Disclaimer- this highlights only important notes to remember.

Please read first Milan book and the AAFR

and 9781119197102.app1 PDF FILE before reading this handout

FINANCIAL INSTRUMENTS PRESENTATION (IAS -32)

5 Objective
The objective of this IAS is to enhance user’s understanding of the significance of financial instruments to an entity’s financial
position, performance and cash flows. The main issues are: -
 Classification of financial instruments from the perspective of issuer;
 Classification of related interest, dividend, losses and gains; and
10  The circumstances in which financial asset can be set off against the liability
Scope
This IAS is applicable to all entities to all types of financial instruments except: -
Those interests in subsidiaries, associates and joint ventures accounted for under IASs 27, 28 & 31, however, where IAS-39, now
IFRS 9 is applied for these instruments, the requirements of this IAS will be operative;
15 1. Employer’s rights and obligations where IAS-19 is applicable;
2. Insurance contracts where IFRS-4 is applicable except embedded derivatives;
3. Contracts and obligations under share based payments under IFRS-2 except where this IAS or IAS-39 is applicable
This Standard shall be applied to those contracts to buy or sell a non-financial item that can be settled net in cash or another
financial instrument, or by exchanging financial instruments, as if the contracts were financial instruments, with the exception of
20 contracts that were entered into and continue to be held for the purpose of the receipt or delivery of a non-financial item in
accordance with the entity’s expected purchase, sale or usage requirements. There are various ways in which a contract to buy or
sell a non-financial item can be settled net in cash or another financial instrument or by exchanging financial instruments.
Examples are: -
(a) When the terms of the contract permit either party to settle it net in cash or another financial instrument or by exchanging
25 financial instruments;
(b) when the ability to settle net in cash or another financial instrument, or by exchanging financial instruments, is not explicit in
the terms of the contract, but the entity has a practice of settling similar contracts net in cash or another financial instrument, or by
exchanging financial instruments (whether with the counter party, by entering into offsetting contracts or by selling the contract
before its exercise or lapse);
30 (c) when, for similar contracts, the entity has a practice of taking delivery of the underlying and selling it within a short period
after delivery for the purpose of generating a profit from short-term fluctuations in price or dealer’s margin; and
(d) When the non-financial item that is the subject of the contract is readily convertible to cash.

Definitions
35 Financial instrument is any contract that gives rise to financial asset of one enterprise and financial liability or equity instrument
of another enterprise.
Financial asset is any asset that is:
a) Cash;
b) An equity instrument of another entity;
40 c)A contractual right:
i. to receive cash or another financial asset from another entity; or
ii. to exchange financial assets or financial liability with another entity under conditions that are potentially favorable to the entity;
or
d) a contract that will or may be settled in the entity’s own instruments and is:
45 i. a non-derivative for which the entity is or may be obliged to receive a variable number of the entity’s own equity instruments; or
ii. a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a
fixed number of the entity’s own equity instruments.
For this purpose the entity’s own equity instruments do not include puttable financial instruments classified as equity instruments
in accordance with paragraphs 16A and 16B, instruments that impose on the entity an obligation to deliver to another party a pro
50 rata share of the net assets of the entity only on liquidation and are classified as equity instruments in accordance with paragraphs
16C and 16D, or instruments that are contracts for the future receipt or delivery of the entity’s own equity instruments.
Examples of financial assets are cash, deposits in other companies, trade receivables, loan
to other companies, investment in debt instruments, investment in shares, and other equity
instruments.
55 Financial liability is any liability that is: -
a) a contractual obligation: -
(i) to deliver cash or another financial asset to another entity; or
(ii) to exchange financial assets or financial liability with another entity under conditions that are potentially un-favorable to the
entity; or
60 b) a contract that will or may be settled in the entity’s own instruments and is:
(i) a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments;
or
(ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a
 fixed number of the entity’s own equity instruments.

