Financial Instruments IAS 32, IfRS 9, IfRS 13, IfRS 7 Final Version

Financial Instruments
Introduction
By Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

What are Financial Instruments ?
• What are Financial Instruments? An instrument that gives rise to a financial asset of one entity and a financial liability of another entity
• Examples :- when an entity issues bonds, for the issuer, the instrument is a financial liability and for the buyer of the bonds it will be a financial
asset
Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

Financial Assets Financial Liability
Cash Equity
Equity Investments Debt (liability)
Hybrid Instruments –Equity and

Bond Investments
Debt
Derivative Assets
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Financial Instruments – Related Standards
IAS 32 Presentation
•Classification of financial liabilities into equity and liabilities and compound

financial instruments
IAS 39 Recognition and Measurement

•IAS 39 was replaced by IFRS 9 with mandatory implementation from January
2018
IFRS 9 Recognition and Measurement
•Recognition and Measurement of Financial Assets and Liabilities

•Impairment of Financial Assets and Liabilities
•Hedge Accounting
IFRS 7 Disclosures
•Disclosure standard of IFRS 9

•Fosters transparency of reporting
IFRS 13 Fair Value Measurement
•Determination of Fair Value of Financial Assets
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IAS 32 Financial Instruments
Presentation

Definitions and Classification
• Financial Assets: - cash, an equity/ debt instrument of another entity, a contractual right to receive cash or financial instrum ent of another
entity. Derivative assets are also part of financial assets
• Financial Liabilities are broken into debt (liability) & equity

Financial Liability
• is a contractual obligation to deliver cash or financial instrument to

another entity, under conditions, which are potentially unfavorable to
the issuer
• interest payments on a bank loan or a bond issue are mandatory and
nondiscretionary, repayment of principal at the maturity
Equity instruments
• do not have a contractual obligation to deliver cash or financial assets

in conditions, which are potentially unfavorable to the issuer
• Ordinary dividend distribution is not mandatory, it will be determined
by the board of directors and shareholders in the company’s general
assembly
• IAS 32 focuses on substance over form for the classification of financial liabilities into debt and equity 5
Debt or Equity ?
• The following factors largely determine whether an instruments fall into the category of debt or equity
 Is the distribution mandatory or discretionary ?
 Is there a maturity or perpetual ?

 Preference over other stakeholders (seniority) Motivation to classify debt as equity
 Claims on liquidation
Reduce gearing ratio to increase debt capacity –
Lower Financial Leverage
• Liquidation ranking of financial liabilities
To avoid a breach in covenants
 Trade creditors
 Secured Loans
Board remuneration may be linked to gearing ratio
 Unsecured loans
 Subordinated debt
 Preference shares
 Equity
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Debt or Equity ?
• Redeemable debt
• Solution : Debt as interest payment is mandatory, repayment at maturity date, high seniority at liquidation (Prior-charge capital)
• Zero coupon bonds
• Solution : Debt, although there is no coupon interest payments, they are usually issued at a deep discount or redeemed at a large premium

reflecting the rolled-over interest
• Perpetual debt
• Solution : a) With discretionary distribution of returns – Equity b) Contractual obligation to pay interest –Debt (Prior-charge capital)
• Employee share options
• Solution : Equity as these are rights to purchase equity shares at a future date at a predetermined price
• Ordinary share issues
• Solution : Equity as dividends are discretionary, no redemption/maturity, least seniority upon liquidation
• Convertible bond issue
• Solution : Have characteristics of debt & equity, hence needs to spilt both portions and report separately
• Preference shares
• Solution : Debt as dividend payment is mandatory and cumulative. Higher seniority vs ordinary shareholders (Prior-charge capital)
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IFRS 9 Financial Instruments
Recognition and Measurement

Classification of Financial Assets - IAS 39
Held for trading / Fair value Objective of holding such instruments is short-term profit taking
through P&L
• Initial measurement at cost
• Subsequent measurement must be at fair value - Mark to market (MTM) exercise
• Gain or losses of MTM must be taken to P&L
• Dividend income of equity investments and interest income from bonds must be taken to P&L
• Gain/loss on disposal must be recognized in P&L

