IFRS 9 – Financial Instruments

25/03/2024

IFRS 9 – Financial Instruments provides guidance on the classification and measurement of financial instruments and includes new guidance on hedge accounting. The credit loss model under IFRS 9 requires financial institutions to recognize provisions for expected future credit losses (Expected Credit Loss model – ECL), rather than only recognizing provisions for incurred losses. This change is considered to have the most significant impact on financial institutions.

IFRS 9 represents one of the most complex changes that financial institutions worldwide have implemented over the past decade. Applying IFRS 9 comes with changes to credit risk models, enhanced governance and control over accounting processes, and closer coordination between risk and finance functions. However, the value IFRS 9 brings far exceeds its implementation costs, as it improves the transparency and resilience of financial institutions.

1. Key Issues to Note When Applying

Content	IFRS
IFRS 9 – Financial Instruments
Objective	Specifies requirements for recognition and measurement, impairment, derecognition, and general hedge accounting.
Initial Measurement of Financial Instruments	All financial instruments are initially measured at fair value, plus or minus transaction costs in the case of financial assets or financial liabilities not measured at fair value through profit or loss.
Subsequent Measurement of Financial Assets	IFRS 9 classifies all financial assets into two categories, those measured at amortized cost and those measured at fair value. When assets are measured at fair value, gains and losses are either fully recognized in profit or loss (Fair Value Through Profit or Loss, FVTPL) or recognized in other comprehensive income (Fair Value Through Other Comprehensive Income, FVTOCI).
Debt Instruments	A debt instrument that meets the following two conditions shall be measured at amortized cost (net of impairment) unless the asset is designated as FVTPL under the fair value option: Business model approach: The objective of the entity’s business model is to hold financial assets to collect contractual cash flows (rather than selling the instrument before contract maturity to realize fair value changes). Cash flow characteristics approach: 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 amount outstanding. A debt instrument that meets the following two conditions shall be measured at FVTOCI unless the asset is designated as FVTPL under the fair value option: Business model approach: The financial asset is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets. Cash flow characteristics approach: 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 amount outstanding. All other instruments must be measured at fair value through profit or loss (FVTPL).
Fair Value Option for Financial Assets	Even when a debt instrument meets the two conditions to be measured at amortized cost or FVTOCI, IFRS 9 includes an option to designate it at initial recognition to be measured at FVTPL if doing so would eliminate or significantly reduce an accounting mismatch (sometimes referred to as “an inconsistency in accounting”), which would otherwise arise from measuring assets or liabilities or recognizing gains and losses on different bases.
Equity Instruments	All equity investments within the scope of IFRS 9 must be measured at fair value in the statement of financial position, with changes in fair value recognized in profit or loss, except for equity investments not held for trading where the entity has elected to present changes in fair value in “other comprehensive income.” There is no “cost exception” for unlisted shares.
Other Comprehensive Income Option	If an investment in equity is not held for trading, the entity can make an irrevocable election at initial recognition to measure it at FVTOCI, with only dividend income recognized in profit or loss.
Subsequent Measurement of Financial Liabilities	There are two recognition methods, including: fair value through profit or loss (FVTPL) and amortized cost. Financial liabilities held for trading are measured at FVTPL, and all other financial liabilities are measured at amortized cost unless the fair value option is applied. IFRS 9 requires that gains and losses on financial liabilities designated as measured at FVTPL be separated into: the portion of the change in fair value attributable to changes in credit risk of the liability, which is presented in other comprehensive income, and the remaining amount of the change in fair value, which is presented in profit or loss. The new guidance allows the entire change in fair value to be recognized in profit or loss only if presenting the credit risk changes in other comprehensive income would create or enlarge an accounting mismatch in profit or loss. This designation is made at initial recognition and is not re-assessed.
Fair Value Option for Financial Liabilities	IFRS 9 includes an option to designate financial liabilities to be measured at FVTPL if: It eliminates or significantly reduces an accounting mismatch (“inconsistency in accounting”) arising from measuring assets or liabilities or recognizing gains and losses on different bases; or The liability is part of a group of financial liabilities or financial assets and liabilities that is managed and its performance evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and information about the group is provided internally to key management personnel of the entity.
Derecognition of Financial Assets	The basic premise for derecognition under IFRS 9 is to determine whether or not the asset qualifies for derecognition. When an asset is assessed for derecognition, it is evaluated whether the asset has been transferred, and if so, whether the transfer qualifies for derecognition. An asset is transferred if the entity has transferred the contractual rights to receive the cash flows or has retained the contractual rights to receive the cash flows but has assumed a contractual obligation to pass them on under an agreement. When the entity determines that the asset has been transferred, it assesses whether substantially all the risks and rewards of ownership of the asset have been transferred. If substantially all the risks and rewards have been transferred, the asset is derecognized. If substantially all the risks and rewards are retained, the asset continues to be recognized. If the entity has neither retained nor transferred substantially all the risks and rewards of the asset, it must evaluate whether it has relinquished control of the asset. If the entity has not retained control, the asset is derecognized; however, if the entity has retained control, it continues to recognize the asset to the extent of its continuing involvement.
