International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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in order to collect contractual cash flows and another portfolio that it manages in order
to trade to realise fair value changes). [IFRS 9.B4.1.2].
Similarly, in some circumstances, it may be appropriate to split a portfolio of financial
assets into sub-portfolios to reflect how an entity manages them. [IFRS 9.B4.1.2]. Those
portfolios would be split and treated as separate portfolios, provided the assets
belonging to each sub-portfolio are defined. A sub-portfolio approach would not be
appropriate in cases where an entity is not able to define which assets would be held to
collect contractual cash flows and which assets would potentially be sold. It is clear that
judgement will need to be applied when determining the level of aggregation to which
the business model assessment should be applied. Splitting a portfolio into two sub-
portfolios might allow an entity to achieve amortised cost accounting for most of the
assets within the portfolio, even if it is required to sell a certain volume of assets. The
entity could define the assets it intends (or is required) to sell as one sub-portfolio while
it defines the assets it intends to keep as another.
5.2
Hold to collect contractual cash flows
A financial asset which is held within a business model whose objective is to hold assets
in order to collect contractual cash flows is measured at amortised cost (provided the
asset also meets the contractual cash flow characteristics test). [IFRS 9.4.1.2]. An entity
manages such assets to realise cash flows by collecting contractual payments over the
life of the instrument instead of managing the overall return on the portfolio by both
holding and selling assets. [IFRS 9.B4.1.2C].
5.2.1
Impact of sales on the assessment
In determining whether cash flows are going to be realised by collecting the financial
assets’ contractual cash flows, it is necessary to consider the frequency, value and timing
of sales in prior periods, whether the sales were of assets close to their maturity, the
reasons for those sales, and expectations about future sales activity. However, the
standard states that sales, in themselves, do not determine the business model and
therefore cannot be considered in isolation. It goes on to say that, instead, information
about past sales and expectations about future sales provide evidence related to how
the entity’s stated objective for managing the financial assets is achieved and,
specifically, how cash flows are realised. An entity must consider information about
past sales within the context of the reasons for those sales and the conditions that
existed at that time as compared to current conditions. [IFRS 9.B4.1.2C].
The standard is slightly cryptic concerning the role of sales. When it says that ‘sales in
themselves do not determine the business model’, the emphasis seems to be on past
sales. Given the guidance in the standard, the magnitude and frequency of sales is
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certainly very important evidence in determining an entity’s business models. However,
the key point is that the standard requires the consideration of expected future sales
while past sales are of relevance only as a source of evidence. Under IFRS 9 there is no
concept of tainting, whereby assets are reclassified if sales activity differs from what
was originally expected.
Although the objective of an entity’s business model may be to hold financial assets in
order to collect contractual cash flows, the entity need not hold all of those instruments
until maturity. Thus an entity’s business model can be to hold financial assets to collect
contractual cash flows even when some sales of financial assets occur or are expected
to occur in the future. [IFRS 9.B4.1.3].
The following scenarios might be consistent with a hold to collect business model:
• The business model may be to hold assets to collect contractual cash flows even if the
entity sells financial assets when there is an increase in the assets’ credit risk. To
determine whether there has been an increase in the assets’ credit risk, the entity
considers reasonable and supportable information, including forward looking
information. Irrespective of their frequency and value, sales due to an increase in the
assets’ credit risk are not inconsistent with a business model whose objective is to hold
financial assets to collect contractual cash flows because the credit quality of financial
assets is relevant to the entity’s ability to collect contractual cash flows. Credit risk
management activities that are aimed at mitigating potential credit losses due to credit
deterioration are integral to such a business model. Selling a financial asset because it
no longer meets the credit criteria specified in the entity’s documented investment
policy is an example of a sale that has occurred due to an increase in credit risk.
However, in the absence of such a policy, the entity may be able to demonstrate in
other ways that the sale occurred due to an increase in credit risk. [IFRS 9.B4.1.3A].
• Sales that occur for other reasons, such as sales made to manage credit
concentration risk (without an increase in the assets’ credit risk), may also be
consistent with a business model whose objective is to hold financial assets in
order to collect contractual cash flows. However, such sales are likely to be
consistent with a business model whose objective is to hold financial assets in
order to collect contractual cash flows only if those sales are infrequent (even if
significant in value) or insignificant in value both individually and in aggregate
(even if frequent). [IFRS 9.B4.1.3B].
