International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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3668 Chapter 45
A change in the fair value of a financial asset that is sold on a regular way basis is not recorded in the financial
statements between trade date and settlement date, even if the entity applies settlement date accounting,
because the seller’s right to changes in the fair value ceases on the trade date.
A
Financial asset accounted for at amortised cost
Trade date accounting
Settlement date accounting
€
€
€ €
Before 29 December 2019 (cumulative net entries)
Financial
asset 1,000
Financial
asset
1,000
Cash
1,000
Cash
1,000
To record acquisition of
To record acquisition of
the asset a year earlier
the asset a year earlier
29 December 2019
Receivable
from 1,010
counterparty
Financial
asset 1,000
Gain on disposal
10
(income statement)
To record disposal of asset
No accounting entries
4 January 2020
Cash
1,010
Cash
1,010
Receivable
from
1,010
Financial asset
1,000
counterparty
Gain on disposal
10
(income statement)
To record settlement of sale contract
To record disposal of asset
B
Financial asset accounted for at fair value through profit or loss
Trade date accounting
Settlement date accounting
€
€
€ €
Before 29 December 2019 (cumulative net entries)
Financial
asset 1,010
Financial
asset
1,010
Cash
1,000
Cash
1,000
Income
statement 10
Income
statement
10
To record acquisition
To record acquisition
and net change in fair
and net change in fair
value up to date
value up to date
29 December 2019
Receivable from
counterparty 1,010
Financial
asset 1,010
To record disposal of asset
No accounting entries
4 January 2020
Cash
1,010
Cash
1,010
Receivable from
counterparty
1,010
Financial asset
1,010
To record settlement of sale contract
To record disposal of asset
Financial instruments: Recognition and initial measurement 3669
C
Debt instrument measured at FVOCI*
Trade date accounting
Settlement date accounting
€
€
€ €
Before 29 December 2018 (cumulative net entries)
Financial
asset 1,010
Financial
asset
1,010
Cash
1,000
Cash
1,000
OCI
10
OCI
10
Trade date accounting
Settlement date accounting
€
€
€ €
29 December 2018
Receivable
from 1,010
counterparty
Financial
asset 1,010
** OCI
10
Gain on sale (income
10
statement)
To record disposal of asset
No accounting entries
4 January 2019
Cash
1,010
Cash
1,010
Receivable
from
1,010
Financial asset
1,010
counterparty
**
OCI
10
Gain on sale (income
10
statement)
To record settlement of sale contract
To record disposal of asset
*
The same analysis will apply to equity investments measured at FVOCI, except that IFRS 9 does not permit ‘recycling’ (i.e.
transfers) of cumulative gains and losses from OCI to profit or loss. However, an entity may transfer the cumulative gains and losses within equity (e.g. from accumulated OCI to retained earnings).
** The transfers from OCI to profit or loss (retained earnings) represent the ‘recycling’ of cumulative gains and losses required by IFRS 9 on disposal of a debt instrument accounted for at FVOCI (see Chapter 46 at 2.3). Disposal is regarded as
occurring on trade date when trade date accounting applies and on settlement date when settlement date accounting applies.
As illustrated above, for a regular way sale, the key differences between trade date and
settlement date accounting relate to the timing of derecognition of a financial asset and
the timing of recognition of any gain or loss arising from the disposal of the financial
asset, unless the financial asset is carried at fair value through profit or loss.
2.2.5.A
Exchanges of non-cash financial assets
The implementation guidance to IFRS 9 addresses the situation in which an entity
enters into a regular way transaction whereby it commits to sell a non-cash financial
asset in exchange for another non-cash financial asset.
This situation raises the question of whether, if the entity applies settlement date accounting
to the asset to be delivered, it should recognise any change in the fair value of the financial
asset to be received arising between trade date and settlement date. A further issue is that,
due to the accounting policy choice available for each category discussed at 2.2.1 above, the
asset being bought may be in a category of asset to which trade date accounting is applied.
