In July 2014 the International Accounting Standards Board (IASB) published the 4th and final version of IFRS 9 Financial Instruments.
This was the conclusion of a major project started in 2002 as part of the Norwalk Agreement (WIKI) between the IASB and US Financial Accounting Standards Board (FASB) as a long term reform of financial instrument accounting.
The project had been divided into three phases in order to allow a step by step approach. Once a phase was completed, the corresponding chapters were created in IFRS 9 and withdrawn from IAS 39 Financial Instruments: Recognition and Measurement.
Phase I: classification and measurement – First chapters of IFRS 9 were issued in November 2009, regarding solely the classification and measurement of financial assets. Additional provisions regarding the classification and measurement of financial liabilities were added in October 2010. Final amendments have been introduced in the last version of July 2014.
Phase II: impairment – A new impairment model has been added in the final version of July 2014 that replaces the complex and multiple impairment models existing in IAS 39.
Phase III: hedge accounting – Issued in November 2013, chapters relating to hedge accounting have not been modified in the final version of IFRS 9.
In December 1998, the International Accounting Standards Board (IASB) issued the accounting standard IAS 39 with the aim to define the principles for the recognition, measurement and disclosures of financial and non-financial instruments. Later, the ever-changing of markets and the creation of new financial instruments, has involved a number of improvements and additions to the accounting standard IAS 39, until 2007.
From the IAS 39 to IFRS 9. New model of classification and measurement of financial instruments
After the start of the economic crisis in 2008, the IASB decided to issue the standard IFRS 9 with a particular attention to classification and measurement of financial instruments. The IASB published the final version of IFRS 9 in July 2014 partly replacing IAS 39. The main new features include a new model of ‘classification and measurement’, impairment – expected credit losses, hedge accounting and own credit. The new standard applied from 1 January 2018 onward.
Differences between IAS 39 and IFRS 9
IFRS 9 specifies how an entity should classify and measure financial assets, financial liabilities, and some contracts to buy or sell non-financial items. IFRS 9 requires an entity to recognise a financial asset or a financial liability in its statement of financial position when it becomes party to the contractual provisions of the instrument. All financial instruments are initially measured at fair value plus or minus, in the case of a financial asset or financial liability not at fair value through profit or loss, transaction costs.
When an entity first recognises a financial asset, it classifies it based on the entity’s business model for managing the asset and the asset’s contractual cash flow characteristics, as follows in one of three valuation models:
Amortised cost—a financial asset is measured at amortised cost if both of the following conditions are met:
the asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows; 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.
Fair value through other comprehensive income—financial assets are classified and measured at fair value through other comprehensive income if they are held in a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets.
Fair value through profit or loss—any financial assets that are not held in one of the two business models mentioned are measured at fair value through profit or loss.
When, and only when, an entity changes its business model for managing financial assets it must reclassify all affected financial assets. This shows how important it is to understand the business model of a financial reporting entity.
Under IFRS 9 assets managed on a fair value basis are by default accounted for at Fair Value through Profit or Loss because they fail the business model test. Hybrid debt instruments that are financial assets with non-closely related embedded derivatives under IAS 39 generally fail to meet the contractual cash flow characteristic test, and thus are also accounted for at Fair Value through Profit or Loss under IFRS 9.
Classification and Measurement
Classification determines how financial assets are accounted for in financial statements and, in particular, how they are measured on an ongoing basis. Requirements for classification and measurement are the foundation of the accounting for financial instruments.
Many application problems emerged from IAS 39 regarded classification and measurement of financial assets, because of the many possible classification categories and related variations of value measurement. For these reasons, the IASB intended to make it easier, for users of financial statements, to understand the information provided in respect of classification and measurement of financial instruments by replacing IAS 39 largely by IFRS 9.
IFRS 9 introduces a logical approach for the classification of financial assets, which is driven by cash flow characteristics and the business model in which an asset is held. This single, principle -based approach replaced existing rule-based requirements that were generally considered to be overly complex and difficult to apply. The new model also resulted in a single impairment model being applied to all financial instruments, thereby removing a source of complexity associated with IAS 39.
Fair value option
IFRS 9 contains an option to designate, at initial recognition, a financial asset as measured at Fair Value through Profit or Loss if doing so eliminates or significantly reduces an ‘accounting mismatch’ that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases. Financial assets designated at Fair Value through Profit or Loss are not subject to the reclassification requirements of IFRS 9.
Process for determining the classification and measurement of financial assets
Expected credit losses in focus Recognise financial assets or liabilities when party
The reality of moving from an ‘incurred loss’ method to a two-step ‘expected loss’ method to record credit-related loss provisions was the most significant focal point of IFRS 9 Financial Instruments. IFRS 9 requires that estimations about credit losses are forward looking and probability weighted. A financial institution’s credit risk management department needs to be actively involved in determining these accounting estimates.
Hedge accounting Recognise financial assets or liabilities when party
IFRS 9 introduced a substantially-reformed model for hedge accounting, with enhanced disclosures about risk management activity. The new model represented a significant overhaul of hedge accounting that aligned the accounting treatment with risk management activities, enabling entities to better reflect these activities in their financial statements.
In addition, as a result of these changes, users of the financial statements were provided with better information about risk management and the effect of hedge accounting on the financial statements.
Own credit Recognise financial assets or liabilities when party
IFRS 9 also removes the volatility in profit or loss that was caused by changes in the credit risk of liabilities elected to be measured at fair value. This change in accounting means that gains caused by the deterioration of an entity’s own credit risk on such liabilities are no longer recognized in profit or loss.