For this purpose, rights, options or warrants to acquire a fixed number of the entity’s own equity instruments for a fixed
amount of any currency are equity instruments if the entity offers the rights, options or warrants pro rata to all of its existing
5 owners of the same class of its own non-derivative equity instruments. Also, for these purposes the entity’s own equity
instruments do not include puttable financial instruments that are classified as equity instruments in accordance with paragraphs
16A and 16B, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the
entity only on liquidation and are classified as equity instruments in accordance with paragraphs 16C and 16D, or instruments that
are contracts for the future receipt or delivery of the entity’s own equity instruments. As an exception, an instrument that meets the
10 definition of a financial liability is classified as an equity instrument if it has all the features and meets the conditions in
paragraphs 16A and 16B or paragraphs 16C and 16D.
Examples of financial liability are trade payables, loans from other companies and debt instruments issued by the entity.
Equity instrument: Any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.
A derivative is a financial instrument:
15 Whose value changes in response to the change in an underlying variable such as an interest rate, commodity or security price, or
index; That requires no initial investment, or one that is smaller than would be required for a contract with similar response to
changes in market factors; and That is settled at a future date.
Contract and contractual refer to an agreement between two or more parties that has clear economic consequences that the
parties have little, if any, discretion to avoid, usually because the agreement is enforceable by law. Contracts, and thus financial
20 instruments, may take a variety of forms and need not be in writing.
A puttable instrument is a financial instrument that gives the holder the right to put the instrument back to the issuer for cash or
another financial asset or is automatically put back to the issuer on the occurrence of an uncertain future event or the death or
retirement of the instrument holder.
Puttable financial instruments will be presented as equity only if all of the following
25 criteria are met:
(i) the holder is entitled to a pro-rata share of the entity’s net assets on liquidation;
(ii) the instrument is in the class of instruments that is the most subordinate and all instruments in that class have identical
features;
(iii)the instrument has no other characteristics that would meet the definition of a financial liability; and
30 (iv) the total expected cash flows attributable to the instrument over its life are based substantially on the profit or loss, the change
in the recognized net assets or the change in the fair value of the recognized and unrecognized net assets of the entity (excluding
any effects of the instrument itself). Profit or loss or change in recognized net assets for this purpose is as measured in
accordance with relevant IFRSs. In addition to the criteria set out above, the entity must have no other instrument that has terms
equivalent to (iv) above and that has the effect of substantially restricting or fixing the residual return to the holders of the puttable
35 financial instruments.
Presentation Financial Liability and Equity
The issuer of a financial instrument shall classify the instrument, or its components parts, on initial recognition as a financial
liability, financial asset or an equity instrument in accordance with the substance of the contractual arrangement and definitions of
a financial liability, a financial asset and equity instrument.
40 Classification
A financial instrument is an equity instrument only if: -
a) the instrument includes no contractual obligation to deliver cash or another financial asset to another entity or to exchange
financial asset/liability with another entity under conditions which are potentially unfavorable to issuer; and
b) if the instrument will or may be settled in the issuer's own equity instruments, it is either:
45 a non-derivative that includes no contractual obligation for the issuer to deliver a variable number of its own equity instruments;
or a derivative that will be settled only by the issuer exchanging a fixed amount of cash or another financial asset for a fixed
number of its own equity instruments.
For this purpose, rights, options or warrants to acquire a fixed number of the entity’s own equity instruments for a fixed amount of
any currency are equity instruments if the entity offers the rights, options or warrants pro rata to all of its existing owners of the
50 same class of its own non-derivative equity instruments. Also, for these purposes the issuer’s own equity instruments do not
include instruments that have all the features and meet the conditions described in paragraphs 16A and 16B or paragraphs 16C and
16D, or instruments that are contracts for the future receipt or delivery of the issuer’s own equity instruments

55

Compound Financial Instruments

Some financial instruments - sometimes called compound instruments - have both a liability and an equity component from the
issuer's perspective. In that case, IAS 32 requires that the component parts be accounted for and presented separately according to
60 their substance based on the definitions of liability and equity. The split is made at issuance and not revised for subsequent
changes in market interest rates, share prices, or other event that changes the likelihood that the conversion option will be
exercised.
To illustrate, a convertible bond contains two components. One is a financial liability, namely the issuer's contractual obligation
to pay cash, and the other is an equity instrument, namely the holder's option to convert into common shares. Another example is
 debt issued with detachable share purchase warrants.
When the initial carrying amount of a compound financial instrument is required to be allocated to its equity and liability
components, the equity component is assigned the residual amount after deducting from the fair value of the instrument as a whole
the amount separately determined for the liability component.
5 On conversion of a convertible instrument at maturity the entity derecognizes the liability component and recognize it as equity.
There is no gain/loss recognition on conversion at maturity. When an entity extinguishes a convertible instrument before maturity
i.e. redemption or repurchase in which original conversion privileges are unchanged, the entity allocates the consideration paid
and transaction cost to liability and equity component at the date of transaction. The method is same as used for original allocation
of debt/equity.
10 Interest, dividends, gains, and losses relating to an instrument classified, as a liability should be reported in the income statement.
This means that dividend payments on preferred shares classified as liabilities are treated as expenses. On the other hand,
distributions (such as dividends) to holders of a financial instrument classified as equity should be charged directly against equity,
not against earnings.
f) Treasury shares
15 The cost of an entity's own equity instruments that it has reacquired ('treasury shares') is deducted from equity. Gain or loss is not
recognized on the purchase, sale, issue, or cancellation of treasury shares. Treasury shares may be acquired and held by the entity
or by other members of the consolidated group. Consideration paid or received is recognized directly in equity.
g) Off-setting
IAS 32 also prescribes rules for the offsetting of financial assets and financial liabilities. It specifies that a financial asset and a
20 financial liability should be offset and the net amount reported when and only when, an enterprise: has a legally enforceable right
to set off the amounts; and intends either to settle on a net basis, or to realize the asset and settle the liability simultaneously.
Offsetting is usually inappropriate when:
• several different financial instruments are used to emulate the features of a single financial instrument (a ‘synthetic instrument’);
• financial assets and financial liabilities arise from financial instruments having the same primary risk exposure (for example,
25 assets and liabilities within a portfolio of forward contracts or other derivative instruments) but involve different counterparties;
• financial or other assets are pledged as collateral for non-recourse financial liabilities;
• financial assets are set aside in trust by a debtor for the purpose of discharging an obligation without those assets having been
accepted by the creditor in settlement of the obligation (for example, a sinking fund arrangement); or
• obligations incurred as a result of events giving rise to losses are expected to be recovered from a third party by virtue of a claim
30 made under an insurance contract.

