Straight away

IFRS bulletin from PwC

IASB proposes limited modifications toIFRS 9

Background

The IASB has issued an exposure draft(ED) proposing limited modifications toIFRS 9 (2010) ‘Financial instruments’.These proposals are to address threespecific areas: application issues thathave arisen in practice since the originalIFRS 9 was issued wof amortised cost; interaction with theInsurance project; and to reducedifferences between IFRS 9 and theFASB’s classification and measurementproposals (which is now largely alignedfor debt instruments).

Key amendments

Clarification of amortised costbusiness modelIn IFRS 9 financial assets qualify foramortised cost measurement if theobjective of the business model is tohold those financial assets in order tocollect contractual cash flows.that objective has not changed in theED, the Board has clarified the primaryobjective of ‘hold to collect’ byproviding additional applicationguidance on the types of businessactivities and the frequency, volumeand nature of sales that would alassets to qualify for amortised costmeasurement. For example, the EDclarifies that sales due to deteriorationin credit quality would not conflict with

28 November 2012

Straight away

IFRS bulletin from PwC

IASB proposes limited modifications to

The IASB has issued an exposure draft(ED) proposing limited modifications toIFRS 9 (2010) ‘Financial instruments’.These proposals are to address threespecific areas: application issues thathave arisen in practice since the originalIFRS 9 was issued with regards to the useof amortised cost; interaction with theInsurance project; and to reducedifferences between IFRS 9 and theFASB’s classification and measurementproposals (which is now largely alignedfor debt instruments).

Key amendments

Clarification of amortised cost

In IFRS 9 financial assets qualify foramortised cost measurement if theobjective of the business model is tohold those financial assets in order tocollect contractual cash flows. Whilstthat objective has not changed in theED, the Board has clarified the primaryobjective of ‘hold to collect’ byproviding additional applicationguidance on the types of businessactivities and the frequency, volumeand nature of sales that would allowassets to qualify for amortised costmeasurement. For example, the EDclarifies that sales due to deteriorationin credit quality would not conflict with

the objective of holding to collect cashflows. In addition, where an entity hasa portfolio with assets that it wouldonly sell in a ‘stress case’ scenario andwhere that ‘stress case’ is expected tobe ‘infrequent’ then that would also beconsistent with the amortised costbusiness model.

Introduction of a fair valuethrough other comprehensiveincome (FVOCI) category foreligible debt instrumentsA FVOCI measurement category foreligible debt instruments is proposed inthe ED. A debt instrument would bemeasured at FVOCI only if it passes thesolely payments of principal andinterest (SPPI) test abusiness model that is managed both inorder to collect contractual cash flowsand for sale. A debt instrument measuredat FVOCI will have the same impairmentand interest income recognition asfinancial assets measured at amortisedcost. Also, the cumulative fair value gainor loss recognised in OCI will be recycledfrom OCI to profit or loss when thesefinancial assets are derecognised.

It is expected that debt instrumentsbacking insurance contracts may fall intothis category and willconsistent measurement with insuranceliabilities under the proposals beingdiscussed in the IASB’s Insuranceproject.

IFRS bulletin from PwC

IASB proposes limited modifications to

the objective of holding to collect cashflows. In addition, where an entity has

assets that it wouldonly sell in a ‘stress case’ scenario andwhere that ‘stress case’ is expected tobe ‘infrequent’ then that would also beconsistent with the amortised cost

Introduction of a fair valuethrough other comprehensive

come (FVOCI) category foreligible debt instrumentsA FVOCI measurement category foreligible debt instruments is proposed inthe ED. A debt instrument would bemeasured at FVOCI only if it passes thesolely payments of principal and

(SPPI) test and is held in abusiness model that is managed both inorder to collect contractual cash flowsand for sale. A debt instrument measuredat FVOCI will have the same impairmentand interest income recognition asfinancial assets measured at amortised

lso, the cumulative fair value gainor loss recognised in OCI will be recycledfrom OCI to profit or loss when thesefinancial assets are derecognised.

It is expected that debt instrumentsbacking insurance contracts may fall intothis category and will therefore have aconsistent measurement with insuranceliabilities under the proposals beingdiscussed in the IASB’s Insurance

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Reclassifications and fair valueoption extended to FVOCIConsistent with the reclassification andfair value option in the current IFRS 9,these provisions have equally beenextended to instruments in the newFVOCI category. Therefore when anentity changes its business model,guidance has been provided on how toaccount for moving between each of thecategories. In addition, a fair value optionis permitted to be applied to debtinstruments that would otherwise beclassified at amortised cost or FVOCI ifdesignating them at fair value throughprofit or loss (FVPL) will reduce orsignificantly eliminate an accountingmismatch.

‘Modified’ contractual cash flowcharacteristics testIn IFRS 9 today, a financial asset couldbe eligible to be measured at amortisedcost (subject to the business modelcriterion) if the financial asset’scontractual terms give rise on specifieddates to cash flows that are solelypayments of principal and interest onthe principal amount outstanding. Inthis context, interest is considerationfor the time value of money and thecredit risk associated with the principalamount outstanding.

Sometimes the debt instrument’scontractual terms, whilst being timevalue of money and credit related, are‘not perfect’ (or there is a ‘modifiedeconomic relationship’ to use the termin the ED). For example, when thefrequency of interest rate reset (saymonthly) does not match the tenor ofthe interest rate (for example, 3 monthLibor) or the interest is leveraged. TheED proposes a new requirement for anentity to consider the effect of the‘modified economic relationship’ whenassessing whether the cash flows on thefinancial asset are still consistent withthe notion of being SPPI.

The ED incorporates a notion thatthere is some variation from the

‘perfect’ instrument that would stillbe acceptable from an SPPIperspective. In order to assess thisacceptability, the ED proposes that anentity compares the financial assetunder assessment to the ‘perfect’ (inthe ED ‘benchmark’) instrument. Ifthe difference between the cash flowsof the benchmark instrument andcash flows of the instrument underassessment is more than insignificant,the instrument must be measured atFVPL because its contractual cashflows are not considered SPPI.

TransitionThe IASB has included two key proposalswith regard to transition in the ED: (1) toallow an entity to early apply only therequirements for the presentation of fairvalue gains or losses attributable tochanges in the issuer’s own credit risk,without the need to early apply IFRS 9 inits entirety and (2) that once IFRS 9 isfinalised (that is, all phases), earlierversions of IFRS 9 are to be withdrawnon a date six months after the publicationof the final version of IFRS 9 and henceentities will no longer be able to applyIFRS 9 in phases.

Am I affected?

Although most entities have financialinstruments and therefore the provisionsin IFRS 9 will apply to them, the limitedmodification in the ED will largely affectentities in the financial services sector.

What’s next

The comment period ends on 28 March2013. Entities should considerresponding to these proposals so theirviews can be considered by the IASB inits re-deliberations and finalisation of theclassification and measurement offinancial instruments. It is also expectedthat the FASB will issue an exposuredraft on their classification andmeasurement model in Q1 2013.