assets in greater volume than would be consistent with a business model whose
objective is to hold financial assets to collect contractual cash flows and would, without
this category, have to record such assets at fair value through profit or loss.
It should be noted firstly that:
(a) the fair value through other comprehensive income classification under IFRS 9
reflects a business model evidenced by facts and circumstances and is neither a
residual classification nor an election;
(b) debt instruments measured at fair value through other comprehensive income will
be subject to the same impairment model as those measured at amortised cost.
Accordingly, although the assets are recorded at fair value, the profit or loss
treatment will be the same as for an amortised cost asset, with the difference
between amortised cost, including impairment allowance, and fair value recorded
in other comprehensive income; and
(c) only relatively simple debt instruments will qualify for measurement at fair value
through other comprehensive income as they will also need to pass the contractual
cash flow characteristics test.
2.2
Equity instruments and derivatives
Equity instruments and derivatives are normally measured at fair value through profit
or loss. [IFRS 9.5.7.1]. However, on initial recognition, an entity may make an irrevocable
election (on an instrument-by-instrument basis) to present in other comprehensive
income subsequent changes in the fair value of an investment in an equity instrument
within the scope of IFRS 9. This option applies to instruments that are neither held for
trading (see 4 below) nor contingent consideration recognised by an acquirer in a
business combination to which IFRS
3 – Business Combinations – applies.
[IFRS 9.5.7.1(b), 5.7.5]. For the purpose of this election, the term equity instrument uses the
definition in IAS 32 – Financial Instruments: Presentation. The use of this election is
covered further at 8 below.
Although most gains and losses on investments in equity instruments designated at fair
value through other comprehensive income will be recognised in other comprehensive
income, dividends will normally be recognised in profit or loss. [IFRS 9.5.7.6]. However,
the IASB noted that dividends could sometimes represent a return of investment instead
of a return on investment. Consequently, the IASB decided that dividends that clearly
represent a recovery of part of the cost of the investment are not recognised in profit
or loss. [IFRS 9.BC5.25(a)]. Meanwhile, gains or losses recognised in other comprehensive
Financial
instruments:
Classification
3599
income are never reclassified from equity to profit or loss on derecognition of the asset,
and consequently, there is no need to review such investments for possible impairment.
Determining when a dividend does or does not clearly represent a recovery of cost
could prove somewhat judgemental in practice, especially as the standard contains no
further explanatory guidance. Also, because it is an exception to a principle, it could
open up the possibility of structuring transactions to convert fair value gains into
dividends through the use of intermediate holding vehicles. However, in the IASB’s
view, those structuring opportunities would be limited because an entity with the ability
to control or significantly influence the dividend policy of the investee would not
account for those investments in accordance with IFRS 9. Furthermore the IASB
require disclosures that would allow the user to compare the dividends recognised in
profit or loss and other fair value changes easily. [IFRS 9.BC5.25(a)].
3 CLASSIFYING
FINANCIAL
LIABILITIES
Financial liabilities are classified and measured either at amortised cost or at fair value
through profit or loss.
In addition, IFRS 9 specifies the accounting treatment for liabilities arising from certain
financial guarantee contracts (see Chapter 41 at 3.4 and Chapter 46 at 2.8) and
commitments to provide loans at below market rates of interest (see Chapter 41 at 3.5
and Chapter 46 at 2.8).
Financial liabilities are measured at fair value through profit or loss when they meet the
definition of held for trading (see 4 below), [IFRS 9 Appendix A], or when they are
designated as such on initial recognition (see 7 below). Designation at fair value through
profit or loss is permitted when either: [IFRS 9.4.2.2]
(a) it eliminates or significantly reduces a measurement or recognition inconsistency
(sometimes referred to as an ‘accounting mismatch’). Such mismatches would
otherwise arise from measuring assets or liabilities or recognising the gains and
losses on them on different bases;
(b) a group of financial liabilities or financial assets and financial liabilities is managed
and its performance is evaluated on a fair value basis in accordance with a
documented risk management or investment strategy, and information is provided
internally on that basis to the entity’s key management personnel (as defined in
IAS 24 – Related Party Disclosures – see Chapter 35 at 2.2.1.D); or
(c) a financial liability contains one or more embedded derivatives that meet certain
conditions. [IFRS 9.4.3.5].
