IFRS 9 Financial Instruments

• Study notes on IFRS 9 Financial Instruments Compiled by Murtaza Quaid, ACA

Topic Overview of IFRS 9 and Related Standards

• IAS 32 covers the presentation of financial instruments.
• IFRS 9 focuses on the recognition and measurement of financial instruments.
• IFRS 7 addresses disclosures related to financial instruments.
• IFRS 13 outlines fair value measurement principles.
• IAS 21 covers the effects of changes in foreign exchange rates.
• IFRIC 16 addresses hedges of a net investment in a foreign operation.
• IFRIC 19 discusses extinguishing financial liabilities with equity instruments.

Key Definitions: Financial Instruments

• A financial instrument creates a financial asset for one entity and a financial liability or equity instrument for another.
• A financial asset is cash, an equity instrument of another entity, a contractual right to receive cash or another financial asset, or a contractual right to exchange financial assets/liabilities under favorable conditions.
• A financial liability is a contractual obligation to deliver cash or another financial asset to another entity, or to exchange financial assets/liabilities under unfavorable conditions
• An equity instrument represents a residual interest in the assets of an entity after deducting all liabilities, such as equity shares or share options.

Examples of Financial Instruments

• Financial Asset examples include cash, investments in equity shares, receivables, investments in debentures, redeemable preference shares, and favorable forward currency contracts.
• Financial Liability examples include trade payables, bank loans, issued debentures, redeemable preference shares, and unfavorable forward currency contracts.
• Equity examples include ordinary shares issued and irredeemable preference shares issued.

Substance Over Form in Financial Instruments

• Some financial instruments may take the legal form of equity but, in substance, are liabilities, such as redeemable preference shares.
• Dividends on redeemable preference shares classify as finance costs in profit or loss.
• Dividends on ordinary shares go in the statement of changes in equity.

Recognition of Financial Instruments

• An entity recognizes a financial asset or liability only when it becomes a party to the instrument's contractual provisions.

Classification of Financial Instruments

• Financial assets can classify as debt or equity investments.
• Debt investments may be measured at amortized cost, fair value through other comprehensive income (OCI), or fair value through profit or loss (PL).
• Equity investments are measured at fair value through OCI or PL.
• Financial liabilities are measured at amortized cost or fair value through PL.
• Equity instruments have no classification

Classifying Financial Assets

• Determine if the asset is an equity investment by asking if it is held for trading.
• Determine if the asset's cash flows solely comprise principal and interest.
• See if the business model's objective is to hold and collect contractual cash flows
• Assess if the business model aims to collect contractual cash flows and sell financial assets
• An entity irrevocably elect the OCI option at initial recognition.

Key Terms: Effective Interest Rate Method

• It calculates the amortized cost of a financial asset/liability and recognizes interest revenue (expense) in PL over the period.
• It is the Internal Rate of Return (IRR) that exactly discounts future cash flows to the initial recognition amount, resulting in a net present value of zero.

Key Terms: Coupon Rate

• Coupons are the annual interest paid on a bond, expressed as a percentage of face value and paid from the issue date until maturity.

Amortized Costs

• This is how a financial asset or liability measures at initial recognition.
• It Deduct principal repayments and add/subtract cumulative amortization using the effective interest method of any difference between initial and maturity amounts.

Transaction Costs

• Transaction costs are costs directly related to the acquisition, issuance, or disposal of a financial instrument. Examples are fees, commissions, levies, transfer taxes, credit assessment fees, and registration charges.
• Incremental costs is one that would not have occurred if not for the acquisition, issuance, or disposal of the financial instrument.
• Financing costs, internal administration costs, and holding costs do not qualify as transaction costs.

Fair Value of Debt Instrument

• This reflects the price at which the debt instrument would transact between market participants in an orderly transaction at the measurement date.

Equity Investment at Fair Value Through OCI

• Equity instrument classifies/measures at FVTOCI if it is not held for trading and the entity has elected an irrevocable choice for this designation upon initial recognition.
• Equity investment at FVTOCI is initially measured at fair value plus transaction costs, and subsequently measured at fair value.
• Changes in fair value recognize in OCI, dividend income recognizes in P/L, and foreign exchange gains/losses go in OCI.
• The fair value reserve is not recycled to P/L on disposal but can be transferred between reserves within equity.

