IFRS 9 — Financial Instruments
IFRS 9 Financial Instruments includes requirements for recognition and measurement, derecognition and hedge accounting. The IASB is adding to the standard as it completes the various phases of its comprehensive project on financial instruments, and so it will eventually form a complete replacement for IAS 39 Financial Instruments: Recognition and Measurement.
IFRS 9 was originally issued in November 2009, reissued in October 2010, and then amended in November 2013. The current version of IFRS 9 does not include a mandatory effective date but is available for adoption (subject to local endorsement requirements). An effective date will be added when all phases of the project are complete and a final version of IFRS 9 is issued.
Note: At its November 2013 meeting, the IASB tentatively decided that the mandatory effective date of IFRS 9 would be no earlier than annual periods beginning on or after 1 January 2017. The IASB then tentatively decided at its February 2014 meeting to select an effective date of 1 January 2018 as the effective date for mandatory application of IFRS 9.
History of IFRS 9
|14 July 2009||Exposure Draft ED/2009/7 Financial Instruments: Classification and Measurement published||Comment deadline 14 September 2009|
|12 November 2009||IFRS 9 Financial Instruments issued, covering classification and measurement of financial assets||Original effective date 1 January 2013, later removed|
|11 May 2010||Exposure Draft ED/2010/4 Fair Value Option for Financial Liabilities published||Comment deadline 16 July 2010|
|28 October 2010||IFRS 9 Financial Instruments reissued, incorporating new requirements on accounting for financial liabilities and carrying over from IAS 39 the requirements for derecognition of financial assets and financial liabilities||Original effective date 1 January 2013, later removed|
|4 August 2011||ED/2011/3 Amendments to IFRS 9 (2009) and IFRS 9 (2010): Mandatory Effective Date published, proposing the adjust the mandatory effective date of IFRS 9 from 1 January 2013 to 1 January 2015||Comment deadline 21 October 2011|
|16 December 2011||Mandatory Effective Date and Transition Disclosures (Amendments to IFRS 9 and IFRS 7) published||Amended the effective date of IFRS 9 to annual periods beginning on or after 1 January 2015 (removed in 2013), and modified the relief from restating comparative periods and the associated disclosures in IFRS 7|
|28 November 2012||Exposure Draft ED/2012/4 Classification and Measurement: Limited Amendments to IFRS 9 (proposed amendments to IFRS 9 (2010)) published||Comment deadline 28 March 2013|
|19 November 2013||IASB issues IFRS 9 Financial Instruments (Hedge Accounting and amendments to IFRS 9, IFRS 7 and IAS 39) amending IFRS 9 to:
||Removed the mandatory effective date of IFRS 9 (2009) and IFRS 9 (2010)|
Amendments under consideration by IASB
- Financial instruments — Limited reconsideration of IFRS 9
- Financial instruments — Impairment
- Financial instruments Macro hedge accounting
Summary of IFRS 9
IFRS 9 is a 'work in progress' and will eventually replace IAS 39 in its entirety
On 12 November 2009, the IASB issued IFRS 9 Financial Instruments as the first step in its project to replace IAS 39 Financial Instruments: Recognition and Measurement. IFRS 9 introduced new requirements for classifying and measuring financial assets that had to be applied starting 1 January 2013, with early adoption permitted. Click for IASB Press Release (PDF 101k).
On 28 October 2010, the IASB reissued IFRS 9, incorporating new requirements on accounting for financial liabilities, and carrying over from IAS 39 the requirements for derecognition of financial assets and financial liabilities (the Basis for Conclusions was also restructured, and IFRIC 9 and the 2009 version of IFRS 9 were withdrawn). Click for IASB Press Release (PDF 33k).
On 16 December 2011, the IASB issued Mandatory Effective Date and Transition Disclosures (Amendments to IFRS 9 and IFRS 7), which amended the effective date of IFRS 9 to annual periods beginning on or after 1 January 2015, and modified the relief from restating comparative periods and the associated disclosures in IFRS 7.
