IFRS 9 is effective for annual periods beginning or after 1 January 2018, with early application permitted. In accounting, 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 requires an entity to recognise a financial asset or a financial liability in its statement of financial position when it becomes party to the contractual provisions of the instrument. At initial recognition, an entity measures a financial asset or a financial liability at its fair value plus or minus. In the case of a financial asset or a financial liability not at fair value through profit or loss, transaction costs are directly attributable to the acquisition or issue of the financial asset or the financial liability [IFRS 9, paragraph 5.1.1]. The accounting experts at GCS Malta discuss IFRS 9 for financial assets in this article.

Accounting for Financial assets

When an entity first recognises a financial asset, it classifies it based on the entity’s business model for managing the asset and the asset’s contractual cash flow characteristics, as follows:

1. Amortised cost – a financial asset is measured at amortised cost if both of the following conditions are met:

  • the asset is held within a business model whose objective is to keep assets to collect contractual cash flows; and
  • 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.

2. Fair value through other comprehensive income – financial assets are classified and measured at fair value through other comprehensive income if they are held in a business model whose objective is achieved by collecting contractual cash flows and selling financial assets.

3. Fair value through profit or loss – any financial assets not held in one of the two business models mentioned above are measured at fair value through profit or loss.

When, and only when, an entity changes its business model for managing financial assets, it must reclassify all affected financial assets based on the general classification criteria.

Classification and measurement

The standard introduces a principle-based system for classifying and measuring financial assets, which depends upon the entity’s business model for managing the financial asset and the financial asset’s contractual cash flow characteristics.

The business model approach refers to how an entity manages its financial assets to generate cashflows either by:

  • collecting contractual cashflows
  • selling financial assets
  • or both

The cash flow characteristics test

The second condition for classification in the amortised cost classification or FVTOCI category can be labelled the solely payments of principal and interest (SPPI) test. The requirement is that 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.

Optional classifications

IFRS 9 permits an FVTOCI option for investments in equity instruments. An entity may make an irrevocable election to present in other comprehensive income subsequent changes in the fair value of an investment in an equity instrument that is not held for trading and is not contingent consideration of an acquirer in a business combination. However, in contrast to the  FVTOCI category for debt instruments:

  • Gains and losses recognised in OCI are not subsequently transferred to profit or loss (sometimes referred to as ‘recycling’); and
  • Equity FVTOCI instruments are not subject to any impairment accounting.
  • Fair value option

IFRS 9 contains a modified version of IAS 39’s ‘fair value option’ – the option to designate a financial asset at fair value through profit or loss in some circumstances. For example, at initial recognition, an entity may designate a financial asset as measured at fair value through profit or loss that would otherwise be measured subsequently at amortised cost or fair value through other comprehensive income. However, such a designation can only be made if it eliminates or significantly reduces an ‘accounting mismatch’ that would otherwise arise.

Reclassification

Financial assets are reclassified when the entity’s business model for managing them changes. This is not expected to occur frequently and ensures that users of financial statements are provided with information on the realisation of cashflows. Disclosure requirements relating to reclassifying financial assets are set out in paragraphs of IFRS 7.12B-D.

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Article by Braden Debono