comprehensive income, without recycling); or
• financial liabilities either at fair value through profit or loss or at amortised cost.
Following the initial recognition of financial assets and financial liabilities, their subsequent
accounting treatment depends principally on the classification of the instrument, although
there are a small number of exceptions. These requirements are summarised in Figure 46.1
below and are considered in more detail in the remainder of this section.
Figure 46.1 Classification and subsequent measurement of financial assets and
financial liabilities
Classification
Instrument type Statement of Fair value gains
Interest and
Impairment Foreign
financial
and losses
dividends
exchange
position
Financial assets and
Debt Amortised – Profit
or
loss:
Profit or loss
Profit or loss
liabilities at
cost
using an
(financial
amortised cost
effective
assets)
interest rate
Debt financial assets
Debt Fair
value Other Profit or loss:
Profit or loss
Profit or loss
at fair value through
comprehensive
using an
other comprehensive
income and
effective
income
recycled to
interest rate
profit or loss
when
derecognised
Fair value through
Debt, equity
Fair value Profit or loss (see
Profit or loss
– Profit
or
loss
profit or loss
or derivative
Chapter 50
(see Chapter 50
(including
at 7.1.1 on
at 7.1.1 on
derivatives not
presentation
presentation
designated in
requirements)
requirements)
effective hedges)
and other
comprehensive
income for
changes in own
credit risk
(see 2.4.1 below)
Equity investments at
Equity Fair
value Other Profit or loss:
– Other
fair value through
comprehensive
dividends
comprehensive
other comprehensive
income
receivable
income
income
(no recycling
(no recycling
to profit or
to profit or
loss when
loss when
derecognised)
derecognised)
Financial instruments: Subsequent measurement 3687
In addition, IFRS 9 sets out the accounting treatment for certain financial guarantee
contracts (see Chapter 41 at 3.4) and commitments to provide a loan at a below market
interest rate (see Chapter 41 at 3.5).
2.1
Debt financial assets measured at amortised cost
Financial assets that are measured at amortised cost require the use of the effective
interest method and are subject to the IFRS 9 impairment rules. [IFRS 9.5.2.1, 5.2.2]. Gains
and losses are recognised in profit or loss when the instrument is derecognised or
impaired, as well as through the amortisation process. [IFRS 9.5.7.2]. The effective interest
method of accounting is dealt with at 3 below, foreign currency retranslation is
discussed at 4 below, modification of financial assets is covered at 3.8 below and
impairment is addressed in Chapter 47.
2.2
Financial liabilities measured at amortised cost
Liabilities that are measured at amortised cost require the use of the effective interest
method with gains or losses recognised in profit or loss when the instrument is
derecognised as well as through the amortisation process. [IFRS 9.5.3.1, 5.7.2]. The
effective interest method of accounting is dealt with at 3 below, foreign currency
retranslation is discussed at 4 below and modification of financial liabilities is covered
at 3.8 below.
2.3
Debt financial assets measured at fair value through other
comprehensive income
For financial assets that are debt instruments measured at fair value through other
comprehensive income (see Chapter 44 at 2.1), the IASB decided that both amortised
cost and fair value information are relevant because debt instruments held by entities in
this measurement category are held for both the collection of contractual cash flows
and the realisation of fair values. [IFRS 9.4.1.2A, BC4.150].
After initial recognition, investments in debt instruments that are classified as measured
at fair value through other comprehensive income are measured at fair value in the
statement of financial position (with no deduction for sale or disposal costs) and
amortised cost information is presented in profit or loss. [IFRS 9.5.7.10, 5.7.11].
Subsequent measurement of debt instruments at fair value through other
comprehensive income involves the following: [IFRS 9.5.7.1(d), 5.7.10, B5.7.1A]
• impairment gains and losses (see Chapter 47) are derived using the same
methodology that is applied to financial assets measured at amortised cost and are
recognised in profit or loss; [IFRS 9.5.2.2, 5.5.2]
• foreign exchange gains and losses (see 4 below) are calculated based on the
amortised cost of the debt instruments and are recognised in profit or loss;
[IFRS 9.B5.7.2, B5.7.2A]
• interest revenue is calculated using the effective interest method (see 3 below) and
is recognised in profit or loss; [IFRS 9.5.4.1]
• other fair value gains and losses are recognised in other comprehensive income;
[IFRS 9.5.7.10, B5.7.1A]
3688 Chapter 46
• when debt instruments are modified (see 3.8 below and Chapter 47 at 8), the
modification gains or losses are recognised in profit or loss;1 [IFRS 9.5.7.10, 5.7.11, 5.4.3] and
• when the debt instruments are derecognised, the cumulative gains or losses
previously recognised in other comprehensive income are reclassified (i.e. recycled)
from equity to profit or loss as a reclassification adjustment. [IFRS 9.5.7.10, B5.7.1A].
