instruments (cash in exchange for bonds). If the market price of the government bonds
rises above $1,000, the conditions will be favourable to the purchaser and unfavourable
to the seller, and vice versa if the market price falls below $1,000. The purchaser has a
contractual right (a financial asset) similar to the right under a call option held and a
contractual obligation (a financial liability) similar to the obligation under a put option
written. The seller has a contractual right (a financial asset) similar to the right under a
put option held and a contractual obligation (a financial liability) similar to the obligation
under a call option written. As with options, these contractual rights and obligations
constitute financial assets and financial liabilities separate and distinct from the
underlying financial instruments (the bonds and cash to be exchanged). Both parties to
a forward contract have an obligation to perform at the agreed time, whereas
performance under an option contract occurs only if and when the holder of the option
chooses to exercise it. [IAS 32.AG18].
Many other types of derivative also embody a right or obligation to make a future
exchange, including interest rate and currency swaps, interest rate caps, collars and
Financial instruments: Definitions and scope 3419
floors, loan commitments, note issuance facilities and letters of credit. An interest rate
swap contract may be viewed as a variation of a forward contract in which the parties
agree to make a series of future exchanges of cash amounts, one amount calculated with
reference to a floating interest rate and the other with reference to a fixed interest rate.
Futures contracts are another variation of forward contracts, differing primarily in that
the contracts are standardised and traded on an exchange. [IAS 32.AG19].
2.2.9 Dividends
payable
As part of its project to provide authoritative accounting guidance for non-cash
distributions (see Chapter 8 at 2.4.2), the Interpretations Committee found itself
debating the seemingly simple question of how to account for a declared but unpaid
cash dividend (or, more accurately, which standard applies to such a liability).
Although there are clear indicators within IFRS that an obligation to pay a cash
dividend is a financial liability, [IAS 32.AG13], the Interpretations Committee originally
proposed that IAS 37 should be applied to all dividend obligations,5 a decision that
appeared to have been made more on the grounds of expediency rather than using
any robust technical analysis. By the time IFRIC 17 – Distributions of Non-cash Assets
to Owners – was published in November 2008, the Interpretations Committee had
modified its position slightly. Aside from those standards dealing with the
measurement of liabilities that are clearly not relevant (e.g. IAS 12), they considered
that others, except IAS 37 or IFRS 9, were simply not applicable because they
addressed liabilities arising only from exchange transactions, whereas IFRIC 17 was
developed to deal with non-reciprocal distributions. [IFRIC 17.BC22]. Finally, IFRIC 17
simply specifies the accounting treatment to be applied to distributions without
linking to any individual standard. [IFRIC 17.BC27]. The Interpretations Committee
concluded that it was not appropriate to conclude that all dividends payable are to be
regarded as financial liabilities.
3 SCOPE
IAS 32, IFRS 7 and IFRS 9 apply to the financial statements of all entities that are
prepared in accordance with International Financial Reporting Standards. [IAS 32.4,
IFRS 7.3, IFRS 9.2.1]. In other words there are no exclusions from the presentation,
recognition, measurement, or even the disclosure requirements of these standards,
even for entities that do not have publicly traded securities or those that are subsidiaries
of other entities.
The standards do not, however, apply to all of an entity’s financial instruments, some of
which are excluded from their scope, for example, insurance contracts (see Chapters 51
and 52). These exceptions are considered in more detail below. Conversely, certain
contracts over non-financial items that behave in a similar way to financial instruments
but do not actually fall within the definition – essentially some commodity contracts –
are included within the scope of the standards and these are considered at 4 below.
3.1
Subsidiaries, associates, joint ventures and similar investments
Most interests in subsidiaries, associates, and joint ventures that are consolidated or
equity accounted in consolidated financial statements are outside the scope of IAS 32,
3420 Chapter 41
IFRS 7 and IFRS 9. However, such instruments should be accounted for in accordance
with IFRS 9 and disclosed in accordance with IFRS 7 in the following situations:
[IAS 32.4(a), IFRS 7.3(a), IFRS 9.2.1(a)]
• in separate financial statements of the parent or investor if the entity chooses not
to account for those investments at cost or using the equity method as described
in IAS 28 – Investments in Associates and Joint Ventures (see Chapter 8 at 2);
[IAS 27.10, IAS 27.11, IAS 28.44]
• when investments in an associate or a joint venture held by a venture capital
organisation, mutual fund, unit trust or similar entity are classified as financial
instruments at fair value through profit or loss on initial recognition (see Chapter 11
at 5.3). [IAS 28.18]. When an entity has an investment in an associate, a portion of
which is held indirectly through a venture capital organisation, mutual fund, unit
trust or similar entity including an investment-linked insurance fund, the entity
may elect to measure that portion of the investment in the associate at fair value
through profit or loss regardless of whether the venture capital organisation,
mutual fund, unit trust or similar entity has significant influence over that portion
of the investment. If the election is made, the equity method should be applied to
any remaining portion of the investment; [IAS 28.19] and
• an investment in a subsidiary by an investment entity that is measured at fair value
through profit or loss using the investment entity exception (see Chapter 6
at 2.2.3). [IFRS 10.31].
