Classification for investments in bonds

Classification for investments in bondsClassification for investments in bonds – Under IFRS 9, bonds should be classified and measured based on an entity’s business model for managing the bonds and their contractual cash flow characteristics (SPPI Test) (see table below).

The business model refers to how an entity manages bonds in order to generate cash flows—either by collecting contractual cash flows, selling the bonds or both. An entity is also required to determine whether the bond’s contractual cash flows are “Solely Payments of Principal and Interest” (SPPI) on the principal amount outstanding.

The entity must assess its business model by looking at several factors, including the expected frequency, volume and timing of asset sales, the measurement of financial asset performance, the management of investment risks, and whether the compensation of business managers is based on a fair value of the assets managed or on the contractual cash flows collected.

Classification for investments in bonds using IFRS 9

Business model test

SPPI Test

Amortized Cost

Hold financial assets to collect contractual cash flows

Solely Payments of Principal and Interest on the principal amount outstanding

Fair Value through Other Comprehensive Income (FVOCI)

Hold financial assets to collect contractual cash flows and for sale

Fair Value through Profit or Loss (FVPL)

Effectively a residual category for bonds that cannot be classified as either Amortized Cost or FVOCI, but an entity can also make an irrevocable election to classify a bond as FVPL to reduce accounting mismatches. Note: both tests are not applicable for FVPL

Something else -   Commodity finance IFRS the 6 best examples

The choice of accounting classification for bonds is likely to be based on many factors in addition to tolerance for balance sheet and P&L volatility. Insurance companies are also likely to consider the sensitivity of their assets and liabilities to changes in interest rates. Insurers whose liabilities are valued on a book value or smoothed basis are likely to have a relatively large proportion of bonds classified as Amortized Cost or FVOCI to reduce the sensitivity of their net assets to changes in interest rates.

The table below presents the closest comparable accounting classifications for bonds in IAS 39 and IFRS 9.

Financial assets

IAS 39 Classification for investments in bonds

IFRS 9 Classification for investments in bonds

Bonds

Held-to-maturity

Amortized cost

Classification for investments in bonds

Available-for-sale

FVOCI

Classification for investments in bonds

Held-for-trading

FVPL

While held-to-maturity is comparable to amortized cost and available-for-sale is comparable to FVOCI in terms of their accounting measurements, they are not identical due to the requirement to include an ECL calculation under IFRS 9 and the difference in impairment models between the two sets of accounting rules. In addition, their classification criteria also differ.

Amortised costs

The amount at which the financial asset or financial liability is measured at initial recognition minus the principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount and, for financial assets, adjusted for any loss allowance. At derecognition before repayment of principal any result is recorded in profit or loss.

Something else -   IFRS 9 Interest-free demand or term loan

Fair value through other comprehensive income

A financial asset is classified as subsequently measured at fair value through other comprehensive income (FVOCI) if:

FVOCI requires changes in subsequent measurements to be recorded in other comprehensive income. At derecognition of the financial assets some changes recorded in other comprehensive income are reclassified  (recycled) to profit or loss, to ensure they are at derecognition at least shown in profit or loss because at that moment a result materialised.

Showing the result of derecognition in profit or loss results in an outcome in profit or loss very similar to the result upon derecognition of financial assets at amortised costs. Other financial assets never recycle because there is no materialisation of a result at transfer of that financial asset. Assets at FVOCI that do not recycle to profit or loss at derecognition have to be tested for impairment (because losses at derecognition will also be recorded in profit or loss and losses have to be recorded as soon as foreseeable, which is not necessarily at derecognition.

Something else -   Valuation techniques Income approach

What is the use of  other comprehensive income

When you sell an investment, you include the amount of money you received on the income statement as part of your income. Suppose you haven’t sold an investment, but it lost $10,000 in value in the past year. If you include that loss with your income it will make your company look less profitable than it really is. Likewise, an increase in value would pad your income.

The solution is to include it in a separate category, “other comprehensive income.” This section of the statement covers gains and losses that don’t affect your income but do affect the equity, the worth of your business assets. You can combine income and comprehensive income into one statement, or separate them into two.

Fair value through profit or loss

Fair value through profit or loss—any financial assets that are not held in one of the two business models (‘Hold to collect‘ and ‘Hold to collect and sell‘) mentioned are measured at fair value through profit or loss.

Classification for investments in bonds

Classification for investments in bonds

Annualreporting provides financial reporting narratives using IFRS keywords and terminology for free to students and others interested in financial reporting. The information provided on this website is for general information and educational purposes only and should not be used as a substitute for professional advice. Use at your own risk. Annualreporting is an independent website and it is not affiliated with, endorsed by, or in any other way associated with the IFRS Foundation. For official information concerning IFRS Standards, visit IFRS.org or the local representative in your jurisdiction.

Something else -   Fair value through profit or loss

Classification for investments in bonds Classification for investments in bonds Classification for investments in bonds Classification for investments in bonds Classification for investments in bonds Classification for investments in bonds Classification for investments in bonds

Leave a comment