Derecognition of Financial Liabilities	A financial liability should be removed from the statement of financial position when, and only when, it is extinguished – that is, when the obligation specified in the contract is discharged, canceled, or expires. In the case of an exchange between an existing borrower and lender of debt instruments with substantially different terms, or a substantial modification of the terms of an existing financial liability, the transaction is accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. Any difference between the carrying amount of the financial liability extinguished and the consideration paid is recognized in profit or loss.
Derivative Instruments	All derivative instruments within the scope of IFRS 9, including those related to unlisted equity investments, are measured at fair value. Changes in fair value are recognized in profit or loss unless the entity has chosen to apply hedge accounting by designating the derivative as a hedging instrument in a qualifying hedging relationship.
Reclassification	For financial assets, reclassification is mandatory between FVTPL, FVTOCI, and amortized cost when, and only when, the entity’s business model for managing the financial assets changes, as the previous model assessment no longer applies. If reclassification is appropriate, it must be applied retrospectively from the reclassification date, defined as the first day of the first reporting period following the change in the business model. The entity does not restate previously recognized gains, losses, or interest. IFRS 9 does not permit reclassification of: Equity investments measured at FVTOCI; or Financial assets or liabilities designated under the fair value option.
Hedge Accounting	The hedge accounting requirements under IFRS 9 are optional. If certain qualifying criteria are met and applied, hedge accounting allows the entity to reflect risk management activities in the financial statements by linking gains or losses on hedging instruments with losses or gains on the hedged risk. The qualifying criteria for hedge accounting are: The hedging relationship qualifies for hedge accounting only when all of the following conditions 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, the entity’s risk management objective, and the strategy for undertaking the hedge. The hedging relationship meets all the hedge effectiveness requirements.
Accounting for Qualifying Hedging Relationships	Fair value hedges: hedges of the exposure to changes in the fair value of a recognized asset or liability, an unrecognized 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 investment designated at FVTOCI). Cash flow hedges: hedges of the exposure to variability in cash flows attributable to a particular risk associated with all or a component of a recognized asset or liability (such as all or some future interest payments on variable-rate debt) or a highly probable forecast transaction that could affect profit or loss. Hedges of a net investment in a foreign operation (as defined in IAS 21), including hedges of the foreign currency exposure, are accounted for similarly to cash flow hedges: The portion of the gain or loss on the hedging instrument determined to be an effective hedge is recognized in OCI; and The ineffective portion is recognized in profit or loss.
Impairment	IFRS 9 requires a uniform impairment model applied to all of the following: – Financial assets measured at amortized cost; – Financial assets mandatorily measured at FVTOCI; – Loan commitments and financial guarantee contracts not measured at FVTPL: Financial guarantee contracts under IFRS 9 (except those measured at FVTPL); Lease receivables within the scope of IAS 17 Leases; and Contract assets under IFRS 15 Revenue from Contracts with Customers (i.e., rights to receive payment after the transfer of goods or services)
Financial Assets Impaired Due to Credit Risk	Under IFRS 9, a financial asset is credit-impaired when one or more events occur that have a detrimental impact on the estimated future cash flows of the financial asset. This includes observable data that comes to the attention of the asset holder about the following events: Significant financial difficulty of the issuer or borrower; Breach of contract, such as default or delinquency in interest or principal payments; The lender, for economic or contractual reasons relating to the borrower’s financial difficulty, granting concessions to the borrower that would not otherwise be considered; It becoming probable that the borrower will enter bankruptcy or other financial reorganization; The disappearance of an active market for the financial asset because of financial difficulties; or The purchase or origination of a financial asset at a deep discount that reflects incurred credit losses.
Basis for Estimating Expected Credit Losses	Any expected credit loss measure under IFRS 9 must reflect a probability-weighted amount determined by evaluating the range of possible outcomes and incorporating the time value of money. Additionally, the entity should consider reasonable and supportable information about past events, current conditions, and forward-looking forecasts when measuring expected credit losses. The standard defines expected credit losses as the weighted average credit losses with the probability of default as the weight. When an entity does not need to identify every possible scenario, it must still consider the risk or probability of credit loss by assessing both the likelihood of default and the likelihood of no credit loss, even when the probability of credit loss is low.
Disclosure	IFRS 9 amends certain disclosure requirements of IFRS 7 Financial Instruments: Disclosures. These include additional disclosures about investments in equity instruments designated at FVTOCI, disclosures about credit risk management and hedge accounting, and disclosures about credit losses and impairment.

2. Tasks to Consider

Assess the impact of classifying and measuring financial instruments.
Assess the application of hedge accounting.
Explore the application of provisioning for expected future losses instead of provisioning only for incurred losses.

Nga Le

Audit & Assurance Director at Crowe Vietnam. A CPA and CTA with 15+ years of experience in audit, tax, and IFRS advisory for medium to large enterprises across diverse sectors including F&B, pharma, manufacturing,...