which this interest element is set and the rate that is used (for example, 3 month LIBOR is used for a 3 month period). However, in some cases this element may be modified (ie imperfect), for example if a financial asset’s interest rate is periodically reset but the frequency of that reset does not match the tenor of the interest rate. Time value of money is the element of interest that provides consideration for only the passage of time. Time value of money For contractual cash flows to be SPPI they must include returns consistent with a basic lending arrangement, so for example, if the contractual cash flows include a return for equity price risk then that would not be consistent with SPPI. Contractual cash flow characteristics Classification and measurement In these cases, an entity will assess the asset’s contractual cash flow characteristics by assessing the modification, qualitatively or quantitatively, to determine whether the contractual cash flows represent SPPI. The objective of this assessment is to determine whether the contractual cash flows could be significantly different to those that would arise if the time value of money element was not modified. In order for the financial asset to have contractual cash flows that are SPPI, the cash flows resulting from the change in contractual terms should be consistent with a basic lending arrangement. A financial asset may contain contractual terms that could change the timing or amount of contractual cash flows. An entity must assess whether the contractual cash flows that could arise both including and excluding the effect of those contractual terms are consistent with SPPI. For example, for a prepayable financial asset to have contractual cash flows that are SPPI, the cash flows if prepayment occurs and the cash flows if prepayment does not occur must both be consistent with SPPI. Contractual terms that change the timing or amount of cash flows Classification and measurement IFRS 9 requires such cash flows to be considered SPPI as long as they do not introduce risk or volatility that is inconsistent with a basic lending arrangement. There may be instances where a government or a regulatory authority sets interest rates. This can result in the time value of money element of interest not representing only consideration for the passage of time. Exception for regulated rates IFRS 9 Financial Instruments | July 2014 | 11 SPPI cash flows are used as a basis for this assessment because amortised cost is a simple measurement technique. It simply allocates interest payments over the life of a financial instrument. IFRS 9 provides amortised cost information in profit or loss (dependent on business model) when a financial asset has simple cash flows that are SPPI. The only issue that the IASB was told needed urgent attention was the volatility in profit or loss caused by changes in the credit risk of financial liabilities that an entity has elected to measure at fair value. The fair value of an entity’s own debt is affected by changes in the entity’s own credit risk (own credit). This means, somewhat counterintuitively, that when an entity’s credit quality declines the value of its liabilities fall, and if those liabilities are measured at fair value a gain is recognised in profit or loss (and vice versa). Many investors and others found this result counterintuitive and confusing. During the development of IFRS 9 the IASB received feedback that the accounting requirements for financial liabilities in IAS 39 had worked well. Most respondents did not think that a fundamental change was needed to the accounting for financial liabilities. Hence, IAS 39’s treatment of financial liabilities is carried forward to IFRS 9 essentially unchanged. This means that most financial liabilities will continue to be measured at amortised cost. 12 | IFRS 9 Financial Instruments | July 2014 IFRS 9 includes the same option as IAS 39 that permits entities to elect to measure financial liabilities at fair value through profit or loss if particular criteria are met. For example, an entity can choose to measure a structured financial liability at fair value in its entirety rather than being required to account for its component parts. This is referred to as the fair value option (FVO). Own credit Financial liabilities in IFRS 9 Financial liabilities and own credit Classification and measurement Such liabilities would continue to be measured in the balance sheet at fair value, which provides information that was confirmed to be useful by users of financial statements. IFRS 9 introduces new requirements for the accounting and presentation of changes in the fair value of an entity’s own debt when the entity has chosen to measure that debt at fair value under the FVO. To address the so-called own credit issue, IFRS 9 requires changes in the fair value of an entity’s own credit risk to be recognised in other comprehensive income rather than in profit or loss. Impairment 14 | IFRS 9 Financial Instruments | July 2014 As the financial crisis unfolded, it became clear that the incurred loss model gave room to a different kind of earnings management, namely to postpone losses. Even though IAS 39 did not require waiting for actual default before impairment is recognised, in practice this was often the case. During the financial crisis, the delayed recognition of credit losses on loans (and other financial instruments) was identified as a weakness in existing accounting standards. Specifically, the existing model in IAS 39 (an ‘incurred loss’ model) delays the recognition of credit losses until there is evidence of a trigger event. This was designed to limit an entity’s ability to create hidden reserves that can be used to flatter earnings during bad times. Why is the IASB addressing impairment? This model is forward-looking and it eliminates the threshold for the recognition of expected credit losses, so that it is no longer necessary for a trigger event to have occurred before credit losses are recognised. Consequently, more timely information is required to be provided about expected credit losses. The main objective of the new impairment requirements is to provide users of financial statements with more useful information about an entity’s expected credit losses on financial instruments. The model requires an entity to recognise expected credit losses at all times and to update the amount of expected credit losses recognised at each reporting date to reflect changes in the credit risk of financial instruments. How will the new requirements improve financial reporting? The complexity of IAS 39, which used multiple impairment models for financial instruments, was also identified as a concern. A forward-looking impairment model Impairment Specifically, IFRS 9 requires an entity to base its measurement of expected credit losses on reasonable and supportable information that is available without undue cost or effort, and that includes historical, current and forecast information. Furthermore, when credit losses are measured in accordance with IAS 39, an entity may only consider those losses that arise from past events and current conditions. The effects of possible future credit loss events cannot be considered, even when they are expected. The requirements in IFRS 9 broaden the information that an entity is required to consider when determining its expectations of credit losses. In addition, under IFRS 9 the same impairment model is applied to all financial instruments that are subject to impairment accounting, removing a major source of current complexity. This includes financial assets classified as amortised cost and fair value through other comprehensive income, lease receivables, trade receivables, and commitments to lend money and financial guarantee contracts. Impairment Entities are required to provide information that explains the basis for their expected credit loss calculations and how they measure expected credit losses and assess changes in credit risk. In addition, entities are required to provide a reconciliation from the opening to the closing allowance balances for 12-month loss allowances separately from lifetime loss allowance balances. This is provided along with a reconciliation from the opening to the closing balances of the related carrying amounts of financial instruments subject to impairment. In addition to improving the accounting for impairment, the new model is accompanied by improved disclosure about expected credit losses and credit risk. Disclosure IFRS 9 Financial Instruments | July 2014 | 15 In addition, in response to requests from users of financial statements, information is required to be provided about the credit risk of financial assets by rating grades and about financial assets on which contractual cash flows have been modified. The reconciliations are required to be provided in a way that enables users of financial statements to understand the reason for changes in the allowance balances (such as whether it is caused by changes in credit risk or increased lending). 16 | IFRS 9 Financial Instruments | July 2014 The calculation of interest revenue on financial assets remains the same as for Stage 1. Lifetime expected credit losses are only recognised if the credit risk increases significantly from when the entity originates or purchases the financial instrument. This serves as a proxy for the initial expectations of credit losses. Lifetime expected credit losses are still recognised on these financial assets. If the credit risk of a financial asset increases to the point that it is considered credit-impaired, interest revenue is calculated based on the amortised cost (ie the gross carrying amount adjusted for the loss allowance). Financial assets in this stage will generally be individually assessed. If the credit risk increases significantly and the resulting credit quality is not considered to be low credit risk, full lifetime expected credit losses are recognised. As soon as a financial instrument is originated or purchased, 12-month expected credit losses are recognised in profit or loss and a loss allowance is established. For financial assets, interest revenue is calculated on the gross carrying amount (ie without adjustment for expected credit losses). Stage 3 Stage 2 Stage 1 What are the stages? Overview of the impairment requirements Impairment It is also not the credit losses on assets that are forecast to actually default in the next 12 months. If an entity can identify such assets or a portfolio of such assets that are expected to have increased significantly in credit risk, lifetime expected credit losses are recognised. It is not the expected cash shortfalls over the next twelve months—instead, it is the effect of the entire credit loss on an asset weighted by the probability that this loss will occur in the next 12 months. 