therefore a derivative. However, paying out a loan in instalments (for example, a
mortgage construction loan where instalments are paid out in line with the progress of
construction) is not regarded as net settlement. [IFRS 9.2.3(b)].
As a matter of fact, most loan commitments could be settled net if both parties agreed,
essentially by renegotiating the terms of the contract. Of more relevance is the question
of whether one party has the practical ability to settle net, e.g. because the terms of the
contract allow net settlement or by the use of some market mechanism.
Where the entity has a past practice of selling the assets shortly after origination, no
guidance is given on what is meant by a class (although the basis for conclusions makes
it clear that an entity can have more than one). [IFRS 9.BCZ2.6]. Therefore, an assessment
will need to be made based on individual circumstances.
Financial instruments: Definitions and scope 3429
Example 41.2: Identifying classes of loan commitment
A banking group has two main operating subsidiaries, one in country A and the other in country B. Although
they share common functions (e.g. information systems) the two subsidiaries’ operations are clearly distinct.
Both subsidiaries originate similar loans under loan commitments. In country A there is an active and liquid
market for the assets resulting from loan commitments issued in that country. The subsidiary operating in
that country has a past practice of disposing of such assets in this market shortly after origination. There is
no such market in country B.
The fact that one subsidiary has a past practice of settling its loan commitments net (as the term is used in
the standard) would not normally mean that the loan commitments issued in country B are required to be
classified as at fair value through profit or loss.
The above example is relatively straightforward – in some circumstances it may be
more difficult to define the class. However, there is no reason why an individual entity
(say a subsidiary of a group) cannot have two or more classes of loan commitment, e.g.
where they result in the origination of different types of asset that are clearly managed
separately. Any associated entitlement to fees should be accounted for in accordance
with IFRS 15 or IFRS 9 (see Chapter 28 and Chapter 46 at 3 respectively). No
accounting requirements are specified for holders of loan commitments, but they will
normally be accounted for as executory contracts – essentially, this means that fees
payable will be recognised as an expense in a manner that is appropriate to the terms
of the commitment. Any resulting borrowing will obviously be accounted for as a
financial liability under IFRS 9.
Although much of the discussion has focused on loan commitments as options to
provide credit, [IFRS 9.BCZ2.2], we believe it can be appropriate to apply the exclusion
from IFRS 9 to non-optional commitments to provide credit, provided the necessary
conditions above are met.
The exclusion is available only for contracts to provide credit. Normally, therefore, it
will be applicable only where there is a commitment to lend funds, and certainly not for
all contracts that may result in the subsequent recognition of an asset or liability that is
accounted for at amortised cost. Consider, for example, a contract between entities A
and B that gives B the right to sell to A a transferable (but unquoted) debt security issued
by entity C that B currently owns. Even if, on subsequent acquisition, A will measure
the debt security at amortised cost or fair value through other comprehensive income,
the contract would not generally be considered a loan commitment as it does not
involve A providing credit to B.
3.6 Equity
instruments
3.6.1
Equity instruments issued
Financial instruments (including options and warrants) that are issued by the reporting
entity and meet the definition of equity instruments in IAS 32 (see 2.1 above and
Chapter 43 at 3 and 4) are outside the scope of IFRS 9. [IFRS 9.2.1(d)].
3430 Chapter 41
In principle, IFRS 7 applies to issued equity instruments except for those that are
derivatives based on interests in subsidiaries, associates or joint ventures (see 3.1 above).
[IFRS 7.3(a)]. However, this is of largely academic interest because IFRS 7 specifies no
disclosure requirements for issued equity instruments.
In fact, the scope of IFRS 7 for these types of instrument is even more curious.
Firstly, it is explained that derivatives over subsidiaries, associates and joint
ventures that are equity instruments from the point of view of the issuer are
excluded from the scope of IFRS 7 because equity instruments are not remeasured
and hence do not expose the issuer to statement of financial position and income
statement risk. Also, the disclosures about the significance of financial instruments
for financial position and performance are not considered relevant for equity
instruments. [IFRS 7.BC8]. Given the reasons quoted, it is not entirely clear why the
IASB did not exclude all instruments meeting the definition of equity in IAS 32 from
the scope of IFRS 7, e.g. non-puttable ordinary shares issued by the reporting entity.
Secondly, it is very difficult to see how a derivative over a reporting entity’s
associate or joint venture could ever meet the definition of equity from the
perspective of the reporting entity.
3.6.2
Equity instruments held
From the point of view of the holder, equity instruments are within the scope of IFRS 7
and IFRS 9 (unless they meet the exception at 3.1 above). [IFRS 9.2.1(d)].
