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IFRS 9 Financial Instruments

Part I: Objective, scope, recognition and derecognition

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• Reasons for issuing IFRS 9

• Scope

• Initial recognition

• Derecognition

• Financial assets– Derecognition– Write-off– Transfers that qualify for

derecognition– Transfers that do not qualify

for derecognition– Continuing involvement in

transferred assets

• Financial assets (continued)– Continuing involvement in

only a part of transferred assets

– Modification of contractual cash flows

• Financial liabilities– Derecognition– Extinguishment accounting– Partial extinguishment

accounting

• Estimates and other judgements

Agenda

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Reasons for issuing IFRS 9

• IAS 39 requirements were difficult to understand, apply and interpret.

• The IASB’s objective in issuing IFRS 9 was to develop a new Standard for the financial reporting of financial instruments that is principle-based and less complex.

• IFRS 9 is IASB’s response to the financial crisis and represents a fundamental reconsideration of the accounting for financial instruments

A Standard for financial instruments

Classification and measurement of financial assets and financial liabilities

Impairment

Hedge accounting

IFR

S 9

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Introduction

Focus

• Recognising and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items.

Objective

• 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.

Main judgeme

nt

• Classification of financial assets• Impairment

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Scope • IFRS 9 shall be applied to all types of financial instruments except:

– interests in subsidiaries, associates and joint ventures (IFRS 10, IAS 27, IAS 28)– rights and obligations under leases (IAS 17) – employee benefits (IAS 19)– own equity instruments (IAS 32)– insurance contracts (IFRS 4)– forward contracts that will result in a business combination (IFRS 3)– loan commitments – except:

– those designated at fair value through profit or loss– loan commitments that can be settled net in cash or by delivering or issuing

another financial instrument– commitments to provide a loan at a below-market interest rate

– share-based payment transactions (IFRS 2)– rights to payments to reimburse the entity for expenditure required to settle a liability

recognised as a provision (IAS 37)– rights and obligations within the scope of IFRS 15 Revenue from Contracts with

Customers that are financial instruments

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Can the contract be settled net in cash or another financial instrument, or by exchanging financial instruments, as if the contract was a financial instrument?

Has the contract been entered into and continues 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 (own use exemption)?

Has the entity chosen to irrevocably designate the contract at fair value through profit or loss in order to eliminate or significantly reduce a recognition inconsistency (accounting mismatch)?

Outside the scope of IFRS 9

Apply IFRS 9

Yes No

Yes

Yes

No

No

Scope Contracts to buy or sell non-financial items

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Initial recognition

Principle

• recognise a financial asset or financial liability when, and only when, the entity becomes a party to the contractual provisions of the instrument

Trade date or settlement date accounting

• accounting policy choice by class of asset – but apply same method consistently (treating assets mandatorily at fair value through profit or loss, assets designated at fair value through profit or loss and investments in equity instruments for which fair value is presented in other comprehensive income as a separate classes)

• only for ‘regular way’ purchases or sales (contract must not permit net settlement)

• Trade date → date an entity commits itself to purchase or sell an asset

• Settlement date → date an asset is delivered to or by an entity

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Derecognition

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Derecognition

Issue

Complicated when

Definition

• When should an entity remove a financial instrument from its financial statements?

• An entity has ongoing involvement with a transferred asset

• Removal of a previously recognised financial asset or financial liability from the statement of financial position

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DerecognitionFinancial assets

Steps of the assessment:• Determine consolidated group, ie including SPEs• Determine whether to assess entire asset or part of

an asset• Apply the derecognition criteria

Assess part of asset only if it comprises:• specifically identified cash flows;• a fully proportionate (pro rata) share of cash flows; or• a fully proportionate (pro rata) share of specifically

identified cash flows

DerecognitionFinancial assets 13

Derecognition

Continue Recognition Continuing involvement

Have rights to

cash flows

expired?

Transferred substantially all risks and

rewards?

Retained substantially all risks and

rewards?

Retained control of the asset?

Have rights to cash

flows been transferred?

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Yes

NoObligation to ‘pass through’ of cash flows

No

Yes Yes

Yes

No

No

Yes

No

Yes

No

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Derecognition of financial assetsEvaluation of the transfer of risks and rewards of ownership

Examples of when an entity has transferred substantially all the risks

and rewards of ownership:

• Unconditional sale of a financial asset;• Sale of a financial asset together with

an option to repurchase at its fair value at the time of repurchase; and

• Sale of a financial asset together with a put or call option that is deeply out of the money (ie an option that is so far out of the money it is highly unlikely to go into the money before expiry).

Examples of when an entity has retained substantially all the risks and

rewards of ownership:

• Sale and repurchase transaction where the repurchase price is a fixed price or the sale price plus a lender’s return;

• Securities lending agreement;• Sale of a financial asset together with a

total return swap that transfers the market risk exposure back to the entity;

• Sale of a financial asset together with a deep in-the-money put or call option (ie an option that is so far in the money that it is highly unlikely to go out of the money before expiry); and

• Sale of short-term receivables in which the entity guarantees to compensate the transferee for credit losses that are likely to occur.