Equity Investment at Fair Value Through P/L

• This is how an equity instrument classifies/measures if it is held for trading or the entity has not elected to classify it as at FVTOCI.
• Equity investment at FVTPL initially measures at fair value, with transaction costs immediately recognized in P/L.
• Equity investment at FVTPL is subsequently measured at fair value.
• Changes in fair value, dividends, and foreign exchange gains/losses recognize in P/L.

Debt Investment at Amortized Cost

• A debt instrument that needs two conditions is measured here, unless designated at FVTPL under the fair value option.
• 'Hold-to-collect’ business model test: to hold the financial asset to collect contractual cash flows.
• 'SPPI' contractual cash flow characteristics test: financial asset give rise to cash flows that are solely payments of principal and interest (SPPI) on the principal amount outstanding on a specified date.
• Debt investment at amortized cost is initially measured at fair value plus transaction costs, and subsequently measured at amortized cost.
• Interest income classifies in P/L using the effective interest rate, foreign exchange gains and losses recognizes in P/L, and credit impairment losses/reversals recognizes in P/L using credit impairment methodology.
• A financial asset may designate as FVPL instead, if classifying at AC would have caused an accounting mismatch.

Debt Investment at Fair Value Through OCI

• These debt instrument meet two conditions, unless designated at FVTPL under the fair value option:
• 'Hold to collect and sell' business model test: achieved by holding the financial asset in order to collect contractual cash flows and selling the financial asset.
• 'SPPI' contractual cash flow characteristics test: contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.
• Debt investment at FVTOCI initially measures at fair value plus transaction costs and subsequently measures at fair value.
• Interest income, foreign exchange gains/losses are in P/L.
• The change in the carrying amount on remeasurement recognizes in OCI.
• Credit impairment losses/reversals go in P/L using credit impairment methodology.
• The cumulative fair value gain or loss recognized in OCI is recycled from OCI to P/L when the related financial asset is derecognized.
• If classifying at FVOCI would have caused an accounting mismatch, a financial asset may designate as FVPL instead.

Debt Investment at Fair Value Through P/L

• Fair value through profit or loss (FVTPL) is the residual category under IFRS 9.
• A debt instrument classifies through profit or loss unless it measures at amortized cost or at fair value through other comprehensive income.
• Debt investment at FVTPL initially measures at fair value, with transaction costs immediately recognized in P/L.
• Debt investment at FVTPL is subsequently measured at fair value.
• Subsequent changes in fair value recognizes in P/L.
• Interest income is recognized in profit or loss using the effective interest rate
• FX gains and losses classify in profit or loss.

Accounting Treatment: Financial Asset

• For Equity Investment FVOCI: initial measure at fair value + TC, expensed out, subsidy measure at fair value, A in fair value goes in OCI
• For Equity Investment FVPL: initial measure at fair value, expensed out, subsidy measure at fair value, A in fair value goes in P/L
• For Debt Investment FVPL: initial measure at fair value + TC, expensed out, subsidy measure at fair value, A in fair value goes in P/L
• For Debt Investment FVOCI: initial measure at fair value + TC, capitalized, subsidy measure at fair value, A in fair value goes in OCI
• For Debt Investment Amortized Cost: initial measure at fair value + TC, capitalized, subsidy measure at fair value, A in fair value goes in OCI
• Equity Investment FVOCI, FCY gain goes in OCI, Equity Investment FVPL FCY gain goes in P/L, Debt Investment FVPL FCY gain goes in P/L, Debt Investment FVOCI FCY gain goes in P/L, Debt Investment Amortized Cost FCY gain goes in P/L
• Equity Investment FVOCI dividend/interest goes to P/L, Equity Investment FVPL dividend/interest goes to P/L, Debt Investment FVPL dividend/interest goes to P/L (IRR), Debt Investment FVOCI dividend/interest goes to P/L (IRR), Debt Investment Amortized Cost dividend/interest goes to P/L (IRR)
• Gain/loss on derecognition of any of these goes to P/L
• Not allowed to go to P/L recycling of gain/loss on derecognition

Classifying Financial Liabilities

• Are the liabilities derivative or financial?
• See if they are designated under fair value
• If no to these two questions, you have Financial Liability Amortized Cost, otherwise you have Financial Liability FVPL.

