The IFRS 9 requirements for the classification and measurement of financial liabilities are substantially unchanged from IAS 39 except for the following:
- Removal of the cost exception for derivative financial liabilities. Classification and Measurement of Financial Liabilities
- Changes in fair value as a result of an entity’s own credit risk are recognized in OCI.
Overall, financial liabilities are still measured at amortized cost except for: Classification and Measurement of Financial Liabilities
- Financial liabilities measured at FVTPL (i.e., those held for trading, designated at FVTPL or contingent consideration recognized by an acquirer in a business combination).
- Loan commitments and financial guarantee contracts for which specific measurement guidance exists. Classification and Measurement of Financial Liabilities
Cost Exception for Derivative Financial Liabilities
IAS 39 required derivative financial liabilities that are linked to, and must be settled by, delivery of an unquoted equity instrument, and whose fair value cannot otherwise be reliably measured, to be measured at cost. This requirement is not included under IFRS 9. Instead, these instruments must be measured at FVTPL.
Changes in Fair Value Attributable to a Change in an Entity’s Own Credit Risk
IFRS 9, consistent with IAS 39, allows an entity to designate certain financial liabilities as measured at FVTPL. This relates to the following situations:
- A contract contains one or more embedded derivatives.
- Designation eliminates, or significantly reduces, an accounting mismatch.
- A group of financial liabilities, or financial assets and financial liabilities, is managed, and its performance is evaluated, on a fair value basis. (IFRS 184.108.40.206 & IFRS 220.127.116.11)
IAS 39 required that all fair value changes on financial liabilities which are irrevocably designated as measured at FVTPL be recognized in profit or loss. This treatment causes concern because it results in an entity recognizing gains in profit or loss when its credit standing deteriorates (and vice versa). This is counterintuitive and creates volatility in profit or loss.
IFRS 9 addresses this concern by requiring that the amount of the change in the fair value of the financial liability that is attributable to changes in the credit risk of that liability (“an entity’s own credit risk”) is presented in OCI. The remaining change is presented in profit or loss. (IFRS 18.104.22.168) Classification and Measurement of Financial Liabilities
However, if this treatment creates, or enlarges, an accounting mismatch in profit or loss, or the liability is a loan commitment or financial guarantee contract designated at FVTPL, the entity must present all gains or losses on that liability (including the effects of changes in the credit risk of that liability) in profit or loss. (IFRS 22.214.171.124-9) Classification and Measurement of Financial Liabilities