International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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either classification of the loans at amortised cost or at fair value through profit or loss.
Proponents of amortised cost classification would argue that, at the date of initial application, even though
the bank intends to sell the business at some point in the future, the loans are still held within a business
model whose objective is to hold them to collect their contractual cash flows. That objective continues
regardless of whether the bank intends or is able to sell the business. In addition, some of the loans may be
fully collected even before the business is sold. Therefore, based on facts and circumstances at the date of
initial application, the loans are considered to be held within a business model whose objective is to hold
them to collect their contractual cash flows.
On the other hand, proponents of the fair value through profit or loss classification would argue that on the
date of initial application, the expectation is that the bank will dispose of the loans rather than hold them to
collect their contractual cash flows. Therefore, from the bank’s perspective, the loans are no longer held
within a business model whose objective is to hold assets to collect their contractual cash flows.
This issue was brought before the Interpretations Committee in November 2016 (see 5.5 above).
10.2.3
Applying the contractual cash flow characteristics test
For existing IFRS reporters, there are no transition provisions relating to the application
of the contractual cash flow characteristics test. Accordingly, the contractual cash flow
characteristics of an asset should be assessed based on conditions at the date of initial
recognition, not at the date of initial application. This is likely to have the most effect
when assessing contractually linked instruments (see 6.6 above) because their
characteristics may have changed significantly between the date of initial recognition
and the date of initial application.
At the date of initial application, it may be impracticable (as defined in IAS 8) for an
entity to assess a modified time value of money element as described in 6.4.2 above on
the basis of the facts and circumstances that existed at the initial recognition of the
financial asset. In such instances, the entity must assess the contractual cash flow
characteristics of that financial asset on the basis of the facts and circumstances that
existed at the initial recognition of the financial asset without taking into account the
requirements related to the modification of the time value of money element as set out
in 6.4.2 above. [IFRS 9.7.2.4]. This means that, in such cases, the entity would apply the
assessment of the asset’s contractual cash flows characteristics as set out in the original
requirements issued in IFRS 9; i.e. without the notion of a modified economic
relationship. [IFRS 9.BC7.55]. As a result, the asset would most likely be classified as
measured at fair value though profit or loss.
Financial
instruments:
Classification
3653
At the date of initial application, it may be impracticable (as defined in IAS 8) for an
entity to assess whether the fair value of a prepayment feature was insignificant, as
described in 6.4.4 above, on the basis of the facts and circumstances that existed at the
initial recognition of the financial asset. If this is the case, an entity shall assess the
contractual cash flow characteristics of that financial asset on the basis of the facts and
circumstances that existed at the initial recognition of the financial asset. For instance
an entity may hold a convertible bond for which the conversion option has expired by
the date of initial application, in such a case the entity would still be obliged to take the
conversion option into consideration. The entity would not take into account the
exception for prepayment features. [IFRS 9.7.2.5]. This means that the asset would be
classified as measured at fair value though profit or loss.
For contractually linked instruments, on initial application of the standard, the look-through
assessment should be performed as at the date that the reporting entity (i.e. the investor in
the tranche) initially recognised the contractually linked instrument. It is inappropriate to
make the risk assessment based on the circumstances existing either at the date that the
arrangement was first established or the date of initial application of IFRS 9.
The situation is slightly different for first-time adopters of IFRS, who are required to
apply the contractual cash flow characteristics test to previously acquired assets on the
basis of the facts and circumstances that exist at the date of transition to IFRSs (or the
beginning of the first IFRS reporting period for entities that choose not to apply IFRS 9
in comparative periods). [IFRS 1.B8, E1].
10.2.4
Making and revoking designations
On application of IFRS 9, entities are required to revisit designations previously made
in accordance with IAS 39 and are given an opportunity to make designations in
accordance with IFRS 9. More specifically, at the date of initial application:
(a) any previous designation of a financial asset as measured at fair value through
profit or loss may be revoked in any case, but must be revoked if such designation
no longer eliminates or significantly reduces an accounting mismatch;
(b) a financial asset or a financial liability may be designated as measured at fair value
through profit or loss if such designation would now eliminate or significantly
reduce an accounting mismatch;
(c) any previous designation of a financial liability as measured at fair value through profit
or loss that was made on the basis that it eliminated or significantly reduced an
accounting mismatch may be revoked in any case, but must be revoked if such
designation no longer eliminates or significantly reduces an accounting mismatch; and
(d) any investment in a non-derivative equity instrument that is not held for trading
may be designated as at fair value through other comprehensive income.
