1. Day-5 outline 1
08:30—Accounting for financial instruments in accordance with IFRSs issued at 1 January 2012, but not the IFRSs they will replace
IFRS 9 Financial Instruments
IAS 39 FI Recognition and Measurement
10:30—IASB’s project to replace IAS 39
11:30—Quiz/discussion/case
13:30—IFRS 7 FI Disclosures
14:30—IFRS 4 Insurance Contracts
16:00—Quiz/discussion/case
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

2. Accounting for financial instruments— IFRS 9 and IAS 39 at 1 January 2012
Joint World Bank and IFRS Foundation ‘train the trainers’ workshop hosted by the ECCB
30 April to 4 May 2012

3. Introduction 3
Replace IAS 39 Recognition and Measurement with IFRS 9 Financial Instruments in phases
Phase I: Classification and measurement (completed)
Phase II: Impairment (in progress)
Phase III: Hedge accounting (in progress)
Offsetting financial assets and financial liabilities (completed)
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

4. IFRS 9 Effective date and transition
IFRS 9 effective 1 January 2015
early application permitted
Restatement of comparative financial statements not required
modified disclosures on transition
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

5. IFRS 9 Main changes from IAS 395
Reduces complexity
only two classification categories
single impairment model (only FI’s at amortised cost)
embedded derivatives no longer separated from financial asset host contracts
Aligns measurement of financial assets with entity’s ‘business model’ and contractual cash flow characteristics of instruments
‘Own credit’ risk issue addressed
Elimination of ‘tainting rules’
that caused bonds to be measured at fair value even if the business model was to hold
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

6. Classification and measurement Financial assets6
Fair Value
(No impairment)
Amortised cost
(one impairment method)
Contractual cash flow characteristics
Business model test
FVO for accounting mismatch (option)
All other Instruments:
Equities
Derivatives
Some hybrid contracts
Equities: OCI presentation available
(alternative)
Reclassification required when business model changes
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 6

7. Financial Assets At amortised cost
Business model:
objective of holding instruments is to collect contractual cash flows rather than to sell prior to contractual maturity to realise fair value changes
not an instrument by instrument approach to classification
assess contractual terms of instruments within such a business model
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

8. Financial Assets At amortised cost continued
Contractual cash flow characteristics
Payments represent solely principal and interest
Interest is consideration for time value of money and credit risk
Prepayment/extension options may qualify
No ‘tainting’ rules for assets at amortised cost
gains or losses from derecognising such items to be presented separately with additional disclosures
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

9. Financial Assets Equity investments: OCI alternative
Alternative presentation of fair value changes in other comprehensive income (OCI)
Scope
investments in equity instruments not held for trading
Features
alternative available instrument by instrument
dividends recognised in P&L
no recycling, impairment or change in presentation
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

10. part of classification
Financial Assets Embedded derivatives
Hybrid contracts
Financial host
Non-financial host
No separation –
part of classification
IAS 39 guidance retained
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 10

11. Fair value option available, if…
Financial Assets Fair Value Option (FVO)
Fair value option available, if…
Accounting mismatch
Managed on fair value basis
Embedded derivative(s)
Not managed to collect contractual cash flows = FV
Hybrid contracts with financial host classified in entirety
*Circumstances when FVO available is unchanged for financial liabilities
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 11

12. Financial Assets Application guidance
Unquoted equities and their derivatives
Fair value measurement required
Cost may be an appropriate estimate of fair value
if more recent information not available or a wide range of outcomes
Does not apply to equities held by financial institutions and investment funds
Contractually linked and non-recourse instruments
Detailed application guidance
‘Look through’ approach
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

13. Financial Assets Summary of Key Changes
IAS 39
IFRS 9
Classification
Many categories each with different measurement methods
Two measurement bases: Amortised cost and Fair Value
Measurement
Irrevocable option at initial recognition to present fair value changes of some equity investments in OCI
Impairment
Different impairment rules depending on category and instrument type
Only debt instruments at amortised cost are tested for impairment
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

14. Financial Assets Summary of Key Changes continued
IAS 39
IFRS 9
Tainting
Tainting rules for held to maturity investments
No tainting rules
Reclass- ification
Some reclassifications permitted/required
Reclassifications required if and only if business model changes
Embedded derivatives
Bifurcation of embedded derivatives required in some cases
No separation, same classification approach (for hybrid financial assets with financial hosts)
FVO
Available if specific criteria are met
Available if eliminating or significantly reducing an accounting mismatch
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