However, for financial liabilities designated as at fair value through profit or loss, the
element of gains or losses attributable to changes in credit risk should normally be
recognised in other comprehensive income with the remainder recognised in profit or loss.
[IFRS 9.5.7.7]. These amounts recognised in other comprehensive income are not recycled to
profit or loss if the liability is ever repurchased. However if this treatment creates or
enlarges an accounting mismatch in profit or loss the entity shall present all gains and losses
on that liability (including the effects of changes in credit risk) in profit or loss. [IFRS 9.5.7.8].
The guidance indicates that an economic relationship is required in these cases. In other
3600 Chapter 44
words the liability’s own credit risk must be offset by changes in the fair value of the other
instrument. If there is no economic relationship between the liability’s own credit risk and
the fair value of the other instrument then the gains and losses arising from the changes in
credit risk cannot be recognised in profit or loss. ‘Economic relationship’ is not defined in
the standard but the IASB noted that the relationship need not be contractual, [IFRS 9.BC5.41],
and that such a relationship does not arise by coincidence. [IFRS 9.BC5.40]. However, judging
from the example given in the standard it would seem that the IASB would not expect this
to be very common. [IFRS 9.B5.7.10]. The standard also requires increased disclosure about
an entity’s methodology for making determinations about potential mismatches. This is
discussed in further detail in Chapter 46 at 2.4.2.
All other financial liabilities, other than derivatives, are generally classified as
subsequently measured at amortised cost using the effective interest method.
[IFRS 9.4.2.1].
The definition of held for trading is dealt with at 4 below and designation at fair value
; through profit or loss is covered further at 7 below.
In contrast to the treatment for hybrid contracts with financial assets hosts, derivatives
embedded within a financial liability host within the scope of IFRS 9 will often be
separately accounted for. That is, they must be separated if they are not closely related
to the host contract, they meet the definition of a derivative, and the hybrid contract is
not measured at fair value through profit or loss (see Chapter 42 at 4). Where an
embedded derivative is separated from a financial liability host, the requirements of
IFRS 9 dealing with classification of financial instruments should be applied separately
to each of the host liability and the embedded derivative.
4
FINANCIAL ASSETS AND FINANCIAL LIABILITIES HELD
FOR TRADING
The fact that a financial instrument is held for trading is important for its classification.
For financial assets that are debt instruments, held for trading is a business model
objective that results in measurement at fair value through profit or loss, as indicated
at 2.1 above and further covered in more detail at 5.4 below. Whether or not an asset is
held for trading is also relevant for the option to designate an equity instrument as
measured at fair value through other comprehensive income (see 2.2 above). Similar to
financial assets, if a financial liability is held for trading it is classified as measured at fair
value through profit or loss (see 3 above).
Financial assets and liabilities held for trading are defined as those that: [IFRS 9 Appendix A]
• are acquired or incurred principally for the purpose of sale or repurchase in the
near term;
• on initial recognition are part of a portfolio of identified financial instruments that
are managed together and for which there is evidence of a recent actual pattern of
short-term profit-taking; or
• are derivatives (except for those that are financial guarantee contracts – see
Chapter 41 at 3.4 – or are designated effective hedging instruments – see
Chapter 49 at 3.2).
Financial
instruments:
Classification
3601
It follows from the definition that if an entity originates a loan with an intention of
syndicating it, the amount of the loan to be syndicated should be classified as held for
trading, even if the bank fails to find sufficient commitments from other participants (a
so-called ‘failed’ loan syndication).
The term ‘portfolio’ in the definition of held for trading is not explicitly defined in
IFRS 9, but the context in which it is used suggests that a portfolio is a group of financial
assets and/or financial liabilities that are managed as part of that group. If there is
evidence of a recent actual pattern of short-term profit taking on financial instruments
included in such a portfolio, those financial instruments qualify as held for trading even
though an individual financial instrument may, in fact, be held for a longer period of
time. [IFRS 9.IG B.11].
A financial asset or liability held for trading will always be measured at fair value
through profit or loss.
Trading generally reflects active and frequent buying and selling, and financial
instruments held for trading are normally used with the objective of generating a profit
from short-term fluctuations in price or a dealer’s margin. [IFRS 9.BA.6].