h) Costs of issuing and reacquiring equity instruments

Costs of issuing or reacquiring equity instruments (other than in a business combination) are accounted for as a deduction from
equity, net of any related income tax benefit. An entity typically incurs various costs in issuing or acquiring its own equity
35 instruments. Those costs might include registration and other regulatory fees, amounts paid to legal, accounting and other
professional advisers, printing costs and stamp duties. The transaction costs of an equity transaction are accounted for as a
deduction from equity (net of any related income tax benefit) to the extent they are incremental costs directly attributable to the
equity transaction that otherwise would have been avoided. The costs of an equity transaction that is abandoned are recognized as
an expense. Transaction costs that relate to the issue of a compound financial instrument are allocated to the liability and equity
40 components of the instrument in proportion to the allocation of proceeds. Transaction costs that relate jointly to more than one
transaction (for example, costs of a concurrent offering of some shares and a stock exchange listing of other shares) are allocated
to those transactions using a basis of allocation that is rational and consistent with similar transactions.

IFRS 9 - RECOGNITION AND MEASUREMENT

45
Background
IFRS 9 Financial Instruments is the IASB’s replacement of IAS 39 Financial Instruments: Recognition and Measurement.
The Standard includes requirements for recognition and measurement, impairment, derecognition and general hedge
accounting.
50 The version of IFRS 9 issued in 2014 supersedes all previous versions and is mandatorily effective for periods beginning on
or after 1 January 2018 with early adoption permitted (subject to local endorsement requirements). For a limited period,
previous versions of IFRS 91 may be adopted early, provided the relevant date of initial application is before 1 February
2015 (again, subject to local endorsement requirements).

55 Observation
The International Accounting Standards Board (IASB) has published an exposure draft (ED/2015/11) that proposes
amendments to IFRS 4 Insurance Contracts that are intended to address concerns about the different effective dates of
IFRS 9 Financial Instruments and the forthcoming new insurance contracts standard. The deadline of comments ended on 8
February and at the time of writing the IASB was considering the responses received.
60
Overview of IFRS 9
Classification and measurement of financial instruments

Initial measurement of financial instruments

 Under IFRS 9 all financial instruments are initially measured at fair value plus or minus, in the case of a financial asset or
financial liability not at fair value through profit or loss, transaction costs. This requirement is consistent with IAS 39.

Financial assets: subsequent measurement

5 Financial asset classification and measurement is an area where many changes have been introduced by IFRS 9.
Consistent with IAS 39, the classification of a financial asset is determined at initial recognition, however, if certain
conditions are met, an asset may subsequently need to be reclassified.
Subsequent to initial recognition, all assets within the scope of IFRS 9 are measured at:
• amortized cost;

10 • fair value through other comprehensive income (FVTOCI); or

• fair value through profit or loss (FVTPL).

The FVTOCI classification is mandatory for certain debt instrument assets unless the option to FVTPL (‘the fair value
option’) is taken. Whilst for equity investments, the FVTOCI classification is an election. The requirements for reclassifying
15 gains or losses recognized in other comprehensive income (OCI) are different for debt and equity investments. For debt
instruments measured at FVTOCI, interest income (calculated using the effective interest rate method), foreign currency
gains or losses and impairment gains or losses are recognized directly in profit or loss. The difference between cumulative
fair value gains or losses and the cumulative amounts recognized in profit or loss is recognized in OCI until derecognition,
when the amounts in OCI are reclassified to profit or loss.
20

25 Debt instruments
A debt instrument that meets the following two conditions must be measured at amortised cost unless the asset is
designated at FVTPL under the fair value option (see below):
 Business model test: The financial asset is held within a business model whose objective is to hold financial assets to
collect their contractual cash flows (rather than to sell the assets prior to their contractual maturity to realise changes in fair
30 value).

