IFRS 9: SIMPLIFIED CLASSIFICATION REQUIREMENTS

ACCG 242: Applied Auditing

MARK JOHN R. DULLOSO July 26, 2018

DOCUMENT TITLE: IFRS 9, Financial Instruments: Understanding the Basics

AUTHOR ORGANIZATION: PwC
CROSS REFERENCING:
No
 Yes [EY, A summary of IFRS 9 and its effects]

Classification of financial instruments is one of the main differences of IFRS 9 from IAS
39. Under the former standard, how assets are classified generally determines the basis for
their measurement. In reverse, under IFRS 9, the basis on which the assets are measured is
the way they are classified. IFRS 9 eliminated the categories of former standard such as held
for maturities into three new categories: financial assets at amortized cost, at fair value through
profit or loss, and at fair value through other comprehensive income.

The new standard offers clear understanding on classifying one financial instrument from
the other and the measurement thereof. It focuses on satisfying the two main requirements in
determining which measurement to be used: business model test and the test that contractual
cash flows are solely payments for principal and interests (SPPI).

If the business model is to hold financial instrument to collect contractual cash flows and
the cash flows are solely for principal and interest payments then measure it at amortized cost
provided it was not elected at fair value through profit or loss. If the business model is to hold
financial instrument to collect contractual cash flows and sell, and the cash flows are solely for
principal and interest payments then measure it at fair value at other comprehensive income
provided it was not elected at fair value through profit or loss. The residual classification is to
measure all other financial instruments at fair value through profit or loss.

However PwC explained that the Business Model test must first be satisfied before the
SPPI (Solely Payments of Principal and Interest) test. It is contrary to the illustration showed in
the Ernst and Young (EY) interpretation wherein the SPPI test is first satisfied before the
business model test. PwC provides its observation that business model test should first be
applied before the SPPI test because it may eliminate the need to apply the more detailed SPPI
test, which is applied at more granular level. However, PwC further said that the ordering
however will not change the outcome.

This simplification from IASB (International Accounting Standards Board) explains the
rationale for limiting the use of Amortized Cost and FVTOCI to financial assets because these
tests are only meaningful only for basic or simple loans and receivables. More complex
arrangements must be measured at FVTPL. The measurement of any other financial
instruments not satisfied by the two qualification into FVTPL is somewhat reasonable because
this will reflect on its current operation. It also gives simpler accounting to more complex
transactions. The only problem that may arise is the availability of fair value in the financial
market, which is almost readily available.
 This simplification gives a clear guidance to the practitioners in giving their judgment as to
the measurement and classification of financial instruments although factors must still be based
on facts. The main revision is the way the different financial instrument are measured. The new
standard gives a better understanding about the nature of transaction to classify it first, whether
amortized cost, FVTPL or FVTOCI, with the satisfaction of the criteria given before measuring
the financial instrument to be reflected in the financial statements rather than measuring it first
before classifying.