In addition to derivatives that are not accounted for as hedging instruments, financial
liabilities held for trading include:
(a) obligations to deliver financial assets borrowed by a short seller (i.e. an entity that
sells financial assets it has borrowed and does not yet own);
(b) financial liabilities that are incurred with an intention to repurchase them in the
near term, such as quoted debt instruments that the issuer may buy back in the
near term depending on changes in fair value; and
(c) financial liabilities that are part of a portfolio of identified financial instruments
that are managed together and for which there is evidence of a recent pattern of
short-term profit-taking. [IFRS 9.BA.7(d)]. However, the fact that a liability is used
merely to fund trading activities does not in itself make that liability one that is
held for trading. [IFRS 9.BA.8].
5
FINANCIAL ASSETS: THE ‘BUSINESS MODEL’
ASSESSMENT
The business model assessment is one of the two steps to classify financial assets. An
entity’s business model reflects how it manages its financial assets in order to generate
cash flows; its business model determines whether cash flows will result from collecting
contractual cash flows, selling the financial assets or both. This assessment is performed
on the basis of scenarios that the entity reasonably expects to occur. This means, the
assessment excludes so-called ‘worst case’ or ‘stress case’ scenarios. For example, if an
entity expects that it will sell a particular portfolio of financial assets only in a stress
case scenario, this would not affect the entity’s assessment of the business model for
those assets if the entity does not reasonably expect it to occur. [IFRS 9.B4.1.2A].
If cash flows are realised in a way that is different from the entity’s expectations at the
date that the entity assessed the business model (for example, if the entity sells more or
fewer financial assets than it expected when it classified the assets), this does not give
3602 Chapter 44
rise to a prior period error in the entity’s financial statements (as defined in IAS 8 –
Accounting Policies, Changes in Accounting Estimates and Errors – see Chapter 3
at 4.6) nor does it change the classification of the remaining financial assets held in that
business model (i.e. those assets that the entity recognised in prior periods and still
holds), as long as the entity considered all relevant and objective information that was
available at the time that it made the business model assessment. Classification of a
financial asset is determined in accordance with the business model in place at the point
of initial recognition and does not change thereafter except in the event of a
reclassification. Reclassifications of financial assets are only permitted, or required, in
rare circumstances (see 9 below) which does not include a simple change in business
model. However, when an entity assesses the business model for newly originated or
newly purchased financial assets, it must consider information about how cash flows
were realised in the past, along with all other relevant information. For instance, if a
business model changes from being hold to collect due to increasing sales out of the
portfolio being incompatible with a hold to collect business model then the existing
assets within the portfolio continue to be measured at amortised cost. Any new assets
recognised in the portfolio after the change would be classified after considering the
new business model (see Example 44.35 below). This means that if there is a change in
the way that cash flows are realised then this will only affect the classification of new
assets when first recognised in the future. [IFRS 9.B4.1.2A].
An entity’s business model for managing the financial assets is a matter of fact and
<
br /> typically observable through particular activities that the entity undertakes to achieve
its objectives. An entity will need to use judgment when it assesses its business model
for managing financial assets and that assessment is not determined by a single factor or
activity. Rather, the entity must consider all relevant and objective evidence that is
available at the date of the assessment. Such relevant and objective evidence includes,
but is not limited to: [IFRS 9.B4.1.2B]
(a) how the performance of the business model and the financial assets held within
that business model are evaluated and reported to the entity’s key management
personnel;
(b) the risks that affect the performance of the business model (and the financial assets
held within) and, in particular, the way those risks are managed; and
(c) how managers of the business are compensated (for example, whether the
compensation is based on the fair value of the assets managed or on the contractual
cash flows collected).
In addition to these three forms of evidence, in most circumstances the expected
frequency, value and timing of sales are important aspects of the assessment. These are
covered in more detail in 5.2.1 below. Entities will need to consider how and to what
extent they document the evidence supporting the assessment of their business model.
5.1
The level at which the business model assessment is applied
The business model assessment should be performed on the basis of the entity’s
business model as determined by the entity’s key management personnel (as defined in
IAS 24 – see Chapter 35 at 2.2.1.D). [IFRS 9.B4.1.1].
Financial
instruments:
Classification
3603
An entity’s business model is determined at a level that reflects how groups of financial
assets are managed together to achieve a particular business objective. This does not
need to be the reporting entity level. The entity’s business model does not depend on
management’s intentions for an individual instrument. Accordingly, this condition is not
an instrument-by-instrument approach to classification and should be determined on a
higher level of aggregation. However, a single entity may have more than one business
model for managing its financial instruments (for example, one portfolio that it manages
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 711
