1 Best and Fine read – IFRS 9 Reclassification of financial instruments

IFRS 9 Reclassification of financial instruments

IFRS 9 Reclassification of financial instruments, this section looks at the circumstances in which financial assets are reclassified, and their measurement on reclassification. Financial liabilities cannot be reclassified. [IFRS 9 4.4.2]

For financial assets, reclassification is required between FVPL, FVOCI and amortised cost, if and only if the entity’s business model objective for its financial assets changes so its previous model assessment would no longer apply (see below). [IFRS 9 4.4.1]

If reclassification is appropriate, it must be done prospectively from the reclassification date which is defined as the first day of the first reporting period following the change in business model. An entity does not restate any previously recognised gains, losses, or interest.

IFRS 9 does not allow reclassification: IFRS 9 Reclassification of financial instrumentsProhibited

The IFRS 9 Reclassification of financial instruments requirements for reclassification of financial instruments are significantly different from those in IAS 39.

IAS 39

IFRS 9

  • IAS 39 contains numerous reclassification rules for the various categories of financial instruments.
  • For instance, a change in intention or ability causes the initial classification to be inappropriate, a reliable measure of fair value becomes available or is no longer available, etc.

(IAS 39.50-54)

  • There is only one principle for reclassification of financial assets. Reclassification of financial assets is required only when an entity changes its business model for managing them.
  • No reclassification of financial liabilities is allowed.

(IFRS 9.4.4.1-2)

IFRS 9 Reclassification of financial instruments

Changes in the business model are expected to be very infrequent, and are determined by the entity’s senior management as a result of external or internal changes. These changes have to be significant to the entity’s operations and demonstrable to external parties.

Accordingly, a change in the objective of an entity’s business model will occur only when an entity either begins or ceases to carry out an activity that is significant to its operations – e.g. when the entity has acquired, disposed of or terminated a business line [IFRS 9, paragraph 4.4.1].

The following examples from IFRS 9, which do not represent a change in the business model, reiterate how rare reclassification of financial instruments is: IFRS 9 Reclassification of financial instruments

  • A change in intention related to particular financial assets (even in circumstances of significant changes in market conditions). IFRS 9 Reclassification of financial instruments
  • The temporary disappearance of a particular market for financial assets.
  • A transfer of financial assets between parts of the entity with different business models. (IFRS 9.B4.4.3)

Note! Financial assets are only reclassified when there are changes in the business model for managing the assets. A change in the entity’s business model is a significant event and, thus, is expected to be uncommon. Financial liabilities cannot be reclassified under IFRS 9. Overall, this simplifies the reclassification of financial instruments under IFRS 9 compared to IAS 39.

In general, reclassification of financial instruments is accounted for prospectively under IFRS 9; i.e. they do not result in restatements of previously recognised gains, losses or interest income.

Accounting for IFRS 9 Reclassification of financial instruments

IFRS 9 5.6, IFRS 9 B5.6.1 – 2

From

To

Accounting treatment

Amortized cost

FVPL

Measure fair value at reclassification date and recognise the difference between fair value and the carrying Amortized costs in profit or loss (PL)

FVPL

Amortized cost

Fair value at reclassification date becomes the new gross carrying amount

Amortized cost

FVOCI

Measure fair value at reclassification date and recognise the difference between fair value and the carrying Amortized costs in other comprehensive income (OCI)

FVOCI

Amortized cost

Cumulative gain or loss previously recognised in OCI is removed from equity (reserve account) and applied against fair value of the financial asset at the reclassification date

FVPL

FVOCI

Asset continues to be measured at fair value but subsequent gains and losses are recognised in OCI rather than PL

FVOCI

FVPL

Asset continues to be measured at fair value and the cumulative gain or loss previously recognized in OCI is reclassified from equity to PL

Example – IFRS 9 Changes in business model

IFRS 9 provides the following examples of circumstances that are or are not changes in the business model.

