The New Ap­proach

Con­sid­er­ing busi­ness mod­els and for­ward-look­ing in­for­ma­tion

Southeast Asia Globe - - Advertorial -

The In­ter­na­tional Ac­count­ing Stan­dard Boards (IASB) de­cided to re­place IAS 39 with IFRS 9 Fi­nan­cial In­stru­ments in re­sponse to strong crit­i­cisms of that Stan­dard in the after­math of the global fi­nan­cial cri­sis of 2007/8.

IFRS 9 fun­da­men­tally rewrites the ac­count­ing rules for fi­nan­cial in­stru­ments. A new ap­proach for fi­nan­cial as­set clas­si­fi­ca­tion is in­tro­duced, and the now dis­cred­ited in­curred loss im­pair­ment model is re­placed with a more for­ward-look­ing ex­pected loss model.

As IFRS 9’s manda­tory ef­fec­tive date is fi­nan­cial year on or af­ter 1 Jan­uary 2018, we strongly sug­gest that com­pa­nies should have adopted the new Stan­dard now. As well as the im­pact on re­ported re­sults, many busi­nesses, par­tic­u­larly busi­nesses in bank­ing sec­tor, will need to col­lect and an­a­lyse ad­di­tional data and im­ple­ment changes to sys­tems.

Cer­tain key ar­eas of the new IFRS 9 in­clude:

Clas­si­fi­ca­tion and mea­sure­ment

The clas­si­fi­ca­tion and mea­sure­ment of fi­nan­cial as­sets was one of the ar­eas of IAS 39 that re­ceived the most crit­i­cism dur­ing the fi­nan­cial cri­sis.

Un­der IFRS 9, each fi­nan­cial as­set is clas­si­fied into one of three main clas­si­fi­ca­tion cat­e­gories: Amor­tised cost

Fair value through other com­pre­hen­sive in­come (FVTOCI)

Fair value through profit or loss (FVTPL). The clas­si­fi­ca­tion is de­ter­mined by both: The en­tity’s busi­ness model for manag­ing the fi­nan­cial as­set (‘busi­ness model test’); and

The con­trac­tual cash flow char­ac­ter­is­tics of the fi­nan­cial as­set (‘cash flow char­ac­ter­is­tics test’).

The Busi­ness Model Test

IFRS 9 uses the term ‘busi­ness model’ in terms of how fi­nan­cial as­sets are man­aged and the ex­tent to which cash flows will re­sult from col­lect­ing con­trac­tual cash flows, sell­ing fi­nan­cial as­sets or both. The Stan­dard pos­i­tively de­fines two such ‘busi­ness mod­els’: A busi­ness model whose ob­jec­tive is to hold the fi­nan­cial as­set in or­der to col­lect con­trac­tual cash flows (‘hold to col­lect’)

A busi­ness model in which as­sets are man­aged to achieve a par­tic­u­lar ob­jec­tive by both col­lect­ing con­trac­tual cash flows and sell­ing fi­nan­cial as­sets (‘hold to col­lect and sell’).

The cash flow char­ac­ter­is­tics test

The sec­ond con­di­tion for clas­si­fi­ca­tion in the amor­tised cost clas­si­fi­ca­tion or FVTOCI can be la­belled the ‘solely pay­ments of prin­ci­pal and in­ter­est’ (SPPI) test. The con­trac­tual terms of the fi­nan­cial as­set must give rise on spec­i­fied dates to cash flows that are solely pay­ments of prin­ci­pal and in­ter­est on the prin­ci­pal amount out­stand­ing.

For the pur­pose of ap­ply­ing this test, ‘prin­ci­pal’ is the fair value of the fi­nan­cial as­set at ini­tial recog­ni­tion. ‘In­ter­est’ con­sists of con­sid­er­a­tion for: The time value of money

The credit risk as­so­ci­ated with the prin­ci­pal amount out­stand­ing dur­ing a par­tic­u­lar pe­riod of time

Other ba­sic lend­ing risks and costs

A profit mar­gin.

Ex­pected credit losses

In pub­lish­ing these re­quire­ments, the IASB aims to rec­tify what was per­ceived to be a ma­jor weak­ness in ac­count­ing dur­ing the fi­nan­cial cri­sis of 2007/8, namely the recog­ni­tion of credit losses at too late a stage. IAS 39’s ‘in­curred loss’ model de­layed the recog­ni­tion of credit losses un­til ob­jec­tive ev­i­dence of a credit loss event had been iden­ti­fied. In ad­di­tion, IAS 39 was crit­i­cised for re­quir­ing dif­fer­ent mea­sures of im­pair­ment for sim­i­lar as­sets de­pend­ing on their clas­si­fi­ca­tion.

IFRS 9’s im­pair­ment re­quire­ments use more for­ward-look­ing in­for­ma­tion to recog­nise ex­pected credit losses. Also, in con­trast to IAS 39, the amount of loss al­lowance is not af­fected by the clas­si­fi­ca­tion of the as­set at amor­tised cost or FVTOCI. Recog­ni­tion of credit losses are no longer de­pen­dent on the en­tity first iden­ti­fy­ing a credit loss event. In­stead an en­tity should con­sider a broader range of in­for­ma­tion when as­sess­ing credit risk and mea­sur­ing ex­pected credit losses, in­clud­ing: Past events, such as ex­pe­ri­ence of his­tor­i­cal losses for sim­i­lar fi­nan­cial in­stru­ments Cur­rent con­di­tions

Rea­son­able and sup­port­able fore­casts that af­fect the ex­pected col­lectabil­ity of the fu­ture cash flows of the fi­nan­cial in­stru­ment.

The three-stage process

The three-stage process re­flects the gen­eral pat­tern of de­te­ri­o­ra­tion of credit qual­ity of a fi­nan­cial in­stru­ment and is il­lus­trated in more de­tail below. This three-stage model is sym­met­ri­cal – in other words fi­nan­cial as­sets are re­clas­si­fied back from stages 2 or 3 (life­time ex­pected losses) to stage 1 (12-months ex­pected losses) if an ear­lier sig­nif­i­cant de­te­ri­o­ra­tion in credit qual­ity sub­se­quently re­verses, or the ab­so­lute level of credit risk be­comes low.


The tran­si­tion to IFRS 9 is mainly ret­ro­spec­tive, apart from the hedge ac­count­ing re­quire­ments. How­ever, a purely ret­ro­spec­tive ap­proach would be pro­hib­i­tively com­plex and po­ten­tially im­prac­ti­cal. IFRS 9 there­fore in­cludes var­i­ous de­tailed ex­emp­tions and sim­pli­fi­ca­tions.

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