On 19 November 2013, the IASB issued IFRS 9 Financial Instruments (Hedge Accounting and amendments to IFRS 9, IFRS 7 and IAS 39) amending IFRS 9 to include the new general hedge accounting model, allow early adoption of the treatment of fair value changes due to own credit on liabilities designated at fair value through profit or loss and remove the 1 January 2015 effective date.
The IASB intends to expand IFRS 9 to add new requirements for impairment of financial assets measured at amortised cost and include limited amendments to the classification and measurement requirements. When these projects are completed an effective date will be added and IFRS 9 will be a complete replacement for IAS 39.
Other sub-projects in the IASB's comprehensive project to replace IAS 39:
- Impairment of financial assets measured at amortised cost
- Limited reconsideration of IFRS 9
- Macro hedge accounting (now being treated as a separate project).
Overview of IFRS 9
Initial measurement of financial instruments
All financial instruments are initially measured at fair value plus or minus, in the case of a financial asset or financial liability not at fair value through profit or loss, transaction costs. [IFRS 9, paragraph 5.1.1]
Subsequent measurement of financial assets
IFRS 9 divides all financial assets that are currently in the scope of IAS 39 into two classifications - those measured at amortised cost and those measured at fair value. Classification is made at the time the financial asset is initially recognised, namely when the entity becomes a party to the contractual provisions of the instrument. [IFRS 9, paragraph 4.1.1]
A debt instrument that meets the following two conditions can be measured at amortised cost (net of any write down for impairment) [IFRS 9, paragraph 4.1.2]:
- Business model test: The objective of the entity's business model is to hold the financial asset to collect the contractual cash flows (rather than to sell the instrument prior to its contractual maturity to realise its fair value changes).
- Cash flow characteristics test: The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal outstanding.
All other debt instruments must be measured at fair value through profit or loss (FVTPL). [IFRS 9, paragraph 4.1.4]
Fair value option
Even if an instrument meets the two amortised cost tests, IFRS 9 contains an option to designate a financial asset as measured at FVTPL if doing so eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an 'accounting mismatch') that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases. [IFRS 9, paragraph 4.1.5]
IAS 39's AFS and HTM categories are eliminated
The available-for-sale and held-to-maturity categories currently in IAS 39 are not included in IFRS 9.
All equity investments in scope of IFRS 9 are to be measured at fair value in the statement of financial position, with value changes recognised in profit or loss, except for those equity investments for which the entity has elected to report value changes in 'other comprehensive income'. There is no 'cost exception' for unquoted equities.
'Other comprehensive income' option
If an equity investment is not held for trading, an entity can make an irrevocable election at initial recognition to measure it at fair value through other comprehensive income (FVTOCI) with only dividend income recognised in profit or loss. [IFRS 9, paragraph 5.7.5]
Despite the fair value requirement for all equity investments, IFRS 9 contains guidance on when cost may be the best estimate of fair value and also when it might not be representative of fair value.
Subsequent measurement of financial liabilities
IFRS 9 doesn't change the basic accounting model for financial liabilities under IAS 39. Two measurement categories continue to exist: fair value through profit or loss (FVTPL) and amortised cost. Financial liabilities held for trading are measured at FVTPL, and all other financial liabilities are measured at amortised cost unless the fair value option is applied. [IFRS 9, paragraph 4.2.1]
Fair value option
IFRS 9 contains an option to designate a financial liability as measured at FVTPL if [IFRS 9, paragraph 4.2.2]:
- doing so eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an 'accounting mismatch') that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases, or
- the liability is part or a group of financial liabilities or financial assets and financial liabilities that is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and information about the group is provided internally on that basis to the entity's key management personnel.
A financial liability which does not meet any of these criteria may still be designated as measured at FVTPL when it contains one or more embedded derivatives that would require separation. [IFRS 9, paragraph 4.3.5]
IFRS 9 requires gains and losses on financial liabilities designated as at fair value through profit or loss to be split into the amount of change in the fair value that is attributable to changes in the credit risk of the liability, which shall be presented in other comprehensive income, and the remaining amount of change in the fair value of the liability which shall be presented in profit or loss. The new guidance allows the recognition of the full amount of change in the fair value in the profit or loss only if the recognition of changes in the liability's credit risk in other comprehensive income would create or enlarge an accounting mismatch in profit or loss. That determination is made at initial recognition and is not reassessed. [IFRS 9, paragraphs 5.7.7-5.7.8]
Amounts presented in other comprehensive income shall not be subsequently transferred to profit or loss, the entity may only transfer the cumulative gain or loss within equity.