 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.

A debt instrument that meets the cash flow characteristics test and is not designated at FVTPL under the fair value option
35 must be measured at FVTOCI if it is held within a business model whose objective is to hold financial assets in order to
collect contractual cash flows and sell financial assets.
All other debt instrument assets are measured at fair value through profit or loss (FVTPL).

Contractual cash flow characteristics test

40 Only debt instruments are capable of meeting the contractual cash flows characteristics test required by IFRS 9. Derivative
assets and investments in equity instruments will not meet the criteria. Contractual cash flows that are solely payments of
principal and interest on the principal amount outstanding are consistent with a basic lending arrangement. In a basic
lending arrangement, consideration for the time value of money and credit risk are typically the most significant elements of
interest. However, in such an arrangement, interest can also include consideration for other basic lending risks (for example,
45 liquidity risk) and costs (for example, administrative costs) associated with holding the financial asset for a particular period
of time. In addition, interest can include a profit margin that is consistent with a basic lending arrangement.
The assessment as to whether contractual cash flows are solely payments of principal and interest is made in the currency
in which the financial asset is denominated. Judgement is needed in assessing whether a payment (or non- payment) of a
contractual cash flow that only arises as a result of the occurrence or non-occurrence of a contingent event leads to the
50 instrument failing the contractual cash flow characteristics test. An entity should consider what risk leads to the occurrence
of the contingent event and whether that risk is consistent with risks associated with a basic lending arrangement. The
contractual cash flows characteristics assessment should consider all the contractual terms of the instrument, not just those
contractual cash flows that are most likely to fall due. When an asset may be prepaid, the contractual cash flow
characteristics assessment requires consideration of the contractual cash flows both before and after the timing of the
55 prepayment option, irrespective of the probability that the instrument may be repaid prior to maturity.
IFRS 9 contains detailed guidance regarding the assessment of the contractual cash flows of an asset and has specific
requirements for non-recourse assets and contractually linked instruments.

Observation
60 The FVTOCI category for debt instruments is not the same as the available-for-sale category under IAS 39. Under IAS 39,
impairment gains and losses are based on fair value, whereas under IFRS 9, impairment is based on expected losses and is
measured consistently with amortised cost assets (see below).
Also, the criteria for measuring at FVTOCI are based on the entity’s business model, which is not the case for the available-
for-sale category. For example under IAS 39, certain instruments can be elected to be classified as available-for-sale,
65 whereas under IFRS 9 the FVTOCI classification cannot be elected for debt instruments.
 Business model assessment
An assessment of business models for managing financial assets is fundamental to the classification of financial 4 iii assets.
An entity’s business model is determined at a level that reflects how groups of financial assets are managed together to
5 achieve a particular business objective. The entity’s business model does not depend on management’s intentions for an
individual instrument. Accordingly, this condition is not an instrument-by-instrument approach to classification and should be
determined at a higher level of aggregation. However, an entity may have more than one business model for managing its
financial assets.
IFRS 9 provides guidance on how to determine whether a business model is to manage assets to collect contractual cash
10 flows or to both collect contractual cash flows and to sell financial assets. When sales of financial assets, other than in
response to credit deterioration, are more than infrequent and more than insignificant in value (either individually or in
aggregate) an assessment is needed to determine whether such sales are consistent with an objective of collecting
contractual cash flows. Further, sales of financial assets may be consistent with the objective of collecting contractual cash
flows if they are made close to the maturity of the financial assets and the proceeds from the sales approximate to the
15 collection of the remaining contractual cash flows.

Fair value option

IFRS 9 contains an option to designate, at initial recognition, a financial asset as measured at FVTPL if doing so eliminates
or significantly reduces an ‘accounting mismatch’ that would otherwise arise from measuring assets or liabilities or
20 recognising the gains and losses on them on different bases. Financial assets designated at FVTPL are not subject to the
reclassification requirements of IFRS 9.

Equity investments
All equity investments in scope of IFRS 9 are measured at fair value in the statement of financial position, with value
25 changes recognized in profit or loss, except for those equity investments for which the entity has elected to present value
changes in other comprehensive income.
The option to designate an equity instrument at FVTOCI is available at initial recognition and is irrevocable. This designation
results in all gains and losses being presented in OCI except dividend income which is recognized in profit or loss.

