In July 2014 the International
Accounting Standards Board (IASB) completed the final element of its
comprehensive response to the issues raised during the financial crisis by
issuing the final version of IFRS 9 Financial Instruments. The package of improvements introduced by
IFRS 9 includes a significantly revised model for classification and
measurement of financial assets, driven by cash flow characteristics and the
business model in which an asset is held, as well as a single, forward-looking
‘expected loss’ impairment model that will require more timely recognition of
expected credit losses. Both are expected to have an operational, financial and
reporting impact on entities affected by the new standard. In addition, IFRS 9
includes a substantially-reformed approach to hedge accounting, which is
outside the scope of this discussion.
Entities will need to apply IFRS 9
retrospectively beginning on January 1, 2018.
Classification
and Measurement
Although the continues to use measurement bases
similar to IAS 39 for financial assets [i.e. a mortised cost, fair value through
other comprehensive income (FVOCI) and fair value through profit and loss
(FVTPL)], the criteria for classification into the appropriate measurement
category are significantly different. On initial recognition IFRS 9 requires
all financial assets (including those that contain embedded derivative features)
to be classified into one of two primary measurement categories i.e. fair value
or a mortised cost. Financial assets are therefore classified in their entirety
rather than being subject to complex bifurcation requirements.
A financial asset qualifies for a mortised cost
measurement only if it meets both of the following conditions:
a)
the
asset is held within a business model whose objective is to hold assets to
collect contractual cash flows; and
b) the contractual terms of the
financial asset give rise on specified dates to cash flows that are solely
payments of principal and interest based on the principal amount outstanding.
Financial assets that fail to meet the above
mentioned criteria are classified and measured at fair value through either OCI
or profit and loss, depending on business model within which the asset is held.
In addition equity instruments will generally
be measured at fair value, except for non-publicly traded equity instruments, where
a company may elect to irrevocably present changes in fair value in Other
Comprehensive Income (OCI).
The following diagram presents the decision
tree for classification and measurement under IFRS 9.
Impairment model
The new impairment model under IFRS 9 replaces
the ‘incurred loss’ model in IAS 39 with an ‘expected credit loss’ model, which
means that a loss event will no longer need to occur before an impairment reserve
is recognised.
IFRS 9 outlines a ‘three-stage’ model for
impairment based on changes in credit quality since initial recognition.
The new model applies to debt instruments
recognised on-balance sheet such as loans or bonds; instruments classified as
measured at a mortised cost or FVOCI and certain loan commitments and
guarantees.
Under the new model if the
credit risk of a financial asset has not increased significantly since its
initial recognition, the financial asset will attract a reserve equal to
12-month expected credit losses. However, if its credit risk has increased,
significantly, it will attract a reserve equal to lifetime expected credit
losses, thereby increasing the amount of impairment recognised. However, the
standard does not define what is meant by ‘significant’ – so judgement will be
needed to determine whether an asset should be transferred between Stages 1, 2,
and 3, and an asset can move both upward (credit deteriorating) and downward
(credit improving) within these Stages.
Convergence with us gaap
The FASB recently elected to discontinue
both the Solely Payments of Principal and Interest and the Business Model
assessment, and instead decided to make targeted improvements to current
requirements related to the classification and measurement of financial assets
under U.S. GAAP, resulting in divergence from the IASB’s classification and
measurement standards under IFRS 9.
The FASB’s proposed impairment
model requires an entity to recognize an impairment loss on financial assets
based lifetime expected losses. As the model only contains a single measurement
approach it does not require day one recognition of 12 months expected losses,with
lifetime losses recognized upon credit deterioration, and hence diverges from
the IFRS 9 impairment model.
The FASB’scurrent expected
credit losses (CECL) standard was issued on June 16, 2016 (ASU 2016-13). The standard is effective from January 1,
2020, for calendar-year public business entities that are SEC filers, and
January 1, 2021, for all other calendar-year entities.
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