IAS 39 - Accounting for Financial Instruments

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For example, a contract to purchase a commodity at a fixed price for delivery at a future date has embedded in it a derivative that is indexed to the price of the commodity. An embedded derivative is a feature within a contract, such that the cash flows associated with that feature behave in a similar fashion to a stand-alone derivative. In the same way that derivatives must be accounted for at fair value on the balance sheet with changes recognised in the income statement, so must some embedded derivatives.

Examples of embedded derivatives that are not closely related to their hosts and therefore must be separately accounted for include:. Those categories are used to determine how a particular financial asset is recognised and measured in the financial statements. Financial assets at fair value through profit or loss. This category has two subcategories:. Available-for-sale financial assets AFS are any non-derivative financial assets designated on initial recognition as available for sale or any other instruments that are not classified as as a loans and receivables, b held-to-maturity investments or c financial assets at fair value through profit or loss.

Fair value changes on AFS assets are recognised directly in equity, through the statement of changes in equity, except for interest on AFS assets which is recognised in income on an effective yield basis , impairment losses and for interest-bearing AFS debt instruments foreign exchange gains or losses. The cumulative gain or loss that was recognised in equity is recognised in profit or loss when an available-for-sale financial asset is derecognised. Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market, other than held for trading or designated on initial recognition as assets at fair value through profit or loss or as available-for-sale.

Loans and receivables for which the holder may not recover substantially all of its initial investment, other than because of credit deterioration, should be classified as available-for-sale. Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments that an entity intends and is able to hold to maturity and that do not meet the definition of loans and receivables and are not designated on initial recognition as assets at fair value through profit or loss or as available for sale.

Held-to-maturity investments are measured at amortised cost. If an entity sells a held-to-maturity investment other than in insignificant amounts or as a consequence of a non-recurring, isolated event beyond its control that could not be reasonably anticipated, all of its other held-to-maturity investments must be reclassified as available-for-sale for the current and next two financial reporting years.

Regular way purchases or sales of a financial asset.

IFRS 9 Financial instruments: External resources

A regular way purchase or sale of financial assets is recognised and derecognised using either trade date or settlement date accounting. The choice of method is an accounting policy. That includes all derivatives. Historically, in many parts of the world, derivatives have not been recognised on company balance sheets. The argument has been that at the time the derivative contract was entered into, there was no amount of cash or other assets paid.

Zero cost justified non-recognition, notwithstanding that as time passes and the value of the underlying variable rate, price, or index changes, the derivative has a positive asset or negative liability value. Initially, financial assets and liabilities should be measured at fair value including transaction costs, for assets and liabilities not measured at fair value through profit or loss. Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction.

Amortised cost is calculated using the effective interest method. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument to the net carrying amount of the financial asset or liability.

Financial assets that are not carried at fair value though profit and loss are subject to an impairment test. If expected life cannot be determined reliably, then the contractual life is used. This option is available even if the financial asset or financial liability would ordinarily, by its nature, be measured at amortised cost — but only if fair value can be reliably measured. Once an instrument is put in the fair-value-through-profit-and-loss category, it cannot be reclassified out with some exceptions. In March the IASB clarified that reclassifications of financial assets under the October amendments see above : on reclassification of a financial asset out of the 'fair value through profit or loss' category, all embedded derivatives have to be re assessed and, if necessary, separately accounted for in financial statements.

A financial asset or group of assets is impaired, and impairment losses are recognised, only if there is objective evidence as a result of one or more events that occurred after the initial recognition of the asset. An entity is required to assess at each balance sheet date whether there is any objective evidence of impairment.

If any such evidence exists, the entity is required to do a detailed impairment calculation to determine whether an impairment loss should be recognised. Assets that are individually assessed and for which no impairment exists are grouped with financial assets with similar credit risk statistics and collectively assessed for impairment. If, in a subsequent period, the amount of the impairment loss relating to a financial asset carried at amortised cost or a debt instrument carried as available-for-sale decreases due to an event occurring after the impairment was originally recognised, the previously recognised impairment loss is reversed through profit or loss.

Impairments relating to investments in available-for-sale equity instruments are not reversed through profit or loss. A financial guarantee contract is a contract that requires the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due.

Some credit-related guarantees do not, as a precondition for payment, require that the holder is exposed to, and has incurred a loss on, the failure of the debtor to make payments on the guaranteed asset when due. An example of such a guarantee is a credit derivative that requires payments in response to changes in a specified credit rating or credit index. 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.

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.

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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. 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.

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. A gain or loss from extinguishment of the original financial liability is recognised in profit or loss. Hedging instrument is an instrument whose fair value or cash flows are expected to offset changes in the fair value or cash flows of a designated hedged item. All derivative contracts with an external counterparty may be designated as hedging instruments except for some written options.

A non-derivative financial asset or liability may not be designated as a hedging instrument except as a hedge of foreign currency risk. For hedge accounting purposes, only instruments that involve a party external to the reporting entity can be designated as a hedging instrument. This applies to intragroup transactions as well with the exception of certain foreign currency hedges of forecast intragroup transactions — see below.