3.7 Business
combinations
3.7.1
Contingent consideration in a business combination
3.7.1.A
Payable by an acquirer
For business combinations accounted for under IFRS 3 – Business Combinations,
contingent consideration that meets the definition of a financial asset or liability will be
measured at fair value, with any resulting gain or loss recognised either in profit or loss
or in other comprehensive income, in accordance with IFRS 9 (see Chapter 9 at 7.1).
[IFRS 3.58(b)(i)].
Further, contingent consideration arising from an acquiree’s prior business combination
that an acquirer assumes in its subsequent acquisition of the acquiree does not meet the
definition of contingent consideration in the acquirer’s business combination. Rather, it
is one of the identifiable liabilities assumed in the subsequent acquisition. Therefore, to
the extent that such arrangements are financial instruments, they are within the scope
of IAS 32, IFRS 9 and IFRS 7.7
3.7.1.B
Receivable by a vendor
IFRS 9 does not go on to explain whether the vendor should be accounting for the
contingent consideration in accordance with its provisions.
In most cases the vendor will have a contractual right to receive cash or another
financial asset from the purchaser and, therefore, it is hard to avoid the conclusion that
the contingent consideration meets the definition of a financial asset and hence is within
the scope of IFRS 9, not IAS 37. IFRS 10 – Consolidated Financial Statements –
Financial in
struments: Definitions and scope 3431
requires consideration received on the loss of control of an entity or business to be
measured at fair value, which is consistent with the treatment required by IFRS 9 for
financial assets.
3.7.2 Contracts
between an acquirer and a vendor in a business combination
IFRS 9 does not apply to forward contracts between an acquirer and a selling
shareholder to buy or sell an acquiree that will result in a business combination at a
future acquisition date. In order to qualify for this scope exclusion, the term of the
forward contract should not exceed a reasonable period normally necessary to obtain
any required approvals and to complete the transaction, for example to accommodate
the completion of necessary regulatory and legal processes. [IFRS 9.2.1(f), BCZ2.39].
It applies only when completion of the business combination is not dependent on
further actions of either party. Option contracts allow one party to control the
occurrence or non-occurrence of future events depending on whether the option is
exercised. Consequently, option contracts that on exercise will result in the reporting
entity obtaining control of another entity are within the scope of IFRS 9, whether or
not they are currently exercisable. [IFRS 9.BCZ2.40, BCZ2.41].
It was suggested that ‘in-substance’ or ‘synthetic’ forward contracts, e.g. the
combination of a written put and purchased call where the strike prices, exercise dates
and notional amounts are equal, or a deeply in- or out-of-the-money option, should be
excluded from the scope of IFRS 9. However, the IASB staff did not agree with the
notion that synthetic forward contracts (which do provide optionality to one or both
parties) are substantially identical to forward contracts (which commit both parties).
The IASB staff accepted that in normal financial instrument transactions, the economics
of a synthetic forward will be favourable to one party to the contract and should
therefore result in its exercise, but a similar assumption does not necessarily hold true
in business combination transactions because one party may choose not to exercise the
option due to other factors. Therefore, it is not possible to assert that the contracts will
always result in a business combination.8
The acquisition of an interest in an associate represents the acquisition of a financial
instrument, not an acquisition of a business. Therefore the scope exclusion should not
be applied by analogy to contracts to acquire investments in associates and similar
transactions. [IFRS 9.BCZ2.42].
Another related issue is the treatment of contracts, whether options or forwards, to
purchase an entity that owns a single asset such as a ship or building which does not
constitute a business. The reason a contract for a business combination is normally
considered to be a financial instrument seems to be because it is a contract to purchase
equity instruments. Consequently, a contract to purchase all of the shares in a single
asset company would also meet the definition of a financial instrument, yet on the face
of it such a contract would not be excluded from the scope of IFRS 9 if the asset did not
represent a business. The IASB staff disagreed with this analysis and argued that such a
contract should be analysed as a contract to purchase the underlying asset which would
normally be outside the scope of IFRS 9.9 Although forward contracts between an
acquirer and a vendor in a business combination are scoped out of IFRS 9 and hence
are not accounted for as derivatives, they are still within the scope of IFRS 7.
3432 Chapter 41
3.8
Contingent pricing of property, plant and equipment and
intangible assets
IAS 32 (as currently worded) is clear that the purchase of goods on credit gives rise to a
financial liability when the goods are delivered (see 2.2.6 above) and that a contingent
obligation to deliver cash meets the definition of a financial liability (see 2.2.3 above).