It should be noted that it is not possible to change the previous designation of a financial
liability to being measured at fair value through profit or loss on the grounds that it is
now managed on a fair value basis.
Such designations and revocations should be made on the basis of the facts and
circumstances that exist at the date of initial application and that classification should
be applied retrospectively. [IFRS 9.7.2.8-10]. For the purposes of (d), an entity should
3654 Chapter 44
determine whether equity investments meet the definition of held for trading as if they
had been acquired at the date of initial application. [IFRS 9.B7.2.1].
At the date of initial application, an entity shall determine whether the own credit
requirements of IFRS 9 would create or enlarge an accounting mismatch in profit or
loss on the basis of the facts and circumstances that exist at the date of initial
application. Those requirements shall be applied retrospectively on the basis of that
determination. [IFRS 9.7.2.14].
10.2.5
Restatement of comparatives
Notwithstanding the general requirement to apply the standard retrospectively, an
entity that adopts the classification and measuremen
t requirements of IFRS 9 (which
include the requirements related to amortised cost measurement for financial assets and
expected credit losses as described in Chapter 47) shall provide the disclosures set out
in IFRS 7 as described in Chapter 50 at 8.2, but need not restate prior periods. An entity
may restate prior periods if, and only if, it is possible without the use of hindsight.
[IFRS 9.7.2.15].
Where prior periods are not restated, any difference between the previous reported
carrying amounts and the new carrying amounts of financial assets and liabilities at the
beginning of the annual reporting period that includes the date of initial application
should be recognised in the opening retained earnings (or other component of equity,
as appropriate) of the annual reporting period that includes the date of initial
application. However, if an entity restates prior periods, the restated financial
statements must reflect all of the requirements in IFRS 9. [IFRS 9.7.2.15].
Where interim financial reports are prepared in accordance with IAS 34, the
requirements in IFRS 9 need not be applied to interim periods prior to the date of initial
application, if it is impracticable to do so. [IFRS 9.7.2.16].
10.2.6
Financial instruments derecognised prior to the date of initial
application
If an entity decides to restate prior periods or chooses to apply IFRS 9 from other than
the beginning of an annual reporting period, it should not apply the standard to financial
assets or financial liabilities that have already been derecognised at the date of initial
application. [IFRS 9.7.2.1]. In other words, following the application of IFRS 9, to the extent
those financial assets or financial liabilities were held during any period presented prior
to the date of initial application, they will be accounted for under IAS 39.
When the reporting entity elects to restate comparative information or, for example,
chooses to apply IFRS 9 from the beginning of an interim reporting period, the effect
of derecognition could potentially be confusing for users of the financial statements,
Therefore, it may require careful explanation. This is because the information for
reporting periods prior to the date of initial application would be prepared on a mixed
basis, partially under IFRS 9 (for those financial instruments not derecognised before
that date) and partially under IAS 39 (for those financial instruments which have been
derecognised prior to that date), reducing the consistency of the information provided.
Financial
instruments:
Classification
3655
10.2.7
Transition adjustments and measurement of financial assets and
liabilities
10.2.7.A
Hybrid financial assets
A hybrid financial asset that is measured at fair value through profit or loss in
accordance with IFRS 9, may previously have been accounted for as a host financial
asset and a separate embedded derivative in accordance with IAS 39. In these
circumstances, if the entity restates prior periods and the fair value of the hybrid
contract had not been determined in those comparative reporting periods, at the end
of each comparative reporting period the fair value of the hybrid contract is deemed to
be the sum of the fair values of the components (i.e. the non-derivative host and the
embedded derivative). [IFRS 9.7.2.6].