12-month expected credit losses are the portion of lifetime expected credit losses that represent the expected credit losses that result from default events on a financial instrument that are possible within the 12 months after the reporting date. What are 12-month expected credit losses? Impairment Effective interest on gross carrying amount Interest revenue 12-month expected credit losses Stage 2 Effective interest on gross carrying amount Lifetime expected credit losses Impairment recognition Stage 1 Effective interest on amortised cost Lifetime expected credit losses Stage 3 Increase in credit risk since initial recognition IFRS 9 Financial Instruments | July 2014 | 17 Because expected credit losses consider the amount and timing of payments, a credit loss (ie cash shortfall) arises even if the entity expects to be paid in full but later than when contractually due. 12-month expected credit losses are the portion of the lifetime expected credit losses associated with the possibility of a default in the next twelve months. Lifetime expected credit losses are an expected present value measure of losses that arise if a borrower defaults on their obligation throughout the life of the financial instrument. They are the weighted average credit losses with the probability of default as the weight. What are lifetime expected credit losses? Lifetime expected credit losses are recognised for those loans within that region (Stage 2) and 12-month expected credit losses, including any changes in that estimate, for other loans (Stage 1). 12-month expected credit losses are recognised for all the loans on initial recognition (Stage 1). 18 | IFRS 9 Financial Instruments | July 2014 • Stage 1 • Stage 2 • Stage 3 Information emerges that a region in the country is experiencing tough economic conditions. Portfolio of home loans originated in a country. Lifetime expected credit losses continue to be recognised and interest revenue switches to a net interest basis. More information emerges and the entity is able to identify the particular loans that have defaulted or will imminently default (Stage 3). Accounting for expected credit losses—example Impairment (c) reasonable and supportable information that is available without undue cost or effort. (b) the time value of money: expected credit losses should be discounted to the reporting date; and (a) the probability-weighted outcome: expected credit losses should represent neither a best or worst-case scenario. Rather, the estimate should reflect the possibility that a credit loss occurs and the possibility that no credit loss occurs; Credit losses are the present value of all cash shortfalls. Expected credit losses are an estimate of credit losses over the life of the financial instrument. When measuring expected credit losses, an entity should consider: What should an entity consider when measuring expected credit losses? IFRS 9 does not prescribe particular measurement methods. Also, an entity may use various sources of data that may be internal (entity-specific) and external. An entity is required to use reasonable and supportable information that is available at the reporting date without undue cost or effort, and that includes information about past events, current conditions and forecasts of future conditions. What information is used? Measuring expected credit losses Impairment IFRS 9 Financial Instruments | July 2014 | 19 Although the model is forward-looking, historical information is always considered to be an important anchor or base from which to measure expected credit losses. However, historical data should be adjusted on the basis of current observable data to reflect the effects of current conditions and forecasts of future conditions. Entities are not required to use a ‘crystal ball’ to predict the future; what an entity uses depends on the availability of information. As the forecast horizon increases, it is expected that the specificity of information used to measure expected credit losses will decrease. (For example, rather than estimating specific cash flow shortfalls it may be necessary to consider information such as historical loss rates adjusted as relevant for current and forecast conditions). 20 | IFRS 9 Financial Instruments | July 2014 Expected credit losses are updated at each reporting date for new information and changes in expectations even if there has not been a significant increase in credit risk. IFRS 9 requires lifetime expected credit losses to be recognised when there are significant increases in credit risk since initial recognition. A true economic loss arises when expected credit losses exceed initial expectations (ie when the lender is not receiving compensation for the level of credit risk to which it is now exposed). Recognising lifetime expected credit losses after a significant increase in credit risk better reflects that economic loss in the financial statements. When credit is first extended the initial creditworthiness of the borrower and initial expectations of credit losses are taken into account in determining acceptable pricing and other terms and conditions. As such, recognising lifetime expected credit losses from initial recognition disregards the link between pricing and the initial expectations of credit losses. Why recognise lifetime expected credit losses only after a significant increase in credit risk? IFRS 9 does not mandate the use of an explicit probability of default to make this assessment. An entity may apply various approaches when assessing whether the credit risk on a financial instrument has increased significantly. The assessment of whether lifetime expected credit losses should be recognised is based on a significant increase in the likelihood or risk of a default occurring since initial recognition. Generally, there will be a significant increase in credit risk before a financial asset becomes credit-impaired or an actual default occurs. Timing of recognising lifetime expected credit losses Assessing significant increases in credit risk Impairment Credit risk analysis is a multifactor and holistic analysis—whether a specific factor is relevant, and its weight compared to other factors will depend on factors such as the type of product, characteristics of the financial instruments and the borrower. An entity should consider reasonable and supportable information that is available without undue cost or effort when determining whether the recognition of lifetime expected credit losses is required. What information should be used? Impairment Lifetime expected credit losses are expected to be recognised before a financial instrument becomes delinquent. Typically, credit risk increases significantly before a financial instrument becomes past-due or other lagging borrower-specific factors (for example, a modification or restructuring) are observed. Assessment of significant increases in credit risk may be done on a collective basis, for example on a group or sub-group of financial instruments. This is to ensure that lifetime expected credit losses are recognised when there is a significant increase in credit risk even if evidence of that increase is not yet available on an individual level. Collective and individual assessment basis IFRS 9 Financial Instruments | July 2014 | 21 However, depending on the nature of the financial instrument and the credit risk information available, an entity may not be able to identify significant changes in credit risk for individual financial instruments before delinquency. It may be necessary to group financial instruments to capture significant increases in credit risk on a timely basis (such as by identifying particular geographical regions that have been most adversely affected by changing economic conditions). 22 | IFRS 9 Financial Instruments | July 2014 An example of a low credit risk instrument is one that has an investment grade rating (although an external rating grade is not a prerequisite for a financial instrument to be considered low credit risk). Credit risk is considered low if the financial instrument has a low risk of default, the borrower has a strong capacity to meet its contractual cash flow obligations in the near term and adverse changes in conditions in the longer term may, but will not necessarily reduce the ability of the borrower to fulfil its obligations. If a financial instrument is determined to have low credit risk at the reporting date an entity may assume that the credit risk of the financial instrument has not increased significantly since initial recognition. Regardless of the way in which an entity assesses significant increases in credit risk, there is a rebuttable presumption that the credit risk on a financial asset has increased significantly since initial recognition when contractual payments are more than 30 days past due. The rebuttable presumption is not an absolute indicator, but is presumed to be the latest point at which lifetime expected credit losses should be recognised even when using forward-looking information. Financial instruments that have low credit risk at the reporting date More than 30 days past due rebuttable presumption Assessing significant increases in credit risk continued... Impairment Hedge accounting 24 | IFRS 9 Financial Instruments | July 2014 The new requirements were first published in November 2013 and are unchanged in the July 2014 publication of IFRS 9 except to reflect the addition of the FVOCI measurement category to IFRS 9. IFRS 9 incorporates new hedge accounting requirements that represent a major overhaul of hedge