IFRS 9 Objectives & Overview

What does IFRS 9 cover?

The standard covers the following key areas:

• Classification and measurement of financial assets and financial liabilities
• Expected credit loss impairment model
• Hedge accounting

How are financial assets classified and measured?

Financial assets are initially measured at fair value plus or minus, in the case of financial assets not at fair value through profit or loss, transaction costs. There are three categories for classification of financial assets:

1. Amortised cost
2. Fair value through other comprehensive income
3. Fair value through profit or loss

Equity instruments held for trading are classified as fair value through profit or loss. If it is not held for trading, there is an irrevocable option to designate the asset on initial recognition at fair value through other comprehensive income. Derivatives are classified as FVTPL unless they are effective hedging instruments in certain hedges.

How are financial liabilities classified and measured?

Financial liabilities are initially measured at fair value plus or minus, in the case of financial liabilities not at fair value through profit or loss, transaction costs. There are two categories for classification of financial liabilities:

1. Amortised cost
2. Fair value through profit or loss (FVTPL)

All trading liabilities and derivatives (unless they are effective hedging instruments in specific hedges) are mandatorily classified as FVTPL.

When is a financial asset derecognised?

• Contractual rights to the cash flows from the financial asset have expired
• Financial asset has been transferred and transfer qualifies for derecognition based on an evaluation of the extent of transfer of the risks and rewards of ownership of the financial asset

If an entity has transferred the financial asset, it then determines whether or not it has transferred all of the risks and rewards of ownership of the asset. What are the potential outcomes of this?

• If yes, the asset is derecognised
• If no, derecognition is precluded and a liability is recognised for the proceeds received
• If neither yes nor no, the entity evaluates whether control has been transferred or not

How do we calculate expected credit losses?

Expected credit losses = Exposures at default (EAD) x Loss-given default (LGD) x Probability of default (PD)

What are the three approaches to applying the IFRS 9 expected credit loss model?

1. The general approach

• Applied to financial assets at amortised cost or fair value through other comprehensive income
• A 12-month expected credit loss is provided on financial assets which have not had a significant increase in credit risk since origination or purchase. The expected credit loss is based on those default events that are possible within the 12 months after the reporting date
• Lifetime expected credit loss is provided on financial assets with significant increase in credit risk since origination or purchase

1. The simplified approach

• Applied to trade receivables , contract assets and lease receivables
• Lifetime expected credit losses are provided using the provision matrix approach

1. Purchased or originated credit-impaired approach

• Applied to financial assets that are credit-impaired at initial recognition
• Credit-adjusted effective interest rate is used so no day one impairment allowance is required

What are the three types of hedges in IFRS 9?

1. Fair value hedge - Hedge of the exposure to changes in fair value of a recognised asset, or liability or a firm commitment. The fair value movements are recognised in the profit or loss
2. Cash flow hedge - Hedge of exposure to variability in cash flows of a recognised asset, or liability or forecast transactions. The effective portion of the gain/loss on the instrument is initially recognised in the OCI and in the PnL. Any ineffectiveness is recognised immediately in the profit or loss
3. Hedge of net investment in a foreign operation - Hedge of exposure to changes in FX rates associated with investment in foreign operations. The effective portion of the gain/loss on the instrument is initially recognised in OCI, and subsequently transferred to the PnL. Any ineffectiveness is recognised immediately in the profit or loss