IFRS 9 –

Financial
Instruments
May 4, 2021
 IFRS 9 Financial Instruments

 A new accounting standard on financial instruments which replaces IAS 39.

 New version of IFRS 9 issued on 24 July 2014
 Effective date: 1 January 2018. However, in late 2016, the IASB agreed to provide entities
whose predominate activities are insurance related the option of delaying implementation until
2021.
 Why the new standard?
IFRS 9 replaces IAS 39, Financial Instruments – Recognition and Measurement.

It is meant to respond to criticisms that IAS 39 is too complex, inconsistent with the way entities
manage their businesses and risks and defers the recognition of credit losses on loans and
receivables until too late in the credit cycle. The IASB had always intended to reconsider IAS 39,
but the financial crisis made this priority.
 Question:

Does IFRS 9 only affect financial institutions?

 Possible consequences of IFRS 9
 More income statement volatility
 Earlier recognition of impairment losses
 Significant new disclosure requirements
 3 Phases of IFRS 9
 Classification and measurement
 Impairment
 Hedging
 Key changes from IAS 39
Key Changes Implication
Different asset classification criteria Change in classification criteria and how financial
assets are reported in the financial statements.
New impairment approach Early recognition of impairment loss
 IFRS 9 Financial Instruments

IAS 39
IFRS 9
• Held-to-maturity
• Amortized Costs
• Fair value through Profit or Loss
• Fair value through Profit or Loss
(FVPL)
(FVPL) (Including Fair Value
 Held for Trading / Derivative
Option)
 Fair value Option
• Fair value through other
• Available for sale (AFS)
comprehensive income (FVOCI)
• Loans and receivables
 Accounting treatment by asset classifications
IAS 39 IFRS 9 Accounting Treatment
Held-to-maturity Amortized Costs Assets measured at amortized costs

Loans and receivables Category eliminated Assets measured at amortized costs

FVPL FVPL Assets measured at FV; changes in

FV reported through P&L
AFS FVOCI Assets measured at FV; changes in
FV reported through equity*

* Realized gain / loss in disposal is treated differently between debts and equities under IFRS 9.
 Classification and Measurement Categories
Category Impact on financial statements
Amortized Cost The asset is measured at the amount recognized at initial recognition minus principal
repayments, plus or minus the cumulative amortization of any difference between that
initial amount and the maturity amount, and any loss allowance. Interest income is
calculated using the effective interest method and is recognized in profit and loss.
Changes in fair value are recognized in profit and loss when the asset is derecognized
or reclassified.
 Effective interest rate
 Effective interest rate (‘EIR’) is the rate that exactly discounts
estimated future cash flows through the expected life of the financial
asset/liability to the gross carrying amount of a financial asset or to
the amortised cost of a financial liability. Gross carrying amount is
the amortised cost of a financial asset before adjusting for any loss
allowance.
 Amortized Cost - Illustration
 On 1 January 2015, Drive, Inc. invested in 20,000 Company X bonds whose face value is $100,
coupon rate is 6% payable annually and time to maturity is 10 years. If the market interest rate
was 6.5%, Drive, Inc. would pay $1,928,112 for these bonds (calculated by discounting the
bonds cash flows stream using the market interest rate i.e. using the following Excel Function:
PV(6.5%,10,-120000,-2000000).
 Drive, Inc. shall record the acquisition of the bonds as follows:
 Amortized Cost - Illustration
 The first interest payment is due on 31 December 2015, which shall equal $120,000
(=$2,000,000*6%). However, Drive, Inc. can’t record $120,000 as interest income because
according to the effective interest method, it also needs to account for the initial discount on the
bonds. It shall record the receipt of first interest payment as follows:

 After the first payment, the value of Company X bonds in books of Drive, Inc. shall be as
follows:
The following amortization table summarises the application of effective interest
rate method over the term of the bond.
 Classification and Measurement Categories
Category Impact on financial statements
FVOCI The asset is measured at fair value.

Loans and receivables. Interest revenue, impairment gains and losses, and a portion of
foreign exchange gains and losses, are recognized in profit and loss on the same basis as
for Amortized Cost assets. Changes in fair value are recognized initially in Other
Comprehensive Income (OCI).