15. Example 1: Equity investment15
Held for trading
Fair value - with changes recognised in profit or loss
Not held for trading
Fair value – irrevocable choice of recognising changes in profit or loss or OCI
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 15

16. Example 2: Debt investment (basic loan features)16
Held to collect contractual cash flows
Amortised cost
(FVO available if criteria are met)
Not held to collect contractual cash flows
Fair value through profit or loss
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 16

17. Example 3: Debt investment (embedded derivative)17
Hybrid contract (as a whole) has basic loan features and is Held to collect contractual CFs
Whole instrument at amortised cost
All other hybrid contracts with financial hosts
Whole instrument at fair value through profit or loss
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 17

18. Classification and measurement Financial liabilities
FVO for mismatch, managed on FV basis and hybrids
Amortised cost
Own credit in OCI
All financial liabilities
Except:
Fair value through P&L
Held for trading
Hybrid financial liabilities are bifurcated
No reclassification permitted
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 18

19. Financial Liabilities FVO and own credit
What is ‘own credit’?
fair value changes in liability arising from changes in the issuer’s credit quality
How is it measured?
often measured as change in margin over a benchmark interest rate
What is the concern?
Gain when credit quality deteriorates, loss when credit quality improves
Reporting such gains and losses is not useful
Board’s Request for Information on measurement of liabilities
ED on classification and measurement
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 19

20. Financial Liabilities FVO and own credit continued
To address ‘own credit risk’
Retain IAS 39 measurement requirements for financial liabilities:
held for trading  fair value through P&L
hybrid liabilities  bifurcation requirements in IAS 39
‘vanilla’ liabilities  amortised cost
maintain FVO (with current eligibility conditions)
BUT
Separate out ‘own credit risk’ for FVO
‘Own credit risk’ portion would be separated in a manner similar to that previously used in IFRS 7 for disclosure (IFRS 7 B4)
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

21. Financial Liabilities FVO and own credit continued
Financial liability at FVO
on statement of financial position at (full) fair value
Change in FV attributable to all factors except ‘own credit risk’
Change in FV attributable to ‘own credit’
(not recycled)
Profit or Loss
Profit
XXX
Statement of Comprehensive Income
Other Comprehensive Income
XXX
Mandatory for all liabilities at FVO unless this would create or enlarge an accounting mismatch
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

22. Impairment IAS 39 requirements:22
IAS 39 requirements:
Incurred loss approach for financial assets
Impairment loss only recognised when:
trigger (loss) event occurs
impact can be reliably estimated
More than one model depending on classification
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

23. Impairment continued Criticisms of the incurred loss approach:23 23
Criticisms of the incurred loss approach:
Expected losses not recognised before trigger events
overstates/front-loads interest revenue
results in ‘too little, too late’ recognition of loan losses
triggers inconsistently applied
Does not reflect the underlying economics of the transaction
Need to improve usefulness of financial statements and timing of recognition of losses
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 23 23

24. Hedging ‘Hedging’ and ‘hedge accounting’ are two different things
What is hedging?
managing risks by using one financial instrument (‘hedging instrument’) purposely to offset the variability in FV or cash flows of a recognised asset or liability, firm commitment, or future cash flows (‘hedged item’)
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

25. Example: Hedging
On 1/12/X1 a jeweler purchased 1,000 ounces of gold for $1,500 per ounce to manufacture jewelry whose selling price fluctuates with changes in the gold price
Jeweler is concerned the gold price will decline.
buys an option (settled net in cash) to sell 1,000 ounces of gold at $1,500 anytime in the next two months. The option is measured at FVTPL.
at 31/12/X1 gold price is $1,400
the $100,000 gain on the option is recognised in profit or loss in 20X1– but the ‘loss’ attributable to the reduced selling price will affect profit or loss in the future (ie when the sale is recognised).
Accounting ‘mismatch’
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

26. What is hedge accounting?
Matching the change in FV of the hedging instrument and the hedged item in profit or loss for the same period
Hedge accounting is only an issue when normal accounting would put the two fair value changes in different periods—sometimes referred to as an ‘accounting mismatch’
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