It follows that the amount recognised in other comprehensive income is the difference
between the total change in fair value and the amounts recognised in profit or loss
(excluding any amounts received in cash, e.g. the coupon on a bond).
2.4
Financial assets and financial liabilities measured at fair value
through profit or loss
After initial recognition, financial assets and financial liabilities that are classified as
measured at fair value through profit or loss (including derivatives that are not
designated in effective hedging relationships) are measured at fair value, with no
deduction for sale or disposal costs (see Chapter
44 at
2, 4, 5.4 and
7).
[IFRS 9.5.2.1, 5.3.1, 5.7.1].
/> The standard helpfully points out that if the fair value of a financial asset falls below
zero it becomes a financial liability (assuming it is measured at fair value). [IFRS 9.B5.2.1].
The standard does not explain what happens if the fair value of a financial liability
becomes positive, but it is safe to assume that it becomes a financial asset and not a
negative liability.
Gains and losses arising from remeasuring a financial asset or financial liability at fair
value should normally be recognised in profit or loss. [IFRS 9.5.7.1]. However, there is an
exception for most non-derivative financial liabilities that are designated as measured
at fair value through profit or loss. For these liabilities the element of the gain or loss
attributable to changes in credit risk (see 2.4.1 below) should normally be recognised in
other comprehensive income (with the remainder recognised in profit or loss).
[IFRS 9.5.7.7, B5.7.8]. These amounts presented in other comprehensive income should not
be subsequently transferred to profit or loss. However, the cumulative gain or loss may
be transferred within equity. [IFRS 9.B5.7.9].
This exception does not apply to loan commitments or financial guarantee contracts,
nor does it apply if it would create or enlarge an accounting mismatch in profit or loss
(see 2.4.2 below). [IFRS 9.5.7.8, 5.7.9]. In these cases, all changes in the fair value of the
liability (including the effects of changes in the credit risk) should be recognised in profit
or loss. [IFRS 9.B5.7.8].
2.4.1
Liabilities at fair value through profit or loss: calculating the gain or
loss attributable to changes in credit risk
IFRS 7 – Financial Instruments: Disclosures – defines credit risk as ‘the risk that one
party to a financial instrument will cause a financial loss for the other party by failing to
discharge an obligation’, which is also part of non-performance risk as defined in
IFRS 13 (see Chapter 14 at 11.3). [IFRS 7 Appendix A]. The change in fair value of a financial
liability that is attributable to credit risk relates to the risk that the issuer will fail to pay
Financial instruments: Subsequent measurement 3689
that particular liability. It may not solely relate to the creditworthiness of the issuer but
may be influenced by other factors, such as collateral.
For example, if an entity issues a collateralised liability and a non-collateralised liability
that are otherwise identical, the credit risk of those two liabilities will be different, even
though they are issued by the same entity. The credit risk on the collateralised liability
will be less than the credit risk of the non-collateralised liability. In fact, the credit risk
for a collateralised liability may be close to zero. [IFRS 9.B5.7.13]. It is important to
distinguish between the terms ‘credit risk’ and ‘the risk of default’ as referred to in the
impairment requirements of the standard (see Chapter 47 at 6.1), since the latter does
not include the benefit of collateral.
For these purposes, credit risk is different from asset-specific performance risk. Asset-
specific performance risk is not related to the risk that an entity will fail to discharge a
particular obligation but rather it is related to the risk that a single asset or a group of
assets will perform poorly (or not at all). [IFRS 9.B5.7.14]. For example, consider:
[IFRS 9.B5.7.15]
(a) a liability with a unit-linking feature whereby the amount due to investors is
contractually determined on the basis of the performance of specified assets. The
effect of that unit-linking feature on the fair value of the liability is asset-specific
performance risk, not credit risk;
(b) a liability issued by a structured entity with the following characteristics:
• the structured entity is legally isolated so the assets in the structured
entity are ring-fenced solely for the benefit of its investors, even in the
event of bankruptcy;
• the structured entity enters into no other transactions and the assets in the
SPE cannot be hypothecated; and
• amounts are due to the structured entity’s investors only if the ring-fenced
assets generate cash flows.