Consequently, it would seem that a financial liability arises on the outright purchase of
an item of property, plant and equipment or an intangible asset, where the purchase
contract requires the subsequent payment of contingent consideration, for example
amounts based on the performance of the asset. Further, because there is no exemption
from applying IFRS 9 to such contracts, one might expect that such a liability would be
accounted for in accordance with IFRS 9, i.e. any measurement changes to that liability
would flow through the statement of profit or loss. This would be consistent with the
accounting treatment for contingent consideration arising from a business combination
under IFRS 3 (see 3.7.1.A above).
However, in practice, contracts can be more complex than suggested in the previous
paragraph and often give rise to situations where the purchaser can influence or control
the crystallisation of the contingent payments, e.g. where the contingent payments take
the form of sales-based royalties. These complexities can raise broader questions about
the nature of the obligations and the appropriate accounting standard to apply. In
March 2016, the Interpretations Committee determined that this issue is too broad for
it to address within the confines of existing IFRS. Consequently, the Interpretations
Committee decided not to add this issue to its agenda.
The Interpretations Committee had discussed this issue a number of times. Initially
the discussions focused on purchases of individual assets but they were later widened
to cover contingent payments made under service concessions. The Interpretations
Committee could not reach a consensus on whether the purchaser should recognise
a liability at the date of purchasing the asset for variable payments that depend on its
future activity or, instead, should recognise such a liability only when the related
activity occurs. It was also unable to reach a consensus on how the purchaser should
measure a liability for such variable payments. Accordingly, it concluded that the
Board should address the accounting for variable payments comprehensively.10 This
issue is discussed in more detail in Chapter 17 at 4.5, Chapter 18 at 4.1.9 and
Chapter 39 at 8.4.1.
Where contingent consideration arises on the sale of an asset that is within the scope
of IAS 16 – Property, Plant and Equipment – or IAS 38 – Intangible Assets – then the
requirements of IFRS 15 apply. IFRS 15 requires that variable consideration (which
includes contingent consideration) be estimated, using one of two methods, but requires
that the amount of the estimate included within the transaction price be constrained to
avoid significant reversals in future periods (see Chapter 28). However, where a single
asset held within a subsidiary is disposed of by selling the shares in the subsidiary, it is
unclear whether to apply IFRS 15 to the sale of the asset or IFRS 10 to the sale of the
shares. As noted at 3.7.1.B above, IFRS 10 requires consideration received on the loss of
control of a subsidiary to be measured at fair value. [IFRS 10.B98(b)(i)]. Therefore
depending on which standard is applied to the disposal, the accounting outcome could
be very different when contingent consideration is involved.
&nb
sp; Financial instruments: Definitions and scope 3433
3.9
Employee benefit plans and share-based payment
Employers’ rights and obligations under employee benefit plans, which are dealt with
under IAS 19 – Employee Benefits – are excluded from the scope of IAS 32, IFRS 7 and
IFRS 9. [IAS 32.4(b), IFRS 7.3(b), IFRS 9.2.1(c)]. The Interpretations Committee noted that
IAS 19 indicates that employee benefit plans include a wide range of formal and
informal arrangements and concluded it was clear that the exclusion of employee
benefit plans from IAS 32 (and by implication IFRS 7 and IFRS 9) includes all employee
benefits covered by IAS 19, for example a liability for long service leave.11
Similarly, most financial instruments, contracts and obligations arising from share-
based payment transactions, which are dealt with under IFRS 2 – Share-based
Payment – are also excluded. However, IAS 32, IFRS 7 and IFRS 9 do apply to
contracts to buy or sell non-financial items in share-based transactions that can be
settled net (as that term is used in this context) unless they are considered to be
‘normal’ sales and purchases (see 4 below). [IAS 32.4(f)(i), IFRS 7.3(e), IFRS 9.2.1(h)]. For
example, a contract to purchase a fixed quantity of oil in exchange for issuing of a
fixed number of shares that could be settled net would be excluded from the scope
of IAS 32, IFRS 7 and IFRS 9 only if it qualified as a ‘normal’ purchase (which would
be unlikely).
In addition, IAS 32 applies to treasury shares (see Chapter 43 at 9) that are
purchased, sold, issued or cancelled in connection with employee share option plans,
employee share purchase plans, and all other share-based payment arrangements.
[IAS 32.4(f)(ii)].
3.10 Reimbursement rights in respect of provisions
Most reimbursement rights in respect of provisions arise from insurance contracts and
are therefore outside the scope of IFRS 9 as set out at 3.3 above. The scope of IFRS 9
is also restricted so as not to apply to other financial instruments that are rights to
payments to reimburse the entity for expenditure it is required to make to settle a
liability that it has recognised as a provision in accordance with IAS 37 in the current or
an earlier period. [IFRS 9.2.1(i)].
However, a residual interest in a decommissioning or similar fund that extends beyond
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