accounting and introduce significant improvements, principally by aligning the accounting more closely with risk management. The objective of hedge accounting is to represent in the financial statements the effect of an entity’s risk management activities when they use financial instruments to manage exposures arising from particular risks and those risks could affect profit or loss (or other comprehensive income, in the case of investments in equity instruments for which an entity has elected to present changes in fair value in other comprehensive income). What is the objective of hedge accounting? An entity uses hedging to manage its exposure to risks, for example, foreign exchange risk, interest rate risk or the price of a commodity. Many choose to apply hedge accounting to show the effect of managing those risks in the financial statements. Why use hedge accounting? A better link between accounting and risk management Hedge accounting Hedging risks and components of items has become common business practice. Investors have said that they want to be able to understand the risks that an entity faces, what management is doing to manage those risks and how effective those risk management strategies are. The hedge accounting requirements in IAS 39 were developed when hedging activities were relatively new and not as widely understood as they are today. As a result of the increased use and sophistication of hedging activities the IASB decided to undertake a fundamental overhaul of all aspects of hedge accounting. Reflecting risk management appropriately In addition, many preparers felt that IAS 39 does not allow entities to adequately reflect their risk management practices. For example, there are instances in which hedge accounting cannot be applied to groups of items, whereas for risk management purposes items are often hedged on a group basis. In addition, IAS 39 does not allow hedge accounting to be applied to components of non-financial items, but when entities hedge such items they usually only hedge components (parts) of them. Many investors believe that the IAS 39 hedge accounting requirements fall short in providing this information. As a result, investors often use non-audited (pro-forma) information to understand risk management. Investors, and others, also believe that the requirements in IAS 39 are arbitrary and too rule-based, and they argue for a closer alignment with risk management. IFRS 9 Financial Instruments | July 2014 | 25 Others believed that the disclosure requirements in IAS 39 did not provide sufficient information in the financial statements about an entity’s risk management activities. Insufficient disclosures This meant that the greatest challenges were faced by those hedging non-financial risks; therefore, entities hedging such risks (such as non-financial institutions) are expected to benefit most from the new hedge accounting model. Why change the hedge accounting requirements? Hedge accounting 26 | IFRS 9 Financial Instruments | July 2014 Groups and net positions Discontinuation and rebalancing Hedge accounting Objective Effectiveness assessment Hedging instruments Hedged items Fundamental review of hedge accounting Aspects reconsidered Alternatives to hedge accounting Presentation and disclosure Hedge accounting The new model more closely aligns hedge accounting with risk management activities undertaken by companies when hedging their financial and non-financial risk exposures. It will enable more entities, particularly non-financial institutions, to apply hedge accounting to reflect their actual risk management activities. This will assist users of financial statements to understand entities’ risk management activities. Closer alignment with risk management The new hedge accounting model enables companies to better reflect their risk management activities in the financial statements. This will help investors to understand the effect of hedging activities on the financial statements and on future cash flows. IFRS 9 eliminates this distinction. As a principle-based approach, IFRS 9 looks at whether a risk component can be identified and measured and does not distinguish between types of items. This will enable more entities to apply hedge accounting that reflects their risk management activities. An example of a risk component in a financial item is the LIBOR risk component of a bond. Risk managers often hedge risk components for non-financial items as well; for instance, they may hedge the oil price component of jet fuel. This is an important issue for many companies. An example of this is the treatment of risk components. Largely as a reflection of less advanced risk management practices when the IAS 39 hedge accounting model was developed, IAS 39 allowed components of financial items to be hedged, but not components of non-financial items. IFRS 9 Financial Instruments | July 2014 | 27 The new model also enables an entity to use information produced internally for risk management purposes as a basis for hedge accounting. Today it is necessary to exhibit eligibility and compliance with the requirements in IAS 39 using metrics that are designed solely for accounting purposes. The new model also includes eligibility criteria but these are based on an economic assessment of the strength of the hedging relationship. This can be determined using risk management data. This should reduce the costs of implementation compared with those for IAS 39 hedge accounting because it reduces the amount of analysis that is required to be undertaken only for accounting purposes. What does the new hedge accounting model achieve? Hedge accounting 28 | IFRS 9 Financial Instruments | July 2014 When an entity enters into derivatives for hedging purposes but hedge accounting cannot be applied, the derivatives are accounted for as if they were trading instruments. This gives rise to volatility in profit or loss that is inconsistent with the economic situation. This means that the hedging relationship is not apparent to users of financial statements and an entity that has reduced its risk by entering into derivatives for hedging purposes may paradoxically appear more risky. Enabling hedge accounting to better reflect risk management improves the information provided to users of financial statements. Improved disclosures are provided with the new hedge accounting model. These disclosures explain both the effect that hedge accounting has had on the financial statements and an entity’s risk management strategy, as well as providing details about derivatives that have been entered into and their effect on the entity’s future cash flows. Today, information about hedge accounting is provided by the type of hedge, and those types are established by accounting standards (such as cash flow and fair value hedges). Users of financial statements have told us this is confusing as these distinctions use terms only used for accounting purposes. To make this information more accessible, information about all hedges is now required to be provided in a single location in the notes to the financial statements. Improved information about risk management activities Hedge accounting Currently, entities undertaking such risk management and using hedge accounting use a combination of IAS 39’s general hedge accounting requirements and the specific model in IAS 39 for accounting for macro hedging. That model only applies to fair value hedges of interest rate risk. IFRS 9 has been designed so that entities are not adversely affected while the new macro project is ongoing. Therefore, an entity undertaking macro hedging activities can apply the new accounting model in IFRS 9 while continuing to apply the specific IAS 39 accounting for macro hedges if they wish to do so. The IASB currently has a separate, active project on accounting for macro hedging activities. In this project, the IASB is exploring a new way to account for dynamic risk management of open portfolios. This project is still at an early stage of development with a Discussion Paper Accounting for Dynamic Risk Management: a Portfolio Revaluation Approach to Macro Hedging having been published in April 2014. Hence, the IASB decided to allow an accounting policy choice to apply either the hedge accounting model in IFRS 9 or IAS 39 in its entirety, with the additional choice to use the IAS 39 accounting for macro hedges if applying IFRS 9 hedge accounting. Although the IASB noted that entities would not be disadvantaged by the change to IFRS 9 and that the change was not expected to be unduly burdensome, it acknowledged that some may prefer to move directly from using IAS 39 to the potential new model for accounting for macro hedging. In response to the draft final hedge accounting requirements posted on the IASB’s website in September 2012, some requested that they be allowed to continue to apply IAS 39 for all of their hedge accounting. IFRS 9 Financial Instruments | July 2014 | 29 Until the completion of the project on ‘macro hedging’ entities can account for their macro hedging activities using the specific model in IAS 39 for portfolio hedges of interest rate risk. In the case of cash flow hedge accounting, so-called ‘proxy hedging’ is still an eligible way to designate a hedged item in accordance with IFRS 9 as long as the designation reflects risk management. This in effect maintains the position that existed prior to IFRS 9. Separate project on accounting for macro hedging Hedge accounting 30 | IFRS 9 Financial Instruments | July 2014 1 Subject to the election to continue to apply IAS 39 hedge accounting. The IFRS Transition Resource Group for Impairment of Financial Instruments (ITG) will provide a discussion forum to support stakeholders on implementation issues that may arise as a result of the new impairment requirements under IFRS 9. The ITG will be comprised of subject matter experts involved in implementation (from preparers and audit firms) and will include regulatory representatives. ITG members will also provide representation from different geographical locations. The IASB announced in June 2014 its intention to create a transition resource group for the new requirements for impairment of financial