Available for sale (AFS)
Intention is not short-term profit taking but will be disposed off if the need arises
•Initial measurement at cost
•Subsequent measurement must be at fair value -Mark to market (MTM) exercise
•Gain or losses of MTM must be taken to Other Comprehensive Income (OCI) –Fair value reserve or AFS reserve
•Dividend income of equity investments and interest income must be taken to P&L
•Gain/loss on disposal must be recognized in P&L
•Recycling fair value reserve to P&L at the time of disposal
Held to maturity (HTM) Instrument is purchased to receive interest until maturity and principal repayment at maturity
No intention to sell it before maturity
•Measurement basis at amortized cost – No MTM
•Interest income of bonds must be taken to P&L
•If an HTM bond is sold before maturity, all HTM bonds needs to be reclassified as AFS
•Gain/loss on disposal must be recognized in P&L
•Equity Investments must not be classified as HTM
Loan and receivables These instruments lack an active market for trading as such difficult to measure at fair value
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•Most common assets in financial institutions such as banks
•Measurement basis at amortized cost – No MTM
•Interest income of bonds must be taken to P&L
Classification of Financial Assets - IFRS 9
•Equity and Bonds are measured at fair value
•MTM gains/losses in P&L
•Dividend & Interest in P&L
Fair value •Disposal gain/losses in P&L
through P&L
•Not available for equities

•Treatment like IAS 39 AFS – Measured at FV with FV changes taken to OCI – FV reserve
•Interest income in P&L
Fair value
through OCI •Gain/loss at disposal recognized in P&L
•FV reserve will be recycled to P&L at the time of disposal
Bonds
•Entities can make irrevocable decision to account the gain/losses on FV measurement in OCI for equities
•Even at the time of disposal any “realized” gains /losses must be routed through equity
Fair value •No recycling of FV reserves to retained earnings or P&L
through OCI •Only dividend income will be included in P&L
•Decision is not reversible – IASB discourages this classification
Equities
•Only available for bonds and loans as equities do not have contractual cash flows
•Effective interest rate of the bonds or loans must be used to accrue interest income and value amortized cost –
don’t use coupon interest rate
•Interest income on bonds or loans will be in the P&L
Amortized
•Disposal gains will be recognized in the P&L
cost
Classification must be based on

a) Contractual cashflow test
b) Business Model Test 10
Contractual Cashflow Test & Business Model Test
Contractual cash flow test Business Model Test
• Does holding a financial asset permit • An entity must evaluate their overall
an entity to receive contractual cash portfolio management strategy to
flow (interest) over the maturity period understand if financial investments are
and receive principal payment? held to maturity to receive contractual

cash flows
• Only bonds will pass through
contractual cash flow test • It must not be performed at individual
security level
• Equity investment will not be eligible;
dividends are discretionary for the • It must be performed at portfolio level
issuer
• Not performed at entity level as an
• Only investments that pass through entity can maintain more than one
contractual cash flow test only can be portfolio with different objectives one
measured at “amortized cost”, subject with trading motive others are HTM
to business model test
• Bonds, which qualify for contractual
• Equity Investment must be always cash flow test, must go through
measured at Fair Value business model test before they are
classified at amortized cost 11
Reclassification between FV to amortized cost and Transaction costs
• The reclassification is permitted under limited circumstances where there is a permanent change in the way the
portfolio is managed

• Reclassifications are not permitted for temporary changes/slippages on the portfolio management objectives
• For investments measured at amortized cost, the transaction cost can be capitalized with the cost of financial
asset
• For instruments measured at FV transaction costs are expensed in the Income Statements
• If irrevocable decision made to take the gain/loss on FV measurement to OCI, the transaction cost is added to the
asset value (capitalized) since except dividend income nothing must be recognized in the income statement – FV
via OCI for equities
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Recognition and De-recognition of Financial Asset
• Recognition of financial instrument only when a contractual rights to receive cash flows or another financial asset
is established
 Purchasing a bond

 Purchasing equity investments
• De-recognition occurs under following circumstances
 Contractual rights to receive cash flows expire
 Entity transfers risk and rewards of the ownership of the financial instrument to another party
 Disposal of bonds and shares
 Maturity of bonds
• Gain/loss arising on disposal or de-recognition must be taken to income statement, except for equity
investments accounted as FV through OCI 13

Recognition and Measurement of Financial Liabilities
• Recognized in the balance sheet when contractual obligation to deliver cash or another financial asset is
established and derecognized when a financial liability is extinguished