In essence, the implementation guidance requires the buying and selling legs of the
exchange transaction to be accounted for independently, as illustrated by the following
example. [IFRS 9.D.2.3].
3670 Chapter 45
Example 45.5: Trade date and settlement date accounting – exchange of non-
cash financial assets
On 29 December 2019 (trade date), an entity enters into a contract to sell Note Receivable A, which is carried
at amortised cost, in exchange for Bond B, which will be classified as held for trading and measured at fair
value. Both assets have a fair value of €1,010 on 29 December 2019, while the amortised cost of Note
Receivable A is €1,000. The entity uses settlement date accounting for financial assets at amortised cost and
trade date accounting for assets held for trading.
On 31 December 2019 (financial year-end), the fair value of Note Receivable A is €1,012 and the fair value
of Bond B is €1,009. On 4 January 2020 (settlement date), the fair value of Note Receivable A is €1,013 and
the fair value of Bond B is €1,007.
The following entries are made:
€
€
29 December 2019
Bond B
1,010
Liability to counterparty
1,010
To record purchase of Bond B (trade date accounting)
31 December 2019
Loss on Bond B (income statement)
1
Bond B
1
To record change in fair value of Bond B
4 January 2020
Liability to counterparty
1,010
Note Receivable A
1,000
Gain on disposal (income statement)
10
To record disposal of receivable A
(settlement date accounting)
Loss on Bond B (income statement)
2
Bond B
2
To record change in fair value of Bond B
The simultaneous recognition, between 29 December and 4 January, of both the asset being bought and the
asset being given in consideration may seem counter-intuitive. However, it is no different from the accounting
treatment of any purchase of goods for credit which results, in the period between delivery of, and payment
for, the goods, in the simultaneous recognition of the goods, the liability to pay the supplier and the cash that
will be used to do so.
3 INITIAL
MEASUREMENT
3.1 General
requirements
On initial recognition, financial assets and financial liabilities at fair value through profit
or loss are normally measured at their fair value on the date they are initially recognised.
The initial measurement of other financial instruments is also based on their fair value,
but adjusted in respect of any transaction costs that are incremental and directly
attributable to the acquisition or issue of the financial instrument. [IFRS 9.5.1.1].
Financial instruments: Recognition and initial measurement 3671
There are however certain exceptions and additional considerations to the general
requirements that we address in the following sections.
3.2
Trade receivables without a significant financing component
IFRS 9 specifically excludes from the general requirements discussed at 3.1 above, trade
receivables that do not have a significant financing component. Such trade receivables
should be measured at initial recognition at their transaction price as defined by IFRS 15.
[IFRS 9.5.1.1, 5.1.3]. On the other hand, trade receivables with a significant financing
component would need to be recognised at their fair value in accordance with the
general requirements at 3.1 above. In this regard, IFRS 15 provides some guidance and
indicates that when adjusting the promised amount of consideration for a significant
financing component, an entity shall use the discount rate that would be reflected in a
separate financing transaction between the entity and its customer at contract inception.
[IFRS 15.64]. We discuss this in further detail in Chapter 28 at 6.5.
3.3
Initial fair value, transaction price and ‘day 1’ profits
IFRS 9 and IFRS 13 acknowledge that the best evidence of the fair value of a financial
instrument on initial recognition is normally the transaction price (i.e. the fair value of
the consideration given or received), although this will not necessarily be the case in all
circumstances (see Chapter 14 at 13.1.1). [IFRS 9.B5.1.1, B5.1.2A, IFRS 13.58]. Although IFRS 13
specifies how to measure fair value, IFRS 9 contains restrictions on recognising
differences between the transaction price and the initial fair value as measured under
IFRS 13, often called day 1 profits, which apply in addition to the requirements of
IFRS 13 (see Chapter 14 at 13.2). [IFRS 13.60, BC138].