IFRS 9 Change in business model

IFRS 9 Reclassification of financial instruments

IFRS 9 Reclassification of financial instruments

IFRS 9 Reclassification of financial instruments

IFRS 9 Reclassification of financial instruments

An entity has a portfolio of commercial loans that it holds to sell in the short term. The entity acquires a company that manages commercial loans and has a business model that holds the loans in order to collect the contractual cash flows. IFRS 9 Reclassification of financial instruments

The original portfolio of commercial loans is no longer for sale, and this portfolio is now managed together with the acquired commercial loans. All of the loans are held to collect the contractual cash flows. [IFRS 9 B4.4.1 (a)] IFRS 9 Reclassification of financial instruments

A financial services firm decides to shut down its retail mortgage business. That business no longer accepts new business and the financial services firm is actively marketing its mortgage loan portfolio for sale. [IFRS 9 B4.4.1 (b)] IFRS 9 Reclassification of financial instruments

IFRS 9 No change in business model

[IFRS 9 B4.4.3]

IFRS 9 Reclassification of financial instruments

IFRS 9 Reclassification of financial instruments

An entity changes its intention for particular financial assets (even in circumstances of significant changes in market conditions). IFRS 9 Reclassification of financial instruments

A particular market for financial assets temporarily disappears.

Financial assets are transferred between parts of an entity with different business models.


Notice: Changes in the way in which assets are managed

As explained in the business model test, the classification of financial assets depends on the way in which they are managed within a business model, and not solely on the objective of the business model itself. Changes in the way that assets are managed within the business model – e.g. an increased frequency of sales – will not result in the reclassification of existing assets, but may result in newly acquired assets being classified differently. Such changes may occur more frequently than changes in the objective of the business model itself. [IFRS 9 B4.1.4.A – C, IFRS 9 B4.4.1, IFRS 9 BC114 – 116, IFRS 9 BCE70]

IFRS 9 does not contain any guidance requiring or allowing an entity to reclassify assets based on a reassessment of the SPPI criterion after initial recognition.


Example – Lapse of a contractual term

IFRS 9 does not provide guidance for circumstances in which:

  • a feature that is significant in arriving at the conclusion that an asset does not meet the SPPI criterion expires before the maturity of the asset; and
  • after the expiry of the feature the asset meets the SPPI criterion.

It appears that the entity should not reclassify the financial asset on expiration of the feature.

For example, assume that a bond is convertible into equity of the issuer and has a 10-year maturity, but the conversion feature is exercisable only for the first five years. If, at the end of five years, the conversion feature has not been exercised, then the bond should remain classified as at FVPL until its maturity.


Timing of reclassification of financial assets

If an entity determines that its business model has changed in a way that is significant to its operations, then it reclassifies all affected assets prospectively from the first day of the next reporting period (the reclassification date). Prior periods are not restated. [IFRS 9 5.6.1]

The change in business model has to be effected before the reclassification date. For reclassification to be appropriate, the entity cannot engage in activities that are consistent with its former business model after the date of change in business model. [IFRS 9 B4.4.2]


Notice: No definition of ‘reporting period’

IFRS 9 does not define the term ‘reporting period’. It appears that the reclassification date depends on the frequency of the entity’s reporting – i.e. quarterly, semi-annually etc. For example, an entity with an annual reporting period ending 31 December that reports quarterly and determines that its business model has changed on 15 March would have a reclassification date of 1 April.


Notice: Long time period between business model change and reclassification

In some cases, there may be a long time period between the change in an entity’s business model and the reclassification date. During this time period, the financial assets existing at the date of change in business model continue to be accounted for as if the business model has not changed – even though this no longer reflects the actual business model in operation. However, it appears that an entity should classify any new assets that were initially recognised after the date of change in business model based on the new business model in effect at the date of their initial recognition. [IFRS 9 BC4.119]

Measurement on reclassification of financial assets

The measurement requirements on the reclassification of financial assets are as follows:

[IFRS 9 5.6, IFRS 9 B5.6.1 – 2, IFRS 9 IE 104 – 114]

Equity investments

All equity investments in scope of IFRS 9 are measured at fair value in the statement of financial position, with value changes recognised in profit or loss, except for those equity investments for which the entity has elected to present value changes in other comprehensive income.

The option to designate an equity instrument at FVOCI is available at initial recognition and is irrevocable. This designation results in all gains and losses being presented in OCI except dividend income which is recognised in profit or loss. IFRS 9 Reclassification of financial instruments

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IFRS 9 Reclassification of financial instruments IFRS 9 Reclassification of financial instruments IFRS 9 Reclassification of financial instruments

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Reclassification of financial assets

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