Business model assessment

A business model assessment is needed for financial assets that meet the SPPI criterion, to determine whether they meet the criteria for classification as subsequently measured at amortised cost or FVOCI. [IFRS 9 B4.1.1 ] Financial assets that do not meet the SPPI criterion are classified as at FVPL irrespective of the business model in which they are held – except for investments in equity instruments, for which an entity may elect to present gains and losses in FVOCI. [IFRS 9 4.1.4, IFRS 9 5.7.5–6]

An entity’s business model for managing financial assets:

• reflects how financial assets are managed to generate cash flows
• is determined by the entity’s key management personnel
• does not depend on management’s intentions for individual instruments but is based on a higher level of aggregation that reflects how groups of financial assets are managed together to achieve a particular business objective.

Classification of financial assets

Consequently, determining the business model within which the financial asset is held is necessary in order to determine the appropriate classification category under IFRS 9. Business model assessment

Management of financial assets

A business model refers to how an entity manages its financial assets in order to generate cash flows. It is determined at a level that reflects how groups of financial assets are managed rather than at an instrument level. IFRS 9 identifies three types of business models: ‘hold to collect’, ‘hold to collect and sell’ and ‘other’. Many entities may only have one business model but it is possible to have more than one. [IFRS 9 B4.1.2A] Business model assessment

Objectives

In order to determine which type of business model(s) an entity has, it is necessary to understand the objectives of each business model and the activities undertaken. In doing so, an entity would need to consider all relevant information including, for example, how business performance is reported to the entity’s key management personnel and how managers of the business are compensated.

The IFRS 9 classification tree

Summary of classifications

The following table summarises the key features of each type of business model and the resultant measurement category.

Additional explanation from IFRS 9 Basis for conclusions

[IFRS 9 BC 4.143] 

In response to the feedback received, the IASB decided to emphasise that the business model assessment in IFRS 9 focuses on how the entity actually manages financial assets in order to generate cash flows. The IASB noted that amortised cost is a simple measurement technique that allocates interest over time using the effective interest rate, which is based on contractual cash flows.

Relevant and useful information

Accordingly, amortised cost provides relevant and useful information about the amounts, timing and uncertainty of cash flows only if the contractual cash flows will be collected. In order to supplement that principle and improve the clarity of the application guidance related to the hold to collect business model, the IASB also decided to expand the discussion in IFRS 9 on the activities that are commonly associated with the hold to collect business model.

[IFRS 9 BC 4.145]

The IASB decided to clarify that the value and frequency of sales do not determine the objective of the business model and therefore should not be considered in isolation. Instead, information about past sales and expectations about future sales (including the frequency, value and nature of such sales) provide evidence about the objective of the business model. Information about sales and sales patterns are useful in determining how an entity manages its financial assets and how cash flows will be realised.

Historical information

Information about historical sales helps an entity to support and verify its business model assessment; that is, such information provides evidence about whether cash flows have been realised in a manner that is consistent with the entity’s stated objective for managing those assets. The IASB noted that while an entity should consider historical sales information, that information does not imply that newly originated or newly purchased assets should be classified differently from period to period solely on the basis of sales activity in prior periods.

No changes

In other words, fluctuations in sales activity in particular periods do not necessarily mean that the entity’s business model has changed. The entity will need to consider the reasons for those sales and whether they are consistent with a hold to collect business model.

Rebalancing of portfolio

For example, a change in the regulatory treatment of a particular type of financial asset may cause an entity to undertake a significant rebalancing of its portfolio in a particular period. Given its nature, the selling activity in that example would likely not in itself change the entity’s overall assessment of its business model if the selling activity is an isolated (ie one-time) event. The entity also needs to consider information about past sales within the context of the conditions that existed at that time as compared to existing conditions and expectations about future conditions.

Business model assessment