INVESTMENTS AT FAIR VALUE THROUGH OTHER
COMPREHENSIVE INCOME
An entity may acquire an investment in an equity instrument that is not held for trading.
At initial recognition, the 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 such an investment. [IFRS 9.5.7.5, B5.7.1]. For this purpose, the term equity
instrument uses the definition in IAS 32, application of which for issuers is dealt with in
detail in Chapter 43.
In particular circumstances a puttable instrument (or an instrument that imposes on the
entity an obligation to deliver to another party a pro rata share of the net assets of the
entity only on liquidation) is classified by the issuer as if it were an equity instrument.
This is by virtue of an exception to the general definitions of financial liabilities and
equity instruments. However, such instruments do not actually meet the definition of
an equity instrument and therefore the related asset cannot be designated at fair value
through other comprehensive income by the holder. [IFRS 9.BC5.21].
This was confirmed by the Interpretations Committee in May 2017 when they
received a request to clarify exactly this point. The Interpretations Committee
observed that ‘equity instrument’ is a defined term, and IAS 32 defines an equity
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instrument as ‘any contract that evidences a residual interest in the assets of an entity
after deducting all of its liabilities’. The Interpretations Committee also observed that
IAS 32.11 specifies that, as an exception, an instrument that meets the definition of a
financial liability is classified as an equity instrument by the issuer if it has all the
features and meets the conditions in paragraphs IAS 32.16A and 16B or IAS 32.16C
and 16D (see Chapter 43 at 4.6).
Accordingly, the Interpretations Committee concluded that a financial instrument that
has all the features and meets the conditions in paragraphs 16A and 16B or paragraphs 16C
and 16D of IAS 32 is not eligible for the presentation election in IFRS 9.4.1.4 as such an
instrument does not meet the definition of an equity instrument in IAS 32.2
The Committee concluded that the requirements in IFRS 9 provide an adequate basis
for the holder of the particular instruments described in the submission to classify such
instruments. In the light of the existing requirements in IFRS Standards, the Committee
determined that neither an IFRIC Interpretation nor an amendment to a Standard was
necessary. Consequently, the Committee decided not to add this matter to its standard-
setting agenda.
Under IFRS 9 all derivatives are deemed to be held for trading. Consequently, this
election cannot be applied to a derivative such as a warrant that is classified as equity
by the issuer. However, it could be applied to investments in preference shares,
‘dividend stoppers’ and similar instruments (see Chapter 43 at 4.5) provided they are
classified as equity by the issuer.
The IASB had originally intended this accounting treatment to be available only for
those equity instruments that represented a ‘strategic investment’. These might include
investments held for non-contractual benefits rather than primarily for increases in the
value of the investment, for example where there is a requirement to hold such an
investment if an entity sells its products in a particular country. However, the Board
concluded that it would be difficult, and perhaps impossible, to develop a clear and
robust principle that would identify investments that are different enough to justify a
different presentation requirement and abandoned this restriction. [IFRS 9.BC5.25(c)].
The subsequent measurement of instruments designated in this way, including recognition
of dividends, is summarised at 2 above and covered in detail in Chapter 46 at 2.5.
The example below illustrates the requirements for the designation of a non-derivative
equity investment at fair value through other comprehensive income, specifically, the
requirement that the instrument meets the definition of an equity instrument in
accordance with IAS 32.
Example 44.33: Callable, perpetual ‘Tier 1’ debt instrument
Consider the example where entity A invests in a perpetual Tier 1 debt instrument, which is redeemable at
the option of the issuer (entity B). The instrument carries a fixed coupon that is deferred if entity B does not
pay a dividend to its ordinary shareholders. If a coupon is not paid it will not accrue additional interest. The
instrument does not have a maturity date.
Under IFRS 9, such an instrument would not be eligible for amortised cost accounting by the holder.
However, given that Entity B does not have a contractual obligation to pay cash, the instrument will qualify
for classification at fair value through other comprehensive income, as it meets the definition of equity from
the perspective of the issuer in accordance with IAS 32.
Financial
instruments:
Classification
3649
9
RECLASSIFICATION OF FINANCIAL ASSETS
In certain rare circumstances, non-derivative debt assets are required to be reclassified
between the amortised cost, fair value through other comprehensive income and fair
value through profit or loss categories. More specifically, when (and only when) an
entity changes its business model for managing financial assets, it should reclassify all
affected financial assets in accordance with the requirements set out at 5 above.