instruments. IFRS 9 is effective for annual periods beginning on or after 1 January 2018. Entities can however choose to apply IFRS 9 before then. From February 2015 entities newly applying IFRS 9 will need to apply the version published in July 2014. This means that entities would need to apply the classification and measurement, impairment and hedge accounting requirements1. As an exception to this, prior to January 2018 the own credit changes can be applied at any time in isolation without the need to otherwise change the accounting for financial instruments. Transition Resource Group Mandatory effective date Implementation Hedge accounting The ITG will not publish authoritative guidance. • provide a forum for stakeholders to learn about the new Standard from others involved with implementation. • inform the IASB about those implementation issues, which will help the IASB determine what, if any, action will be needed to address those issues; and • solicit, analyse, and discuss stakeholder issues arising from implementation of the new Standard; • hold public meetings; Specifically, the ITG will: The Basis for Conclusions on IFRS 9 analyses the considerations of the IASB when developing IFRS 9 including an analysis of the feedback received on the proposals that preceded the Standard and how the IASB responded to that feedback. It also includes an analysis of the likely effects of IFRS 9. Further information Official pronouncements of the IASB are available in electronic format to eIFRS subscribers. Publications are available for ordering from our website at www.ifrs.org. This Project Summary has been compiled by the staff of the IFRS Foundation for the convenience of interested parties. The views within this document are those of the staff who prepared this document and are not the views or the opinions of the IASB and should not be considered authoritative in any way. The content of this Project Summary does not constitute any advice. Important information IFRS 9 Financial Instruments | July 2014 | 31 Printed on 100 per cent recycled paper 100% The IFRS Foundation is a not-for-profit corporation under the General Corporation Law of the State of Delaware, USA and operates in England and Wales as an overseas company (Company number: FC023235) with its principal office as above. 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Please address publications and copyright matters to: IFRS Foundation Publications Department 30 Cannon Street, London EC4M 6XH, United Kingdom Tel: +44 (0)20 7332 2730 Fax: +44 (0)20 7332 2749 Email: publications@ifrs.org Web: www.ifrs.org The IFRS Foundation logo/the IASB logo/the IFRS for SMEs logo/‘Hexagon Device’, ‘IFRS Foundation’, ‘eIFRS’, ‘IASB’, ‘IFRS for SMEs’, ‘IAS’, ‘IASs’, ‘IFRIC’, ‘IFRS’, ‘IFRSs’, ‘SIC’, ‘International Accounting Standards’ and ‘International Financial Reporting Standards’ are Trade Marks of the IFRS Foundation. The IFRS Foundation is a not-for-profit corporation under the General Corporation Law of the State of Delaware, USA and operates in England and Wales as an overseas company (Company number: FC023235) with its principal office as above. INTERNATIONAL FINANCIAL REPORTING STANDARD CONTENTS from paragraph INTRODUCTION IN1 INTERNATIONAL FINANCIAL REPORTING STANDARD 9 FINANCIAL INSTRUMENTS CHAPTERS 1 OBJECTIVE 1.1 2 SCOPE 2.1 3 RECOGNITION AND DERECOGNITION 3.1.1 4 CLASSIFICATION 4.1.1 5 MEASUREMENT 5.1.1 6 HEDGE ACCOUNTING 6.1.1 7 EFFECTIVE DATE AND TRANSITION 7.1.1 APPENDICES A Defined terms B Application guidance C Amendments to other Standards APPROVAL BY THE BOARD OF IFRS 9 ISSUED IN NOVEMBER 2009 APPROVAL BY THE BOARD OF THE REQUIREMENTS ADDED TO IFRS 9 IN OCTOBER 2010 APPROVAL BY THE BOARD OF AMENDMENTS TO IFRS 9: MANDATORY EFFECTIVE DATE IFRS 9 AND TRANSITION DISCLOSURES (AMENDMENTS TO IFRS 9 (2009), IFRS 9 (2010) AND IFRS 7) ISSUED IN DECEMBER 2011 IFRS 9 FINANCIAL INSTRUMENTS (HEDGE ACCOUNTING AND AMENDMENTS TO IFRS 9, IFRS 7 AND IAS 39) ISSUED IN NOVEMBER 2013 APPROVAL BY THE BOARD OF IFRS 9 FINANCIAL INSTRUMENTS ISSUED IN JULY 2014 BASIS FOR CONCLUSIONS (see separate booklet) DISSENTING OPINIONS APPENDIX A Previous dissenting opinions APPENDIX B Amendments to the Basis for Conclusions on other Standards ILLUSTRATIVE EXAMPLES (see separate booklet) GUIDANCE ON IMPLEMENTING IFRS 9 FINANCIAL INSTRUMENTS APPENDIX Amendments to the guidance on other Standards 3 ! IFRS Foundation IFRS 9 FINANCIAL INSTRUMENTS—JULY 2014 International Financial Reporting Standard 9 Financial Instruments (IFRS 9) is set out in paragraphs 1.1–7.3.2 and Appendices A–C. All the paragraphs have equal authority. Paragraphs in bold type state the main principles. Terms defined in Appendix A are in italics the first time they appear in the IFRS. Definitions of other terms are given in the Glossary for International Financial Reporting Standards. IFRS 9 should be read in the context of its objective and the Basis for Conclusions, the Preface to International Financial Reporting Standards and the Conceptual Framework for Financial Reporting. IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors provides a basis for selecting and applying accounting policies in the absence of explicit guidance. ! IFRS Foundation 4 INTERNATIONAL FINANCIAL REPORTING STANDARD Introduction Reasons for issuing IFRS 9 IN1 IFRS 9 Financial Instruments sets out the requirements for recognising and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items. This Standard replaces IAS 39 Financial Instruments: Recognition and Measurement. IN2 Many users of financial statements and other interested parties told the International Accounting Standards Board (IASB) that the requirements in IAS 39 were difficult to understand, apply and interpret. They urged the IASB to develop a new Standard for the financial reporting of financial instruments that was principle-based and less complex. Although the IASB amended IAS 39 several times to clarify requirements, add guidance and eliminate internal inconsistencies, it had not previously undertaken a fundamental reconsideration of the reporting for financial instruments. IN3 In 2005 the IASB and the US national standard-setter, the Financial Accounting Standards Board (FASB), began working towards a long-term objective of improving and simplifying the reporting for financial instruments. This work resulted in the publication of the Discussion Paper, Reducing Complexity in Reporting Financial Instruments, in March 2008. Focusing on the measurement of financial instruments and hedge accounting, the Discussion Paper identified several possible approaches for improving and simplifying the accounting for financial instruments. The responses to the Discussion Paper indicated support for a significant change in the requirements for reporting financial instruments. In November 2008 the IASB added this project to its active agenda. IN4 In April 2009, in response to the feedback received on its work responding to the global financial crisis, and following the conclusions of the G20 leaders and the recommendations of international bodies such as the Financial Stability Board, the IASB announced an accelerated timetable for replacing IAS 39. The IASB’s approach to replacing IAS 39 IN5 The IASB had always intended that IFRS 9 would replace IAS 39 in its entirety. However, in response to requests from interested parties that the accounting for financial instruments be improved quickly, the IASB divided its project to replace IAS 39 into three main phases. As the IASB completed each phase, it created chapters in IFRS 9 that replaced the corresponding requirements in IAS 39. IN6 The three main phases of the IASB’s project to replace IAS 39 were: (a) Phase 1: classification and measurement of financial assets and financial liabilities. In November 2009 the IASB issued the chapters of IFRS 9 relating to the classification and measurement of financial assets. Those chapters require financial assets to be classified on the basis of the business model within which they are held and their contractual cash 5 ! IFRS Foundation IFRS 9 FINANCIAL INSTRUMENTS—JULY 2014 flow characteristics. In October 2010 the IASB added to IFRS 9 the requirements related to the classification and measurement of financial liabilities. Those additional requirements are described further in paragraph IN7. In July 2014 the IASB made limited amendments to the classification and measurement requirements in IFRS 9 for financial assets. Those amendments are described further in paragraph IN8. (b) Phase 2: impairment methodology. In July 2014 the IASB added to IFRS 9 the impairment requirements related to the accounting for expected credit losses on an entity’s financial assets and commitments to extend credit. Those requirements are described further in paragraph IN9. (c) Phase 3: hedge accounting. In November 2013 the IASB added to IFRS 9 the requirements related to hedge accounting. Those additional requirements are described further in paragraph IN10. Classification and measurement IN7 In November 2009 the IASB issued the chapters of IFRS 9 relating to the classification and measurement of financial assets. Financial assets are classified on the basis of the business model within which they are held and their contractual cash flow characteristics. In October 2010 the IASB added to IFRS 9 the requirements for the classification and measurement of financial liabilities. Most of those requirements were carried forward unchanged from IAS 39. However, the requirements related to the fair value option for financial liabilities were changed to address own credit risk. Those improvements respond to consistent feedback from users of financial statements and others that the effects of changes in a liability’s credit risk ought not to affect profit or loss unless the liability is held for trading. In November 2013 the IASB amended IFRS 9 to permit entities to early apply those requirements without applying the other requirements of IFRS 9 at the same time. IN8 In July 2014 the IASB made limited amendments to the requirements in IFRS 9 for the classification and measurement of financial assets. Those amendments addressed a narrow range of application questions and introduced