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International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

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by International GAAP 2019 (pdf)


  or loss. [IFRS 9.B4.1.6]. In order to be considered to be managed on a fair value basis, the

  portfolio needs to be managed in accordance with a documented risk management or

  investment strategy and for information, prepared on a fair value basis, about the group

  of instruments to be provided internally to the entity’s key management personnel (this

  is as defined in IAS 24 see Chapter 35 at 2.2.1.D), for example the entity’s board of

  directors and chief executive officer. [IFRS 9.4.2.2(b)]. Further, it is explained that if an

  entity manages and evaluates the performance of a group of financial assets, measuring

  that group at fair value through profit or loss results in more relevant information.

  [IFRS 9.B4.1.33]. Documentation of the entity’s strategy need not be extensive but should

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  be sufficient to demonstrate that the classification at fair value through profit or loss is

  consistent with the entity’s risk management or investment strategy. [IFRS 9.B4.1.36].

  In each case, the entity manages the financial assets with the objective of realising cash

  flows through the sale of the assets. The entity makes decisions based on the assets’ fair

  values and manages the assets to realise those fair values. As a consequence, the entity’s

  objective will typically result in active buying and selling. Even though the entity will

  collect contractual cash flows while it holds financial assets in the fair value through

  profit or loss category, this is only incidental and not integral to achieving the business

  model’s objective. [IFRS 9.B4.1.5, B4.1.6].

  5.5

  Consolidated and subsidiary accounts

  A question that arises over the application of IFRS 9 concerns how to apply the business

  model test in the consolidated accounts to a subsidiary which is classified as held for

  sale in accordance with IFRS 5 – Non-current Assets Held for Sale and Discontinued

  Operations. In particular, when the financial assets of a subsidiary are held with the

  objective of collecting contractual cash flows but the subsidiary itself is held for sale

  under IFRS 5, whether the financial assets of the subsidiary should be considered to be

  within a hold to collect or a hold to sell business model.

  The IFRS Interpretations Committee were asked precisely this question in

  November 2016. They noted that, in its consolidated financial statements, an entity

  assesses the relevant requirements of IFRS 9 from the group perspective and will advise

  the IASB when it discusses the issue. However, until the IASB has concluded on this issue,

  it is unclear how the business model test would be applied in these circumstances.1

  5.6

  Applying the business model test in practice

  The application of the business model test is illustrated through a number of examples,

  in all the following examples in this section it is assumed that the instruments will meet

  the contractual cash flows characteristics test.

  Example 44.1: The level at which the business model assessment should be

  applied

  A global banking group operates two business lines, retail banking and investment banking. These businesses

  both operate in the same five locations by means of separate subsidiaries. Each subsidiary has its own Board of

  Directors that is responsible for carrying out the strategic objectives as set by the group’s Board of Directors.

  The financial assets held by the investment banking business are measured at fair value through profit or loss

  in line with the group’s strategy, which defines the business model, to actively trade these financial assets.

  Within the retail banking business, four of the five subsidiaries hold debt securities in line with the group’s

  objective to collect contractual cash flows. However, the fifth subsidiary holds a portfolio of debt securities

  that it expects to sell before maturity. These assets are not held for trading, but individual assets are sold if

  the portfolio manager believes he or she can reinvest the funds in assets with a higher yield. As a result, a

  more than infrequent number of sales that are significant in value are anticipated for this portfolio and it is

  unlikely that this portfolio would meet the amortised cost criteria if it were assessed on its own.

  The bank will need to exercise judgement to determine the appropriate level at which to assess its business

  model(s). Hence, different conclusions are possible depending on the facts and circumstances.

  This does not mean that the bank has an accounting policy choice, but it is, rather, a matter of fact that can be

  observed by the way the organisation is structured and managed. In many organisations, key management

  personnel may determine the overall strategy and then delegate their authority for executing the strategy to others.

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  instruments:

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  The combination of the overall strategy and the effect of the delegated authority are among the factors that can be

  considered in the determination of business models.

  In the specified fact pattern, the determining factor is whether the fifth subsidiary is managed independently

  from the other four subsidiaries (and performance is assessed and management is compensated accordingly). If

  it is separately managed, the number of business models is three (i.e. investment banking, one business model

  for the first four subsidiaries and a third business model for the fifth subsidiary). If not, the number of business

  models is two (i.e. one for retail banking and one for investment banking). In the case of two business models,

  all of the debt securities held by the retail banking business would be accounted for at fair value through other

  comprehensive income, unless the sales activity of the fifth subsidiary is not significant to the bank.

