IFRS 9

Financial Instruments
Compiled by: Murtaza Quaid, ACA
 IFRS 9: Financial Instruments

In this Part:
 Definition
 Recognition
 Classification
 Initial Measurement
 Subsequent Measurement
Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments
 DEFINITIONS
A “financial instrument” is a contract that gives rise to both:
Financial  A financial asset in one entity; and
Instrument  A financial liability or equity instrument in another entity.

A “financial asset” is any asset that is:

 Cash; or
 An equity instrument of another entity; or
Financial Asset  A contractual right to receive cash or another financial asset from another entity; or
 A contractual right to exchange financial assets or financial liabilities with another
entity under conditions that are potentially favourable to the entity.

A “financial liability” is any liability that is :

 A contractual obligation to deliver cash or another financial asset to another entity; or
Financial Liability  A contractual obligation to exchange financial assets or financial liabilities with another
entity under conditions that are potentially unfavourable to the entity.

An “equity instrument” is any contract that evidences a residual interest in the assets of an
Equity entity after deducting all of its liabilities. Examples include equity shares and equity share
options issued by an entity.
Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments
 DEFINITIONS

Financial Instrument

Financial Asset Financial Liability Equity

Examples include: Examples include: Examples include:
 Cash in hand or at bank;  Trade Payables;  Ordinary shares
 Investment in equity shares;  Bank loan; issued; and
 Receivables;  Debentures issued;  Irredeemable
preference shares
 Investment in debentures;  Redeemable preference
issued.
 Investment in redeemable preference shares; and shares issued; and
 Favorable forward currency contracts.  Unfavorable forward
currency contracts.

Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments

 DEFINITIONS
 Some financial instruments have the legal form of equity but are, in
substance, liabilities. For example, an issuer (company) has contractual
Substance over obligation to deliver cash in case of redeemable preference shares.
form  Therefore, dividend on redeemable preference shares is treated as finance
cost in profit or loss while dividend on ordinary shares is presented in
statement of changes in equity.

RECOGNITION
 An entity shall recognize a financial asset or a financial liability in
its statement of financial position, when, and only when, the
entity becomes party to the contractual provisions of the
financial instrument.

Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments

 CLASSIFICATION

Financial Instrument

Financial Asset Financial Liability Equity

1. Amortized cost
No Classification
Debt Investment Equity Investment 2. Fair value through PL
1. Amortized cost 1. Fair value through OCI

2. Fair value through OCI 2. Fair value through PL

3. Fair value through PL

Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments

 CLASSIFICATION OF FINANCIAL ASSET

No Yes Is the business model’s Yes

Is the asset an equity Are the asset’s contractual
objective to hold to
investment? cash flows solely principal
collect contractual cash
and interest?
flows?
Yes
Yes No No
Is it held for trading?
Is the business model’s
No objective achieved both
No
Has the entity elected the by collecting contractual
No cash flows and by selling
OCI option at initial
recognition (irrevocable)? financial assets?

Yes Yes
Equity Investment Equity Investment Debt Investment Debt Investment Debt Investment
FVOCI FVPL FVPL FVOCI Amortized Cost

Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments

 KEY TERMS
 Transaction costs are incremental costs that are directly attributable to the acquisition,
issue or disposal of a financial instrument. Examples of transaction costs are: fees and
commissions paid to agents, advisers, brokers and dealers; levies by regulatory
agencies and securities exchanges; transfer taxes and duties; credit assessment fees;
registration charges and similar costs.
Transaction Costs
 An incremental cost is one that would not have been incurred if the entity had not
acquired, issued or disposed of financial instrument.
 Examples of costs that do not qualify as transaction costs are financing costs, internal
administration costs and holding costs.

 The effective interest rate is the internal rate of return (IRR) or that exactly discounts
Effective Interest the future cash flows to the amount initially recognized for the financial asset or
Rate financial liability. Thus, it results in a net present value of zero. It is the IRR of all cash
flows associated with lending or borrowing.

 The effective interest rate method is a method used in the calculation of the
Effective Interest amortized cost of a financial asset / liability and the allocation & recognition of the
Rate Method interest revenue (expense) in P/L over the period.
Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments
 EQUITY INVESTMENT AT FAIR VALUE THROUGH OCI

Equity instrument can be classified and measured at FVTOCI if:

 The equity instrument is not held for trading; and
Classification
 The entity has elected an irrevocable choice for this designation upon initial
recognition of the asset (i.e. subsequent reclassification is not allowed).

