The new IFRS 9 setting out the recognition and measurement requirements of financial instruments is finally here. If you want to stay in the know, you need to read below, says Morné Grobbelaar
At the end of July 2014 the International Accounting Standards Board (IASB) issued the final completed version of IFRS 9: Financial Instruments (IFRS 9) replacing the old version of IFRS 9, as well as IAS 39: Financial Instruments: Recognition and Measurement (IAS 39).
IFRS 9 now brings together the classification and measurement, impairment and hedge accounting requirements for financial instruments. It is effective for years beginning 1 January 2018 with early adoption permitted.
So, what is actually going to change?
CLASSIFICATION AND MEASUREMENT
IFRS 9 has three classification categories, compared to IAS 39’s four. The entity’s business model for managing financial assets – i.e. how the entity manages them – affects the classification.
The question to ask is: Does the entity collect contractual cash flows, sell the financial assets or both? The application of this is demonstrated in table 1.
The contractual cash flow characteristics of the financial asset affect the measurement as set out in table 2 above.
The IAS 39 classification of financial liabilities was carried forward to IFRS 9 essentially unchanged, with financial liabilities recognised at amortised cost except for financial liabilities at fair value through profit and loss, financial liabilities recognised when transfers of financial assets do not qualify for de-recognition, financial guarantee contracts,and certain commitments.
IFRS 9 does, however, introduce new requirements for the accounting and presentation of financial liabilities where the entity has chosen to measure these financial liabilities at fair value through profit or loss. The gain or loss on a financial liability that is designated at fair value through profit or loss attributable to changes in the credit risk of that liability must be presented in other comprehensive income.
IFRS 9 introduces the expected credit loss model for determining impairments. The model is forward looking, so that it is no longer necessary for a trigger event to have occurred before credit losses (impairments) are recognised. Expected credit losses are recognised throughout the life of the asset and on all financial assets within the scope of the model. This expected credit loss model follows a three-stage approach (see diagram 1):
- Stage 1 (initial expectation): On initial recognition of the financial asset, the asset is assessed for any expected credit losses over a period of 12 months. Any expected credit losses are recognised immediately in profit or loss or in an allowance account.
- Stage 2 (annual assessment): The 12-month expected credit losses is used, unless credit risk has increased significantly since initial recognition and the resulting credit quality is not considered low credit risk, then the full lifetime expected credit losses (present value of expected losses if the borrower defaults using a probability weighting) are recognised.
- Stage 3 (Specific impairment): When the credit risk increases to the point where the asset is not expected to be fully recovered, the life-time expected credit loss is recognised.
Effective interest is calculated on the gross carrying amount for stages 1 and 2 and on amortised cost for stage 3.
Hedge accounting has been fundamentally revised to a more principle-based approach. IFRS 9 requires disclosure explaining the entity’s risk management strategy and the effect that hedge accounting has on the financial statements, with all hedge information disclosed in one place in the notes.
The hedging strategy still needs to be documented, with some new allowances. Hedged items are now extended to include components of non-financial instruments and hedge instruments can now include any non-derivative financial instruments.
The hedge effectiveness and rebalancing is not as strict any more, but discontinuing a hedge may no longer just be a voluntary termination.
In applying the requirements of IFRS 9, companies will need to re-look at their financial instrument classifications, impairment policies as well as hedge accounting intentions.
To do all of the above, companies will have to start its assessment of the impact of this standard and possibly change their systems to accommodate them sooner rather than later.
Author: Morné Grobbelaar CA(SA) is national senior manager – IFRS at Mazars