30 Financial liabilities: Subsequent measurement

The IFRS 9 accounting model for financial liabilities is broadly the same as that in IAS 39. However, there are two key
differences compared to IAS 39.
 The presentation of the effects of changes in fair value attributable to an entity’s credit risk.

35 Financial liabilities held for trading, ( e.g. derivative liabilities), as well as loan commitments and financial guarantee
contracts that are designated at FVTPL under the fair value option, will continue to be measured at fair value with all
changes being recognized in profit or loss. However, for all other financial liabilities designated as at FVTPL using the fair
value option, IFRS 9 requires the amount of the change in the liability’s fair value attributable to changes in the credit risk to
be recognized in OCI with the remaining amount of change in fair value recognized in profit or loss, unless this treatment of
40 the credit risk component creates or enlarges a measurement mismatch. Amounts presented in other comprehensive
income are not subsequently transferred to profit or loss.

Observation
In cases where amounts payable under an obligation are only paid when amounts are due on specified assets (e.g. with
45 some asset-backed securities), care is required in differentiating between credit risk and asset-specific performance risk.
IFRS 9 is clear that asset-specific performance risk is not related to the risk that an entity will fail to discharge a particular
obligation but rather it is related to the risk that a single asset or a group of assets will perform poorly (or not at all).
Therefore any changes in fair value attributable to asset-specific performance should be recognized in profit or loss, not in
other comprehensive income.
50 The elimination of the cost exemption for derivative liabilities to be settled by the delivery of unquoted equity
instruments.

The part of IFRS 9 dealing with financial assets removed the cost exemption in IAS 39 for unquoted equity instruments and
related derivative assets where fair value is not reliably determinable. IFRS 9 also removed the cost exemption for derivative
55 liabilities that will be settled by delivering unquoted equity instruments whose fair value cannot be determined reliably (e.g. a
written option where, on exercise, an entity would deliver unquoted shares to the holder of the option). Therefore all
derivatives on unquoted equity instruments, whether assets or liabilities, are measured at fair value under IFRS 9.

Fair value option

60 The IFRS 9 eligibility requirements for applying the fair value option to measure financial liabilities at FVTPL are consistent
with those of IAS 39.

Derivatives
All derivatives in scope of IFRS 9, including those linked to unquoted equity investments, are measured at fair value. Fair
65 value changes are recognized in profit or loss unless the entity has elected to apply hedge accounting by designating the
derivative as a hedging instrument in an eligible hedging relationship in which some or all gains or losses may be
recognized in other comprehensive income.
 Embedded derivatives
An embedded derivative is a component of a hybrid contract that also includes a non-derivative host, with the effect that
some of the cash flows of the combined instrument vary in a way similar to a stand-alone derivative.
The embedded derivative concept that exists in IAS 39 has been included in IFRS 9 to apply only to hosts that are not
5 financial assets within the scope of the Standard, i.e. financial liabilities and host contacts not in the scope of IFRS 9, such
as leases, purchase contracts, service contracts, etc. Consequently, embedded derivatives that, under IAS 39, would have
been separately accounted for at FVTPL, because they were not closely related to a host financial asset will no longer be
separated. Instead, the contractual cash flows of the financial asset are assessed in their entirety, and the asset as a whole
is measured at FVTPL if the contractual cash flow characteristics test is not passed.
10 The embedded derivative guidance that exists in IAS 39 is included in IFRS 9 to help identify when an embedded derivative
is closely related to a financial liability host contract or a host contract not within the scope of the Standard (e.g. lease
contracts, insurance contracts, contracts for the purchase or sale of non-financial items).
Reclassification
For financial assets, reclassification is required between FVTPL, FVTOCI and amortised cost; if and only if the entity’s
15 business model objective for its financial assets changes so its previous business model assessment would no longer apply.
IFRS 9 does not allow reclassification:
 when the fair value option has been elected in any circumstance for a financial asset;

 or equity investments (measured at FVTPL or FVTOCI); or

 for financial liabilities.

20
If an entity reclassifies a financial asset, it is required to apply the reclassification prospectively from the reclassification date,
defined as the first day of the first reporting period following the change in business model 8 iii that results in the entity
reclassifying financial assets. Previously recognized gains, losses (including impairment gains or losses) or interest are not
restated.
25 Impairment
IFRS 9 introduces a new impairment model based on expected losses, (rather than incurred loss as per IAS 39) which has a
wider scope of application than IAS 39.
Scope
IFRS 9 requires the same expected loss impairment model to apply to all of the following:
30 •financial assets measured at amortised cost;

•financial assets mandatorily measured at FVTOCI;

•loan commitments when there is a present obligation to extend credit (except where these are measured at FVTPL);

•financial guarantee contracts to which IFRS 9 is applied (except those measured at FVTPL);

•lease receivables within the scope of IAS 17 Leases (or, when applied, IFRS 16 Leases); and

35 •contract assets within the scope of IFRS 15 Revenue from Contracts with Customers.