 Equity investment at FVTOCI is initially measured at fair value plus transaction costs.
 Equity investment at FVTOCI is subsequently measured at fair value.
 Subsequent changes in the fair value of the equity instrument are recognised in OCI
and accumulated in fair value reserve.
Accounting
 Dividend earned is recognized in P/L.
Treatment
 Foreign exchange gains and losses are recognized in OCI.
 On disposal of the investment, the fair value reserve is not recycled to P/L.
However, it can be transferred between reserves within equity (i.e. from FV reserve
to retained earnings).

Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments

 EQUITY INVESTMENT AT FAIR VALUE THROUGH P/L

Equity instrument is classified and measured at FVTPL if:

Classification  The equity instrument is held for trading; or
 The entity has not elected to classify the equity investment as at FVTOCI.

 Equity investment at FVTPL is initially measured at fair value.

 Transaction costs are immediately recognised in P/L.
Accounting  Equity investment at FVTPL is subsequently measured at fair value.
Treatment  Subsequent changes in the fair value of the equity instrument are recognised in P/L.
 Dividend is recognized in P/L.
 Foreign exchange gains and losses are recognized in P/L.

Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments

 DEBT INVESTMENT AT AMORTIZED COST
A debt instrument that meets the following two conditions must be measured at
amortized cost unless the asset is designated at FVTPL under the fair value option (see
exception):
 ‘Hold-to-collect’ business model test: The asset is held within a business model whose
Classification objective is to hold the financial asset in order to collect contractual cash flows (i.e. no
intention to trade in the instruments); and
 ‘SPPI’ contractual cash flow characteristics test: The contractual terms of the 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.
Accounting  Debt investment at amortized cost is subsequently measured at amortized cost.
Treatment  Interest income is recognized in P/L using the effective interest rate.
 Foreign exchange gains and losses on the amortized cost are recognized in P/L.

Exception: Even if both of above requirements are met, a financial asset may be designated as FVPL instead, if classifying at AC
would have caused an accounting mismatch.
Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments
 DEBT INVESTMENT AT FAIR VALUE THROUGH OCI
A debt instrument that meets the following two conditions must be measured at fair value through
other comprehensive income (FVTOCI) unless the asset is designated at FVTPL under the fair value
option (see execption):
 ‘Hold to collect and sell’ business model test: The asset is held within a business model whose
Classification objective is achieved by both holding the financial asset in order to collect contractual cash flows
and selling the financial asset; and
 ‘SPPI’ contractual cash flow characteristics test: 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.

 Debt investment at FVTOCI is initially measured at fair value plus transaction costs.
 Debt investment at FVTOCI is subsequently measured at fair value.
 Interest income is recognized in P/L using the effective interest rate.
Accounting
 Foreign exchange gains and losses are recognized in P/L.
Treatment  Change in the carrying amount on remeasurement to fair value is recognised in OCI;
 The cumulative fair value gain or loss recognised in OCI is recycled from OCI to P/L when the
related financial asset is derecognised.

Exception: Even if both of above requirements are met, a financial asset may be designated as FVPL instead, if classifying at AC
would have caused an accounting mismatch.
Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments
 DEBT INVESTMENT AT FAIR VALUE THROUGH P/L

Fair value through profit or loss (FVTPL) is the residual category in IFRS 9. A debt
Classification instrument must be measured at fair value through profit or loss unless it is measured at
amortized cost or at fair value through other comprehensive income.

 Debt investment at FVTPL is initially measured at fair value.

 Transaction costs are immediately recognised in P/L.
Accounting  Debt investment at FVTPL is subsequently measured at fair value.
Treatment  Subsequent changes in the fair value of the debt instrument are recognised in P/L.
 Interest income is recognized in profit or loss using the effective interest rate.
 Foreign exchange gains and losses are recognized in profit or loss.

Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments

 ACCOUNTING TREATMENT - FINANCIAL ASSET

Debt Debt
Equity Investment Equity Investment Debt Investment
Accounting Treatment Investment Investment
FVOCI FVPL Amortized Cost
FVPL FVOCI
Initial measurement Fair value + TC Fair value Fair value Fair value + TC Fair value + TC
Transaction cost Capitalized Expensed out Expensed out Capitalized Capitalized
Subs. measurement Fair value Fair value Fair value Fair value Amortized cost
Δ in fair value OCI P/L P/L OCI Not applicable
Impairment Not applicable Not applicable Not applicable P/L P/L
FCY gain / (loss) OCI P/L P/L P/L P/L
Dividend / Interest P/L P/L P/L (IRR) P/L (IRR) P/L (IRR)
Gain / (loss) on
derecognition
P/L P/L P/L P/L P/L

Recycling of gain/(loss) to
P/L on derecognition
Not allowed Not applicable Not applicable Allowed Not applicable

Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments

 CLASSIFICATION OF FINANCIAL LIABILITY

Is the liability a derivative or financial Yes

liability that is held for trading?