Financial Liability at Amortized Cost

• It is classified/measured at amortized cost, unless the financial liability is a derivative or for trading (must be measured at FVTPL), or the entity elects to measure the financial liability at FVTPL to eliminate accounting mismatch.
• Examples: Trade payables, Loan payables with standard interest rates, Bank borrowings.
• Initial measure at fair value less transaction costs.
• Subsequent measures at amortized cost.
• Recognize Interest exchange in P/L using the effective interest rate.
• Recognize FX gains and losses on the amortized cost in P/L.

Financial Liability at Fair Value Through P/L

• At initial recognition, a financial liability is classified and measured at fair value through profit (FVPL) if the liability is a derivative or held for trading, or the entity elects to measure the financial liability at FVTPL to eliminate accounting mismatch.
• Examples: Interest rate swaps, Commodity futures/option contracts, Foreign exchange future/option contracts, Convertible note liabilities designated at FVTP;L and Contingent consideration payable that arises from one or more business combinations.
• Financial liability at FVTPL is initially measured at fair value, and transaction costs are immediately recognised in P/L.
• Financial liability at FVTPL is subsequently measured at fair value.
• Interest exchange is recognized in P/L using the effective interest rate, foreign exchange gains/losses go in profit or loss, and change in the carrying amount on remeasurement to fair value is recognised in P/L.
• Change in fair value that relate to the change in the entity's own credit status recognizes in OCI (instead of P/L).
• On derecognition of the financial liability, the cumulative change in fair value arising from change in entity's own credit status is required to remain in OCI and is not recycled to P/L, though IFRS 9 permits entities to transfer the amount between reserves within equity.

Accounting Treatment - Financial Liability

• Initial measure the Financial Liability Amortized Cost at Fair value – TC, otherwise measure at Fair value
• Expensed out Financial Liability at FVPL, otherwise capitalized
• Subs measurement is Amortized cost for Financial Liability Amortized Cost, otherwise measure at fair value
• in fair value for Financial Liability Amortized Cost is Not applicable, otherwise P/L (except gain in fair value due to gain in credit risk – OCI)
• FCY gain / (loss) go to P/L for both
• P/L (IRR) for interest expense for both

Equity Instruments

• Defined as any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.
• Equity instruments initially recognize at fair value less any transaction costs. When equity shares give are issued, they are recorded at a nominal value, with the excess consideration received being classified in Premium account.
• Transaction costs classifies as a deduction from equity
• Distributions to holders of an equity instrument classifies directly in equity, but changes in the fair value is not classified in the financial statements.
• Redemptions or re-financings of equity instruments recognize as changes in equity.

Treasury Shares

• These shares deduct from equity if they are shares that are bought back
• Gains and Losses classifyin P/L on the issue, repurchase or cancellation of an entity's own equity instruments, otherwise its classifiesdirectly in equity. They may be bought back by other members of the consolidated entity

Regular Way Transaction

• It buy or sells a financial asset under terms requiring asset delivery within the timeframe established by marketplace regulation/convention.
• An entity accounts for regular way purchase/sale of financial assets using trade date or settlement date accounting.
• They apply the same method to all purchases and sales of similar classified financial assets.

Regular Way Transaction

• Entity accounts for changes in fair value this way: not measured for assets measured at amortized cost and measured in P/L or OCI if measured at fair value.
• Trade date accounting - recognize or de-recognize asset and liability on that date.
• Settlement date accounting - recognize or de-recognize an asset on the date it is delivered by, or to, another entity.

Financial Liability or Equity?

• Classification of financial instruments as debt versus equity affects how debt and equity are presented.
• Classify financial instrument as financial liability (debt): report item within current or non-current liabilities and interest/dividend payments, gains/losses go in profit and loss.
• Classify financial instrument as equity: distributions go in statement of changes in equity and do not affect reported profit.

Financial Liability or Equity?

• Classification as a financial liability increases gearing and reduces reported profit.
• Classification as equity decreases gearing and has no effect on reported profit.
• Getting the classification right is important. IAS 32 strives to follow a substance-based approach (rather than legal form) to show items that behave like debt or equity.

Financial Liability or Equity?

• A financial liability has a contractual obligation to deliver cash/financial assets or exchange financial instruments with another entity on potentially unfavorable terms.
• An equity instrument offers the residual interest in the company's assets after deducting all liabilities.
• If there is contractual obligation to deliver cash/financial instrument or to exchange financial assets/liabilities in unfavorable conditions, then it is a financial liability.