• Extinguishment of Financial Liability
 Financial liability is fully settled
 Substantial modifications to the existing term and conditions of the liability ( de-recognition of original liability and recognize
new one)
 Exchange of one financial liability with another liability
• Substantial modification: Present value of existing financial liability and new liability has a difference of at least
10%
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Measurement of Financial Liabilities
Fair value (FV) Model
Amortized cost model
• FV model was introduced for financial
• Amortized cost model liabilities to eliminate the mismatch of
accounting treatment of assets and liabilities
• This was the only method to measure
•

Any gains/losses on changes in FV of finance
financial liabilities under IAS 39 liabilities must be taken to P&L except,
• Gain/loses arising on FV of financial
• IFRS 9 provides an option to choose liabilities which are caused by “credit risk”
FV model of the financial liability (issuer)
• If FV of a debt instrument falls due to a
credit rating downgrade of the issuer, the
• Interest expense charged to P&L gain must be accounted in OCI (equity)
based on effective interest rate • An entity cannot have a P&L credit due to
a deterioration of their own credit quality
• Balance sheet must represent the • Any changes in FV due to market risk
liability based on effective interest rate should be in P&L
on the liability • If FV changes on credit risks create large
accounting mismatches between financial
asset and financial liabilities, then gain or
losses on fair value measurement can still be
taken to P&L. Example :- A bond was issued to
buy an investment property which is accounted
at fair value 15
IFRS 13 Fair Value Measurement

Fair Value Definition and Presentation
• IFRS 13 Definition of Fair Value: The price that would be received to sell an asset or amount that must be paid to
transfer a liability between market participants in an orderly transaction at the measurement date

• The above definition replaced the old definition of Fair Value : the value at which an asset can be sold, or a liability
settled in an arm’s length transaction; arm’s length transaction is a transaction between unknown willing and
knowledgeable parties
• Provides guidelines to measure the fair value of an asset and expects financial investments to be classified into
either “Level 1”, “Level 2” or “Level 3” based on the inputs used to calculate the fair value of the financial
assets
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Fair Value Methodology – How fair value is determined ?
Level 1 Based on observable market data
• Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity
can access at the measurement date
• Active market must be a liquid market with many buyers and sellers

Level 2 Based on observable market data
• Quoted prices for identical assets in an inactive market OR
• Quoted prices for similar (proxy) assets in an active market
• Active market must be a liquid market with many buyers and sellers
Level 3 Based on unobservable market data

• Unobservable inputs used to determine the fair value
• Companies using their own internal models and assumptions to arrive at the fair value of the assets
• Inferior method of determining fair value of assets and liabilities due its subjectivity
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Key Consideration in the determination of Fair Value
• A company must always try to use the Level 1/ Level 2 observable inputs to identify the fair value of the asset
• Level 3 must be only when Level 1, Level 2 not available

• Level 3 not preferable due to subjectivity involved in the determination of fair value as it can be easily gamed to
either increase the fair value of assets or reduce fair value of liabilities
• Analysts can identify what % of FV based financial assets are in Level 1, 2 and 3 helping them to ascertain
reliability of the fair values included in the balance sheet (composition of FV hierarchy)
• Analysts usually adjust company valuation downwards if a company has a large proportion of financial
assets measured using level 3 inputs
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Impairment of Financial Assets

Major changes from IAS 39 to IFRS 09
IAS 39 – Incurred Loss Model

Performing Assets Non-Performing
Credit losses are incurred only when the loss Loans/ under Assets/
event has occurred Good observation Bad Loans
Loans

IFRS 9 Expected Credit Loss
model
Initial Recognition – 12M ECL Stage 1 Stage 2 Stage 3
If credit quality deteriorates life time ECL STAGE 1 STAGE 2 STAGE 3
Significant increase Objective evidence

in Credit Risk (PD) of impairment
Impairment 12-month ECL Lifetime ECL
(PD) – Probability of default
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Amount of Impairment and staging
• The amount of impairment to be recognized on these financial instruments depends on whether or not they have significantly
deteriorated since their initial recognition
• Stage 1 :- Financial instruments whose credit quality has not significantly deteriorated since their initial recognition – 12 months
expected credit losses approach

