IFRS9.

On 24 July 2014, the International Accounting Standards Board (IASB) completed the final element of its overall response to the financial crisis by publishing the final version of the standard “IFRS 9 – Financial Instruments”, replacing the standard “IAS 39 – Financial Instruments: recognition and Measurement”.

IFRS 9 is to date still not approved by the European Union.

1. Introduction

IFRS : What does it mean ?

IFRS stands for International Financial Reporting Standards.

The objective of these international financial reporting standards is to standardize the presentation of accounting data internationally exchanged.

IFRS 9 : What does it mean ?

IFRS 9 Financial Instruments is an accounting standard that will supersede in 2018 the IAS 39 standard considered complex and difficult to understand.

2. Why the transition to IFRS 9 ?

In 2008, following the financial crisis and at the request of G20, works got underway to review the IAS 39 standard for financial instruments.

This IAS 39 standard, entered into force on January 01, 2001, addressed the recognition and measurement of financial instruments (Assets, liabilities, derivatives), hedging transactions and derecognition rules of financial assets and liabilities.

The general principle underlying the standard IAS 39 is the fair value measurement of financial assets and liabilities;

A report, dated 13 October 2009, showed that the fair value measurement played a role in precipitating the crisis.

Considered so complicated and inadequate for real practise of financial instruments management within a financial instrument, the IAS 39 standard will be replaced by the new IFRS 9 standard as of 1st January 2018.

3. Background

Within the framework of this standard review, the International Accounting Standards Board (IASB) has published , on July 24, 2014, the final version of the standard « IFRS 9 – Financial instruments », superseding the standard « IAS 39 – Financial Instruments: recognition and measurement ».

IFRS9_Figure4

4. Goal of the IFRS 9 standard

This new standard defines the new rules for financial instruments classification and measurement, the impairment of financial assets credit risk and hedge accounting, excluding macro-hedging transactions.

  • The standard gathers in one single standard the different stages of IAS 39 standard replacement project.
  • A single and logic approach for the classification and measurement of financial assets, reflecting the economic model within which they are managed, as well as the relevant contractual cash flows
  • Integration of a new model for financial assets impairment,
  • Streamlined approach for hedge accounting.

5. What does this standard govern?

The IFRS 9 standard relies on three milestones:

IFRS9_Figure5

  • A single and logic approach for the classification and measurement of financial assets, reflecting the economic model within which they are managed, as well as the relevant contractual cash flows,
  • A new single model for financial assets impairment, prospective, based on anticipated losses,
  • A streamlined approach for hedge accounting.

6. Legal framework

The IFRS 9 standard will be mandatory as of January 01, 2018, with a crucial stage for IFRS 9 standard application in the information system in 2016. The IFRS 9 standard has not yet been the subject to the approval of the European Union.

7. Application scope

The standard is applied to financial instruments traded in the markets or derivatives (without exception mentioned by the standard IAS 39).

8. Milestone 1: Classification and measurement

–  The classification defines how assets are recognised in the financial reports, along with their measurement.

It is noted that the important points of milestone 1 are as follows:

  • the classification of financial assets under IFRS 9 relies on the analysis of two cumulative criteria:
    • On one side the inherent characteristics of the financial instrument (SPPI) and from the other side the implemented management model.

    • From an operational point of view, this stage will require significant analysis and documentation of financial assets (problems with different concerned products with their characteristics and specification).
Inherent characteristics of the financial instrument (SPPI)

By nature, the financial instruments of equities generate flows that are not SPPI.

The contractual methods of a financial asset, constituting a financial instrument of a debt to measure at the amortised cost of fair value of OCI, must generate cash flows, representing only payments of principal and interests).

These flows are consistent with the flow of the base loan contract (also called « plain vanilla »), where the interests represent only the counterparty:

  • time value of money ;
  • credit risk (these two elements are typically the main components of interests) ;
  • costs (administrative fees for example) linked to loan holding;
  • beneficiary margin (that must be consistent with the base loan margin).

