IFRS 9 Financial instruments – Recognition

An entity shall recognise a financial asset or a financial liability in its statement of financial position when, and only when, the entity becomes party to the contractual provisions of the instrument.

IFRS 9 The Business Model Test

Under IFRS 9, a necessary condition (see IFRS 9 Classification and Measurement of Financial Instruments) for classifying a loan or receivable at Amortized Cost or FVOCI is whether the asset is part of a group or portfolio that is being managed within a business model whose objective is to collect contractual cash flows (Amortized Cost), or to both collect contractual cash flows and to sell (FVOCI). Otherwise, the asset is measured at FVPL. The key elements of this test are listed below.

Observe: IFRS 9 recommends applying the Business Model test before applying the SPPI test because this may eliminate the need to apply the more detailed SPPI test, which is applied at a more granular level.

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The IFRS 9 Framework for financial assets

IFRS 9 recognises three different accounting policies for financial instruments. These principles determine the value of the financial instruments on the balance sheet.

The initial measurement is based on amortised costs, this is the amount for which an asset or liability is initially recognised in the balance sheet less principal repayments, plus or minus the cumulative amortisation of the difference between that initial amount and the redemption amount calculated by using the effective interest method and less any write-downs (directly or through the use of a provision) arising from impairment or un-collectibility.

The second measurement basis is the fair value through other comprehensive Read more

Do the SPPI contractual cash flow characteristics test

A typical example of an instrument where the contractual cash flows would not meet SPPI would be a debt instrument with an interest rate that is linked to the issuer’s share price. Similarly, a debt instrument with an equity conversion feature, under which the holder has an option to convert the debt instrument into a fixed number of the issuer’s equity shares on maturity, would not meet the SPPI test.

However, if an issuer uses its own shares as a ‘currency’ to settle a convertible debt instrument, then this might meet the SPPI test. This could be in circumstances in which the equity conversion feature is for a variable number of the issuer’s equity shares that have a fair Read more

Equity investments at FVOCI

IFRS 9 requires all equity investments to be measured at fair value. The default approach is for all changes in fair value to be recognised in profit or loss.

However, for equity investments that are neither held for trading nor contingent consideration recognised by an acquirer in a business combination, entities can make an irrevocable election at initial recognition to classify the instruments as at FVOCI, with all subsequent changes in fair value being recognised in other comprehensive income (OCI). This election is available for each separate investment.

Under this new FVOCI category, fair value changes are recognised in OCI while dividends are recognised in profit or loss (unless they clearly represent a recovery Read more

Instruments that fail(ed) the SPPI test

The following instruments in IFRS 9 have be carefully judged by the IASB and fail(ed) the Solely Payment of Principal and Interest test.

[IFRS 9 B4.1.9D, IFRS 9 B4.1.14]

Contract description

Considerations

A bond that is convertible into a fixed number of equity instruments of the issuer.

The SPPI test is not met because the return on the bond is not just consideration for the time value of money and credit risk, but also reflects the value of the issuer’s equity.

An inverse floating interest rate loan – e.g. the interest rate on the loan increases if an interest rate index decreases.

The SPPI test is not met because interest has an inverse relationship to

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Instruments that may fail the SPPI test

Careful consideration and a documented decision regarding the Solely Payment of Principal and Interest test is needed in the following cases:

[IFRS 9 B4.1.13, IFRS 9 BC4.186, IFRS 9 BC4.190]

Contract description

Considerations

A bond with a stated maturity and payments of principal and interest linked to an unleveraged inflation index of the currency in which the instrument is issued. The principal amount is protected. This linkage resets the time value of money to the current level.

Linking payments of principal and interest to an unleveraged inflation index resets the time value of money to a current level, so the interest rate on the instrument reflects ‘real’ interest. Therefore, the interest amounts are consideration for the time value

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Changes in contractual provisions

How do you account for contractual provisions in a financial instruments contract that change the timing or amount of contractual cash flows?

Contractual cash flows of some financial assets may change over their lives. For example, an asset may have a floating interest rate. Also, in many cases an asset can be prepaid or its term extended. [IFRS 9 B4.1.10, IFRS 9 B4.1.12]

For such assets, an entity determines whether the contractual cash flows that could arise over the life of the instrument meet the SPPI criterion. It does so by assessing the contractual cash flows that could arise both before and after the change in contractual cash flows.

In some cases, contractual cash flows may change Read more

IFRS 9-The SPPI test explained by example!!!

The solely payments of principal and interest (SPPI) test requires that the contractual terms of the financial asset (as a whole) give rise to cash flows that are solely payments of principal and interest on the principal amounts outstanding ie cash flows that are consistent with a basic lending arrangement. Here are some examples to obtain an understanding for the IFRS reasoning:

Loan with zero interest and no fixed repayment terms

Relevant IFRS paragraphs [IFRS9.B4.1.7] – [IFRS 9.B4.1.9]

Parent A provides a loan to Subsidiary B. The loan is classified as a current liability in Subsidiary B’s financial statements and has the following terms:

  • No interest;
  • Repayable on demand of Parent A.

Question: Does the loan … Read more

Cash flows identification- Not-Only Principal and interest

IFRS 10 Consolidated Financial StatementsThe following examples illustrate contractual cash flows that are not solely payments of principal and interest on the principal amount outstanding. For the context within IFRS 9: Financial Instruments, reference is made to IFRS 9 The Solely Payments of Principal and Interest Test .

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Cash flows identification- Only Principal and interest

Cash flows solely payments of principal and interest on the principal amount

The following examples illustrate contractual cash flows that are solely payments of principal and interest on the principal amount outstanding. For the context within IFRS 9: Financial Instruments, reference is made to IFRS 9 The Solely Payments of Principal and Interest Test (IFRS 9 The solely payments of principal and interest test).

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