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Financial assetsWrite-off

No reasonable expectations of recovering

a financial asset in its entirety or a portion thereof

Reduce the gross carrying amount

Write-off → a derecognition

event

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Transfers that qualify for derecognition

• On derecognition of a financial asset in its entirety:– the difference between carrying amount and consideration

received shall be recognised in profit or loss

• If an entity transfers a financial asset that qualifies for derecognition in its entirety but:

– the entity retains the right to service the financial asset for a fee → recognise either a servicing asset or servicing liability; or

– if the transfer results in the entity obtaining a new financial asset or assuming a new financial liability or servicing liability → recognise the new financial asset, financial liability or servicing liability at fair value

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Transfers that qualify for derecognition(continued)

Part transferred qualifies for derecognition in its entirety

• allocate previous carrying amount of the larger financial asset between part that continues to be recognised and part derecognised on the basis of the relative fair values•recognise gain or loss equal to the difference between carrying amount of part derecognised and consideration received

Transfer ofa ‘part’

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Continue to be recognised

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Transfers that do not qualify for derecognition

Substantially all risks and rewards of ownership of transferred asset retained

• continue to recognise transferred asset in its entirety

• consideration received →recognise financial liability

• recognise any income on the transferred asset and any expense incurred on the financial liability

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Continuing involvement in transferred assets

• Recognise to the extent of continuing involvement reflecting the extent of exposure to changes in the value of the transferred asset

• Example: guaranteeing transferred asset - continuing involvement = lower of (i) amount of the asset and (ii) maximum amount of the consideration received that the entity could be required to repay (‘guarantee amount’)

Transferred asset

• Measured in such a way that the net carrying amount of the transferred asset and the associated liability is:

• (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.

Associated liability

• Recognised changes in the fair value of the transferred asset and the associated liability are accounted for consistently and shall not be offset

• The entity shall continue to recognise any income on transferred asset to the extent of its continuing involvement and any expense incurred on the associated liability – these amounts shall not be offset

Subsequent measurement

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Continuing involvement in only a part of transferred financial assets

Allocate previous carrying amount

between the part that continues to be

recognised and the part derecognised on

the basis of the relative fair values

Recognise gain or loss

equal to difference between carrying

amount (measured at date of derecognition) allocated to the part derecognised and

consideration received

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Modification of contractual cash flowsFinancial asset

• Renegotiation or modification of contractual cash flows that does not result in the derecognition:

– Recalculate the gross carrying amount as the present value of the renegotiated or modified contractual cash flows discounted at the original effective interest rate (or credit-adjusted effective interest rate for purchased or originated credit-impaired financial assets)

– Recognise a modification gain or loss in profit or loss– Any costs or fees incurred → adjust the carrying amount

of the modified financial asset and amortised over the remaining term of the modified financial asset

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Period Beginning GCA**

Impairment (loss)/gain

Modification (loss)/gain

Interest revenue

Cash flows

Ending GCA**

Loss allow-ance

Ending amortised

cost amount

A B C DGross: A x 5%

E F = A + C + D - E

G H=F-G

1 CU1,000 (CU20) CU50 CU50 CU1,000 CU20 CU980

2 CU1,000 (CU10) CU50 CU50 CU1,000 CU30 CU970

3 CU1,000 (CU70) (CU300) CU50 CU50 CU700 CU100 CU600

* Refer to Example 11 in paragraph IE66-IE73 of IFRS 9 Financial Instruments

**Stands for gross carrying amount

• Bank A originates a five-year loan - repayment of the outstanding contractual amount in full at maturity.

• Contractual par amount = CU1,000 with an interest rate of 5% payable annually. The effective interest rate is 5%.

• Period 3 - following significant financial difficulty of the borrower, Bank A modifies the contractual cash flows on the loan. It extends the contractual term of the loan by one year so that the remaining term at the date of the modification is three years. The modification does not result in the derecognition of the loan by Bank A.

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Modification of contractual cash flowsExample*

DerecognitionFinancial Liabilities

Extinguished?• discharged• cancelled• expired

Derecognition

Continued recognition

Substantial modification/ substantially

different terms?(includes 10% PV

test)

Exchange of debt

Modification

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No No

Yes Yes

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Derecognition financial liabilities – application of the criteria

Payment to a third party (eg trust)

Does not extinguish debt without legal release from obligation

In-substance

defeasance Issuer of a debt instrument repurchases that instrument

Extinguish debt even if issuer intends to resell it in the near term

Repurchase of own debt

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If a financial liability is extinguished (ie obligation is discharged, cancelled through legal release or expires):

• the financial liability is derecognised;• 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.

If an exchange of debt instruments or modification of terms is accounted for as an extinguishment (ie substantially different terms/substantial modification):• the original financial liability is derecognised;• a new financial liability is recognised;• any costs or fees incurred are recognised as part of the gain or loss on the

extinguishment

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Partial extinguishment accounting

When repurchasing part of a financial liability:

Allocate previous carrying amount of existing financial liability between part not derecognised and part derecognised on basis of relative fair values

Recognise gain or loss on only part derecognised (amount = carrying amount of that part minus consideration paid)

Estimates and other judgements

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Main judgements and estimates in applying IFRS 9

Recognition and derecognition •To apply the derecognition requirements, an entity will need to apply judgement to determine whether substantially all the risks and rewards of ownership of a transferred asset have been transferred and, if neither party has substantially all the risks and rewards of ownership, which party has control.

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