[IFRS 9.4.4.1]. The reclassification should be applied prospectively from the
‘reclassification date’, [IFRS 9.5.6.1], which is defined as:
‘The first day of the first reporting period following the change in business model
that results in an entity reclassifying financial assets.’ [IFRS 9 Appendix A].
Accordingly, any previously recognised gains, losses or interest should not be restated.
[IFRS 9.5.6.1].
In our view, the reference to reporting period includes interim periods for which the
entity prepares an interim report. For example, an entity with a reporting date of
31 December might determine that there is a change in its business model in
August 2018. If the entity prepares and publishes quarterly reports in accordance with
IAS 34 – Interim Financial Reporting, the reclassification date would be 1 October 2018.
However, if the entity prepares only half-yearly interim reports or no interim reports
at all, the reclassification date would be 1 January 2019.
Changes in the business model for managing financial assets are expected to be very
infrequent. They must be determined by an entity’s senior management as a result of
external or internal changes and must be significant to the entity’s operations and
demonstrable to external parties. Accordingly, a change in the objective of an entity’s
business model will occur only when an entity either begins or ceases to carry on an
activity that is significant to its operations, and generally that will be the case only when
the entity has acquired or disposed of a business line (see 5.5 above for the interaction
between IFRS 9 and IFRS 5). Examples of a change in business model include the
following: [IFRS 9.B4.4.1]
(a) An entity has a portfolio of commercial loans that it holds to sell in the short term.
The entity acquires a company that manages commercial loans and has a business
model that holds the loans in order to collect the contractual cash flows. The
portfolio of commercial loans is no longer for sale, and the portfolio is now
managed together with the acquired commercial loans and all are held to collect
the contractual cash flows.
(b) A financial services firm decides to shut down its retail mortgage business. That
business no longer accepts new business and the financial services firm is actively
marketing its mortgage loan portfolio for sale.
A change in the objective of an entity’s business model must be effected before the
reclassification date. For example, if a financial services firm decides on 15 February to
shut down its retail mortgage business and hence must reclassify all affected financial
assets on 1 April (i.e. the first day of the entity’s next reporting period, assuming it
reports quarterly), the entity must not accept new retail mortgage business or otherwise
engage in activities consistent with its former business model after 15 February.
[IFRS 9.B4.4.2].
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The following are not considered to be changes in business model: [IFRS 9.B4.4.3]
(a) a change in intention related to particular financial assets (even in circumstances
of significant changes in market conditions);
(b) a temporary disappearance of a particular market for financial assets; and
(c) a transfer of financial assets between parts of the entity with different business
models.
Example 44.34: Change in the way a portfolio is managed
An entity’s business model objective for a portfolio meets the criteria for amortised cost measurement but,
subsequently, the entity changes the way it manages the assets.
Having determined that the objective for a portfolio originally met the business model test to be classified at
amortised cost, if the entity subsequently changes the way it manages the assets (which results in a more than
an infrequent number of sales), so that the business model would no longer qualify for amortised cost
accounting, the question of how the entity should measure the existing assets and any newly acquired assets
then arises.
Although more than an infrequent number of sales have occurred, unless there has been a fundamental change
in the entity’s business model, the requirements of the standard regarding reclassification are unlikely to be
triggered. Changes in the business model for managing financial assets that trigger reclassification of
financial assets must be significant to the entity’s operations and demonstrable to external parties. They are
expected to be very infrequent.
Assuming that the assets are not reclassified, it is likely that the entity will have to divide the portfolio into
two sub-portfolios going forward – one for the old assets and one for any new assets acquired.
Financial assets previously held will remain at amortised cost. New financial assets acquired will be measured
at fair value through profit or loss or at fair value through other comprehensive income. Whether the assets
are measured at fair value through profit or loss or at fair value through other comprehensive income depends
on the new business model and the characteristics of the assets.
Unlike a change in business model, the contractual terms of a financial asset are known
at initial recognition. However, the contractual cash flows may vary over that asset’s
life based on its original contractual terms. Because an entity classifies a financial asset
at initial recognition on the basis of the contractual terms over the life of the instrument,
reclassification on the basis of a financial asset’s contractual cash flows is not permitted,
unless the asset is sufficiently modified that it is derecognised. [IFRS 9.BC4.117].