• In addition, sales may be consistent with the objective of holding financial assets
in order to collect contractual cash flows if the sales are made close to the maturity
of the financial assets and the proceeds from the sales approximate the collection
of the remaining contractual cash flows. [IFRS 9.B4.1.3B]. How an entity defines
‘close’ and ‘approximate’ will be a matter of judgment.
If more than an infrequent number of sales are made out of a portfolio and those sales
are more than insignificant in value (either individually or in aggregate), the entity needs
to assess whether and how such sales are consistent with an objective of collecting
contractual cash flows. An increase in the frequency or value of sales in a particular
period is not necessarily inconsistent with an objective to hold financial assets in order
to collect contractual cash flows, if an entity can explain the reasons for those sales and
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demonstrate why those sales do not reflect a change in the entity’s business model and,
hence, sales will in future be lower in frequency or value. [IFRS 9.B4.1.3B]. This assessment
is about expectations and not about intent. For instance, the fact that it is not the entity’s
objective to realise fair value gains or losses is not sufficient in itself to be able to
conclude that measurement at amortised cost is appropriate.
Furthermore, whether a third party (such as a banking regulator in the case of some
liquidity portfolios held by banks) imposes the requirement to sell the fin
ancial assets,
or that activity is at the entity’s discretion, is not relevant to the business model
assessment. [IFRS 9.B4.1.3B].
In contrast, if an entity manages a portfolio of financial assets with the objective of
realising cash flows through the sale of the assets, the assets would not be held under a
hold to collect business model. For example, an entity might actively manage a portfolio
of assets in order to realise fair value changes arising from changes in credit spreads and
yield curves. In this case, the entity’s business model is not to hold those assets to collect
the contractual cash flows. Rather, the entity’s objective results in active buying and
selling with the entity managing the instruments to realise fair value gains.
IFRS 9 does not explain how ‘infrequent’ and ‘insignificant in value’ should be interpreted
in practice. Overall, those thresholds could lead to diversity in application, although it is
an area where we expect that consensus and best practices will emerge over time.
The overarching principle is whether the entity’s key management personnel have
made a decision that, collecting contractual cash flows but not selling financial assets is
integral to achieving the objective of the business model. [IFRS 9.B4.1.2C, B4.1.4A]. Under
that objective, an entity will not normally expect that sales will be more than infrequent
and more than insignificant in value.
Many organisations hold portfolios of financial assets for liquidity purposes. Assets in
those portfolios are regularly sold because sales are required by a regulator to
demonstrate liquidity, because the entity needs to cover everyday liquidity needs or
because the entity tries to maximise the yield of the portfolio. It follows that such
portfolios (except those that may be sold only in stress case scenarios) might not be
measured at amortised cost depending on facts and circumstances (see also 5.6 below).
With reference to measuring ‘insignificant in value’, the standard refers to more than an
infrequent number of such sales being made out of a portfolio. [IFRS 9.B4.1.3B]. The
reference point to measuring ‘insignificant in value’ could therefore be considered to
be the portfolio, particularly as it is the portfolio that is subject to the business model
assessment. The assessment of more than insignificant in value therefore requires
consideration of the sales value against the total size of the portfolio. In addition to the
sales value based assessment, an entity could also consider whether the gain or loss on
sale is significant compared to the total return on the portfolio. However the gain or
loss approach, on its own, would not be an appropriate method as the standard is
specific about the importance of sales in making the assessment. Loans are often sold
at amounts close to their carrying value making it possible for very significant volumes
of sales to generate insignificant gains or losses.
The standard is not explicit as to whether any test of insignificance should be performed
period by period, or by taking into account sales over the entire life of the portfolio.
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However, if a period by period approach were to be used, the determination of whether
sales are insignificant in value would depend on the length of the period, which means that
two entities with identical portfolios but with different lengths of the reporting period
would arrive at different assessments. Further, if a bank holds a portfolio of bonds with an
average maturity of 20 years, sales of, say, 5% each year would mean that a considerable
portion of the portfolio will have been sold before it matures, which would not seem to be
consistent with a business model of holding to collect. Therefore applying the average life
of the portfolio would seem to be more relevant than applying the reporting period.