Derecognition of financial assets
The basic premise for the derecognition model in IFRS 9 (carried over from IAS 39) is to determine whether the asset under consideration for derecognition is: [IFRS 9, paragraph 3.2.2]
- an asset in its entirety or
- specifically identified cash flows from an asset (or a group of similar financial assets) or
- a fully proportionate (pro rata) share of the cash flows from an asset (or a group of similar financial assets). or
- a fully proportionate (pro rata) share of specifically identified cash flows from a financial asset (or a group of similar financial assets)
Once the asset under consideration for derecognition has been determined, an assessment is made as to whether the asset has been transferred, and if so, whether the transfer of that asset is subsequently eligible for derecognition.
An asset is transferred if either the entity has transferred the contractual rights to receive the cash flows, or the entity has retained the contractual rights to receive the cash flows from the asset, but has assumed a contractual obligation to pass those cash flows on under an arrangement that meets the following three conditions: [IFRS 9, paragraphs 3.2.4-3.2.5]
- the entity has no obligation to pay amounts to the eventual recipient unless it collects equivalent amounts on the original asset
- the entity is prohibited from selling or pledging the original asset (other than as security to the eventual recipient),
- the entity has an obligation to remit those cash flows without material delay
Once an entity has determined that the asset has been transferred, it then determines whether or not it has transferred substantially all of the risks and rewards of ownership of the asset. If substantially all the risks and rewards have been transferred, the asset is derecognised. If substantially all the risks and rewards have been retained, derecognition of the asset is precluded. [IFRS 9, paragraphs 3.2.6]
If the entity has neither retained nor transferred substantially all of the risks and rewards of the asset, then the entity must assess whether it has relinquished control of the asset or not. If the entity does not control the asset then derecognition is appropriate; however if the entity has retained control of the asset, then the entity continues to recognise the asset to the extent to which it has a continuing involvement in the asset. [IFRS 9, paragraph 3.2.9]
These various derecognition steps are summarised in the decision tree in paragraph B3.2.1.
Derecognition of financial liabilities
A financial liability should be removed from the balance sheet when, and only when, it is extinguished, that is, when the obligation specified in the contract is either discharged or cancelled or expires. [IFRS 9, paragraph 3.3.1] Where there has been an exchange between an existing borrower and lender of debt instruments with substantially different terms, or there has been a substantial modification of the terms of an existing financial liability, this transaction is accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. A gain or loss from extinguishment of the original financial liability is recognised in profit or loss. [IFRS 9, paragraphs 3.3.2-3.3.3]
All derivatives, including those linked to unquoted equity investments, are measured at fair value. Value changes are recognised in profit or loss unless the entity has elected to treat the derivative as a hedging instrument in accordance with IAS 39, in which case the requirements of IAS 39 apply.
An embedded derivative is a component of a hybrid contract that also includes a non-derivative host, with the effect that some of the cash flows of the combined instrument vary in a way similar to a stand-alone derivative. A derivative that is attached to a financial instrument but is contractually transferable independently of that instrument, or has a different counterparty, is not an embedded derivative, but a separate financial instrument. [IFRS 9, paragraph 4.3.1]
The embedded derivative concept of IAS 39 has been included in IFRS 9 to apply only to hosts that are not assets within the scope of the standard, Consequently, embedded derivatives that under IAS 39 would have been separately accounted for at FVTPL because they were not closely related to the financial host asset will no longer be separated. Instead, the contractual cash flows of the financial asset are assessed in their entirety, and the asset as a whole is measured at FVTPL if any of its cash flows do not represent payments of principal and interest. The embedded derivative concept of IAS 39 is now included in IFRS 9 and continues to apply to financial liabilities and hosts not within the scope of the standard (e.g. leasing contracts, insurance contracts, contracts for the purchase or sale of a non-financial items).
