Home Articles ANALYSIS: One man’s loss is another one’s gain

ANALYSIS: One man’s loss is another one’s gain

This article is the second of a three-part series on the requirements of the final IFRS 9 financial instruments. In this part Genevieve Naik takes a look at financial liabilities

Whilst some entities breathe a sigh of relief that the mandatory effective date of the final IFRS 9 has been pushed out to 1 January 2018, others have chosen to voluntarily adopt various versions of the unfinished standard. Why? One of the reasons may be the changes introduced in respect of financial liabilities. In particular, specific reference in IFRS 9 to fair value changes attributable to an entity’s own credit risk seems to have highlighted a rather interesting “accounting anomaly” – as an entity’s credit risk increases, the fair value of its financial liabilities decreases. The impact? Entities that designate financial liabilities under the fair value option will recognise gains as their credit ratings decrease. A closer look at the changes may reveal more.


Under IFRS 9, entities still have the ability to designate, at initial recognition, a financial liability as measured at fair value through profit or loss (the fair value option). IAS 39 Financial Instruments: Recognition and Measurements currently requires all fair value measurement gains and losses to be included in profit or loss. By contrast, IFRS 9 generally requires all gains and losses attributable to changes in an entity’s own credit risk to be included in other comprehensive income1 (OCI). The remainder of the total gain or loss is included in profit or loss.

As noted above, the specific reference to changes attributable to an entity’s own credit risk seems to have highlighted that fair value gains will be recognised in respect of financial liabilities as an entity’s credit risk increases. Of course, the counterparty holding the financial asset will recognise fair value losses.

The introduction of IFRS 13 Fair Value Measurements has also sparked debates on debit valuation adjustments (DVA) – in particular, the question as to how and when an entity should consider its own credit risk when determining the fair value of its financial liabilities.

While this anomaly arguably results in a rather attractive outcome for entities that designate their financial liabilities at fair value, it did not come about on the introduction of IFRS 9 or IFRS 13.

In fact, IAS 39 has always required fair value to reflect the credit quality of the instrument (IAS 39.AG69). In practice, however, entities often only considered credit quality when fair valuing a financial asset (for example a debtor) instead of considering it for all financial instruments, including financial liabilities.

So, on a closer look it appears that the fair value option under IFRS 9 is not much different to that under IAS 39. The only real change is that, in respect of financial liabilities, generally credit-related gains (or losses) will be recognised in OCI rather than in profit or loss.

This will hopefully alleviate the concerns of those entities, including the Financial Crisis Advisory Group,2 who felt uncomfortable as (mainly) banks which had designated liabilities under the fair value option recognised large gains in profit or loss as credit spreads on their own debt widened during the financial crisis. This part of IFRS 9 is available for early adoption before 1 January 2018 (that is,  entities may apply IAS 39 with the own credit requirements of IFRS 9).


IFRS 9 eliminates the fair value exception contained in IAS 39 for derivative liabilities that are linked to and must be settled by delivery of an unquoted equity instrument. Under IAS 39, where the fair value of such derivatives cannot be determined, they are measured at cost. Under IFRS 9, they must always be measured at fair value.

On the one hand, this change may be seen in a negative light, as it will require additional work. Entities will be required to perform additional fair value calculations. However, as discussed under the fair value option, where fair values are lower than the original cost, entities will recognise gains.

Apart from this change, IFRS 9 continues to require that most financial liabilities be measured at amortised cost. The IAS 39 exemptions in relation to financial guarantee contracts and loan commitments remain unchanged in IFRS 9.


That is the question. IFRS 9 still requires separation of embedded derivatives from the financial liability if specified conditions are met. We will discuss this in more detail in a later part of this series.


Entities have the opportunity to make use of the extended period until 2018 to relook at their financial liabilities and update their systems accordingly. Failure to do so could result in them being caught off guard at the eleventh hour. ❐


1 Other comprehensive income comprises items of income and expense that are not recognised in profit or loss as required or permitted by IFRS, for example property, plant and equipment revaluation gains or losses.

2 The Financial Crisis Advisory Group was an advisory body to the International Accounting Standards Board (IASB) during the peak of the financial crisis in Europe. The advisory group considered how improvements in financial reporting could help enhance investor confidence in financial markets. The advisory group also helped identify significant accounting issues that required the urgent and immediate attention of the IASB, as well as issues for longer-term consideration. ❐

Author: Genevieve Naik (CA)SA is a senior manager in the Department of Professional Practice at KPMG