Investments in equity instruments. Dividends are recognized when the entity’s right to
receive payment is established, it is probable the economic benefits will flow to the entity
and the amount can be measured reliably. Changes in fair value are recognized in OCI and
are never recycled to profit and loss, even if the asset is sold or impaired.
 Classification and Measurement Categories
Category Impact on financial statements
FVPL The asset is measured at fair value. Changes in fair value are recognized in profit and
loss as they arise.
Criteria for
classifying
and measuring
financial
assets
 Contractual Cash Flows Assessment
 Are cash flows solely payments of principal and interest (SPPI)?
o Yes – go to Business Model test
o No – FVPL or FVOCI
 Principal is the amount transferred by the current holder for the financial asset (i.e. considering
discount/premium)
 Interest generally represents returns for time value of money, credit risk, liquidity spread, etc.
(e.g., cash flows from equity securities do not qualify as “interest”)
 The interest must be significantly linked to time value of money and credit risk.
Business Model Tests
 Business Model Test
 Hold to Collect
A financial asset is managed on a ‘hold to collect’ basis where the entity’s
business objective is to hold the financial asset in order to collect its contractual
cash flows. The ‘hold to collect’ business model test does not require that
financial assets are always held until their maturity - the test will likely still be
met if there are only infrequent sales, and those sales occur for reasons such as
to realise cash to deal with an unforeseen need for liquidity, or concerns about
the collectability of the contractual cash flows.
 Business Model Test
 Hold to collect and sell
A financial asset is managed on a ‘hold to collect and sell’ basis where the
entity’s business objective is to both hold the financial asset in order to collect
its contractual cash flows, and sell the financial asset. The ‘hold to collect and
sell’ business model results in a greater frequency and volume of sales than the
‘hold to collect’ business model because selling financial assets is an integral
part of achieving the entity’s business objective for the financial asset.
Examples:
 Embedded Derivatives
 IAS 39 requires an entity to measure derivative financial assets embedded in non-trading
financial assets separately at FVPL if the economic risks and characteristics of the derivative are
not closely related to the host contract and the entire contract is within the scope of IAS 39.
 Under IFRS 9, there is no special treatment for these arrangements—the entire contract is to be
classified as Amortized Cost, FVPL or FVOCI following the basic criteria discussed above.
(The IAS 39 embedded derivative classification and measurement requirements continue to
apply to financial liabilities and non-financial contracts.)
 Financial liabilities designated at FVPL
 Under IAS 39, the entire change in the fair value of financial liabilities designated as FVPL
always are recognized in profit and loss.
 IFRS 9 modifies this requirement to specify that the portion of the change attributable to
changes in the entity’s own credit risk is recognized in OCI, with no recycling, unless:
 OCI presentation would create or enlarge an accounting mismatch in profit and loss; or
 The liability is a loan commitment or financial guarantee contract
 IFRS 9 - Impairment
 Investments in equity instruments. On the one hand, IFRS 9 eliminates impairment assessment
requirements for investments in equity instruments because, as indicated above, they now can
only be measured at FVPL or FVOCI without recycling of fair value changes to profit and loss.
 On the other hand, IFRS 9 establishes a new approach for loans and receivables, including trade
receivables—an “expected loss” model that focuses on the risk that a loan will default rather
than whether a loss has been incurred.
THE SPPI TEST - EXAMPLES
 Parent A provides a loan to Subsidiary B. The loan is classified as a current liability in
Subsidiary B’s financial statements and has the following terms:

 No interest
 No fixed repayment terms
 Repayable on demand of Parent A.

Question: Does the loan meet the ‘SPPI’ contractual cash flows characteristic test?

Answer: Yes. The terms provide for the repayment

of the principal amount of the loan on demand.
 Parent A Parent A provides a loan of $20 million to Subsidiary B. The loan has the following
terms:
 No interest
 Repayable in six years.
Question: Does the loan meet the ‘SPPI’ contractual cash flows characteristic test?

Answer: Yes. The principal (fair value) is $20 million discounted to its present
value using the market interest rate at initial recognition. The final repayment of
$20 million represents a payment of principal and accrued interest.
  Entity D lends Entity E $14 million for five years at an interest rates of 6%.

 Entity E is a property developer that will use the funds to buy a piece of land and construct residential apartments
for sale.

 In addition to the 6% interest, Entity D will be entitled to an additional 11% of the final net profits from the project.
Question: Does the loan meet the ‘SPPI’ contractual cash flows characteristic test?

Answer: No. The profit linked element means that the contractual cash flows do not reflect only
payments of principal and interest that consist of only the time value of money and credit risk.

Therefore, the loan will fail the requirements for amortized cost classification. Entity D will
account for the loan at fair value through profit or loss.
  Entity B lends Entity C $8 million for five years, subject to the following terms:

 Interest is based on the prevailing variable market interest rate

 Variable interest rate is capped at 7%
 Repayable in five years.

Question: Does the loan meet the SPPI contractual cash flows characteristic test?

Answer: Yes. Contractual cash flows of both a fixed rate instrument and a floating rate instrument
are payments of principal and interest as long as the interest reflects consideration for the time
value of money and credit risk.

Therefore, a loan that contains a combination of a fixed and variable interest rate meets the
contractual cash flow characteristics test.
 Reclassification of financial assets and liabilities
 IAS 39 includes complex provisions governing when it is appropriate and not appropriate to reclassify
financial instruments from one classification and measurement category to another. IFRS 9 replaces
these requirements with two general requirements:

 In the rare circumstances when an entity changes its business model for managing financial assets, it must
reclassify all affected financial assets according to the basic classification and measurement criteria discussed
earlier.
 An entity cannot reclassify financial liabilities.

 In general, reclassifications of financial assets are accounted for prospectively under IFRS 9; i.e., they
do not result in restatements of previously recognized gains, losses or interest income.