The contractual methods, generating risks exposure or contractual cash flows volatility without link to those of the base loan contract (such as the exposure to rate fluctuations of equity or a merchandise for example), does not generate contractual cash flows considered only as solely payments of principal and interests.

This SPPI concept somehow replaces the embedded derivative for the financial assets. If the financial instrument cash flows do not meet this criterion, the transaction may not be disaggregated and the « embedded derivative » may not be recognised separately at the fair value and the host contract at the amortised cost. In such case, the entire contract shall be recognised at the fair value through the income statement.

Management models

The qualification of the management model followed by an entity for the financial assets management plays a fundamental role in classifying the financial assets.

The Standard defines two management models related to the financial assets:

  • Those present within a model. The purpose is to hold them in order to receive contractual cash flows
  • Those held within the management model. The purpose is to receive the contractual cash flows and to sell the financial assets.

Therefore, once the management model applied to the asset does not correspond to one of the IFRS 9 management model, the asset is classified by default in FVPL category.

  • According to the combination analysis of the two criteria, the IFRS 9 standard will impose 3 ways of measuring an asset, instead of four in IAS 39 (loans and receivables, assets held to maturity, assets measured at fair value through the income statement or on option, and available-for sale assets):
    • the financial assets are measured at the fair value through profit and loss account, (Fair Value through Profit and Loss or FVTPL)
    • or the assets are valued at the fair value through other comprehensive Income (Fair Value through other comprehensive Income or FVTOCI). The fair value changes are recognized in equities. The profits and losses remain till derecognition, date on which they are reclassified to incomes,This category is divided into two sub- categories:
      • FVOCI recyclable to profit or loss for the debt instruments (on accounting closure, the fair value changes are recognized in equities. The profits and losses remain till derecognition, date on which they are reclassified to incomes) ;
      • FVOCI non-recyclable for equity instruments (FV changes observed in OCI are not recyclable in income statement: i.e. they may not be transferred later on to income statement. They may be transferred to cumulated profit or loss within the equities. Consequently, in case shares sale, no profit or loss is recognised upon the sale. Only the dividends will be transferred to the profit and loss account.
    • or the financial assets are measured on amortised cost.

9. Milestone 2: Impairment

The belated recognition of loans and other financial instruments losses has been identified as a major weakness of the standard IAS 39.

IFRS 9 introduces a new impairment model requiring more timely recognition of expected losses.

At each closure date, the financial institution shall measure the expected losses for a financial instrument for an amount corresponding to the expected losses if the credit risk of the financial instrument has increased since its initial recognition.

10. Hedge accounting

The IFRS 9 standard introduces a model for hedge accounting that aligns the accounting processing with the risk management activities.

The purpose of this hedge accounting is to represent, on the financial reports, the impacts of risk management activities of a banking institution using the financial instruments to manage the risks that could affect the net income.

11. Calendar

The compliance of establishments with IFRS 9 will be mandatory as of January 1st, 2018, with a crucial stage for IFRS 9 standard application in the information system in 2016.

The IFRS 9 on financial instruments will be finally adopted by the European Union during the first semester of 2016.

12. IFRS 9 challenges

IFRS 9 standard implementation is not limited to an accounting project. The project will have impact on all business sectors and activities:

  • impacts on the organisation,
  • impacts on the Risks and Finance functions,
  • impacts on the production of accounting, regulatory and prudential reporting,
  • impacts on the information systems and processes adaptation,
  • impacts on the data (quality, completeness, history, production and analysis deadline),
  • impacts on the information and training level : standard acquisition,
  • impacts on the economic model of each financial institution,
  • impacts on the financial communication.

The year 2016 will be a year of implementation works and IS developments for banks.

13. Document sources & sites

 IFRS 9 – Financial instruments – IFRS Focus

IAS 39 – Financial instruments – recognition and measurement

Master’s thesis in Accounting and Audit control of Julien le Parco, Paris Dauphine University 2011-2012

Report of Morand/Marteau on accounting standards and financial crisis (in French)

– www.ifrs.org

– www.focusifrs.com