For financial assets, reclassification is required between FVTPL and amortised cost, or vice versa, if and only if the entity's business model objective for its financial assets changes so its previous model assessment would no longer apply. [IFRS 9, paragraph 4.4.1]
If reclassification is appropriate, it must be done prospectively from the reclassification date. An entity does not restate any previously recognised gains, losses, or interest.
IFRS 9 does not allow reclassification where:
- the 'other comprehensive income' option has been exercised for a financial asset, or
- the fair value option has been exercised in any circumstance for a financial assets or financial liability.
The hedge accounting requirements in IFRS 9 are optional. If certain eligibility and qualification criteria are met, hedge accounting allows an entity to reflect risk management activities in the financial statements by matching gains or losses on financial hedging instruments with losses or gains on the risk exposures they hedge.
The hedge accounting model in IFRS 9 is not designed to accommodate hedging of open, dynamic portfolios. As a result for a fair value hedge of interest rate risk of a portfolio of financial assets or liabilities an entity can apply the hedge accounting requirements in IAS 39 instead of those in IFRS 9. [IFRS 9 paragraph 6.1.3]
In addition when an entity first applies IFRS as amended in November 2013, it may choose as its accounting policy choice to continue to apply the hedge accounting requirements of IAS 39 instead of the requirements of Chapter 6 of IFRS 9 [IFRS 9 paragraph 7.2.16]
Qualifying criteria for hedge accounting
A hedging relationship qualifies for hedge accounting only if all of the following criteria are met:
- the hedging relationship consists only of eligible hedging instruments and eligible hedged items.
- at the inception of the hedging relationship there is formal designation and documentation of the hedging relationship and the entity’s risk management objective and strategy for undertaking the hedge.
- the hedging relationship meets all of the hedge effectiveness requirements (see below) [IFRS 9 paragraph 6.4.1]
Only contracts with a party external to the reporting entity may be designated as hedging instruments. [IFRS 9 paragraph 6.2.3]
A hedging instrument may be a derivative (except for some written options) or non-derivative financial instrument measured at FVTPL unless it is a financial liability designated as at FVTPL for which changes due to credit risk are presented in OCI. For a hedge of foreign currency risk, the foreign currency risk component of a non-derivative financial instrument, except equity investments designated as FVTOCI, may be designated as the hedging instrument. [IFRS 9 paragraph 6.2.1-6.2.2]
IFRS 9 allows a proportion (e.g. 60%) but not a time portion (eg the first 6 years of cash flows of a 10 year instrument) of a hedging instrument to be designated as the hedging instrument. IFRS 9 also allows only the intrinsic value of an option, or the spot element of a forward to be designated as the hedging instrument. An entity may also exclude the foreign currency basis spread from a designated hedging instrument. [IFRS 9 paragraph 6.2.4]
IFRS 9 allows combinations of derivatives and non-derivatives to be designated as the hedging instrument. [IFRS 9 paragraph 6.2.5]
Combinations of purchased and written options do not qualify if they amount to a net written option at the date of designation. [IFRS 9 paragraph 6.2.6]
A hedged item can be a recognised asset or liability, an unrecognised firm commitment, a highly probable forecast transaction or a net investment in a foreign operation and must be reliably measurable. [IFRS 9 paragraph 6.3.1-6.3.3]
An aggregated exposure that is a combination of an eligible hedged item as described above and a derivative may be designated as a hedged item. [IFRS 9 paragraph 6.3.4]
