Loan receivable classification and measurement

Loan receivable classification and measurement – Once it has been determined that a loan receivable is within the scope of IFRS 9, it must be classified into one of three categories:

  1. Amortised cost; Loan receivable classification and measurement
  2. Fair Value through Profit or Loss (FVPL); or Loan receivable classification and measurement
  3. Fair Value through Other Comprehensive Income (FVOCI).

The classification decision is based on (i) the business model within which the loan is held and (ii) whether its contractual cash flows meet the ‘solely payments of principal and interest’ (SPPI) test, as illustrated below:

Business model >  Hold to collect Hold to collect and sell Other
Cash Flow Characteristic SPPI Amortised costs FVOCI FVPL
Other FVPL FVPL FVPL

All related company loan receivables that are classified at amortised cost or at FVOCI are subject to the ECL model which means that impairment losses are recognised in profit or loss. Loan that are classified at FVPL are not subject to the ECL model because all fair value changes must be recognised in profit or loss. Fair values must be determined in accordance with the requirements in IFRS 13 Fair Value Measurement.

In short the three categories are:Loan receivable classification and measurement

Something else -   Loss given default

a. Amortised cost Loan receivable classification and measurement

This is part of the classification of financial assets. IFRS 9 Definition: 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. Loan receivable classification and measurement

Subsequent measurement

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).

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.

Something else -   Pass through testing

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.

Examples:

  • debt instruments i.e. regular loans held to received repayment of principal and earn interest from,
  • accounts receivable.

b. Fair Value through Other Comprehensive Income (FVOCI)

This is also part of the classification of financial assets. A financial asset is classified as subsequently measured at fair value through other comprehensive income (FVOCI) if: Loan receivable classification and measurement

Subsequent measurement

  • Fair value, with all gains and losses recognised in other comprehensive income Financial assets at fair value through other comprehensive income
  • Changes in fair value are subsequently recycled to profit and loss Financial assets at fair value through other comprehensive income
  • Dividends are recognised in profit or loss.
Something else -   Indicators of a possible default

Example:

c. Fair Value through Profit or Loss (FVPL) Loan receivable classification and measurement

This is also part of the classification of financial assets. The fair value through profit or loss classification comes from the situation in which 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 .

Subsequent measurement

At each balance sheet date, the financial asset, classified and measured at fair value through profit or loss, is re-measured at fair value. Changes in fair value from reporting date to reporting date are recognized in profit and loss as they arise.

Examples

Financial assets at fair value through profit or loss may include the following financial instruments:

  • Investments in money market funds,
  • Preference shares (equity instruments),
  • Listed equity investments (including, for example, NYSE-listed, LSE-listed,  or ISE listed),
  • (Un)listed equity investments that are held for trading or available for sale,
  • (Un)listed equity investments for which the reporting entity has not elected to classify and measure them at fair value through other comprehensive income,
  • Derivatives,
  • Contingent consideration,
  • Debt instruments (loans, bonds) that do not meet the criteria for classification as subsequently measured at either amortised cost or fair value through other comprehensive income (FVOCI).

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Loan receivable classification and measurement

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Something else -   ECL

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