• Stage 2 :- Financial instruments whose credit quality has significantly deteriorated since their initial recognition – Life time
expected credit losses over the maturity
• Stage 3 :- Financial instruments for which there is an objective evidence of an impairment at the reporting date – life time expected
credit losses over the maturity
• Applicable to any financial assets with credit risk

 Bonds
 Loans in a banking book
 Receivables in a trading company
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Major changes from IAS 39 to IFRS 09
• Replaced incurred loss model on financial asset and moved towards expected loss model to identify losses, which are likely to be incurred in the future
• Previously IAS 39 focused only on losses, which have already been incurred, Example,
 A customer’s loan installment is overdue in a bank. Bank will create a specific provision for the customer as per bank’s policy or regulations (like 30-60
days overdue -25% provision, 60-90 days overdue 50% provision, over 90 days 100% provisions)
 If a loan is already impaired, interest income of the customer gets suspended (no longer gets accrued into the bank’s income statement)

• IFRS 9 Expected loss model takes a forward-looking approach, where expected losses are identified based on likelihood of impairment in the
future, even for good loans
• Expected Credit Loss (ECL) model has two different approaches

 Expected credit losses for the next 12 months from the reporting date
 Lifetime expected credit losses
• At initial recognition of a loan, a credit allowance/provision will be created based on the next 12 months expected credit lo sses – Stage 1. Unless if a
company buys down-graded assets, where the assets will be categorized as stage 2 or 3 at initial measurement itself, requiring life-time ECL
• If the credit risk increases substantially in the following years, lifetime expected credit losses (stage 2/3) must be used i nstead of 12 months expected
credit losses. However, if credit quality improves in the future, 12 month expected credit loss approach could be brought bac k (stage 1)
• Generally for investment grade (BBB and above) bonds/loans, lifetime expected credit losses are not required as they are stag e 1 assets
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Identification of Credit Deterioration Triggers
Identification of indicators which will trigger a shift from Stage 1 to Stage 2 or Stage 3
• Significant changes in external market indicators
• Increase in Credit spread

• Significant change in the credit rating
• Significant financial difficulty of issuer/borrower
• Internal credit rating downgrade
• Significant change in the value of the collateral
• Significant change in external macro-economic factors related to the borrowing entity, such as covid-19
• Significant or expected adverse change in regulatory, economic environment of the borrower
• Change in the risk premium to a borrower thereby increasing the pricing
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Expected loss model in a bank’s lending portfolio– Key Terminology
• Exposure at defaults (ED - carrying value of credit risky assets)
• Probability of default (PD)
 Can be estimated based on historical loan loss experience for retail customers
 Can be estimated based on published PDs by rating agencies based on credit rating (BBB -2.5%, BB 3.25%, B 4.00% etc)

• Loss given default (LGD)
Impairment =
 Availability of collateral/security must be factored into impairment calculation Exposure X PD X LGD
 LGD would be 100% less recovery rate
 Recovery rate reflects the amount that can be recovered by selling the security at the time of default
• Example :- Bank X has a loan book of $100m and $5m are non-performing loans. It’s the bank policy to have 100% provision
against non-performing loans. Probability of default is 8% and availability of collateral is 60%. Calculate amount of provision is
needed as per IAS 39 and IFRS 9?
• IAS 39 requires provisions based on incurred loss model; hence the provision will be only on bad loans – $5m (stage 3)
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• IFRS 9 will have an additional provision based on expected loss model even for good loans of the bank - $95m X 8% X
(100%-60%) = 3.04 m + 5m = $8.04 m total provision required

Covid-19 - Guidelines from IASB on ECL
March 2020

Covid-19 - Guidelines from IASB on ECL - March 2020
• IASB in March 2020 issued a statement clarifying accounting for ECL in the light of current uncertainty resulting from the co vid-19 pandemic
• It requires that lifetime ECLs be recognized when there is a significant increase in credit risk (SICR) on a financial instrument. However, it

does not set bright lines or a mechanistic approach to determining when lifetime losses are required to be recognized
• Entities should not continue to apply their existing ECL methodology mechanically. For example, the extension of payment holidays to
all borrowers in particular classes of financial instruments should not automatically result in all those instruments being
considered to have suffered an SICR
• Entities are required to develop estimates based on the best available information about past events, current conditions and forecasts of
economic conditions. In assessing forecast conditions, consideration should be given both to the effects of covid-19 and the
significant government support measures being undertaken
No mechanistic approach in
determining SICR
Source – Directly sourced from IASB Update2019
FS
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Covid-19 - Guidelines from IASB on ECL - March 2020
• It is likely to be difficult at this time to incorporate the specific effects of covid-19 and government support measures on a reasonable and
supportable basis. However, changes in economic conditions should be reflected in macroeconomic scenarios applied by entities and in
their weightings. Update macro economic variables in the model