The hedged item must generally be with a party external to the reporting entity however as an exception the foreign currency risk of an intragroup monetary item may qualify as a hedged item in the consolidated financial statements if it results in an exposure to foreign exchange rate gains or losses that are not fully eliminated on consolidation. In addition, the foreign currency risk of a highly probable forecast intragroup transaction may qualify as a hedged item in consolidated financial statements provided that the transaction is denominated in a currency other than the functional currency of the entity entering into that transaction and the foreign currency risk will affect consolidated profit or loss. [IFRS 9 paragraph 6.3.5 -6.3.6]
An entity may designate an item in its entirety or a component of an item as the hedged item. The component may be a risk component that is separately identifiable and reliably measurable; one or more selected contractual cash flows; or components of a nominal amount. [IFRS 9 paragraph 6.3.7]
A group of items (including net positions is an eligible hedged item only if:
- it consists of items individually, eligible hedged items;
- the items in the group are managed together on a group basis for risk management purposes; and
- in the case of a cash flow hedge of a group of items whose variabilities in cash flows are not expected to be approximately proportional to the overall variability in cash flows of the group:
- it is a hedge of foreign currency risk; and
- the designation of that net position specifies the reporting period in which the forecast transactions are expected to affect profit or loss, as well as their nature and volume [IFRS 9 paragraph 6.6.1]
For a hedge of a net position whose hedged risk affects different line items in the statement of profit or loss and other comprehensive income, any hedging gains or losses in that statement are presented in a separate line from those affected by the hedged items. [IFRS 9 paragraph 6.6.4]
Accounting for qualifying hedging relationships
There are three types of hedging relationships:
Fair value hedge: a hedge of the exposure to changes in fair value of a recognised asset or liability or an unrecognised firm commitment, or a component of any such item, that is attributable to a particular risk and could affect profit or loss (or OCI in the case of an equity instrument designated as at FVTOCI). [IFRS 9 paragraph 6.5.2(a) and 6.5.3]
For a fair value hedge, the gain or loss on the hedging instrument is recognised in profit or loss (or OCI, if hedging an equity instrument at FVTOCI and the hedging gain or loss on the hedged item adjusts the carrying amount of the hedged item and is recognised in profit or loss. However, if the hedged item is an equity instrument at FVTOCI, those amounts remain in OCI. When a hedged item is an unrecognised firm commitment the cumulative hedging gain or loss is recognised as an asset or a liability with a corresponding gain or loss recognised in profit or loss. [IFRS 9 paragraph 6.5.8]
If the hedged item is a financial instrument measured at amortised cost any hedge adjustment is amortised to profit or loss based on a recalculated effective interest rate. Amortisation may begin as soon as an adjustment exists and shall begin no later than when the hedged item ceases to be adjusted for hedging gains and losses. [IFRS 9 paragraph 6.5.10]
Cash flow hedge: a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated with all, or a component of, a recognised asset or liability (such as all or some future interest payments on variable-rate debt) or a highly probable forecast transaction, and could affect profit or loss. [IFRS 9 paragraph 6.5.2(b)]
For a cash flow hedge the cash flow hedge reserve in equity is adjusted to the lower of the following (in absolute amounts):
- the cumulative gain or loss on the hedging instrument from inception of the hedge; and
- the cumulative change in fair value of the hedged item from inception of the hedge.
The portion of the gain or loss on the hedging instrument that is determined to be an effective hedge is recognised in OCI and any remaining gain or loss is hedge ineffectiveness that is recognised in profit or loss.