a ‘fair value through other comprehensive income’ measurement category for particular simple debt instruments. The introduction of that third measurement category responded to feedback from interested parties, including many insurance companies, that this is the most relevant measurement basis for financial assets that are held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets. Impairment methodology IN9 Also in July 2014 the IASB added to IFRS 9 the impairment requirements relating to the accounting for an entity’s expected credit losses on its financial assets and commitments to extend credit. Those requirements eliminate the threshold that was in IAS 39 for the recognition of credit losses. Under the impairment approach in IFRS 9 it is no longer necessary for a credit event to have occurred before credit losses are recognised. Instead, an entity always accounts for expected credit losses, and changes in those expected credit losses. The amount ! IFRS Foundation 6 INTERNATIONAL FINANCIAL REPORTING STANDARD of expected credit losses is updated at each reporting date to reflect changes in credit risk since initial recognition and, consequently, more timely information is provided about expected credit losses. Hedge accounting IN10 In November 2013 the IASB added to IFRS 9 the requirements related to hedge accounting. These requirements align hedge accounting more closely with risk management, establish a more principle-based approach to hedge accounting and address inconsistencies and weaknesses in the hedge accounting model in IAS 39. In its discussion of these general hedge accounting requirements, the IASB did not address specific accounting for open portfolios or macro hedging. Instead, the IASB is discussing proposals for those items as part of its current active agenda and in April 2014 published a Discussion Paper Accounting for Dynamic Risk Management: a Portfolio Revaluation Approach to Macro Hedging. Consequently, the exception in IAS 39 for a fair value hedge of an interest rate exposure of a portfolio of financial assets or financial liabilities continues to apply. The IASB also provided entities with an accounting policy choice between applying the hedge accounting requirements of IFRS 9 or continuing to apply the existing hedge accounting requirements in IAS 39 for all hedge accounting because it had not yet completed its project on the accounting for macro hedging. Other requirements IN11 In addition to the three phases described above, in March 2009 the IASB published the Exposure Draft Derecognition (Proposed amendments to IAS 39 and IFRS 7). However, in June 2010 the IASB revised its strategy and work plan and decided to retain the existing requirements in IAS 39 for the derecognition of financial assets and financial liabilities but to finalise improved disclosure requirements. Those new disclosure requirements were issued in October 2010 as an amendment to IFRS 7 Financial Instruments: Disclosures and had an effective date of 1 July 2011. In October 2010 the requirements in IAS 39 for the derecognition of financial assets and financial liabilities were carried forward unchanged to IFRS 9. IN12 As a result of the added requirements described in paragraphs IN7 and IN11, IFRS 9 and its Basis for Conclusions (as issued in 2009) were restructured in 2010. Many paragraphs were renumbered and some were re-sequenced. New paragraphs were added to accommodate the guidance that was carried forward unchanged from IAS 39. In addition, new sections were added to IFRS 9. Otherwise, the restructuring did not change the requirements in IFRS 9 (2009). In addition, the Basis for Conclusions on IFRS 9 was expanded in 2010 to include material from the Basis for Conclusions on IAS 39 that discusses guidance that was carried forward without being reconsidered. Minor editorial changes were made to that material. IN13 In 2014, as a result of the added requirements described in paragraph IN9, additional minor structural changes were made to the application guidance on Chapter 5 (Measurement) of IFRS 9. Specifically, the paragraphs related to the measurement of investments in equity instruments and contracts on those investments were renumbered as paragraphs B5.2.3–B5.2.6. These requirements 7 ! IFRS Foundation IFRS 9 FINANCIAL INSTRUMENTS—JULY 2014 were not otherwise changed. This renumbering made it possible to add the requirements for amortised cost and impairment as Sections 5.4 and 5.5. ! IFRS Foundation 8 INTERNATIONAL FINANCIAL REPORTING STANDARD International Financial Reporting Standard 9 Financial Instruments Chapter 1 Objective 1.1 The objective of this Standard is to establish principles for the financial reporting of financial assets and financial liabilities that will present relevant and useful information to users of financial statements for their assessment of the amounts, timing and uncertainty of an entity’s future cash flows. Chapter 2 Scope 2.1 This Standard shall be applied by all entities to all types of financial instruments except: (a) those interests in subsidiaries, associates and joint ventures that are accounted for in accordance with IFRS 10 Consolidated Financial Statements, IAS 27 Separate Financial Statements or IAS 28 Investments in Associates and Joint Ventures. However, in some cases, IFRS 10, IAS 27 or IAS 28 require or permit an entity to account for an interest in a subsidiary, associate or joint venture in accordance with some or all of the requirements of this Standard. Entities shall also apply this Standard to derivatives on an interest in a subsidiary, associate or joint venture unless the derivative meets the definition of an equity instrument of the entity in IAS 32 Financial Instruments: Presentation. (b) rights and obligations under leases to which IAS 17 Leases applies. However: (i) lease receivables recognised by a lessor are subject to the derecognition and impairment requirements of this Standard; (ii) finance lease payables recognised by a lessee are subject to the derecognition requirements of this Standard; and (iii) derivatives that are embedded in leases are subject to the embedded derivatives requirements of this Standard. (c) employers’ rights and obligations under employee benefit plans, to which IAS 19 Employee Benefits applies. (d) financial instruments issued by the entity that meet the definition of an equity instrument in IAS 32 (including options and warrants) or that are required to be classified as an equity instrument in accordance with paragraphs 16A and 16B or paragraphs 16C and 16D of IAS 32. However, the holder of such equity instruments shall apply this Standard to those instruments, unless they meet the exception in (a). (e) rights and obligations arising under (i) an insurance contract as defined in IFRS 4 Insurance Contracts, other than an issuer’s rights and obligations arising under an insurance contract that meets 9 ! IFRS Foundation IFRS 9 FINANCIAL INSTRUMENTS—JULY 2014 the definition of a financial guarantee contract, or (ii) a contract that is within the scope of IFRS 4 because it contains a discretionary participation feature. However, this Standard applies to a derivative that is embedded in a contract within the scope of IFRS 4 if the derivative is not itself a contract within the scope of IFRS 4. Moreover, if an issuer of financial guarantee contracts has previously asserted explicitly that it regards such contracts as insurance contracts and has used accounting that is applicable to insurance contracts, the issuer may elect to apply either this Standard or IFRS 4 to such financial guarantee contracts (see paragraphs B2.5–B2.6). The issuer may make that election contract by contract, but the election for each contract is irrevocable. (f) any forward contract between an acquirer and a selling shareholder to buy or sell an acquiree that will result in a business combination within the scope of IFRS 3 Business Combinations at a future acquisition date. The term of the forward contract should not exceed a reasonable period normally necessary to obtain any required approvals and to complete the transaction. (g) loan commitments other than those loan commitments described in paragraph 2.3. However, an issuer of loan commitments shall apply the impairment requirements of this Standard to loan commitments that are not otherwise within the scope of this Standard. Also, all loan commitments are subject to the derecognition requirements of this Standard. (h) financial instruments, contracts and obligations under share-based payment transactions to which IFRS 2 Share-based Payment applies, except for contracts within the scope of paragraphs 2.4–2.7 of this Standard to which this Standard applies. (i) rights to payments to reimburse the entity for expenditure that it is required to make to settle a liability that it recognises as a provision in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets, or for which, in an earlier period, it recognised a provision in accordance with IAS 37. (j) rights and obligations within the scope of IFRS 15 Revenue from Contracts with Customers that are financial instruments, except for those that IFRS 15 specifies are accounted for in accordance with this Standard. 2.2 The impairment requirements of this Standard shall be applied to those rights that IFRS 15 specifies are accounted for in accordance with this Standard for the purposes of recognising impairment gains or losses. 2.3 The following loan commitments are within the scope of this Standard: (a) ! IFRS Foundation loan commitments that the entity designates as financial liabilities at fair value through profit or loss (see paragraph 4.2.2). An entity that has a past practice of selling the assets resulting 10 INTERNATIONAL FINANCIAL REPORTING STANDARD from its loan commitments shortly after origination shall apply this Standard to all its loan commitments in the same class. (b) loan commitments that can be settled net in cash or by delivering or issuing another financial instrument. These loan commitments are derivatives. A loan commitment is not regarded as settled net merely because the loan is paid out in instalments (for example, a mortgage construction loan that is paid out in instalments in line with the progress of construction). (c) commitments to provide a loan at a below-market interest rate (see paragraph 4.2.1(d)). 