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An embedded derivative as a component of a hybrid (combined) financial instrument that also includes a non-derivative host contract. Some of the cash flows of the combined instrument vary in a way similar to a stand-alone derivative.
An example is the conversion option in convertible debt. The fair value of the convertible (hybrid) instrument changes, in part, with movements in the fair value of the equity shares into which it is convertible – which would be similar to a stand-alone option.
IAS 39 requires an entity, when it first becomes a party to a hybrid contract, to assess whether any embedded derivatives contained in the contract are required to be separated from the host contract and accounted for as
if they were stand-alone derivatives.
IFRIC 9 addresses:
- whether IAS 39 requires such an assessment to be made only when the entity first becomes a party to the hybrid contract, or whether the assessment be reconsidered throughout the life of the contract.
- whether a first-time adopter of IFRSs should make its assessment on the basis of the
conditions that existed when the entity first became a party to the contract, or those prevailing when the entity adopts IFRSs for the first time.
IFRIC 9 concludes that an entity must assess whether an embedded derivative is required to be separated from the host contract and accounted for as a derivative when the entity first becomes a party to the contract. Subsequent reassessment is prohibited unless there is a change in the terms of the contract that significantly modifies the cash flows that otherwise would be required under the contract, in which case reassessment is required.
A first-time adopter must assess whether an embedded derivative is required to be separated on the basis of the conditions that existed at the date it first became a party to the contract, unless there was a subsequent change in terms of the contract that significantly modified the cash flows.
IFRIC 9 is effective for annual periods beginning on or after 1 June 2006. Earlier application is encouraged.
Discussion at the December 2008 IASB Meeting
The Board agreed to propose a fast-track amendment to IFRIC 9 to make clear that, on Reclassification, an entity is required to assess whether an embedded derivative must be separately accounted for under IAS 39. The amendment will be effective for periods ending on or after 15 December 2008.
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