Presenting and Disclosing Financial Instruments in Accordance with IAS 32 and IFRS 7

However, they may qualify for hedge accounting in individual financial statements. Hedged item is an item that exposes the entity to risk of changes in fair value or future cash flows and is designated as being hedged.

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A fair value hedge is a hedge of the exposure to changes in fair value of a recognised asset or liability or a previously unrecognised firm commitment or an identified portion of such an asset, liability or firm commitment, that is attributable to a particular risk and could affect profit or loss. At the same time the carrying amount of the hedged item is adjusted for the corresponding gain or loss with respect to the hedged risk, which is also recognised immediately in net profit or loss.

A cash flow hedge is a hedge of the exposure to variability in cash flows that i is attributable to a particular risk associated with a recognised asset or liability such as all or some future interest payments on variable rate debt or a highly probable forecast transaction and ii could affect profit or loss.

If a hedge of a forecast transaction subsequently results in the recognition of a financial asset or a financial liability, any gain or loss on the hedging instrument that was previously recognised directly in equity is 'recycled' into profit or loss in the same period s in which the financial asset or liability affects profit or loss. A hedge of a net investment in a foreign operation as defined in IAS 21 The Effects of Changes in Foreign Exchange Rates is accounted for similarly to a cash flow hedge.

A hedge of the foreign currency risk of a firm commitment may be accounted for as a fair value hedge or as a cash flow hedge. In June , the IASB amended IAS 39 to make it clear that there is no need to discontinue hedge accounting if a hedging derivative is novated, provided certain criteria are met. For the purpose of measuring the carrying amount of the hedged item when fair value hedge accounting ceases, a revised effective interest rate is calculated. If hedge accounting ceases for a cash flow hedge relationship because the forecast transaction is no longer expected to occur, gains and losses deferred in other comprehensive income must be taken to profit or loss immediately.

If the transaction is still expected to occur and the hedge relationship ceases, the amounts accumulated in equity will be retained in equity until the hedged item affects profit or loss. If a hedged financial instrument that is measured at amortised cost has been adjusted for the gain or loss attributable to the hedged risk in a fair value hedge, this adjustment is amortised to profit or loss based on a recalculated effective interest rate on this date such that the adjustment is fully amortised by the maturity of the instrument.

Amortisation may begin as soon as an adjustment exists and must begin no later than when the hedged item ceases to be adjusted for changes in its fair value attributable to the risks being hedged. These words serve as exceptions. Once entered, they are only hyphenated at the specified hyphenation points.

Alternative 1: Simplified Approach.

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The simplified approach can be applied for trade receivables, contract assets and lease receivables that do not have significant financing component normally held by entities that do not have sophisticated credit risk management systems like financial institutions. Under the simplified approach, there is no need to calculate a month ECL and assess whether a significant increase in credit risk has occurred. A loss allowance should be measured at initial recognition and throughout the life of the receivable at an amount equal to lifetime ECLs for the assets.

Alternative 2: Purchased or Originated Credit-impaired Assets. Purchased or originated credit-impaired assets refer to assets that have observable evidence of impairment at the point of initial recognition for example, the financial asset was purchased at a deep discount, or the borrower had significant financial difficulty at initial recognition of asset.

In such a scenario, the initial month ECLs would have already been reflected in the fair values at which they were initially recognized. Recording a 12 month-ECL allowance over the discounted financial assets would be double counting the credit losses for these assets with high credit risk. For such assets, there is therefore no need to account for an additional month ECL allowance on initial recognition. Most businesses implement some risk management strategies to manage their exposures to different risks like interest rate, exchange rate or commodity price risks.

Applying hedge accounting to its financial instruments for hedging is a matter of choice for companies. Hedge accounting affects the timing of recognition of hedging gains and losses. By applying hedge accounting, entities can better match the gains or losses of the hedging instrument with gains or losses of their corresponding hedged items. If an entity chooses not to apply hedge accounting, hedging instruments will need to be classified and measured like any other financial instruments, as required by IFRS 9. With hedge accounting, the hedging instrument will be matched with its corresponding hedged item, so that gains and losses on both the hedging instrument and hedged item are recognized in the same accounting period.

There are 3 main types of hedge relationships:. This is a new change under IFRS 9. Gains or losses on the hedging instrument to be recognized in OCI cash flow hedge reserve should be the lower of:. In other words, if the amount in i exceeds the amount in ii , i. For forecast transactions that result in recognition of a non-financial asset or liability e. The accounting for net investment hedges is similar to that of cash flow hedges. As exchange differences arising from consolidation of net assets hedged item are recognized as foreign currency translation reserve in OCI, gains or losses on the hedging instrument are also recognized in OCI, to the extent that the hedge is effective.

Hope this gives you a good understanding of the main points covered in IFRS 9 and IAS 39, and you can better appreciate how financial instruments are recorded in the financial statements! Login Sign up. Username or Email. Forgot password?