In January 2013, the Interpretations Committee concluded that impairments of
investments in subsidiaries, associates and joint ventures accounted for at cost in the
separate financial statements of the investor are dealt with by IAS 36 – Impairment of
Assets – not IFRS 9.6
Whilst the scope of IFRS 9 excludes interests in associates and joint ventures accounted
for using the equity method, [IFRS 9.2.1(a)], it was initially unclear whether the scope also
excludes long-term interests in an associate or joint venture that, in substance, form
part of the net investment in the associate or joint venture (see Chapter 11 at 8).
However, in October 2017, the IASB issued an amendment to IAS 28 clarifying that
IFRS 9, including its impairment requirements, applies to the measurement of long-
term interests in an associate or a joint venture that form part of the net investment in
the associate or joint venture, but to which the equity method is not applied. [IAS 28.14A].
The amendment has an effectiv
e date of 1 January 2019. Early adoption is permitted,
provided that fact is disclosed, which allows the amendment to be adopted at the same
time as IFRS 9. [IAS 28.45G]. The transitional requirements of IFRS 9 are followed if the
amendments are adopted at the same time as that standard (see Chapter 47 at 16.2)
[IAS 28.45H] and similar transitional requirements set out in IAS 28 are applied if the
amendments are adopted after IFRS 9 (see Chapter 11 at 8). [IAS 28.45I].
IAS 32, IFRS 7 and IFRS 9 apply to most derivatives on interests in subsidiaries,
associates and joint ventures, irrespective of how the investment is otherwise
accounted for. However, IFRS 9 does not apply to instruments containing potential
voting rights that, in substance, give access to the economic benefits arising from an
Financial instruments: Definitions and scope 3421
ownership interest which is consolidated or equity accounted (see Chapter 7 at 2.2,
Chapter 11 at 4.3 and Chapter 12 at 4.2.2). [IFRS 10.B91].
From the perspective of an entity issuing derivatives, the requirements of IFRS 9 and
IFRS 7 do not apply if such derivatives meet the definition of an equity instrument of the
entity. [IAS 32.4(a), IFRS 7.3(a), IFRS 9.2.1(a)]. For example, a written call option allowing the holder
to acquire a subsidiary’s shares that can be settled only by delivering a fixed number of
those shares in exchange for a fixed amount of cash might meet the definition of equity in
the group’s consolidated financial statements (see 3.6 below and Chapter 43 at 5.1).
Sometimes an entity will make a strategic investment in the equity of another party.
These are often made with the intention of establishing or maintaining a long-term
operating relationship with the investee. Unless they are equity accounted as associates
or joint ventures, these investments are within the scope of IFRS 9. [IFRS 9.B2.3].
3.2 Leases
Whilst all rights and obligations under leases that represent financial instruments and to
which IAS 17 or IFRS 16 applies (see Chapters 23 and 24) are within the scope of IAS 32
and IFRS 7, they are only within the scope of IFRS 9 to the following extent:
• lease receivables and lease liabilities are subject to the derecognition provisions
(see Chapter 48);
• lease receivables are subject to the ‘expected credit loss’ requirements (see
Chapter 47 at 5); and
• the relevant provisions that apply to derivatives embedded within leases (see
Chapter 42 at 5.3).
Otherwise the applicable standard is IAS 17 or IFRS 16, not IFRS 9. [IFRS 9.2.1(b)].
3.3
Insurance and similar contracts
Although insurance contracts as defined in IFRS 4 or IFRS 17 often satisfy the definition
of a financial instrument, for the most part they are excluded from the scope of IAS 32,
IFRS 7 and IFRS 9. [IAS 32.4(d), IFRS 7.3(d), IFRS 9.2.1(e)]. IFRS 4 is discussed in Chapter 51 and
IFRS 17, which was published in May 2017, replaces IFRS 4 and is applicable for
accounting periods beginning on or after 1 January 2021, is discussed in Chapter 52.
An insurance contract is defined as one under which one party (the insurer or issuer)
accepts significant insurance risk from another party (the policyholder) by agreeing to
compensate the policyholder if a specified uncertain future event (the insured event)
adversely affects the policyholder. Insurance risk is defined as risk, other than financial
risk, transferred from the holder of a contract to the issuer. Financial risk is defined as
the risk of a possible future change in one or more of a specified interest rate, financial
instrument price, commodity price, foreign exchange rate, index of prices or rates,
credit rating or credit index or other variable, provided in the case of a non-financial
variable that the variable is not specific to a party to the contract. [IFRS 4 Appendix A,
IFRS 17 Appendix A]. In many cases it will be quite clear whether a contract is an insurance
contract or not, although this will not always be the case and IFRS 4 and IFRS 17 contain
several pages of guidance on this definition (see Chapter 51 at 3 and Chapter 52 at 3).