  Example 44.2: Splitting portfolios

  Entity A has debt instruments worth CU100, comprising notes with maturities of three to five years. CU10

  of the portfolio is sold and reinvested at least once a year, while the remaining CU90 investments are typically

  held to near their maturity. First, the entity needs to use judgement to determine whether it has:

  (a) Two business models: (i) CU90 debt instruments held to near their maturity; and (ii) CU10 debt

  instruments which are actively bought and sold, provided those assets can be separately identified, or

  (b) One business model applied to the overall portfolio of CU100 debt investments

  If scenario (a) above is considered more appropriate (e.g. the entity intends to continue to sell and reinvest

  part of the portfolio in the same proportions as it has in past years), the entity could achieve amortised cost

  classification for a majority of the debt instruments and would probably need to account for the remaining

  debt instruments at fair value through profit or loss. This is more likely to be the case where there is clearly

  a different management objective for the two groups of assets and their performance is measured, and

  management is compensated, accordingly.

  Alternatively, if scenario (b) is considered more appropriate, the entity needs to determine whether the level

  of expected sales and repurchases is more than infrequent and is significant in value, requiring the whole

  portfolio to be measured at fair value through profit or loss or fair value through other comprehensive income

  (see 5.2.1 above). Whether the assets are required to be measured at fair
value through profit or loss instead

  of fair value through other comprehensive income depends on whether the portfolio is managed on a fair

  value basis and fair value information is primarily used to assess asset’s performance and to make decisions.

  Example 44.3: Credit risk management activities

  An entity holds investments to collect their contractual cash flows. The funding needs of the entity are

  predictable and the maturity of its financial assets is matched to its estimated funding needs.

  The entity performs credit risk management activities with the objective of maintaining the credit risk of the

  portfolio within defined risk limits. In the past, sales have typically occurred when the financial assets’ credit

  risk has increased such that the assets no longer meet the entity’s documented investment policy.

  Reports to key management personnel focus on the credit quality of the financial assets and the contractual

  return. The entity also monitors fair values of the financial assets, among other 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 avoiding 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, this conclusion cannot be extended to sales to avoid excessive credit

  concentration (see also Example 44.4 below).

  Although the entity considers, among other information, the financial assets’ fair values from a liquidity

  perspective (i.e. the cash amount that would be realised if the entity needs to sell assets), the entity’s objective

  is to hold the financial assets in order to collect the contractual cash flows.

  Therefore, under the fact pattern specified, the entity will still be able to measure the portfolio at amortised cost.

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  In the absence of a documented investment or similar policy, the entity may be able to demonstrate in other

  ways that a sale only occurred due to an increase in credit risk. [IFRS 9.B4.1.4 Example 1].

  Example 44.4: Sales to manage concentration risk

  An entity sells financial assets to manage the concentration of the entity’s credit risk to a particular obligor,

  country or industrial sector, without an increase in the assets’ credit risk.

  Such sales may be consistent with a business model whose objective is to hold financial assets in order to

  collect contractual cash flows, but only to the extent that they are infrequent (even if significant in value) or

  insignificant in value both individually and in aggregate (even if frequent). That means such sales are treated

  no differently than sales for any other reason. Thus, such sales are more likely to be consistent with a business

  model whose objective is to hold financial assets in order to collect contractual cash flows and to sell financial

  assets. [IFRS 9.B4.1.3B].

  Example 44.5: Credit-impaired financial assets in a hold to collect business

  model

  An entity’s business model is to purchase portfolios of financial assets, such as loans. Those portfolios may

  or may not include financial assets that are credit-impaired, that is, there have already been one or more

  events occurring before purchase that have had a detrimental impact on future cash flows. If payment on the

  loans is not made on a timely basis, the entity attempts to realise the contractual cash flows through various

  means – for example, by making contact with the debtor by mail, telephone or other methods. The entity’s

  objective is to collect contractual cash flows and the entity does not manage any of the loans in this portfolio

  with an objective of realising cash flows by selling them.

  The objective of the entity’s business model is to hold the financial assets in order to collect the contractual

  cash flows. [IFRS 9.B4.1.4 Example 2].