Thus, changes in the fair value of the liability primarily reflect changes in the fair
value of the assets. The effect of the performance of the assets on the fair value of
the liability is asset-specific performance risk, not credit risk.
Unless an alternative method more faithfully represents the change in fair value of a
financial liability that is attributable to credit risk, the standard states that this amount
should be determined as the amount of change in the fair value of the liability that is
not attributable to changes in market conditions that give rise to what it defines as
‘market risk’. [IFRS 9.B5.7.16]. Changes in market conditions that give rise to market risk
include changes in a benchmark interest rate, the price of another entity’s financial
instrument, a commodity price, foreign exchange rate or index of prices or rates.
[IFRS 9.B5.7.17].
The standard says that if the only significant relevant changes in market conditions for
a financial liability are changes in ‘an observed (benchmark) interest rate’, the amount
to be recognised in other comprehensive income can be estimated as follows:
[IFRS 9.B5.7.18]
3690 Chapter 46
(a) first, the liability’s internal rate of return at the start of the period is computed using
the fair value and contractual cash flows at that time and the observed (benchmark)
interest rate at the start of the period is deducted from this, to arrive at an
instrument-specific component of the internal rate of return;
(b) next, the present value of the cash flows associated with the liability is calculated
using the liability’s contractual cash flows at the end of the period and a discount
rate equal to the sum of the observed (benchmark) interest rate at the end of the
period and the instrument-specific component of the internal rate of return at the
start of the period as determined in (a); and
(c) the difference between the fair value of the liability at the end of the period and
the amount determined in (b) is the change in fair value that is not attributable to
changes in the observed (benchmark) interest rate and this is the amount to be
presented in other comprehensive income.
It should be noted that ‘market risk’ is defined to include movements in ‘a benchmark
rate’. The latter term is not itself defined but typically it would encompass both ‘risk
free’ rates, such as AAA rated government bond rates or overnight rates, and rates such
as 3 month LIBOR or EURIBOR, which include an element of credit risk. It would
therefore appear that the standard is ambivalent as to whether the amount of change in
fair value that is attributable to changes in credit risk of a liability is measured by
reference to risk free rates, or by comparison to the credit risk already present in LIBOR.
Using the former, the amount will reflect any changes in credit risk of the liability,
whereas using the latter it will only reflect changes in credit risk specific to the liability.
Further, the change in credit risk will differ depending on whether the selected
noted that regulators are encouraging benchmark rates such as LIBOR to be
discontinued over the next three years, in favour of risk free benchmarks based on
overnight rates. It would follow that the change in the amount attributable to credit risk
will in future reflect all changes in credit risk.
This method is illustrated in the following example, adapted from that provided in the
Illustrative Examples attached to the standard. [IFRS 9.IE1-IE5].
Example 46.1: Estimating the change in fair value of an instrument attributable
to its credit risk
On 1 January 2019, Company J issues a 10-year bond with a par value of €150,000 and an annual fixed
coupon rate of 8%, which is consistent with market rates for bonds with similar characteristics. J uses 3 month
Euro LIBOR as its observable (benchmark) interest rate. At the date of inception of the bond, 3 month Euro
LIBOR is 5%. At the end of the first year:
• 3 month Euro LIBOR has decreased to 4.75%; and
• the fair value of the bond is €153,811 which is consistent with an interest rate of 7.6% (i.e. the remaining
cash flows on the bond, €12,000 per year for nine years and €150,000 at the end of nine years, discounted
at 7.6% equals €153,811).
For simplicity, this example assumes a flat yield curve, that all changes in interest rates result from a parallel
shift in the yield curve, and that the changes in 3 month Euro LIBOR are assumed to be the only relevant
changes in market conditions.
The amount of change in the fair value of the bond that is not attributable to changes in market conditions
that give rise to market risk is estimated as follows:
Financial instruments: Subsequent measurement 3691
Step (a)
The bond’s internal rate of return at the start of the period is 8%. Because the observed (benchmark) interest rate
(3 month Euro LIBOR) is 5%, the instrument-specific component of the internal rate of return is deemed to be 3%.
Step (b)
The contractual cash flows of the instrument at the end of the period are:
• interest: €12,000 [€150,000 × 8%] per year for each of years 2020 (year 2) to 2028 (year 10).
• principal: €150,000 in 2028 (year 10).
The discount rate to be used to calculate the present value of the bond is thus 7.75%, which is the 4.75% end
of period 3 month LIBOR rate, plus the 3% instrument-specific component calculated as at the start of the
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 729