27. Hedge accounting IAS 39 requirements
Hedge accounting recognises the offsetting effects of changes in the fair values or the cash flows of the hedging instrument and the hedged item.
Strict conditions must be met before hedge accounting is possible:
there must be formal designation and documentation of a hedge, including the risk management strategy for the hedge.
the hedging instrument must be expected to be highly effective in achieving offsetting changes in fair value or cash flows of the hedged item that are attributable to the hedged risk. WU
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

28. Types of hedge accounting Fair value hedge accounting
Hedge exposure to fair value changes of recognised asset or liability or unrecognised firm commitment (or portion of these attributable to a particular risk)
Hedge of the foreign currency risk of a firm commitment
Recognition of gains and losses on hedged item and hedging instrument in profit and loss and adjust the carrying amount of the hedged item (if not measured at cost) WU
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

29. Example: Fair value hedge accounting
Entity borrows 1,000, 3 years, 5% fixed rate, payable at the end, measured at amortised cost
Hedged with a derivative whose value is linked to an interest rate index
End of year 1, market rate = 6%. FV of 50 payable in 1 year at 6% + 1,050 payable 2 years at 6% = 50 x ,050 x = 982, but this 18 ‘gain’ is not recognised
Value of the derivative declines to -20
Note: there is small ineffectiveness = 2
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

30. Example: Fair value hedge accounting continued
Financial position when loan made:
Cash 1,000
Loan payable 1,000
Adjust loan end of year 1 to reflect rate change:
Loan payable (hedge acct)
P&L (18 gain – 20 loss) 2
Derivative (Liability)
Financial position end of year 1:
Derivative (Liability) 20
Loan payable 982
Equity 2
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

31. Types of hedge accounting Cash flow hedge accounting
Hedge of the exposure to variability in cash flows attributable to a particular risk associated with
a recognised asset or liability or
a highly probable forecast transaction
Hedge of the foreign currency risk of a firm commitment
Portion of hedge deemed to be effective:
gains and losses recognised in OCI
Portion of hedge deemed to be ineffective:
gains and losses recognised in profit or loss
Treatment of cumulative gains or losses differs based on what ‘type’ of asset or liability is subsequently recognised
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

32. Example: Cash flow hedge accounting
Entity sells goods for 1,000 floating rate 3-year note receivable
Interest rate risk managed with a derivative (interest rate swap)
End of year 1 interest rates increase – PV of cumulative cash flows increase by 100
But FV of swap decreases by 105
Note: Some hedge ineffectiveness
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

33. Example: Cash flow hedge accounting continued
Opening financial position:
Receivable 1,000
Equity 1,000
Ineffective portion of hedge:
P&L 5 (ineffective portion of hedge)
OCI (Equity) 100
Derivative (Liability) 105
Closing financial position:
Equity (OCI) 100 (effective portion of hedge)
Derivative (Liability)
Equity 995
example continued next slide...
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

34. Types of hedge accounting Net investment in foreign operation
Hedge of a net investment in a foreign operation
as defined in IAS 21
accounted for similarly to cash flow hedges WU
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

35. Example: Net Investment in foreign operation
Entity A has a wholly-owned subsidiary, Entity B. Entity has a CU functional currency and Entity B has a FCU functional currency. Entity A paid FCU100,000 for the investment in net assets at fair value of FCU80, Goodwill of FCU20,000 was recognised.
At acquisition, Entity A loaned Entity CU15,000 (exchange rate was FCU2:CU1). Settlement is not planned or expected in the near future.
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

36. Example: Net Investment in foreign operation continued
At acquisition, Entity A designates the net investment in Entity B as a hedged item in its consolidated financial statements.
The maximum amount that can be designated is FCU130,000
Net assets at FV: FCU80,000
Goodwill: FCU20,000
Loan: FCU30,000
If the loan was expected to be settled in the foreseeable future, it would not form part of the net investment.
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

37. Questions or comments?
Expressions of individual views by members of the IASB and its staff are encouraged. The views expressed in this presentation are those of the presenter. Official positions of the IASB on accounting matters are determined only after extensive due process and deliberation.
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

38. 38 38
The requirements are set out in International Financial Reporting Standards (IFRSs), as issued by the IASB at 1 January 2012 with an effective date after 1 January but not the IFRSs they will replace.
The IFRS Foundation, the authors, the presenters and the publishers do not accept responsibility for loss caused to any person who acts or refrains from acting in reliance on the material in this PowerPoint presentation, whether such loss is caused by negligence or otherwise.
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 38