Financial Liability or Equity?

• An entity issues a share to another party: entity is not obliged to deliver cash (or another financial instrument) to the shareholder; the payment of dividends is at the discretion
• The substance of a financial instrument classifies, rather than its legal form. Certain legally classified equity instruments have financial liabilities and so the classifications should reflect that.
• Redeemable preference shares that are required, under the terms of its issue, to be redeemed at a specified date for a specified amount is a financial liability.

Financial Liability or Equity?

• A contract resulting in the receipt or delivery of an entity's own shares is not automatically equity. The classification depends on the so-called 'fixed test' in IAS 32.
• The contract settles by the entity delivering a fixed number of its own equity instruments in exchange for a fixed amount of cash which is an equity instrument.
• By fixing upfront the number of shares to deliver on settlement of the instrument in question, the holder is exposed to the upside and downside risk of movements in the entity's share price, which is why it is equity.
• If the amount of cash or own equity shares to deliver is variable, then the contract is a financial liability. Why? Because using a variable number of instruments to settle a contract makes similar to using currency, so it is inapropriate

Financial Liability or Equity?

• Instruments classifying as liability with dividends are non-discretionary; with redemption is at the option of instrument holder; a instrument with limited life; or redemption triggered by a future uncertain event beyond the control of both the issuer and the holder of the instrument.
• Instruments classifying as equity with dividends are discretionary; with shares classifiedas non-redeemable; or those instruments with liquidation date.

Preference Shares: Debt or Equity?

• They give fixed-amount payments each year to shareholders, before dividends get delivered, or are ahead of any distributions that need to make during a windup.
• Types: redeemable, irredeemable (perpetual) preference shares and convertible .

Classification of Preference Shares

• Company should classify based on its characteristics as:Fin liability; equity and with compound components containing both liability and equity.
• The key to determining when to use equity: how much does the entity need to make payments to pre shareholders.

Preference Shares: Debt or Equity?

• Redemption is mandatory: classify as financial liability, shares get obligation.
• Redemption at the choice of the holder: classify as financial liability, shares get obligation.
• Redemption at the choice of the issuer: classify as Equity; shares do not get the deliver cash.

Irredeemable Non-cumulative Preference Shares

• Classifiesas Equity, cause entities have no obligation to the sharesholder and those people only have right.

Compound Financial Instrument

• Combines both the liability and equity components and is non-derivative.
• Key components: financial liability (an issuer's contract to pay cash) and equity instruments (a way to convert a loan to equities given.
• Ex: convertable bonds where bonds get issued, and with the risk that it will give risk to other equities or cash payment if needed.
• These bonds give lower interest rate which can increase risk.
• They split equity component from debt component
• Issue costs allocated from equity vs liability based on previously recognized pro rata.

Compound Financial Instrument

• If Conversion is Exercised: derecognize debt with capital/premium as equity.
• The old component stays as equity whether by transfer or not!.
• The higher the conversion, the more shares get given; with gains and losses being recognized in P/L.
• If Conversion is NOT Exercised then derecog lia with cash/bank as credit.

Loan Repurchase

• Allocations: recalculate consideration or transaction cost base off components for liability/equity and with gain recognize with the lia.
• Allocations: recoganize the equities

Modification/Restructuring of Financial Asset

• Recalcu all modifed flows by discounted base using old rate for effecteness. (use carry amount).
• Look modifications/Recieve payments into carrying asset as amortized. Use rate to amortization

Modification/Restructuring Of Fin Liability

• To recognize an existing Loan; get consent from the lender to look at pay and the terms. The asset mod comes if terms are significantly different from rate.
• The discount value of new terms and fees are 10% with old val at risk.
• Check the discounted of old and add and take and look for all terms

Modification/Restructuring Financial Liability: Accounting

• The loan must be a substantially big: dereg or record value in place.
• Do not derecorig at value at all; recalculate and then discount cashflows. Compare and then mod amount at the rate.

Modification/Restructuring Financial Liability

• Original Loans that modify: get added to P/L since new loan to look over costs and gains for extinguishs.

Modification/Restructuring -Terms

The value is changed for amortitzation to calulate modification of liability.