• If the effects of covid-19 cannot be reflected in models, post-model overlays or adjustments will need to be considered. The environment is
subject to rapid change and updated facts and circumstances should continue to be monitored as new information becomes available
• Indeed, in the current stressed environment, IFRS 9 and the associated disclosures can provide much needed transparency to users of
financial statements
• Several prudential and securities regulators have published guidance commenting on the application of IFRS 9 in the current e nvironment
(including the European Banking Authority, the European Central Bank, the European Securities and Market Authority, the Prude ntial
Regulation Authority and the Malaysian Accounting Standards Board). IASB recommends to make use of regulator guidance when available
Source – Directly sourced from IASB Update2019

FS
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Expected loss model on Trade Receivables - Illustration
• A trading company has $1,000,000 receivables in its balance sheet as at 31st March 2020 pertaining to a single customer, which
operates a restaurant chain
• Current Covid-19 induced lock-down forced all restaurants and eateries to be closed. Therefore, this acts as a trigger event
(impairment indicator) for the trading company to recalibrate its ECL model and estimate an impairment loss for the receivables

• As per IFRS 9, ECL needs to be estimated based on unbiased and probability-weighted outcomes. Therefore, its recommended to
perform a scenario analysis and identify the expected losses based on a range of outcomes. A simple example is given below
• Restaurant business is one among the key sectors negatively impacted by the Covid-19 including aviation, hospitality, banking etc.
Scenario Description PD LGD ECL = $ 1 mln X PD X LGD
Best Case Restaurant re- 20% 10% $ 20,000

opens in 1 month
Most likely Restaurant re- 60% 25% $150,000 Exposure less
opens in 3 months ECL of $630,000
will be
Worse Case Restaurant re- 20% 100% $200,000 recognized in
opens in 6 months Balance Sheet
Est ECL $370,000
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Hedge Accounting

Definitions and Scope
• Derivative: A Financial instrument or contract which has the following characteristics
 Its value changes in response to a change in interest rate or fair value of financial investment or a commodity or exchange rate
 Requires no financial investment
 Settled at a future date

• Derivatives are financial instruments measured at fair vale, where the fair value changes due to the changes in price or valu e of the underlying item or instruments
Examples include,
 Forward contracts
 Futures contracts
 Options
 Interest rate swaps
• Hedging for accounting purposes means designating one or more hedging instruments so that their fair value change is an offse t by the whole or part of the fair value
changes or cash flow changes of a hedged item (underlying item)
• Hedged item is an underlying asset or liability, which either exposes itself to fair value risk or cash flow risk. Example in cludes, Fixed rate bonds are exposed to fair
value risk and variable rate bonds are exposed to cash flow risk
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• Derivative instrument is a designative derivative whose changes in the FV are expected to offset the FV changes / Cash flow c hanges of the underlying asset
Hedged risk, Hedged item and Hedging Instrument
Current Spot Rate

UK Exporter 1.2US$ = GBP
Plans to export GBP 1 million worth of
goods in a year from now

Importer is
Hedged
Item Pays US$ 1.22 million After a Provides GBP 1 million
year
He enters into a 1 year forward

Concerned that rate agreement to buy GBP at a Hedging
US Importer USD would fixed rate of 1.22USD with a Instrument
Plans to import GBP 1 million worth of

depreciate counter-party (bank)
goods in a year from now against GBP
Hedged Risk
Hedged risk is a foreign currency exchange rate risk
Hedged item is a highly probable forecast transaction (sale)
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Hedging instrument is a foreign currency forward contract to buy GBP for a
fixed rate at a fixed date
Types of Hedges- IAS 39 & IFRS 9
Hedge Types

Fair Value Hedge Hedge of a Net Investment in a
Cash Flow Hedge
Foreign Operation
RISK RISK RISK
Changes in Fair Value Variability in Cash Flows Change in FV or CF of