A derivative is a financial instrument: Whose value changes in response to the change in an underlying variable such as

an interest rate, commodity or security price, or index; That requires no initial investment, or one that is smaller than would
be

40 required for a contract with similar response to changes in market factors; and That is settled at a future date.

Examples of derivatives

Forwards: Contracts to purchase or sell a specific quantity of a financial instrument, a commodity, or a foreign currency at a
specified price determined at the outset, with delivery or settlement at a specified future date. Settlement is at maturity by
actual delivery of the item specified in the contract, or by a net cash settlement.

45 Interest Rate Swaps and Forward Rate Agreements: Contracts to exchange cash flows as of a specified date or a series
of specified dates based on a notional amount and fixed and floating rates.

Futures: Contracts similar to forwards but with the following differences: Futures are generic exchange-traded, whereas
forwards are individually tailored. Futures are generally settled through an offsetting (reversing) trade, whereas forwards are
generally settled by delivery of the underlying item or cash settlement.

50 Options: Contracts that give the purchaser the right, but not the obligation, to buy (call option) or sell (put option) a specified
quantity of a particular financial instrument, commodity, or foreign currency, at a specified price (strike price), during or at a
specified period of time. These can be individually written or exchange-traded. The purchaser of the option pays the seller
(writer) of the option a fee (premium) to compensate the seller for the risk of payments under the option.

Caps and Floors: These are contracts sometimes referred to as interest rate options. An interest rate cap will compensate
55 the purchaser of the cap if interest rates rise above a predetermined rate (strike rate) while an interest rate floor will
compensate the purchaser if rates fall below a predetermined rate. The amortized cost of a financial asset or financial
 liability is the amount at which the financial asset or financial liability is measured at initial recognition minus principal
repayments, plus or minus the cumulative amortization using the effective interest method of any difference between that
initial amount and the maturity amount, and minus any reduction for impairment or un-collectability.

The effective interest method is a method of calculating the amortized cost of a financial asset or a financial liability and of
5 allocating the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly
discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when
appropriate, a shorter period to the net carrying amount of the financial asset or financial liability. When calculating the
effective interest rate, an entity shall estimate cash flows considering all contractual terms of the financial instrument but
shall not consider future credit losses. The calculation includes all fees and points paid or received between parties to the
10 contract that are an integral part of the effective interest rate, transaction costs, and all other premiums or discounts.

Transition to IFRS 9
IFRS 9 is effective for annual periods beginning on or after 1 January 2018 and, subject to local endorsement requirements,
is available for early adoption. An entity with a date of initial application before 1 February 2015 can apply earlier versions of
IFRS 9 in the annual periods that begin prior to 1 January 2018, again subject to local endorsement requirements.
15 IFRS 9 should be applied retrospectively in accordance with IAS 8 Accounting Policies, Changes in Accounting
Estimates and Errors, subject to certain exemptions and exceptions some of which are considered below.
 The effective interest method requirements.
If it is impracticable (as defined in IAS 8) for an entity to apply retrospectively the effective interest method, the entity treats
the fair value of the financial asset or financial liability at the end of each comparative period as the gross carrying amount of
20 the financial asset or the amortised cost of the financial liability. In such circumstances, the fair value of the financial asset or
financial liability at the date of initial application is treated as the new gross carrying amount of that financial asset or the new
amortised cost of that financial liability at the date of initial application of IFRS 9.