No

Yes
Is it designated under the fair value option?

No

Financial Liability Financial Liability

Amortized Cost FVPL
Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments
 FINANCIAL LIABILITY AT AMORTIZED COST
At initial recognition, financial liability is classified and measured at amortized cost unless
either:
 The financial liability is a derivative or held for trading and is therefore required to be
Classification measured at FVTPL; or
 The entity elects to measure the financial liability at FVTPL to eliminate accounting
mismatch.

 Trade payables;
Examples  Loan payables with standard interest rates (such as a benchmark rate plus a margin);
 Bank borrowings.

 Financial liability at amortized cost is initially measured at fair value less transaction
costs.
Accounting  Financial liability at amortized cost is subsequently measured at amortized cost.
Treatment  Interest exchange is recognized in P/L using the effective interest rate.
 Foreign exchange gains and losses on the amortized cost are recognized in P/L.

Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments

 FINANCIAL LIABILITY AT FAIR VALUE THROUGH P/L
At initial recognition, financial liability may be classified and measured at fair value through profit
(FVPL) only if:
Classification  it eliminates or significantly reduces a measurement or recognition inconsistency; or
 this would allow the company to reflect a documented risk management strategy.

 Interest rate swaps

 Commodity futures/option contracts
Examples  Foreign exchange future/option contracts
 Convertible note liabilities designated at FVTP;L
 Contingent consideration payable that arises from one or more business combinations.

 Financial liability at FVTPL is initially measured at fair value.

 Transaction costs are immediately recognised in P/L.
 Financial liability at FVTPL is subsequently measured at fair value.
Accounting  Interest exchange is recognized in P/L using the effective interest rate.
Treatment  Foreign exchange gains and losses are recognized in profit or loss.
 Change in the carrying amount on remeasurement to fair value is recognised in P/L. However,
change in fair value that relate to the change in the entity’s own credit status is recognized in
OCI (instead of P/L).
Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments
 ACCOUNTING TREATMENT - FINANCIAL LIABILITY

Accounting Financial Liability Financial Liability

Treatment Amortized Cost FVPL

Initial measurement Fair value – TC Fair value

Transaction cost Capitalized Expensed out

Subs. measurement Amortized cost Fair value

P/L (except Δ in fair value

Δ in fair value Not applicable due to Δ in credit risk –
OCI)

FCY gain / (loss) P/L P/L

Interest Expense P/L (IRR) P/L (IRR)

Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments

 CLASSIFICATION OF FINANCIAL ASSET & FINANCIAL LIABILITY

Financial Assets Financial Liability

Equity Investment Debt Instrument

Fair value Fair value

Fair value Fair value Fair value
through other Amortized through other Amortized
through profit through profit / through
comprehensive cost comprehensive cost
/ loss loss profit / loss
income income

Compiled by: Murtaza Quaid, ACA

 EQUITY
An equity instrument is defined as any contract that evidences a residual interest in the assets of an
Definition entity after deducting all of its liabilities.

 Equity instruments are initially measured at fair value less any transaction costs. In many legal
jurisdictions when equity shares are issued they are recorded at a nominal value, with the
excess consideration received recorded in a share premium account and the issue costs being
written off against the share premium.
Accounting  Transaction costs of an equity transaction shall be accounted for as a deduction from equity.
Treatment  Distributions to holders of an equity instrument (i.e. Dividend) shall be recognised by the
entity directly in equity.
 Changes in the fair value of an equity instrument are not recognised in the financial statements.
 Redemptions or re-financings of equity instruments are recognised as changes in equity.

 If an entity reacquires its own equity instruments, those instruments (‘treasury shares’) shall be
deducted from equity.
 No gain or loss shall be recognised in P/L on the purchase, sale, issue or cancellation of an
Treasury Shares entity’s own equity instruments. Consideration paid or received shall be recognised directly in
equity.
 Such treasury shares may be acquired and held by the entity or by other members of the
consolidated group.
Compiled by: Murtaza Quaid, ACA IFRS 9: Financial Instruments