Net Investment
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What Do We Hedge ?
Fixed Item Hedging fixed items would mean a fair value hedge
• Fixed rate bonds are subject to interest rate risk

• Fixed Interest Loan • When interest rate increases, bond price will fall, so
• Fixed Interest Bond that the YTM of the bond will remain unchanged Fair Value Risk
• Inventories
• When interest rate decreases, bond price will
increase, so that the YTM of the bond will remain
unchanged
Variable Item Hedging of floating rate items and forecast future

transactions would generally mean a cash-flow hedge
• Variable Interest Loan

• Variable Interest Bond
• Forecast Future Transactions involving cashflows Cash Flow Risk
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Common features between IAS 39 & IFRS 9
• Hedge accounting is optional in both standards
• Common terminologies such as hedged item, hedging instrument, fair value hedge, cash flow hedge, hedge
effectiveness, etc.,

• Both standards require formal hedge documentation in order to qualify for hedge accounting
• Classification of hedges into Fair Value hedge, Cash Flow hedge and hedge on net investment in foreign
operation
• Both standards require hedge effectiveness to be accounted for in P&L
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Key Changes in IFRS 9
• What is permitted to be used as a hedging instrument?
 IAS 39 principles were inconsistent and did not provide sufficient choices to risk practitioners to choose a hedging instrument
 IAS 39 mandates a hedging instrument must be a derivative. Use of non-derivative to manage risk exposures will not quality for
hedge accounting. IFRS 9 accepts hedging a risk exposure using a non derivative asset/liability. For example, a risk manager

can now hedge the fair value risk of an entity’s crude oil inventories by purchasing a fund investment with commodity linked
instruments. However, IAS 39 did not permit hedge accounting in these cases
• What is permitted to be a hedged item ?
 IAS 39 required all risk aspects of a non-financial item to be hedged to qualify for hedge accounting. For example, an airline
company requiring to hedge its ‘jet fuel’ needed to hedge all aspects of risk related to jet fuel (price risk, foreign currency risk and
other risk) to qualify for hedge accounting
 IFRS 9 allows to hedge a specific risk of a non-financial item to qualify for hedge accounting. Hence, a company can buy forward
contracts on crude oil to hedge its price risk on jet fuel, while leaving other risk aspects unhedged. IFRS 9 considers the practical
aspects of managing risks by an entity as a risk manager can develop a risk appetite for an entity to only hedge the most
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sensitive portion of a non-financial assets, while leaving other risk exposures unhedged
Key Changes in IFRS 9 – Hedged Item
Price Risk
Foreign HEDGED ITEM

Currency Risk IAS 39

Other Risks
Hedged Item-
Jet Fuel
Price Risk
HEDGED ITEM
IFRS 9
Foreign
Currency Risk
IFRS 9 permits hedging

Other Risks risks on a standalone basis
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• What is permitted to be a hedged item ?
 Hedging net positions on a currency was not permitted in IAS 39
 Hedging net positions on a currency is permitted in IFRS 9. Example : If an entity has foreign currency assets of US$ 200 million
and US $ 150 million of foreign currency liability, the net exposure of US$ 50 million. IFRS 9 permits hedging of the net position of

US$ 50 million rather than hedging both assets and liabilities separately
• Rebalancing a hedge means modifying a hedge in IFRS 9 (practical way of managing risks), but IAS 39 required
terminating the hedge relationship and starting a new hedge documentation all over again
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• Hedge effectiveness Testing
 IAS 39 principles was complex and used a numeric 80-125% rule to test the hedge effectiveness
 The fair value change in the hedging instrument must offset the fair value or cash flow changes of a hedged item (Highly
effective). FV change of hedging instrument must be 80% - 125% of the FV change in the hedged item

 Accountants were forced to perform these calculations only for the purpose of IAS 39 as practically risk was not managed based
on this approach within the company
 IFRS 9 Objective based hedge effectiveness testing, replaced arbitrary 80-125% rule for hedge effectiveness in IAS 39
 IFRS 9 simplified hedge effectiveness testing
 Hedging relationship needs to be effective (economic relationship between hedged item and hedging instrument is negative) as
per IFRS 9
• Detailed disclosures on entity’s internal risk management policies of managing various kind of risks such as credit
risk, interest rate risk, currency risk and market price risk and liquidity risk
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• IFRS 9 aligns its methodology to practical way of managing risks in an organization
• Discontinuation of hedge accounting voluntarily was permitted under IAS 39
• Voluntary discontinuation of hedge accounting in IFRS 9 is not permitted
• Hedge accounting can only be discontinued under following circumstances,

