Financial instruments

A new international standard, IFRS 9, is untangling the complex requirements for reporting financial instruments

In Brief

  • IFRS 9 can be used now and is mandatory for annual periods starting on or after 1 January 2018
  • The standard simplifies financial instruments accounting and addresses issues from the GFC
  • Major changes impact classification and measurement, impairment and hedge accounting

Overview

A new international financial reporting standard, IFRS 9 Financial Instruments, is now available for use. It simplifies the complex requirements of its predecessor, IAS 39 Financial Instruments: Recognition and Measurement. The new standard also addresses issues highlighted by the global financial crisis:

  • the timeliness of recognition of expected credit losses
  • the complexity of multiple impairment models
  • own credit risk.

The standard retains some of the principles in IAS 39. However, significant changes have been made in three key areas:

  • classification and measurement of financial assets
  • impairment
  • hedge accounting.

IFRS 9 will be mandatory for annual periods starting on or after 1 January 2018.

Supporting implementation

IASB support materials

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Changes to consider

  • Classification and measurement of financial assets

    IFRS 9 introduces a single classification and measurement approach for financial assets that reflects:

    • the business model in which financial assets are managed; and
    • the financial assets’ contractual cash flow characteristics.

    Categories of financial assets

    A financial asset is categorised in one of three ways:

    • amortised cost
    • fair value through profit and loss (FVTPL), including an irrevocable election to present changes in fair value for certain equity investments in other comprehensive income (OCI)
    • fair value through other comprehensive income (FVTOCI).

    Financial assets with embedded derivatives

    The classification and measurement of financial assets containing embedded derivatives has been simplified. Bifurcation is no longer required when the host contract is a financial asset within the scope of IFRS 9.

    Reclassification

    Financial assets must be reclassified between categories when the business model for managing those financial assets changes. This is the only circumstance under which reclassification is allowed, so such changes are expected to be uncommon. No reclassification of financial liabilities is permitted.

  • Impairment

    The new standard replaces the “incurred loss” model with an “expected credit loss” model. This change is anticipated to generate more useful information about an entity’s expected credit losses on financial instruments.

    Specifically, the standard requires entities to account for expected credit losses from the moment when financial instruments are first recognised, rather than when a trigger event occurs. Entities are required “to update the amount of expected credit losses recognised at each reporting date to reflect changes in credit risk,” according to the International Accounting Standards Board (IASB).

    The expected credit loss model applies to all financial instruments that are subject to impairment accounting, including trade receivables and lease receivables. This is another way that the new standard is simpler than its predecessor. The model measures 12-month expected credit losses and lifetime expected credit losses.

  • Hedge accounting

    Changes to the hedge accounting model aim to:

    • make hedge accounting easier to understand
    • align hedge accounting more closely with the risks the entity faces, the strategies management is taking to manage the risks, and the effectiveness of those strategies
    • ease the burden associated with hedge effectiveness testing
    • allow more risks to be hedged.

    Macro hedging is not dealt with in IFRS 9. It is the subject of a separate project by the International Accounting Standards Board (IASB). Until that project is complete, entities can choose to:

    • apply IFRS 9 hedging requirements, which carry forward guidance from IAS 39 on portfolio fair value hedges; or
    • continue applying IAS 39 hedging requirements.