2.4 This Standard shall be applied to those contracts to buy or sell a non-financial item that can be settled net in cash or another financial instrument, or by exchanging financial instruments, as if the contracts were financial instruments, with the exception of contracts that were entered into and continue to be held for the purpose of the receipt or delivery of a non-financial item in accordance with the entity’s expected purchase, sale or usage requirements. However, this Standard shall be applied to those contracts that an entity designates as measured at fair value through profit or loss in accordance with paragraph 2.5. 2.5 A contract to buy or sell a non-financial item that can be settled net in cash or another financial instrument, or by exchanging financial instruments, as if the contract was a financial instrument, may be irrevocably designated as measured at fair value through profit or loss even if it was entered into for the purpose of the receipt or delivery of a non-financial item in accordance with the entity’s expected purchase, sale or usage requirements. This designation is available only at inception of the contract and only if it eliminates or significantly reduces a recognition inconsistency (sometimes referred to as an ‘accounting mismatch’) that would otherwise arise from not recognising that contract because it is excluded from the scope of this Standard (see paragraph 2.4). 2.6 There are various ways in which a contract to buy or sell a non-financial item can be settled net in cash or another financial instrument or by exchanging financial instruments. These include: (a) when the terms of the contract permit either party to settle it net in cash or another financial instrument or by exchanging financial instruments; (b) when the ability to settle net in cash or another financial instrument, or by exchanging financial instruments, is not explicit in the terms of the contract, but the entity has a practice of settling similar contracts net in cash or another financial instrument or by exchanging financial instruments (whether with the counterparty, by entering into offsetting contracts or by selling the contract before its exercise or lapse); (c) when, for similar contracts, the entity has a practice of taking delivery of the underlying and selling it within a short period after delivery for the purpose of generating a profit from short-term fluctuations in price or dealer’s margin; and 11 ! IFRS Foundation IFRS 9 FINANCIAL INSTRUMENTS—JULY 2014 (d) when the non-financial item that is the subject of the contract is readily convertible to cash. A contract to which (b) or (c) applies is not entered into for the purpose of the receipt or delivery of the non-financial item in accordance with the entity’s expected purchase, sale or usage requirements and, accordingly, is within the scope of this Standard. Other contracts to which paragraph 2.4 applies are evaluated to determine whether they were entered into and continue to be held for the purpose of the receipt or delivery of the non-financial item in accordance with the entity’s expected purchase, sale or usage requirements and, accordingly, whether they are within the scope of this Standard. 2.7 A written option to buy or sell a non-financial item that can be settled net in cash or another financial instrument, or by exchanging financial instruments, in accordance with paragraph 2.6(a) or 2.6(d) is within the scope of this Standard. Such a contract cannot be entered into for the purpose of the receipt or delivery of the non-financial item in accordance with the entity’s expected purchase, sale or usage requirements. Chapter 3 Recognition and derecognition 3.1 Initial recognition 3.1.1 An entity shall recognise a financial asset or a financial liability in its statement of financial position when, and only when, the entity becomes party to the contractual provisions of the instrument (see paragraphs B3.1.1 and B3.1.2). When an entity first recognises a financial asset, it shall classify it in accordance with paragraphs 4.1.1–4.1.5 and measure it in accordance with paragraphs 5.1.1–5.1.3. When an entity first recognises a financial liability, it shall classify it in accordance with paragraphs 4.2.1 and 4.2.2 and measure it in accordance with paragraph 5.1.1. Regular way purchase or sale of financial assets 3.1.2 A regular way purchase or sale of financial assets shall be recognised and derecognised, as applicable, using trade date accounting or settlement date accounting (see paragraphs B3.1.3–B3.1.6). 3.2 Derecognition of financial assets 3.2.1 In consolidated financial statements, paragraphs 3.2.2–3.2.9, B3.1.1, B3.1.2 and B3.2.1–B3.2.17 are applied at a consolidated level. Hence, an entity first consolidates all subsidiaries in accordance with IFRS 10 and then applies those paragraphs to the resulting group. 3.2.2 Before evaluating whether, and to what extent, derecognition is appropriate under paragraphs 3.2.3–3.2.9, an entity determines whether those paragraphs should be applied to a part of a financial asset (or a part of a group of similar financial assets) or a financial asset (or a group of similar financial assets) in its entirety, as follows. ! IFRS Foundation 12 INTERNATIONAL FINANCIAL REPORTING STANDARD (a) (b) Paragraphs 3.2.3–3.2.9 are applied to a part of a financial asset (or a part of a group of similar financial assets) if, and only if, the part being considered for derecognition meets one of the following three conditions. (i) The part comprises only specifically identified cash flows from a financial asset (or a group of similar financial assets). For example, when an entity enters into an interest rate strip whereby the counterparty obtains the right to the interest cash flows, but not the principal cash flows from a debt instrument, paragraphs 3.2.3–3.2.9 are applied to the interest cash flows. (ii) The part comprises only a fully proportionate (pro rata) share of the cash flows from a financial asset (or a group of similar financial assets). For example, when an entity enters into an arrangement whereby the counterparty obtains the rights to a 90 per cent share of all cash flows of a debt instrument, paragraphs 3.2.3–3.2.9 are applied to 90 per cent of those cash flows. If there is more than one counterparty, each counterparty is not required to have a proportionate share of the cash flows provided that the transferring entity has a fully proportionate share. (iii) The part comprises only a fully proportionate (pro rata) share of specifically identified cash flows from a financial asset (or a group of similar financial assets). For example, when an entity enters into an arrangement whereby the counterparty obtains the rights to a 90 per cent share of interest cash flows from a financial asset, paragraphs 3.2.3–3.2.9 are applied to 90 per cent of those interest cash flows. If there is more than one counterparty, each counterparty is not required to have a proportionate share of the specifically identified cash flows provided that the transferring entity has a fully proportionate share. In all other cases, paragraphs 3.2.3–3.2.9 are applied to the financial asset in its entirety (or to the group of similar financial assets in their entirety). For example, when an entity transfers (i) the rights to the first or the last 90 per cent of cash collections from a financial asset (or a group of financial assets), or (ii) the rights to 90 per cent of the cash flows from a group of receivables, but provides a guarantee to compensate the buyer for any credit losses up to 8 per cent of the principal amount of the receivables, paragraphs 3.2.3–3.2.9 are applied to the financial asset (or a group of similar financial assets) in its entirety. In paragraphs 3.2.3–3.2.12, the term ‘financial asset’ refers to either a part of a financial asset (or a part of a group of similar financial assets) as identified in (a) above or, otherwise, a financial asset (or a group of similar financial assets) in its entirety. 13 ! IFRS Foundation IFRS 9 FINANCIAL INSTRUMENTS—JULY 2014 3.2.3 An entity shall derecognise a financial asset when, and only when: (a) the contractual rights to the cash flows from the financial asset expire, or (b) it transfers the financial asset as set out in paragraphs 3.2.4 and 3.2.5 and the transfer qualifies for derecognition in accordance with paragraph 3.2.6. (See paragraph 3.1.2 for regular way sales of financial assets.) 3.2.4 3.2.5 3.2.6 An entity transfers a financial asset if, and only if, it either: (a) transfers the contractual rights to receive the cash flows of the financial asset, or (b) retains the contractual rights to receive the cash flows of the financial asset, but assumes a contractual obligation to pay the cash flows to one or more recipients in an arrangement that meets the conditions in paragraph 3.2.5. When an entity retains the contractual rights to receive the cash flows of a financial asset (the ‘original asset’), but assumes a contractual obligation to pay those cash flows to one or more entities (the ‘eventual recipients’), the entity treats the transaction as a transfer of a financial asset if, and only if, all of the following three conditions are met. (a) The entity has no obligation to pay amounts to the eventual recipients unless it collects equivalent amounts from the original asset. Short-term advances by the entity with the right of full recovery of the amount lent plus accrued interest at market rates do not violate this condition. (b) The entity is prohibited by the terms of the transfer contract from selling or pledging the original asset other than as security to the eventual recipients for the obligation to pay them cash flows. (c) The entity has an obligation to remit any cash flows it collects on behalf of the eventual recipients without material delay. In addition, the entity is not entitled to reinvest such cash flows, except for investments in cash or cash equivalents (as defined in IAS 7 Statement of Cash Flows) during the short settlement period from the collection date to the date of required remittance to the eventual recipients, and interest earned on such investments is passed to the eventual recipients. When an entity transfers a financial asset (see paragraph 3.2.4), it shall evaluate the extent to which it retains the risks and rewards of ownership of the financial asset. In this case: (a) ! IFRS Foundation if the entity transfers substantially all the risks and rewards of ownership of the financial asset, the entity shall derecognise the financial asset and recognise separately as assets or liabilities any rights and obligations created or retained in the transfer. 