 Permanent change in risk management objectives of the company supported by revised risk appetite statement
 Expiry of hedge
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Accounting Treatment for Fair Value Hedges
Fair Value Hedge –
Steps
Description Debit Credit
1) Identify fair
Loss on hedging P/L – FV loss on Balance Sheet – value of both
instrument hedging instrument Financial Liabilities on your hedged

hedging instrument item and
hedging
Gain on the hedging Balance Sheet – P/L – FV gain on instrument at
instrument Financial assets from hedging instrument the reporting
hedging instruments date
2) Recognize fair
value gain or
Gain on the hedged Balance Sheet – P/L – Gain on the
loss on hedging
item Hedged item hedged item
instrument to
Loss on the hedged P/L – Loss on the Balance Sheet – P&L
item hedged item Hedged item 3) Recognize fair
value gain or
loss on hedged
item to P&L
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Accounting Treatment for Cash Flow Hedges
Description Debit Credit Cash Flow Hedge –

Steps
Loss on hedging OCI – Cash Flow Balance Sheet – 1) Identify
instrument -effective Hedge Reserve Financial Liabilities on gain/loss on
portion hedging instrument

hedging
Loss on the hedging P&L – In-effective Balance Sheet – instrument at
instrument – portion of loss on the Financial Liabilities on reporting date
ineffective portion hedging instrument hedging instrument 2) Split the
effective and
Gain on the hedging Balance Sheet – OCI – Cash flow hedge ineffective
instrument – effective Financial Assets on reserve portion
portion hedging instrument 3) Recognize
effective portion
Gain on the hedging Balance Sheet – P/L – Ineffective to OCI
instrument – Financial Assets on portion of gain on 4) Recognize in-
ineffective portion hedging instrument hedging instrument effective portion
to P&L
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IBOR Re-form and Hedge Accounting

Interbank Offered Rate (IBOR) Reform and Impact on Hedge Accounting
• It is project to replace LIBOR from its status as a bench-mark interest rate to an adjusted Risk-Free Rate as a bench-mark
• The project was triggered by years of LIBOR manipulation by banks and to fix the security issues that let the banks involve i n LIBOR
rigging
• Currently LIBOR is applicable for following products

 Variable Interest Rate Loans Risk Free Rate +
LIBOR
 Syndicated loans
Spread + Duration
 Variable Interest Rate Bond
 Term loans with prices linked to LIBOR
 Interest Rate Swaps – Pay fixed Receive Floating
 Interest Rate Swaps – Receive Fixed Pay Floating
• By December 2021, LIBOR should be fully replaced by the respective adjusted Risk-Free Rates. Relevant Institutions related to IBOR re-
form such as Financial Conduct authority have confirmed that there are no changes to the LIBOR replacement project due to Cor ona
• It is also expected that any new contracts starting from April 2021 must use an alterative reference/bench -mark rate to ensure a smooth
transition into adjusted risk-free rates by December 2021. Cash products and derivatives must be linked to a new reference rate
• Risk-free rates needs to be adjusted for duration (tenor) and spread relating to credit risk. Credit risk is already embedded in to
LIBOR
44
Interbank Offered Rate (IBOR) Reform and Impact on Hedge Accounting
• The Secured Overnight Finance Rate (SOFR) in USA will replace LIBOR. SOFR will be purely based on transaction data whereas LI BOR was partially
dependent partially market data – expert judgment.
• Similarly, in the UK, Sterling Over Night Index Average (SONIA) rate is expected to replace UK LIBOR.