Impairment of Financial Assets

• It operates to incur only the lost which it can impair and the recovery.
• Standard looks to address institutions recognition of credit over assets.

Expected Loss Model

• Credit losses- the differences which all cashflows or receivables get discounted.
• It all adds with risk to with with loss weighted as avg.
• What it gets to go on life-time : it adds with credit from default on its asset.
• What goes on to the month value - The amounts with is by default.

Expected Loss Model

• Key: IFRS to check the stages to be impaired. The rate must be looked over then and expected at rate!
• The stages are then based with new rates and amounts over the time.
• The stages get written by ammount

Expected Loss Model

• What is in scope over IFRS9: debt and assets, guarantees, leases over custom.
• Rules doesn't add to value if it impairs of expected loss

Expected Loss Model

• Simplified- its all receivable when components gets financed; contract if it is less at loss.
• General - debts get measured at rates with FVO.
• Entities should choose policy accounting when looking and appliacting it,

General Approach for Expected Loss

• General: Follow to value of fair and it adds over income
• At initation with all credit assets; look at months and get them valued through recognition.

Subsequest

• Check what assectments need to be done, it adds on values for all things.
• Credit is what you include from econ or martket.
• For a credit that does get to impare: Asset gets written off
• future Interest gets recognize over rates with new amort

General Approach at Impariment over Assets

• When events can impact cashflows. It can be used to look at data: such as issue default.
• • If all estimates is done; then it measure with cashflows from rate.

FUTURE RECOG NITION

• Interest it added later all by amortization

Model: Expected Loss on General

• It applies to measured with equal at cost.
• It gives risk with credits by months and time with those risks.
• It it recognised at profit.

General Ap: Loss allowance

• Moves for credit recognized at the cost off sets (set with the assets )It give is preesentative look which does lower the doubles.
• Value of fair: gets the income- the is where income recognizes over what the cost to value.

Gen Approach Presentation

• Credits will be on types
• debt measure its amor- recognize the profit ( with helds assets over it ) look the carry!
• Portiol with it: portion is a credit and income

Model: SIMP

• Assets or recievables must value to their limits.
• Recived that value must calc matrix off assets.

Over Credit values:

• An asset that pay to is impaire with no sepa.
• Value must check for sub; gets recoganazed for ALL
• Interest must effect rates

Reclassification for values

• Gets reclass when it changes.
• Gets only check and determine over managment internally or externally.
• Must revalue over 1st day or periods from that action.
• Get investments but not debt, equities get held.

Equity. is not allowed.

• Standard that exisits
• what occurs with it; those in place or that not are different.

Reclass by Change

• Commerical with loan.
• portofiol is no longer and with acquired those rates occur
• it decided to with retail at the sale off store

Reclass- that does not

_ It was not made with intent.

• It can disappear from martket in a split second
• transfers and that that rate has to

Reclass Meas

• It will continuu to fair with fair value for amortizied,
• Rate based off value does effect its impairement
• fair v- adjust the fair with loss or amount
• check initial because that rate stays consistent.

Derivatives

• When you relook with changing values over rates and numbers and its on a future date
• futures, contracts options and all common swaps exisit
• will depend with rates; look over it with contract

Can use for a hedge to speculate : initauly should fair value all, at rates

_ look over then as that the rate is

Futures

Contracts standers that allow to buy or sell items At its quality with excha change at hand _ get setted in cash.

FORWAR

its tailoremd as contact that allows the buy or sell. its on spec date at some price agreed. settlement that adds or accurs . doesn'tdo what others do

options:

the the conatract or can be bought or sold with set prcies. The option difffers from one, or is not ever there with holder.

swaps

An agreenmet or rate of that the will is over time and amount

• One pay to that that other with the principle.
• might the be asses.

hedge acc

Its an that in its look in order to lower the price, Companies in a way that to value as the is detrimental. Hedge give and and not get it so and that it is reduced!

pumpkins bought what would fall at it is it?

value of that rate is so at the reporiting

HEEDGE

It allows for to to match and to be at so low its to prepare. Hedge is the optonal . hedge at the meeting criteria: the consits only at hedge - its of risk and what it .

what is that edgeeitem?

the asset with liability , the transactions then get to operation, the entire entity will risk and be deisgnate

what is that hedge instrument?

or that one is liability or fair asset and to the value. It gets and for with a part has can designate instruments