If an entity determines that the fair value on initial recognition differs from the
transaction price, the difference is recognised as a gain or loss only if the fair value is
based on a quoted price in an active market for an identical asset or liability (i.e. a
Level 1 input) or based on a valuation technique that uses only data from observable
markets. Otherwise, the difference is deferred and recognised as a gain or loss only to
the extent that it arises from a change in a factor (including time) that market
participants would take into account when pricing the asset or liability. [IFRS 9.5.1.1A,
B5.1.2A]. The subsequent measurement and the subsequent recognition of gains and
losses should be consistent with the requirements of IFRS 9 that are covered in detail
in Chapter 46. [IFRS 9.B5.2.2A].
Therefore, entities that trade in financial instruments are prevented from immediately
recognising a profit on the initial recognition of many financial instruments that are not
quoted in active markets or whose fair value is not measured based on valuation
techniques that use only observable inputs. Consequently, locked-in profits will emerge
over the life of the financial instruments, although precisely how they should emerge is
not at all clear. The IASB was asked to clarify that straight-line amortisation was an
appropriate method of recognising the day 1 profits but decided not to do so. IFRS 9
does not discuss this at all, although IAS 39 used to state (without further explanation)
that straight-line amortisation may be an appropriate method in some cases, but will not
be appropriate in others. [IAS 39(2006).BC222(v)(ii)].
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3.3.1
Interest-free and low-interest long-term loans
As noted in 3.3 above, the fair value of a financial instrument on initial recognition is
normally the transaction price. IFRS 9 further explains that if part of the consideration
given or received was for something other than the financial instrument, the entity should
measure the fair value of the financial instrument in accordance with IFRS 13. For example,
the fair value of a long-term loan or receivable that carries no interest could be estimated
as the present value of all future cash receipts discounted using the prevailing market rate(s)
of interest for instruments that are similar as to currency, term, type of interest rate, credit
risk and other factors. Any additional amount advanced is an expense or a reduction of
income unless it qualifies for recognition as some other type of asset. IFRS 13 requires the
application of a similar approach in such circumstances. [IFRS 9.B5.1.1, IFRS 13.60]. For example,
an entity may provide an interest free loan to a supplier in order to receive a discount on
goods or services purchased in the future and the difference between the fair value and the
amount advanced might well be recognised as an asset, for example under IAS 38 –
Intangible Assets – if the entity obtains a contractual right to the discounted supplies.
Similar issues often arise from transactions between entities under common control. In
fact, IFRS 13 suggests a related party transaction may indicate that the transaction price
is not the same as the fair value of an asset or liability (see Chapter 14 at 13.3). For
example, parents sometimes lend money to subsidiaries on an interest-free or low-
interest basis where the loan is not repayable on demand. Where, in its separate
financial statements, the parent (or subsidiary) is required to record a receivable (or
payable) on initial recognition at a fair value that is lower than cost, the additiona
l
consideration will normally represent an additional investment in the subsidiary (or
equity contribution from the parent).
Another example is a loan received from a government that has a below-market rate of
interest which should be recognised and initially measured at fair value. The benefit of
the below-market rate loan, i.e. the excess of the consideration received over the initial
carrying amount of the loan, should be accounted for as a government grant. [IAS 20.10A].
The treatment of government grants is discussed further in Chapter 25.
If a financial instrument is recognised where the terms are ‘off-market’ (i.e. the
consideration given or received does not equal the instrument’s fair value) but instead a
fee is paid or received in compensation, the instrument should be recognised at its fair
value that includes an adjustment for the fee received or paid. [IFRS 9.B5.1.2].
Example 45.6: Off-market loan with origination fee
Bank J lends $1,000 to Company K. The loan carries interest at 5% and is repayable in full in five years’
time, even though the market rate for similar loans is 8%. To compensate J for the below market rate of
interest, K pays J an origination fee of $120. There are no other directly related payments by either party.