[IFRS 4 Appendix B, IFRS 17.B2-B30].
3422 Chapter 41
Financial guarantee contracts, which meet the definition of an insurance contract if the
risk transferred is significant, are normally accounted for by the issuer under IFRS 9 and
disclosed in accordance with IFRS 7 (see 3.4 below). [IFRS 9.B2.5(a)].
The application guidance makes it clear that insurers’ financial instruments that are not
within the scope of IFRS 4 or IFRS 17 (when applied) should be accounted for under
IFRS 9. [IFRS 9.B2.4].
3.3.1 Weather
derivatives
Contracts which require a payment based on climatic variables (often referred to as
‘weather derivatives’) or on geological or other physical variables are within the scope
of IFRS 9 unless they fall within the scope of IFRS 4 or IFRS 17. [IFRS 9.B2.1]. Generic or
standardised contracts will rarely meet the definition of insurance contracts because
the variable is unlikely to be specific to either party to the contract. [IFRS 4.B18(l), B19(g),
IFRS 17.B26(k), B27(g)]. This is illustrated in the following example.
Example 41.1: Rainfall contract – derivative financial instrument or insurance
contract?
Company E has contracted to lease a stall at an open-air event from which it plans to sell goods to people
attending the event. The event will be held at a village approximately 100 km from Capital City.
Because E is concerned that poor weather may deter people from attending the event, it enters into a contract
with Financial Institution K, the terms of which are that, in return for a premium paid by E on inception of
the contract, K will pay a fixed amount of money to E if, during the day of the event, it rains for more than
three hours at the meteorological station in the centre of Capital City.
The non-financial variable in the contract, i.e. rainfall at the meteorological station, is not specific to E.
Particularly, E will only suffer loss as a result of rainfall at the village, not at Capital City. Also, because the
potential payment to be received is for a fixed amount, it might not be possible to demonstrate that E has
suffered a loss for which it has been compensated. Therefore, E should account for the contract as a financial
instrument under IFRS 9.
3.3.2
Contracts with discretionary participation features
IFRS 4 and IFRS 17 are clear that investment contracts that have the legal form of an
insurance contract but do not expose the insurer to significant insurance risk (see
Chapters 51 and 52) are financial instruments and not insurance contracts. [IFRS 4.B19(a),
IFRS 17.B27(a)]. Investment contracts (normally taking the form of life insurance policies)
which contain what are called discretionary participation features, essentially rights of
the holder to receive additional benefits whose amount or timing is, contractually, at
the discretion of the issuer, are accounted for under IFRS 4. [IFRS 4 Appendix A].
Accordingly, IFRS 9 and the parts of IAS 32 dealing with the distinction between
financial liabilities and equity instruments (see Chapter 43 at 4) do not apply to such
contracts, although the disclosure requirements of IFRS 7 do ap
ply. [IAS 32.4(e), IFRS 9.2.1(e),
IFRS 4.2(b), IFRS 7.3]. When IFRS 17 is applied, such contracts would fall within its scope if
(and only if) the entity also issues insurance contracts as the IASB believes that applying
IFRS 17 to these contracts in these circumstances would provide more relevant
information about the contracts than would be provided by applying other standards.
[IFRS 17.3(c), BC65(a)]. In rare cases where an entity issues contracts with a discretionary
participation feature but does not issue any insurance contracts, those contracts would
fall within the scope of IAS 32 and IFRS 9.
Financial instruments: Definitions and scope 3423
3.3.3
Separating financial instrument components including embedded
derivatives from insurance contracts
IFRS 9 applies to derivatives that are embedded in insurance contracts or contracts
containing discretionary participation features (see 3.3.2 above) if the derivative itself
is not within the scope of IFRS 4. [IFRS 9.2.1(e)]. When IFRS 17 is applied, entities will
use IFRS 9 to determine whether a contract contains an embedded derivative to be
separated and apply IFRS 9 to those components that are separated. [IFRS 17.11(a)].
IFRS 7 applies to all embedded derivatives that are separately accounted for.
[IFRS 7.3(d)].
In addition, IFRS 17 requires an entity to separate the investment component (the
amount an insurance contract requires the entity to repay to the policyholder even if
an insured event does not occur [IFRS 17.BC108]) from a host insurance contract if the
component is ‘distinct’ (see Chapter 52 at 11.2). The separated component is accounted
for in accordance with IFRS 9. [IFRS 17.11(b)].
3.4
Financial guarantee contracts
Where a contract meets the definition of a financial guarantee contract (see 3.4.1 below)
the issuer is normally required to apply specific accounting requirements within IFRS 9,
which are different from those applying to other financial liabilities – essentially the
contract is measured at fair value on initial recognition and this amount is amortised to
profit or loss provided it is not considered probable that the guarantee will be called
(see Chapter 46 at 2.8). There are exceptions to this general requirement and these are
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 676
