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Financial instruments — Limited amendments to IFRS 9 (classification and measurement) (IASB/FASB)

Date recorded:

Overall Business Model Assessment

The boards discussed the meaning of the term business model, the role of cash flow realisation, and the level on which the business model is assessed. The staff’s recommendations only consisted of clarifications to the guidance in IFRS 9 Financial Instruments (i.e., no recommendations for fundamental changes were made).

The staff noted the FASB’s proposed ASU and the IASB’s ED/2012/4 proposed additional clarifications on the meaning of the term “business model” and the information that the holder should consider in making their assessment as well as on the level at which the assessment should be performed (i.e., whether this is an instrument by instrument assessment or whether some level of aggregation is required). Concerns were raised that current guidance places undue emphasis on the level of sales that can challenge an amortised cost based classification rather than the underlying reason for these sale and this implicitly leads to a “tainting rule” similar to the guidance for held-to-maturity assets in IAS 39 Financial Instruments: Recognition and Measurement. In addition, current guidance on reclassifications appears to be too strict.

The boards tentatively decided to clarify that the business model assessment should:

  1. refer to the way financial assets are managed in order to generate cash flows and create value for the entity;
  2. allocate financial assets to the respective categories (FVPL, FVOCI, amortised cost) that will provide the most relevant and useful information about how activities and risks are managed to generate cash flows and create value; and
  3. consider the level of aggregation that reflects the way that these financial assets are managed together to achieve a particular common objective.

The boards discussed clarifications of how the business model—and a change in the business model—should be assessed and tentatively decided to clarify that:

  1. the entity’s business model is often observable through particular activities that are undertaken to achieve the objectives of that business model;
  2. the volume of any sales activity should not be considered in isolation and that the underlying reason for these sales should be considered; and
  3. a change in business model only occurs when an entity either stops or starts doing something on a level that is significant to its operations. This is generally the case when the entity has acquired or disposed of a business line.

The IASB also tentatively decided to clarify that:

  1. Business activities usually reflect the way in which the performance of the business model and underlying financial assets are evaluated and reported.
  2. An entity should consider all relevant and objective information that is available at the date of the assessment but should not consider every ‘what if’ or worse-case scenario if this is not reasonably expected to occur.
  3. If cash flows are realised in a way that is different from the entity’s expectations at the date the business model assessment was made, it will not trigger a restatement of prior period financial statements or a change of the classification of the remaining financial assets as long as the entity considered all relevant and objective information that was available at the time it made the assessment.

Regarding the reclassification date, IFRS 9 defines it as the first day of the first reporting period following the change in business model whereas the FASB’s proposed ASU describes it as the last day of the reporting period in which the change in business model occurs. The FASB tentatively decided to converge its guidance.


Hold to Collect Business Model

The boards discussed clarifications to the hold to collect business model and tentatively decided to clarify the application guidance for the hold to collect business model. In particular they tentatively decided to:

  1. reinforce the current hold to collect “cash flows (value) realisation” concept;
  2. emphasise that insignificant and/or infrequent sales may not be inconsistent with the hold to collect business model regardless of the reason for such sales;
  3. clarify that historical sales information and patterns should not be considered in isolation and are not determinative; and
  4. clarify that credit risk management activities aimed at minimising potential credit losses due to credit deterioration are integral to the hold to collect objective.

Examples of activities that would typically be associated with the hold to collect business model include:

  1. managing financial assets to generate interest income via collection of interest and principal over the life of the instrument;
  2. performing credit risk management activities with the objective of minimising credit losses; and
  3. managing financial assets within a business model where performance is evaluated based on the interest revenue and/or impairment charges.

Examples of activities that would not typically be associated with the hold to collect business model include:

  1. financial assets managed for trading purposes;
  2. financial assets purchased or sold for short-term profit taking;
  3. financial assets managed to maximise fair value gains;
  4. compensation to employees managing these financial assets based on their fair value changes;
  5. financial assets held in liquidity portfolios where significant portions are sold to meet liquidity needs;
  6. the entity seeking to maintain a particular yield profile.

In addition, as part of the clarifications under point (a) above, the FASB tentatively decided that the guidance on the hold to collect business model should emphasise activities aimed at achieving the business model’s objective.

The boards tentatively decided that sales made in managing concentration of credit risk should be assessed in the same way as any other sales made in the business model rather than through a separate type of assessment.


Fair Value Categories

The boards tentatively decided to retain two fair value measurement categories, that is fair value through other comprehensive income (FVOCI) and fair value through profit or loss (FVPL), and to define the business model that results in measurement at FVOCI and to retain FVPL as the residual measurement category.

The boards tentatively decided to clarify the application guidance for the FVPL measurement category, specifically that financial instruments managed and evaluated on a fair value basis must be measured at FVPL. In these cases decision making will be based on changes in the fair value and with the objective of realising this fair value.

The boards tentatively decided to clarify the application guidance for the FVOCI measurement category, and specify that:

  1. in the FVOCI business model, managing financial assets both to collect contractual cash flows and for sale is the outcome of the way in which financial assets are managed to achieve a particular objective rather than the objective itself. The assets classified in FVOCI are managed to achieve the business model objectives (such as liquidity management, interest rate risk management, yield management and duration mismatch management) by both collecting contractual cash flows and selling;
  2. both collection of contractual cash flows and realisation of cash flows through selling are integral to the performance of the FVOCI business model. No specific threshold is set for the frequency or amount of sales in the FVOCI business model; and
  3. particular activities are typically aimed at achieving the FVOCI business model objectives.

In addition, the FASB tentatively decided to remove the guidance in the FASB’s Exposure Draft requiring an individual asset for which an entity has at initial recognition not yet determined whether it will hold the financial asset to collect contractual cash flows or sell to be measured at FVOCI.

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