• Euro, Canada Dollar, Mexican Peso, Singaporean Dollar are currently working towards replacing LIBOR as well.
• In the USA and UK, most of the new bond issuances and loans are linked to new bench-mark rates. However, a large proportion of derivative products
are still linked to LIBOR
• The IBOR reform will have significant implications for IFRS 9 hedge accounting mainly in the following areas
 IFRS 9 and IAS 39 – Modification of Financial Instruments
 IFRS 9 and IAS 39 – Update of Hedge Documentation and effectiveness Testing
 IFRS 9 and IAS 39 – Separately identifiable risk components not yet established in the benchmark reference rates
• There is an exposure draft issued by IASB on Hedge Accounting with a 45-day response period ending 25 th May 2020
United States United Kingdom

LIBOR SOFR LIBOR SONIA
45
Are you ready for a new bench-mark rate ?
Review LIBOR Exposures
• Identify and review existing LIBOR exposures in cash products and

contracts

New Appropriate Action
Products
must be
referenced to • Identify fallback clauses in the contracts
Risk Free • Update contracts with fallback clauses
Return • Assess and determine accounting implications
System and Technology Changes
• Comprehensive assessment of systems and data requirements

• Implement changes to the treasury systems to incorporate changes
• System updates for accounting changes 46
Disclosures

Key Disclosure Requirements in IFRS 7
• IFRS 07 helps to improve the quality of information presented in the financial statements with detailed disclosures
on Financial Assets and Liabilities to improve transparency in reporting
• The two main categories of disclosures required by IFRS 7 are:

 Information about the significance of financial instruments
 Information about the nature and extent of risks arising from financial instruments
• Financial asset by type need to be reported
 Fair value
 Amortized cost
• Fair value hierarchy - fair value based financial assets must be broken into Level 1, 2, 3 based on the methods
used to identify fair value
48
Key Disclosure Requirements in IFRS 7
• Nature and purpose of financial instruments
• Outcome of business model test and contractual cash flow test need to be disclosed along with objectives of each portfolio
• Risks exposure of Financial Assets must be clearly identified and discussed along with risk management practices of management
 Market price risk
 Exchange rate risk

 Interest rate risk
 Credit risk
 Liquidity risk
 Past due risk
• Qualitative disclosures -overall risk appetite of companies and how they manage the risk exposure of financial assets
• Financial Liabilities by type need to be disclosed

 Fair value
 Amortized cost
• Identification of debt (financial liability /equity) based on IAS 32 classification and presentation
• Disclosures on hedge accounting

 description of each hedge, hedging instrument, and fair values of those instruments, and nature of risks being hedged
 Hedge ineffectiveness
• Disclosures on transferred financial assets

49
Q&A
Contact – sudhanshiya@yahoo.com

Financial Instruments IAS 32, IfRS 9, IfRS 13, IfRS 7 Final Version

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Financial Instruments IAS 32, IfRS 9, IfRS 13, IfRS 7 Final Version

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Financial Instruments

By Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

Equity Investments Debt (liability)

Hybrid Instruments –Equity and

•Classification of financial liabilities into equity and liabilities and compound

IAS 39 Recognition and Measurement

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

IFRS 9 Recognition and Measurement

•Recognition and Measurement of Financial Assets and Liabilities

•Disclosure standard of IFRS 9

IFRS 13 Fair Value Measurement

•Determination of Fair Value of Financial Assets

By Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

entity. Derivative assets are also part of financial assets

• Financial Liabilities are broken into debt (liability) & equity

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

• is a contractual obligation to deliver cash or financial instrument to

• do not have a contractual obligation to deliver cash or financial assets

 Is the distribution mandatory or discretionary ?

 Is there a maturity or perpetual ?

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

• Zero coupon bonds

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

• Employee share options

• Ordinary share issues

• Convertible bond issue

By Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

•Not available for equities

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

Classification must be based on

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

via OCI for equities

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

• De-recognition occurs under following circumstances

 Contractual rights to receive cash flows expire

 Disposal of bonds and shares

investments accounted as FV through OCI 13

established and derecognized when a financial liability is extinguished

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

 Financial liability is fully settled

 Exchange of one financial liability with another liability

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

By Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

Level 3 Based on unobservable market data

• Level 3 must be only when Level 1, Level 2 not available

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

assets measured using level 3 inputs

By Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

IAS 39 – Incurred Loss Model

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

Significant increase Objective evidence

Impairment 12-month ECL Lifetime ECL

(PD) – Probability of default

deteriorated since their initial recognition

expected credit losses approach

Umasudhan Subramaniam, CFA, FRM, FCCA, ACMA, MSc

expected credit losses over the maturity

credit losses over the maturity

• Applicable to any financial assets with credit risk