25
Impairment measurement requirements. The impairment requirements are applied retrospectively subject to meeting
specific exceptions. At the date of initial application, an entity shall use reasonable and supportable information that is
available without undue cost or effort to determine the credit risk at the date that the financial instrument was initially
recognized (or for loan commitments and financial guarantee contracts the date that the entity became a party to the
30 irrevocable commitment) and compare that to the credit risk at the date of initial application of IFRS 9. If it would require
undue cost or effort at the date of initial application to determine whether there has been a significant increase in credit risk
since initial recognition, an entity should recognise a loss allowance at an amount equal to lifetime expected credit losses at
each reporting date until that financial instrument is derecognized. However, if the financial instrument has low credit risk at
the reporting date, the entity may assume that the credit risk has not increased significantly since initial recognition.
35  Hedge accounting requirements.
On initial application of IFRS 9, an entity can decide to continue applying the hedge accounting requirements of IAS 39
instead of the requirements set out in IFRS 9. This decision applies to all of the entity’s hedging relationships. The
requirements for hedge accounting in IFRS 9 are generally applied prospectively. To apply hedge accounting from the date
of initial application all qualifying criteria must be met at that date. However, the accounting for the time value of options
40 should be applied retrospectively if, in accordance with IAS 39, only the change in an option’s intrinsic value was designated
as a hedging instrument in a hedging relationship. This only applies to hedging relationships that existed at the beginning of
the earliest comparative period or were designated thereafter. Under the same provision, the accounting for the forward
element of forward contracts may be applied retrospectively, if, in accordance with IAS 39, only the change in the spot
element of a forward contract was designated as a hedging instrument in a hedging relationship. If electing retrospective
45 application this should be applied to all hedging relationships that qualify for this election. Similarly the accounting for foreign
currency basis spreads may be applied retrospectively for those hedging relationships that existed at the beginning of the
earliest reporting period or were designated thereafter, which may be elected on a hedge-by-hedge basis.
The date of initial application for IFRS 9 is the date when an entity first applies the Standard. To reduce the burden for
preparers when an entity first applies IFRS 9 it is not required to restate prior periods. However, entities are required to
50 provide comprehensive disclosures about financial assets and liabilities at the date of initial application.
If an entity transitioning from IAS 39 chooses to restate prior year comparatives, it is required to apply IAS 39 in the
comparative period to items that have already been derecognized at the date of initial application. Consequently a
combination of IAS 39 and IFRS 9 could apply in the comparative period.

55 Hedge accounting
The application of the hedge accounting requirements in IFRS 9 is optional. If certain eligibility and qualification criteria are
met, hedge accounting can allow an entity to reflect its risk management activities in the financial statements by matching
gains or losses on hedging instruments (e.g. derivatives) with losses or gains on the risk exposures they hedge (e.g. foreign
currency sales).
60 The hedge accounting model in IFRS 9 is not designed to accommodate hedging of open, dynamic portfolios. For a fair
value hedge of interest rate risk of a portfolio of financial assets or liabilities an entity adopting IFRS 9 can apply the hedge
accounting requirements in IAS 39 in combination with the general ‘macro’ hedge accounting requirements in IFRS 9.
Furthermore, when an entity first applies IFRS 9, it may choose as its accounting policy choice to continue to apply all of the
hedge accounting requirements of IAS 39 instead of the requirements of Chapter 6 of IFRS 9. The following summarises the
65 hedge requirements of Chapter 6 of IFRS 9 and how they compare with IAS 39.
Qualifying criteria for hedge accounting
 A hedging relationship qualifies for hedge accounting only if all of the following criteria are met:
 the hedging relationship consists only of eligible hedging instruments and eligible hedged items;

 at inception of the hedging relationship there is formal designation and documentation of the hedging relationship and the
entity’s risk management objective and strategy for undertaking the hedge; and

5  the hedging relationship meets all of the hedge effectiveness requirements.

Hedging instruments
The main difference in IFRS 9 compared to IAS 39 is that the inclusion of non-derivative financial instruments measured at
FVTPL can be eligible hedging instruments. The bulk of changes in respect of hedging instruments relate to how they are
10 accounted for, specifically, the accounting for option contracts, forwards and foreign currency basis spread.
Option contracts
Under IAS 39, entities that hedge account with option contracts generally recognise the fair value change in the time value
component of the option in profit or loss. However, risk management generally views the time value of an option (usually
equal to the premium paid at inception) as a cost of hedging. In other words, a cost incurred to protect the entity against
15 unfavourable changes in price. This risk management is included in IFRS 9. Under IFRS 9 the accounting for the time value
can be viewed as a two-step process.
The first step is to defer in OCI, over the term of the hedge, the fair value change of the time value component of the option
contract to the extent that it relates to the hedged item.
The second step is to reclassify amounts from equity to profit or loss. However, the basis of this reclassification depends on
20 the categorisation of the hedged item which will be either:
 a transaction related hedged item (e.g. a hedge of a forecast transaction); or

 a period related hedged item (e.g. a hedge of an existing item, such as inventory, over a period of time).