  Example 44.6: Hedging activities in a hold to collect business model

  A bank holds a portfolio of variable rate loans and enters into interest rate swaps to change the interest rate

  on particular loans in the portfolio from a floating interest rate to a fixed interest rate.

  The fact that the entity has entered into derivatives to modify the cash flows of the portfolio does not in itself

  change the entity’s business model. [IFRS 9.B4.1.4 Example 2].

  Example 44.7: Securitisation

  An entity has a business model with the objective of originating loans to customers and subsequently to sell

  those loans to a securitisation vehicle. The securitisation vehicle issues instruments to investors. The

  originating entity controls the securitisation vehicle and thus consolidates it. The securitisation vehicle

  collects the contractual cash flows from the loans and passes them on to its investors.

  It is assumed for the purposes of this example that the loans continue to be recognised in the consolidated

  statement of financial position because they are recognised by the securitisation vehicle.

  The consolidated group originated the loans with the objective of holding them to collect the contractual cash

  flows and, therefore, measures them at amortised cost. The same conclusion may be drawn if the securitisation

  vehicle is not consolidated but the originating entity is unable to derecognise the assets (see 5.2.2 above).

  However, the originating entity has an objective of realising cash flows on the loan portfolio by selling the

  loans to the securitisation vehicle, so for the purposes of its separate financial statements it would not be

  considered to be managing this portfolio in order to collect the contractual cash flows, but to sell them. The

  loans would probably need to be recorded at fair value through profit or loss as long as they continue to be

  recognised. [IFRS 9.B4.1.4 Example 3].

  Example 44.8: Liquidity portfolio for stress case scenarios

  A financial institution holds financial assets to meet liquidity needs in a ‘stress case’ scenario (e.g. a run on

  the bank’s deposits). The entity does not anticipate selling these assets except in such a scenario. The entity

  monitors the credit quality of the financial assets and its objective in managing the financial assets is to collect

  Financial

  instruments:

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  the contractual cash flows. The entity evaluates the performance of the assets on the basis of interest revenue

  earned and credit losses realised.

  However, the entity also monitors the fair value of the financial assets from a liquidity perspective to ensure

  that the cash amount that would be realised if the entity needed to sell the assets in a stress case scenario

  would be sufficient to meet the entity’s liquidity needs. Periodically, the entity makes sales that are

  insignificant in value to demonstrate liquidity.

  The objective of the entity’s business model is to hold the financial assets to collect contractual cash flows.

  The analysis would not change even if during a previous stress case scenario the entity made sales that were

  significant in value in order to meet its liquidity ne
eds. Similarly, recurring sales activity that is insignificant

  in value is not inconsistent with holding financial assets to collect contractual cash flows.

  However, the assessment would change if the entity periodically sells debt instruments that are significant in

  value to demonstrate liquidity, or if the entity sells the debt instruments to cover everyday liquidity needs.

  See Examples 44.9 and 44.10 below. [IFRS 9.B4.1.4 Example 4].

  Example 44.9: Anticipated capital expenditure

  A non-financial entity anticipates capital expenditure in a few years. The entity invests its excess cash in

  short-term and long-term financial assets so that it can fund the expenditure when the need arises. Many of

  the financial assets have contractual lives that exceed the entity’s anticipated investment period. Therefore

  the entity will need to sell some of the assets before maturity to meet those funding needs.

  The objective of the business model is achieved by both collecting contractual cash flows and selling financial assets.

  In contrast, consider an entity that anticipates a cash outflow in five years to fund capital expenditures and

  invests excess cash in short-term financial assets. When the investments mature, the entity reinvests the cash

  into new short-term financial assets. The entity maintains this strategy until the funds are needed, at which

  time the entity uses the proceeds from the maturing financial assets to fund the capital expenditures. Only

  insignificant sales occur before maturity (unless there is an increase in credit risk). The objective of such a

  business model is to hold financial assets in order to collect contractual cash flows. [IFRS 9.B4.1.4C Example 5].

  Example 44.10: Liquidity portfolio for everyday liquidity needs

  A financial institution holds financial assets to meet its everyday liquidity needs. In the past, this has resulted

  in frequent sales activity and such sales have been significant in value. This activity is expected to continue

  in the future as everyday liquidity needs can rarely be forecast with any accuracy.

  The objective of the business model is meeting everyday liquidity needs. The entity achieves those objectives

  by both collecting contractual cash flows and selling financial assets. This means that both collecting

 

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