14 INTERNATIONAL FINANCIAL REPORTING STANDARD (b) if the entity retains substantially all the risks and rewards of ownership of the financial asset, the entity shall continue to recognise the financial asset. (c) if the entity neither transfers nor retains substantially all the risks and rewards of ownership of the financial asset, the entity shall determine whether it has retained control of the financial asset. In this case: (i) if the entity has not retained control, it shall derecognise the financial asset and recognise separately as assets or liabilities any rights and obligations created or retained in the transfer. (ii) if the entity has retained control, it shall continue to recognise the financial asset to the extent of its continuing involvement in the financial asset (see paragraph 3.2.16). 3.2.7 The transfer of risks and rewards (see paragraph 3.2.6) is evaluated by comparing the entity’s exposure, before and after the transfer, with the variability in the amounts and timing of the net cash flows of the transferred asset. An entity has retained substantially all the risks and rewards of ownership of a financial asset if its exposure to the variability in the present value of the future net cash flows from the financial asset does not change significantly as a result of the transfer (eg because the entity has sold a financial asset subject to an agreement to buy it back at a fixed price or the sale price plus a lender’s return). An entity has transferred substantially all the risks and rewards of ownership of a financial asset if its exposure to such variability is no longer significant in relation to the total variability in the present value of the future net cash flows associated with the financial asset (eg because the entity has sold a financial asset subject only to an option to buy it back at its fair value at the time of repurchase or has transferred a fully proportionate share of the cash flows from a larger financial asset in an arrangement, such as a loan sub-participation, that meets the conditions in paragraph 3.2.5). 3.2.8 Often it will be obvious whether the entity has transferred or retained substantially all risks and rewards of ownership and there will be no need to perform any computations. In other cases, it will be necessary to compute and compare the entity’s exposure to the variability in the present value of the future net cash flows before and after the transfer. The computation and comparison are made using as the discount rate an appropriate current market interest rate. All reasonably possible variability in net cash flows is considered, with greater weight being given to those outcomes that are more likely to occur. 3.2.9 Whether the entity has retained control (see paragraph 3.2.6(c)) of the transferred asset depends on the transferee’s ability to sell the asset. If the transferee has the practical ability to sell the asset in its entirety to an unrelated third party and is able to exercise that ability unilaterally and without needing to impose additional restrictions on the transfer, the entity has not retained control. In all other cases, the entity has retained control. 15 ! IFRS Foundation IFRS 9 FINANCIAL INSTRUMENTS—JULY 2014 Transfers that qualify for derecognition 3.2.10 If an entity transfers a financial asset in a transfer that qualifies for derecognition in its entirety and retains the right to service the financial asset for a fee, it shall recognise either a servicing asset or a servicing liability for that servicing contract. If the fee to be received is not expected to compensate the entity adequately for performing the servicing, a servicing liability for the servicing obligation shall be recognised at its fair value. If the fee to be received is expected to be more than adequate compensation for the servicing, a servicing asset shall be recognised for the servicing right at an amount determined on the basis of an allocation of the carrying amount of the larger financial asset in accordance with paragraph 3.2.13. 3.2.11 If, as a result of a transfer, a financial asset is derecognised in its entirety but the transfer results in the entity obtaining a new financial asset or assuming a new financial liability, or a servicing liability, the entity shall recognise the new financial asset, financial liability or servicing liability at fair value. 3.2.12 On derecognition of a financial asset in its entirety, the difference between: (a) the carrying amount (measured at the date of derecognition) and (b) the consideration received (including any new asset obtained less any new liability assumed) shall be recognised in profit or loss. 3.2.13 If the transferred asset is part of a larger financial asset (eg when an entity transfers interest cash flows that are part of a debt instrument, see paragraph 3.2.2(a)) and the part transferred qualifies for derecognition in its entirety, the previous carrying amount of the larger financial asset shall be allocated between the part that continues to be recognised and the part that is derecognised, on the basis of the relative fair values of those parts on the date of the transfer. For this purpose, a retained servicing asset shall be treated as a part that continues to be recognised. The difference between: (a) the carrying amount (measured at the date of derecognition) allocated to the part derecognised and (b) the consideration received for the part derecognised (including any new asset obtained less any new liability assumed) shall be recognised in profit or loss. 3.2.14 When an entity allocates the previous carrying amount of a larger financial asset between the part that continues to be recognised and the part that is derecognised, the fair value of the part that continues to be recognised needs to be measured. When the entity has a history of selling parts similar to the part that continues to be recognised or other market transactions exist for such parts, recent prices of actual transactions provide the best estimate of its fair value. When there are no price quotes or recent market transactions to support ! IFRS Foundation 16 INTERNATIONAL FINANCIAL REPORTING STANDARD the fair value of the part that continues to be recognised, the best estimate of the fair value is the difference between the fair value of the larger financial asset as a whole and the consideration received from the transferee for the part that is derecognised. Transfers that do not qualify for derecognition 3.2.15 If a transfer does not result in derecognition because the entity has retained substantially all the risks and rewards of ownership of the transferred asset, the entity shall continue to recognise the transferred asset in its entirety and shall recognise a financial liability for the consideration received. In subsequent periods, the entity shall recognise any income on the transferred asset and any expense incurred on the financial liability. Continuing involvement in transferred assets 3.2.16 3.2.17 If an entity neither transfers nor retains substantially all the risks and rewards of ownership of a transferred asset, and retains control of the transferred asset, the entity continues to recognise the transferred asset to the extent of its continuing involvement. The extent of the entity’s continuing involvement in the transferred asset is the extent to which it is exposed to changes in the value of the transferred asset. For example: (a) When the entity’s continuing involvement takes the form of guaranteeing the transferred asset, the extent of the entity’s continuing involvement is the lower of (i) the amount of the asset and (ii) the maximum amount of the consideration received that the entity could be required to repay (‘the guarantee amount’). (b) When the entity’s continuing involvement takes the form of a written or purchased option (or both) on the transferred asset, the extent of the entity’s continuing involvement is the amount of the transferred asset that the entity may repurchase. However, in the case of a written put option on an asset that is measured at fair value, the extent of the entity’s continuing involvement is limited to the lower of the fair value of the transferred asset and the option exercise price (see paragraph B3.2.13). (c) When the entity’s continuing involvement takes the form of a cash-settled option or similar provision on the transferred asset, the extent of the entity’s continuing involvement is measured in the same way as that which results from non-cash settled options as set out in (b) above. When an entity continues to recognise an asset to the extent of its continuing involvement, the entity also recognises an associated liability. Despite the other measurement requirements in this Standard, the transferred asset and the associated liability are measured on a basis that reflects the rights and obligations that the entity has retained. The associated liability is measured in such a way that the net carrying amount of the transferred asset and the associated liability is: 17 ! IFRS Foundation IFRS 9 FINANCIAL INSTRUMENTS—JULY 2014 (a) the amortised cost of the rights and obligations retained by the entity, if the transferred asset is measured at amortised cost, or (b) equal to the fair value of the rights and obligations retained by the entity when measured on a stand-alone basis, if the transferred asset is measured at fair value. 3.2.18 The entity shall continue to recognise any income arising on the transferred asset to the extent of its continuing involvement and shall recognise any expense incurred on the associated liability. 