For instance, no reclassification is permitted or required if the conversion option of a
convertible bond lapses. If, however, a convertible bond is converted into shares, the
shares represent a new financial asset to be recognised by the entity. The entity would
then need to determine the classification category for the new equity investment.
A related question to the above is to what extent the contractual cash flow
characteristics test influences the test of whether a financial asset is sufficiently
modified such that it is derecognised. It has been suggested that a modification which
would result in the asset failing the contractual cash flow characteristics test is a
‘substantial modification’ that would result in derecognition of the asset (see also
Chapter 48 at 3.4). That is because an asset that is measured at fair value through profit
or loss is substantially different to an asset measured at amortised cost or fair value
through other comprehensive income. Whether or not a modified asset would still meet
the contractual cash flow characteristics test or not could be a helpful indicator for the
derecognition assessment.
Financial
instruments:
Classification
3651
10
EFFECTIVE DATE AND TRANSITION
This section covers the requirements that are applicable when an entity, which had not
previously applied the November 2009 (IFRS
9(2009)), October 2010 or
November 2013 version of IFRS 9, applies the final version.
Previous versions of IFRS 9 are no longer available for early adoption. Consequently,
the requirements that are applicable in those situations are not covered in this
publication, but are described in earlier editions.
10.1 Effective
date
IFRS 9 was mandatorily applicable for periods beginning on or after 1 January 2018.
[IFRS 9.7.1.1]. The narrow scope amendment covering prepayment features with negative
compensation is mandatorily applicable for periods beginning on or after 1 January 2019
with early application permitted (see 6.4.4.A above). Insurance companies, i.e. entities
whose activities are predominantly connected with insurance, have the option to delay
application of IFRS 9 until 1 January 2021 or to apply IFRS 9 with an overlay approach
(see Chapter 51 at 10).
10.2 Transition
provisions
IFRS 9 contains a general requirement that it should be applied retrospectively,
although it also specifies a number of exceptions which are considered in the rest of
this section. [IFRS 9.7.2.1]. The transition to IFRS 9 also requires additional disclosures
which are described in Chapter 50 at 8.2.
10.2.1
Date of initial application
A number of the transition provisions refer to the ‘date of initial application’. This is the
date when an entity first applies the requirements of IFRS 9, which is the beginning of
the period in which it first reports under IFRS 9, not the earliest period for which
comparative figures are amended. [IFRS 9.7.2.2].
10.2.2
Applying the ‘business model’ assessment
Entities should make the business model assessment (see 5 above) on the basis of the
facts and circumstances that exist at the date of initial application. The resulting
classification s
hould be applied retrospectively, irrespective of the entity’s business
model in prior reporting periods. [IFRS 9.7.2.3]. For these purposes, an entity should
determine whether financial assets meet the definition of held for trading as if they had
been acquired at the date of initial application. [IFRS 9.B7.2.1].
The following examples illustrate two practical issues which an entity may need to
consider when applying the business model assessment at the date of initial application
of IFRS 9.
Example 44.35: Loans previously reclassified from trading under IAS 39
At the date of initial application of IFRS 9, a bank holds a portfolio of loans that it intends to sell as soon as
possible, but is currently unable to do so due to illiquidity in the market. The bank had taken advantage of
the October 2008 amendments to IAS 39 and because it had the intention and ability to hold the assets for
the foreseeable future had reclassified this portfolio from trading to loans and receivables.
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An entity applying IFRS 9 for the first time should apply the business model assessment at the date of initial
application. Given management’s intention to sell the assets as soon as possible, the presumption would be
that the portfolio should be classified as at fair value through profit or loss. It does not matter that the bank
may have to hold the portfolio for the foreseeable future due to the market’s illiquidity. The standard is clear
that the entity’s objective should be to hold the assets to collect the contractual cash flows to qualify for
amortised cost classification. Such a portfolio would not meet the fair value through other comprehensive
income criteria either if the intention is to sell all of the financial assets in the near term.
Example 44.36: Loans held within a business intended for disposal
An international bank has a variety of businesses each of which is managed separately. Before the date of
initial application of IFRS 9, the bank makes a strategic decision to dispose of its auto finance business,
which originates loans. The portfolio of loans is held under a business model whose objective is to collect
their contractual cash flows. The bank intends to dispose of the entire business, including personnel, IT
systems and buildings, and not merely a portfolio of loans.
There is no ‘right’ answer in respect of these facts and circumstances. Arguments can be articulated to support
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 722
