As mentioned in our previous article, IFRS 9 specifies how an entity should classify and measure financial assets, financial liabilities, and some contracts to buy or sell non-financial items. IFRS 9 is effective for annual periods beginning or after 1 January 2018, with early application permitted. The accounting team at GCS Malta discuss IFRS 9 for liabilities in this article.

Classification and measurement of financial liabilities in accounting

Most of IAS 39’s requirements were carried forward unchanged to IFRS 9. However, changes were made to address issues related to own credit risk where an entity takes the option to measure financial liabilities at fair value.

Own credit risk -­ Where an entity chooses to measure its debt at fair value, IFRS 9 now requires the amount of the change in fair value due to changes in the entity’s own credit risk to be presented in other comprehensive income. The only exception to the new requirement is where the effects of changes in the liability’s credit risk would create or enlarge an accounting mismatch in profit or loss, in which case all gains or losses on that liability are to be presented in profit or loss.

Reclassification – IFRS 9 prohibits an entity from reclassifying any financial liability.

Derecognition of financial assets and liabilities – The IASB determined that IAS 39’s requirements in this area had performed reasonably during the financial crisis. IAS 39’s derecognition requirements have therefore been incorporated into IFRS 9 unchanged.

Impairment

Expected credit losses

IAS 39’s ‘incurred loss’ model delayed the recognition of credit losses until objective evidence of a credit loss event had been identified. However, IFRS 9’s impairment requirements use more forward-looking information to recognise expected credit losses. As a result, credit loss recognition is no longer dependent on the entity first identifying a credit loss event. Instead, an entity should consider a broader range of information when assessing credit risk and measuring expected credit losses.

In applying this more forward-looking approach, a distinction is made between:

• Financial instruments that have not deteriorated significantly in credit quality since initial recognition or that have low credit risk; and
• Financial instruments that deteriorated significantly in credit quality since initial recognition and whose credit risk is not low.

‘12-month expected credit losses’ are recognised for the first of these two categories, while ‘lifetime expected credit losses’ are recognised for the second category. An asset moves from 12-month expected credit losses to lifetime expected credit losses when there had been a significant deterioration in credit quality since initial recognition and the credit risk is more than ‘low’. There is also a third stage in the model. For assets with objective evidence of impairment, interest is calculated based on the amortised cost net of the loss provision (this stage is essentially the same as the incurred loss model used in IAS 39).

Determining significant increases in credit risk

IFRS 9 requires an entity to assess at each reporting date whether the credit risk on a financial instrument has increased significantly since initial recognition. Where a financial instrument is determined to have low credit risk at the reporting date, it may assume that the credit risk on the instrument has not increased significantly since initial recognition. However, 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.

Measurement of expected credit losses

Under IFRS 9, expected credit losses are a probability-weighted estimate of credit losses (i.e. the present value of all cash shortfalls) over the expected life of the financial instrument.

Hedge Accounting

IFRS 9’s new requirements align hedge accounting more closely with entities’ risk management activities and should serve to reduce profit or loss volatility

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Article by Braden Debono