If a hedged forecast transaction subsequently results in the recognition of a non-financial item or becomes a firm commitment for which fair value hedge accounting is applied, The amount that has been accumulated in the cash flow hedge reserve is removed and included directly in the initial cost or other carrying amount of the asset or the liability. In other cases The amount that has been accumulated in the cash flow hedge reserve is reclassified to profit or loss in the same period(s) as the hedged cash flows. [IFRS 9 paragraph 6.5.11]
When an entity discontinues hedge accounting for a cash flow hedge, if the hedged future cash flows are still expected to occur, the amount that has been accumulated in the cash flow hedge reserve remains there until the future cash flows occur; if the hedged future cash flows are no longer expected to occur, that amount is immediately reclassified to profit or loss [IFRS 9 paragraph 6.5.12]
A hedge of the foreign currency risk of a firm commitment may be accounted for as a fair value hedge or a cash flow hedge. [IFRS 9 paragraph 6.5.4]
Hedge of a net investment in a foreign operation (as defined in IAS 21), including a hedge of a monetary item that is accounted for as part of the net investment, is accounted for similarly to cash flow hedges:
- the portion of the gain or loss on the hedging instrument that is determined to be an effective hedge is recognised in OCI; and
- the ineffective portion is recognised in profit or loss. [IFRS 9 paragraph 6.5.13]
The cumulative gain or loss on the hedging instrument relating to the effective portion of the hedge is reclassified to profit or loss on the disposal or partial disposal of the foreign operation. [IFRS 9 paragraph 6.5.14]
Hedge effectiveness requirements
In order to qualify for hedge accounting, the hedge relationship must meet the following effectiveness criteria at the beginning of each hedged period:
- there is an economic relationship between the hedged item and the hedging instrument;
- the effect of credit risk does not dominate the value changes that result from that economic relationship; and
- the hedge ratio of the hedging relationship is the same as that actually used in the economic hedge [IFRS 9 paragraph 6.4.1(c)]
Rebalancing and discontinuation
If a hedging relationship ceases to meet the hedge effectiveness requirement relating to the hedge ratio but the risk management objective for that designated hedging relationship remains the same, an entity adjusts the hedge ratio of the hedging relationship (i.e. rebalances the hedge) so that it meets the qualifying criteria again. [IFRS 9 paragraph 6.5.5]
An entity discontinues hedge accounting prospectively only when the hedging relationship (or a part of a hedging relationship) ceases to meet the qualifying criteria (after any rebalancing). This includes instances when the hedging instrument expires or is sold, terminated or exercised. Discontinuing hedge accounting can either affect a hedging relationship in its entirety or only a part of it (in which case hedge accounting continues for the remainder of the hedging relationship). [IFRS 9 paragraph 6.5.6]
Time value of options
When an entity separates the intrinsic value and time value of an option contract and designates as the hedging instrument only the change in intrinsic value of the option, it recognises some or all of the change in the time value in OCI which is later removed or reclassified from equity as a single amount or on an amortised basis (depending on the nature of the hedged item) and ultimately recognised in profit or loss. [IFRS 9 paragraph 6.5.15] This reduces profit or loss volatility compared to recognising the change in value of time value directly in profit or loss.
Forward points and foreign currency basis spreads
When an entity separates the forward points and the spot element of a forward contract and designates as the hedging instrument only the change in the value of the spot element, or when an entity excludes the foreign currency basis spread from a hedge the entity may recognise the change in value of the excluded portion in OCI to be later removed or reclassified from equity as a single amount or on an amortised basis (depending on the nature of the hedged item) and ultimately recognised in profit or loss. [IFRS 9 paragraph 6.5.16] This reduces profit or loss volatility compared to recognising the change in value of forward points or currency basis spreads directly in profit or loss.
Credit exposures designated at FVTPL
If an entity uses a credit derivative measured at FVTPL to manage the credit risk of a financial instrument (credit exposure) it may designate all or a proportion of that financial instrument as measured at FVTPL if:
- the name of the credit exposure matches the reference entity of the credit derivative (‘name matching’); and
- the seniority of the financial instrument matches that of the instruments that can be delivered in accordance with the credit derivative.
An entity may make this designation irrespective of whether the financial instrument that is managed for credit risk is within the scope of IFRS 9 (for example, it can apply to loan commitments that are outside the scope of IFRS 9). The entity may designate that financial instrument at, or subsequent to, initial recognition, or while it is unrecognised and shall document the designation concurrently. [IFRS 9 paragraph 6.7.1]
If designated after initial recognition, any difference in the previous carrying amount and fair value is recognised immediately in profit or loss [IFRS 9 paragraph 6.7.2]An entity discontinues measuring the financial instrument that gave rise to the credit risk at FVTPL if the qualifying criteria are no longer met and the instrument is not otherwise required to measure the instrument at FVTPL. The fair value at discontinuation becomes its new carrying amount. [IFRS 9 paragraph 6.7.3 and 6.7.4]
IFRS 9 amends some of the requirements of IFRS 7 Financial Instruments: Disclosures including added disclosures about investments in equity instruments designated as at FVTOCI.