3.2.19 For the purpose of subsequent measurement, recognised changes in the fair value of the transferred asset and the associated liability are accounted for consistently with each other in accordance with paragraph 5.7.1, and shall not be offset. 3.2.20 If an entity’s continuing involvement is in only a part of a financial asset (eg when an entity retains an option to repurchase part of a transferred asset, or retains a residual interest that does not result in the retention of substantially all the risks and rewards of ownership and the entity retains control), the entity allocates the previous carrying amount of the financial asset between the part it continues to recognise under continuing involvement, and the part it no longer recognises on the basis of the relative fair values of those parts on the date of the transfer. For this purpose, the requirements of paragraph 3.2.14 apply. The difference between: (a) the carrying amount (measured at the date of derecognition) allocated to the part that is no longer recognised and (b) the consideration received for the part no longer recognised shall be recognised in profit or loss. 3.2.21 If the transferred asset is measured at amortised cost, the option in this Standard to designate a financial liability as at fair value through profit or loss is not applicable to the associated liability. All transfers 3.2.22 If a transferred asset continues to be recognised, the asset and the associated liability shall not be offset. Similarly, the entity shall not offset any income arising from the transferred asset with any expense incurred on the associated liability (see paragraph 42 of IAS 32). 3.2.23 If a transferor provides non-cash collateral (such as debt or equity instruments) to the transferee, the accounting for the collateral by the transferor and the transferee depends on whether the transferee has the right to sell or repledge the collateral and on whether the transferor has defaulted. The transferor and transferee shall account for the collateral as follows: ! IFRS Foundation 18 INTERNATIONAL FINANCIAL REPORTING STANDARD (a) If the transferee has the right by contract or custom to sell or repledge the collateral, then the transferor shall reclassify that asset in its statement of financial position (eg as a loaned asset, pledged equity instruments or repurchase receivable) separately from other assets. (b) If the transferee sells collateral pledged to it, it shall recognise the proceeds from the sale and a liability measured at fair value for its obligation to return the collateral. (c) If the transferor defaults under the terms of the contract and is no longer entitled to redeem the collateral, it shall derecognise the collateral, and the transferee shall recognise the collateral as its asset initially measured at fair value or, if it has already sold the collateral, derecognise its obligation to return the collateral. (d) Except as provided in (c), the transferor shall continue to carry the collateral as its asset, and the transferee shall not recognise the collateral as an asset. 3.3 Derecognition of financial liabilities 3.3.1 An entity shall remove a financial liability (or a part of a financial liability) from its statement of financial position when, and only when, it is extinguished—ie when the obligation specified in the contract is discharged or cancelled or expires. 3.3.2 An exchange between an existing borrower and lender of debt instruments with substantially different terms shall be accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. Similarly, a substantial modification of the terms of an existing financial liability or a part of it (whether or not attributable to the financial difficulty of the debtor) shall be accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. 3.3.3 The difference between the carrying amount of a financial liability (or part of a financial liability) extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities assumed, shall be recognised in profit or loss. 3.3.4 If an entity repurchases a part of a financial liability, the entity shall allocate the previous carrying amount of the financial liability between the part that continues to be recognised and the part that is derecognised based on the relative fair values of those parts on the date of the repurchase. The difference between (a) the carrying amount allocated to the part derecognised and (b) the consideration paid, including any non-cash assets transferred or liabilities assumed, for the part derecognised shall be recognised in profit or loss. 19 ! IFRS Foundation IFRS 9 FINANCIAL INSTRUMENTS—JULY 2014 Chapter 4 Classification 4.1 Classification of financial assets 4.1.1 4.1.2 Unless paragraph 4.1.5 applies, an entity shall classify financial assets as subsequently measured at amortised cost, fair value through other comprehensive income or fair value through profit or loss on the basis of both: (a) the entity’s business model for managing the financial assets and (b) the contractual cash flow characteristics of the financial asset. A financial asset shall be measured at amortised cost if both of the following conditions are met: (a) the financial asset is held within a business model whose objective is to hold financial assets in order to collect contractual cash flows and (b) 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. Paragraphs B4.1.1–B4.1.26 provide guidance on how to apply these conditions. 4.1.2A A financial asset shall be measured at fair value through other comprehensive income if both of the following conditions are met: (a) the financial asset is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets and (b) 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. Paragraphs B4.1.1–B4.1.26 provide guidance on how to apply these conditions. 4.1.3 4.1.4 For the purpose of applying paragraphs 4.1.2(b) and 4.1.2A(b): (a) principal is the fair value of the financial asset at initial recognition. Paragraph B4.1.7B provides additional guidance on the meaning of principal. (b) interest consists of consideration for the time value of money, for the credit risk associated with the principal amount outstanding during a particular period of time and for other basic lending risks and costs, as well as a profit margin. Paragraphs B4.1.7A and B4.1.9A–B4.1.9E provide additional guidance on the meaning of interest, including the meaning of the time value of money. A financial asset shall be measured at fair value through profit or loss unless it is measured at amortised cost in accordance with paragraph 4.1.2 or at fair value through other comprehensive income in ! IFRS Foundation 20 INTERNATIONAL FINANCIAL REPORTING STANDARD accordance with paragraph 4.1.2A. However an entity may make an irrevocable election at initial recognition for particular investments in equity instruments that would otherwise be measured at fair value through profit or loss to present subsequent changes in fair value in other comprehensive income (see paragraphs 5.7.5–5.7.6). Option to designate a financial asset at fair value through profit or loss 4.1.5 Despite paragraphs 4.1.1–4.1.4, an entity may, at initial recognition, irrevocably designate a financial asset as measured at fair value through profit or loss 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 (see paragraphs B4.1.29–B4.1.32). 4.2 Classification of financial liabilities 4.2.1 An entity shall classify all financial liabilities as subsequently measured at amortised cost, except for: (a) financial liabilities at fair value through profit or loss. Such liabilities, including derivatives that are liabilities, shall be subsequently measured at fair value. (b) financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or when the continuing involvement approach applies. Paragraphs 3.2.15 and 3.2.17 apply to the measurement of such financial liabilities. (c) financial guarantee contracts. After initial recognition, an issuer of such a contract shall (unless paragraph 4.2.1(a) or (b) applies) subsequently measure it at the higher of: (d) (i) the amount of the loss allowance determined in accordance with Section 5.5 and (ii) the amount initially recognised (see paragraph 5.1.1) less, when appropriate, the cumulative amount of income recognised in accordance with the principles of IFRS 15. commitments to provide a loan at a below-market interest rate. An issuer of such a commitment shall (unless paragraph 4.2.1(a) applies) subsequently measure it at the higher of: (i) the amount of the loss allowance determined in accordance with Section 5.5 and (ii) the amount initially recognised (see paragraph 5.1.1) less, when appropriate, the cumulative amount of income recognised in accordance with the principles of IFRS 15. 21 ! IFRS Foundation IFRS 9 FINANCIAL INSTRUMENTS—JULY 2014 (e) contingent consideration recognised by an acquirer in a business combination to which IFRS 3 applies. Such contingent consideration shall subsequently be measured at fair value with changes recognised in profit or loss. Option to designate a financial liability at fair value through profit or loss 4.2.2 An entity may, at initial recognition, irrevocably designate a financial liability as measured at fair value through profit or loss when permitted by paragraph 4.3.5, or when doing so results in more relevant information, because either: (a) it 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 (see paragraphs B4.1.29–B4.1.32); or (b) a group of financial liabilities or financial assets and financial liabilities is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and information about the group is provided internally on that basis to the entity’s key management personnel (as defined in IAS 24 Related Party Disclosures), for example, the entity’s board of directors and chief executive officer (see paragraphs B4.1.33–B4.1.36). 4.3 Embedded derivatives 4.3.1 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. An embedded derivative causes some or all of the cash flows that otherwise would be required by the contract to be modified according to a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract. 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. Hybrid contracts with f...
Purchase answer to see full attachment