For transaction related hedged items the cumulative change in fair value deferred in OCI is recognized in profit or loss at the
25 same time as the hedged item. If the hedged item first gives rise to the recognition of a non-financial asset or a non-financial
liability the amount in equity is recognized in the statement of financial position and recorded as part of the initial carrying
amount of the hedged item. This amount is recognized in profit or loss at the same time as the hedged item affects profit or
loss in accordance with the normal accounting for that hedged item.
For period related hedged items the reclassification of amounts deferred in equity is different. Instead of matching the option
30 cost with a specific transaction, the amount of the original time value of the option that relates to the hedged item is
amortised from equity to profit or loss on a rational basis (e.g. straight line) over the term of the hedging relationship.
Forward contracts and foreign currency basis spreads
Under IAS 39, if only the spot component of a forward contract is designated in a hedge, the forward points are recognized
in profit or loss on a fair value basis – giving rise to volatility in profit or loss. Under IFRS 9, an alternative 13 iii accounting
35 treatment for forward points is provided which, unlike the accounting for the time value of an option contract, is a choice
rather than a requirement. If applied, the accounting treatment is similar to that of the time value of an option when hedging
a period related hedged item as described above. That is, the fair value change of the forward points is deferred in OCI and
reclassified through profit or loss over the hedged period on a rational basis.
Under IFRS 9, an entity may also exclude the foreign currency basis spread from a designated hedging instrument and may
40 apply the same accounting treatment described above for the forward points.
Hedged items
IFRS 9 introduces more significant changes to the types of items that are eligible for hedge accounting and how entities can
designate those hedged items.
Risk component hedging
45 Under IAS 39 an entity may hedge part or all of the cash flows of a financial item due to all risks inherent in the hedged item,
or it may choose to hedge part or all of the cash flows due to only specific risks. This approach is known as ‘hedging
portions’ and is only permitted if the risk of the financial item can be identified and hedge effectiveness can be assessed and
measured reliably.
IFRS 9 extends the eligibility of risk components to include non-financial items, provided the component is separately
50 identifiable and reliably measurable. Consequently, entities may apply hedge accounting for risk components of non-
financial items that would not be permitted under IAS 39 (e.g. the crude oil component of jet fuel). It is noteworthy that the
risk component does not necessarily have to be contractually specified for it to be separately identifiable.
However, if the risk component is not contractually specified it may be more difficult to isolate parts of the market price into
identifiable and measurable risk components. In particular, it will be challenging for entities to analyse how market
55 participants price certain non-financial items to determine whether a risk component is separately identifiable and reliably
measurable.

Measurement at initial recognition

IFRS 9 carries forward with one exception the IAS 39 requirement to measure all financial assets and liabilities at fair value
60 at initial recognition (adjusted in some cases for transaction costs). The exception is for trade receivables that do not contain
a significant financing component, as defined by IFRS 15, Revenue from Contracts with Customers. These are measured at
the transaction price (e.g., invoice amount excluding costs collected on behalf of third parties, such as sales taxes).
Determining whether a significant financing component exists involves considering things like the difference between the
 cash price for an asset and the transaction price in the contract, the term of the receivable and prevailing interest rates. As a
practical expedient, entities can presume that a trade receivable does not have a significant financing component if the
expected term is less than one year.

5 Classification and measurement of financial assets after initial recognition

Under IAS 39, how assets are classified generally determines the basis for their measurement. Under IFRS 9, the reverse is
true—the basis on which assets are measured is the way they are classified.

Comparing IFRS 9 and IAS 39 classification and measurement categories

IFRS 9 IAS 39
Classifications and measurement Classifications Measurement model
models
Amortized Cost Loans and receivables Amortized Cost
FVPL FVPL FVPL
FVOCI Available for sale FVOCI
Held to maturity Amortized Cost

10 ]

IFRS 9 classification and measurement categories

Category Impact on financial statements
Amortized Cost The asset is measured at the amount recognized at initial
recognition minus principal repayments, plus or minus the
cumulative amortization of any difference between that
initial amount and the maturity amount, and any loss
allowance. Interest income is calculated using the
effective interest method and is recognized in profit and
loss. Changes in fair value are recognized in profit and
loss when the asset is derecognized or reclassified.

FVOCI The asset is measured at fair value.

Loans and receivables. Interest revenue, impairment
gains and losses, and a portion of foreign exchange gains
and losses, are recognized in profit and loss on the same
basis as for Amortized Cost assets. Changes in fair value
are recognized initially in Other Comprehensive Income
(OCI). When the asset is derecognized or reclassified,
changes in fair value previously recognized in OCI and
accumulated in equity are reclassified to profit and loss on
a basis that always results in an asset measured at
FVOCI having the same effect on profit and loss as if it
were measured at Amortized Cost.
Investments in equity instruments. Dividends are
recognized when the entity’s right to receive payment is
established, it is probable the economic benefits will flow
to the entity and the amount can be measured reliably.
Dividends are recognized in profit and loss unless they
clearly represent recovery of a part of the cost of the
investment, in which case they are included in OCI.
Changes in fair value are recognized in OCI and are
never recycled to profit and loss, even if the asset is sold
 or impaired.

FVPL The asset is measured at fair value. Changes in fair value

are recognized in profit and loss as they arise.