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.
Classifying bond investments using IFRS 9
Hold financial assets to collect contractual cash flows
Hold financial assets to collect contractual cash flows and for sale
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
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.
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.