IFRS 9: Amendments to IAS 39
IFRS 9 is a part of a 3-phase process of re-writing of IAS 39. IFRS 9 is the first phase, and replaces provisions of IAS 39 pertaining to classification and measurement of financial assets and liabilities. In order to understand this Standard, readers should also understand original requirements of IAS 39. The two phases pertain to hedge accounting, and use of amortised cost as the basis for valuation of assets.
One of the key elements of IAS 39 is classification of financial assets and liabilities – it is based on the classification that assets/liabilities come for fair value accounting. It may be recalled that there are 4 major classes of financial assets under IAS 39 – loans and receivables, hold to maturity assets, available for sale assets, and trading assets. In case of liabilities, there may be trading and non-trading liabilities. In addition, there are assets that may be optionally fair-valued through P/L account based on certain conditions.
IFRS 9 intends to simplify the classification with only 2 classes: assets that are carried at amortised cost and assets that are fair valued. Of course, the third category of optional valuation through P/L account remains. Hence, as per IFRS 9, there are 3 classes of financial assets – those that are optionally FVTPL-ed, those carried at amortised cost, and those that are fair valued.
Assets at amortised cost:
Under IFRS 9, an asset will be measured at cost if BOTH the conditions below are satisfied:
- the asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows.
- 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.
Both the conditions are above are significant, and the Standard offers detailed guidance to determine whether the conditions exist. Before discussing those conditions, it is important to understand that under IAS 39, the amortised cost basis was applicable if the asset in question was a loan/receivable, or was a hold-to-maturity asset. Under IFRS 9, the hold-to-maturity classification is not important – instead, the two conditions above become important.
The classification on amortised cost basis is, as a first condition, applicable only to instruments that consist of interest and principal cash flows. This would obviously include loans and other interest-bearing instruments. As a second condition, the classification is applicable only to such instruments which are held for realization, and not for disposal. That is, the assets are not a part of an asset group or portfolio which is commonly traded. Unlike the HTM category, here, there is no firm commitment to hold the assets to maturity: on the other hand, the asset being part of a non-trading portfolio is sufficient to categorise it for amortised cost accounting. Also, it is possible under circumstances to sell assets that were forming part of an amortised cost portfolio – para B4.3. This categorization does not have to be done instrument by instrument – it may based on a broader level of grouping [B4.2]. There are several examples given below Para B4.4 where the business model may consist of holding assets.
Assets at fair value:
All assets other than those that are permitted to be held at amortised cost are to be fair valued. Hence, fair valuation is the rule, and amortised cost is an exception.
Assets optionally at fair value:
The Standard allows entities to measure financial assets at fair value if doing so avoids an accounting mismatch that would arise by not measuring the asset at fair value. This is true for all such assets whose risks are managed based on fair values.
Gains or losses on assets:
IFRS 9 tries to reduce some of the complexity associated with fair valuation under IAS 39. Under IAS 39, it may be recalled that available-for-sale and trading assets are treated on fair value basis. In case of available-for-sale assets, the gains/losses on fair valuation are taken to Other Comprehensive Income, while gains/losses on trading assets are taken to profit and loss account.
Under IFRS 9, the gains/losses are treated as follows:
- In case of assets, including assets held on amortised cost basis, if the asset is a part of a hedging relationship (that is, is a hedged item), the gains/losses will be dealt with as per IAS 39.
- In case of assets that are fair valued, and are not part of hedging relationship or are not an equity instrument, the gains/losses on fair valuation are transferred to profit and loss account.
- In case the asset is an equity instrument, the gains/losses on fair valuation may, at the option of the entity, be taken to other comprehensive income. The election has to be done irrevocably.
- In case of assets treated on amortised cost basis, the gains/losses on valuation are treated only when the asset is disposed off or reclassified.
Separation of embedded derivatives:
IAS 39 required separation of all embedded derivatives. IFRS 9 requires separation of embedded derivatives only if the host contract is not a financial instrument. In that case, the separated derivative will be treated as per IAS 39/IFRS 9.
In case of host contracts that are financial instruments, the classification norms of IFRS 9, that is, amortised cost, fair value or optionally fair valued, will be applicable. It is unlikely that such an embedded derivative contract will qualify to be treated at amortised cost – hence, the likely treatment is fair value.