At the date of initial application, any difference between the fair value of the entire
hybrid contract at the date of initial application and the sum of the fair values of the
components of the hybrid contract at the date of initial application should be recognised
in the opening retained earnings (or other component of equity, as appropriate) of the
reporting period of initial application. [IFRS 9.7.2.7].
IFRS 9 abolishes the separation of embedded derivatives from financial assets required
by IAS 39. Under IFRS 9, most financial assets with separable embedded derivatives
would be required to be classified in their entirety as at fair value through profit or loss.
For example, a loan might contain a profit participation feature that provides the lender
with an additional return based on a share of profits of the borrower. However, in some
cases, it might be possible to renegotiate the transaction as two separate instruments
before the transition to IFRS 9 – one instrument being a loan, the host instrument
(which could be recorded at amortised cost or fair value through other comprehensive
income) and the other being the profit-sharing derivative (to be recorded at fair value
through profit or loss). This would only be possible, we believe, if after the
renegotiation, the two new instruments are in substance separate financial instruments.
Indicators that this is the case would include:
• each instrument can be closed out or transferred separately, which will be a test
of commercial practicality as well as legal possibility; or
• there are no clauses that have the effect that the cash flows on one instrument will
affect those on the other, except for typical master netting arrangements.
The case for recognising the contracts as two separate financial instruments would be
strengthened if the two new contracts were entered into at prevailing market prices. In
that case the original compound instrument is derecognised under IAS 39 and a gain or
loss is recognised when the two new instruments are first recorded at their fair values.
10.2.7.B
Financial assets and liabilities measured at amortised cost
It may be impracticable to apply retrospectively the effective interest method to a
financial asset or liability that is measured at amortised cost on transition to IFRS 9, e.g. if
it was previously classified at fair value through profit or loss. In those circumstances, the
fair value of the financial asset or liability at the end of each comparative period should
be treated as its gross carrying amount or amortised cost, respectively. Also, the fair value
3656 Chapter 44
of the financial asset or financial liability at the date of initial application should be treated
as its new gross carrying amount or amortised cost, respectively, at that date. [IFRS 9.7.2.11].
Aside from this exception, the effective interest method should be applied
retrospectively. This means that for any financial asset reclassified in accordance with the
October 2008 amendments to IAS 39, for example from trading to loans and receivables
or available-for-sale, the effective interest method should be applied based on the original
cost of the asset, not the amounts determined on reclassification. This is because
retrospective application means that an entity presents its financial statements as if it had
always applied IFRS 9. However, the standard does not have the same reclassification
requirements as IAS 39. Hence, the entity has to go back to the date of initial recognition
of the financial instrument in order to determine the accounting treatment.
10.2.7.C
Unquoted equity investments
An investment in an unquoted equity instrument (or a derivative that is linked to and
must be settled by delivery of such an unquoted equity instrument) might previously
have been measured at cost in a
ccordance with IAS 39. In those circumstances the
instrument should be measured at fair value at the date of initial application of IFRS 9.
Any difference between the previous carrying amount and fair value should be
recognised in the opening retained earnings (or other component of equity, as
appropriate) of the reporting period that includes the date of initial application.
[IFRS 9.7.2.12-13]. This means that that previous periods cannot be restated. The Board
explains that this is because as an entity would not have previously determined the fair
value of an investment in an unquoted equity instrument it will not now have the
necessary information to determine fair value retrospectively without using hindsight.
[IFRS 9.BC7.15].
References
1
IFRIC Update, November 2016.
2 IFRIC Update, May 2017.
3657
Chapter 45
Financial instruments:
Recognition and
initial measurement
1 INTRODUCTION .......................................................................................... 3659
2 RECOGNITION ............................................................................................ 3659
2.1
General requirements ....................................................................................... 3659
2.1.1
Receivables and payables ................................................................ 3660
2.1.2
Firm commitments to purchase or sell goods or services ......... 3660
2.1.3 Forward
contracts ............................................................................. 3660
2.1.4 Option
contracts
................................................................................
3660
2.1.5
Planned future transactions (forecast transactions) .................... 3660
2.1.6
Transfers of financial assets not qualifying for
derecognition by transferor – Impact on recognition ................ 3661
2.1.7 Cash
collateral ..................................................................................... 3661
2.1.8 Principal