This classification of Financial asset valued at amortised costs is part of the decision model for the classification and measurement of financial assets, that started in the IFRS 9 Framework for financial assets.
This is the category classification criteria at initial recognition.
A financial asset is measured at amortised cost if both of the following conditions are met:
- the asset is held within a portfolio with a business model whose objective is to hold assets in order to collect the contractual cash flows (‘hold to collect’ business model); and
- the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.
[IFRS 9 4.1.2]. Financial asset valued at amortised costs
Subsequent measurement Financial asset valued at amortised costs
The asset is measured at the amount recognized at initial recognition minus principal repayments, plus or minus the cumulative amortization of any difference between that initial amount and the maturity amount (discount or premium (if any)), and any loss allowance (impairment). Interest income is calculated using the effective interest method and is recognized in profit and loss. Changes in fair value are only recognized in profit and loss when the asset is derecognized (sold!) or reclassified (very rare situation).
But do not forget the fair value option. Financial asset valued at amortised costs
Discount or premium
Accounting standards require that any discount or premium arising on acquisition of a financial asset carried at amortized cost should be amortized using the effective interest rate method. Under the effective interest method, the interest income recognized is calculated by applying the market interest rate to the carrying amount of the bond and the difference between the interest income so recognized and the interest income paid (which equals the product of maturity value of the bond and the stated interest rate) is used to write-off the discount or premium such that the discount or premium is zero at the end of the bond term.
The effective interest rate method
The effective interest rate method is used in the calculation of the amortised cost of a financial asset or a financial liability and in the allocation and recognition of the interest revenue or interest expense in profit or loss over the relevant period. But many assets and liabilities valued at amortised cost are valued at cost, because they are received or paid within a short period (i.e. discounted value equals cost). Financial asset valued at amortised costs
The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, an entity shall estimate cash flows considering all contractual terms of the financial instrument (e.g., prepayment, call and similar options) but shall not consider future credit losses. Financial asset valued at amortised costs
The calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs, and all other premiums or discounts. There is a presumption that the cash flows and the expected life of a group of similar financial instruments can be estimated reliably.
However, in those rare cases when it is not possible to estimate reliably the cash flows or the expected life of a financial instrument (or group of financial instruments), the entity shall use the contractual cash flows over the full contractual term of the financial instrument (or group of financial instruments).
See also: The IFRS Foundation