IFRS 9 Financial Instruments| An Analysis

Introduction:

IFRS 9 is crucial and important especially in Covid time. This IFRS application is very testing for Companies in Covid time. This article is only summary. Even summary is also covered few points only.

1. Name of the Standard:

IFRS -9 - Financial Instruments, became mandatory from January 2018. This standard contains - three main topics: classification and measurement of financial instruments, impairment of financial assets, and hedge accounting.

The IASB attempted to develop the new standard in phases, releasing each component of the new standard separately. – Classification and measurement financial assets-2009, Classification and measurement financial liabilities-2010 Hedge accounting and impairment -2014

The version of IFRS 9 issued in 2014 supersedes all previous versions and is mandatorily effective for periods beginning on or after 1 January 2018 with early adoption permitted.

2. Ind-AS 109 is a replica of IFRS 9:

ICAI - Ind AS has explained this AS in 200 pages. Huge . You will Find Decision Tree And Examples. It has 7 chapters and around 200 pages documents starting from 301 page to 500 pages

3. IFRS 9 specifies how an entity should:

classify and measure financial assets, financial liabilities, and some contracts to buy or sell non-financial items. The version of IFRS 9 issued in 2014 supersedes all previous versions and is mandatorily effective for periods beginning on or after 1 January 2018 with early adoption permitted

4.Scope of this Standard:

IFRS 9 does NOT define financial instruments. You can find the definitions of financial instruments in IAS 32 Financial Instruments: Presentation. • IFRS 9 does NOT deal with your own (issued) equity instruments like your own shares, issued warrants, written options for equity, etc. This IFRS DOES deal with the equity instruments of someone else, because they are financial assets from your point of view. It NOT deal with your investments in subsidiaries, associates and joint ventures (look to IFRS 10, IAS 28 and related).

5. Focus:

Over all, this IFRS gives more focus on contractual agreement than Future economic benefit. Recognition and De recognition of financial Instruments is main. It has more focus on Derecognition subject & recognition is simple one

6. Recognition of financial Instrument is on 2 different dates:

It may be trade date or settlement date. Every company will have their explanation sentence on this in their annual report.

7. Derecognition of Financial Instruments:

Expire of Rights or Transfer of rights are envisaged in this. Contractual right to receive cash flow from assets expires or b) the entity transfers Financial asset and risk and reward of ownership

De recognition of Financial liabilities happens when it is extinguished ( Discharged cancelled or expired). Discharged is by paying in cash or instrument or goods. Canceled by legally and expired by passage of time

Legal Substance is important in de-recognition of Financial Liability than economic Substance

8. Classification of Financial Assets:

There are 2 important tests that need to be conducted - Why & How much. Why stands for Business Model Test & How much test for Contractual Cash flow test

Business Model tells Why an asset is acquired and maintained to HOLD OR TO SELL

Based on the above test, 3 different category -

A) Measured at amortized cost
B) measured at Fair value through P/L
C) Measured at Fair Value Through OCI

9. Type of Category for FA:

A) Measured at amortized cost Assets – If any FA met both conditional Tests, then FA measured at Amortized cost. Usually Debt Securities & Loans

B) measured at Fair value through P/L – Who are not meeting the above 2 tests. You can also choose this test for all other FA too

C  Measured at Fair Value Through OCI – Entities that acquire shares not held for trading, the Company can choose this category IRREVOCABLE Choice to recognize in this method.

10. Like FA, even Financial liabilities have categories:

Here it has only 2 types -a ) measured at Fair value through P/L b) FL Measured through Amortized Cost.

All FL which are held for trading & need to recognised through PL. All other financial liabilities are through amortized cost

Besides above 2 , there are 3 different categories are there in IFRS – a) Liabilities related to failed de recognition of assets b) Financial Guarantee contracts c) Some loan commitments

11. Measurement:

All FA & FL need to be measured. Initial Recognition of assets/liabilities - which are measured at Fair Value through PL - must at Fair Value. All other FA & FL must be at – Fair Value +Transaction Cost. One e exception - Trade Receivables are measured at Transaction Value Itself

After initial recognition, subsequent recognition will be AGAIN of 2 types. Based on the Initial category – Fair Value. Now changes in measurement must be effected through PL except Equity and Debt instruments. These 2 must be through OCI. NO RECYCLING ALLOWED FOR EQUITY INSTRUMENTS. However, the dividend is recognized in PL

For FA/FL which are measured at amortized cost – there is no question of subsequent recognition. Amortization and interest charge will be done to P/L without making any changes.

12. Impairment of Assets (IA):

A new concept introduced in 2014. General Rule is that an entity needs to recognize LOSS ALLOWANCE for EXPECTED CREDIT LOSS on FA at Amortized cost & FA at FV measured at OCI ( meeting both Business model test and contractual Test)

Lease receivables (IAS 17 applies), Contract Assets (IFRS 15) applies for impairment of assets

13. Measurement of IA:

Here general approach of 3 stages is preferred. However, no stage approach of a Simplified approach is given for Trade receivables specific. All FA which is IA must come under the general approach.

General approach – Stage 1 – 12 month ECL, then Lifetime ECL can be done in stage 2 and stage 3

The loss allowance shall be recognized in other comprehensive income and shall not reduce the carrying amount of the financial asset in the balance sheet.

An entity shall measure the loss allowance for a financial instrument at an amount equal to the lifetime expected credit losses if the credit risk on that financial instrument has increased significantly since initial recognition.

I think #Covid19 situation is making this para very crucial and important. It determines the economic health of a company and country too

14. RECLASSIFICATION:

Is allowed between category based on intention or condition of holding. no restatement of the financial statements is required. Even no need of a reversal of gain/loss is required. assets from amortized to fair value, any change in value will be routed to p/l. assets from p/l category to amortized category, then fair value become carrying value

15. Hedge Accounting:

Derivative measured at fair value through profit or loss may be designated as a hedging instrument, except for some written options.

For hedge accounting purposes, only contracts with a party external to the reporting entity (ie external to the group or individual entity that is being reported on) can be designated as hedging instruments. Hedged items can be a recognized asset or liability, an unrecognized firm commitment, a forecast transaction, or a net investment in a foreign operation. The hedged item can be single or group item. Item must be reliably measurable.

No hedge accounting of transactions in the CFS level. However foreign currency risk is not completely removed in Consolidated, same can be shown.

There are 3 types of hedging relationship – a) Fair Value Hedge b) Cash Flow Hedge c) Net investment in the foreign relationship

An entity shall discontinue hedge accounting prospectively only when the hedging relationship (or a part of a hedging relationship) ceases to meet the qualifying criteria (after taking into account any rebalancing of the hedging relationship, if applicable)