It will be important to observe what practices emerge as the standard is applied.
5.2.2
Transferred financial assets that are not derecognised
There are a number of circumstances where an entity may sell a financial asset but those
assets will remain on the selling entity’s statement of financial position. For example, a
bank may enter into a ‘repo’ transaction whereby it sells a debt security and at the same
time agrees to repurchase it at a fixed price. Similarly, a manufacturer may sell trade
receivables as part of a factoring programme and provide a guarantee to the buyer to
compensate it for any defaults by the debtors. In each case, the seller retains
substantially all risks and rewards of the assets and the financial assets would not be
derecognised in line with the requirements of IFRS 9.
The inevitable question that arises in these circumstances is whether these transactions
should be regarded as sales when applying the business model assessment. In this
context, IFRS 9 contains in example 3 of paragraph B4.1.4 only one passing reference
to derecognition, but it does suggest that it is the accounting treatment and not the legal
form of a transaction that determines whether the entity has ceased to hold an asset to
collect contractual cash flows. Application of such an approach would give an
intuitively correct answer for repo transactions, in which the seller is required to
repurchase the asset at an agreed future date and price, and which are, in substance,
secured financing transactions rather than sales. However, as the IASB did not provide
the basis for the treatment in the example quoted above, it is not clear if accounting
derecognition should always be the basis for the assessment. For instance, if a loan is
sold under an agreement by which the seller will indemnify the purchaser for any credit
losses (for instance if it is factored with recourse) and so the asset is not derecognised,
it is not clear whether there has been a sale for the purposes of the IFRS 9 business
model assessment, given that the transferor will never retake possession of the asset.
We therefore believe that, except for instruments such as repos where the seller retains
substantially all the risks and rewards of the asset, an entity has an accounting policy
choice of whether it considers the legal form of the sale or the economic substance of
the transaction when analysing sales within a portfolio.
5.3
Hold to collect contractual cash flows and selling financial assets
The fair value through other comprehensive income measurement category is a
mandatory category for portfolios of financial assets that are held within a business model
whose objective is achieved by both collecting contractual cash flows and selling financial
assets (provided the asset also meets the contractual cash flow test). [IFRS 9.4.1.2A].
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instruments:
Classification
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In this type of business model, the entity’s key management personnel have made a
decision that both collecting contractual cash flows and selling are fundamental to
achieving the objective of the business model. There are various objectives that may be
consistent with this type of business model. For example, the objective of the business
model may be to manage everyday liquidity needs, to maintain a particular interest yield
profile or to match the duration of the financial
assets to the duration of the liabilities
that those assets are funding. To achieve these objectives, the entity will both collect
contractual cash flows and sell the financial assets. [IFRS 9.B4.1.4A].
Compared to the business model with an objective to hold financial assets to collect
contractual cash flows, this business model will typically involve greater frequency and
value of sales. This is because selling financial assets is integral to achieving the business
model’s objective rather than only incidental to it. There is no threshold for the
frequency or value of sales that can or must occur in this business model. [IFRS 9.B4.1.4B].
As set out in the standard, the fair value through other comprehensive income is a
defined category and is neither a residual nor an election. However, in practice, entities
may identify those debt instruments which are held to collect contractual cash flows
(see 5.2 above), those which are held for trading, those managed on a fair value basis
(see 5.4 below) and those for which the entity applies the fair value option to avoid a
measurement mismatch, (see 7.1 below), and then measure the remaining debt
instruments at fair value through other comprehensive income. As a consequence, the
fair value through other comprehensive income category might, in effect, be used as a
residual, just because it is far easier to articulate business models that would be classified
at amortised cost or at fair value through profit or loss.
5.4
Other business models
IFRS 9 requires financial assets to be measured at fair value through profit or loss if they
are not held within either a business model whose objective is to hold assets to collect
contractual cash flows or within a business model whose objective is achieved by both
collecting contractual cash flows and selling financial assets. A business model that
results in measurement at fair value through profit or loss is where the financial assets
are held for trading (see 4 above). Another is where the financial assets are managed on
a fair value basis (see Example 44.14 below).
When the standard explains what it means by a portfolio of financial assets that is
managed and whose performance is evaluated on a fair value basis it refers to the
requirements for designating financial liabilities as measured at fair value through profit