TOPIC 4 (PART 1)

MFRS 9 FINANCIAL
INSTRUMENTS
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 OVERVIEW
Related Accounting Standard:
 MFRS 7 Financial Instruments: Disclosures
 MFRS 9 Financial Instruments
 MFRS 32 Financial instruments: Presentation
 MFRS 139 Financial Instruments: Recognition and Measurement

Financial Instruments covered in BKAR2023:

 Financial assets
 Financial liabilities
 Accounting for Financial Instruments
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 ACCOUNTING STANDARDS
 MFRS 9 replaces the existing MFRS 139 "Financial Instruments: Recognition and
Measurement" from 1 January 2018 and introduces changes in the following four areas:
 Classification and meansurement of financial assets
 Accounting for changes in own credit risk in financial liabilities
 Impairment, and 
 Hedge accounting

 The new standard nevertheless retains certain principles in MFRS 139. For example, the
requirements on derecognition of financial assets and liabilities as well as classification and
measurement of financial liabilities remain unchanged.

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 OVERVIEW
Financial Instrument:
“ any contract that gives rise to a financial asset of one entity and a financial
liability or equity instrument of another entity”

a) Primary instruments:
 Cash, receivables, investments (stocks or bonds), payables

b) Secondary (derivative) instruments:

 Financialoptions, forward exchange contracts, futures, interest rate
swaps, structured notes & embedded derivatives

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 IFRS/MFRS 9
There are changes to the three main sections of IFRS 9:
1. Classification and measurement – The new classification requirements are based on both the entity’s
business model for managing the financial assets and the contractual cash flow characteristics of a financial
asset. The more principles-based approach of IFRS 9 requires the careful use of judgment in its application.
2. Impairment - The IASB has sought to address a key concern that arose as a result of the financial crisis,
that the incurred loss model in IAS 39 contributed to the delayed recognition of credit losses. As such, it has
introduced a forward-looking expected credit loss model.
3. Hedge accounting – The aim of the new hedge accounting model is to provide useful information about
risk management activities that an entity undertakes using financial instruments, with the effect that
financial reporting will reflect more accurately how an entity manages its risk and the extent to which
hedging mitigates those risks.

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 FINANCIAL ASSETS
MFRS 9 sets out three major classifications;
1) amortised cost (AC),
2) fair value through profit or loss (FVTPL) and
3) fair value through other comprehensive income (FVOCI).

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7
 FINANCIAL ASSETS – DEBT
INSTRUMENTS
 There are 3 classifications:

1. Amortised cost
 Amortised cost applies to instruments for which an entity has a business model to hold the
financial asset to collect the contractual cash flows. The characteristics of the contractual
cash flows are that of solely payments of the principal amount and interest (referred to as
“SPPI”).
• Principal is the fair value of the instrument at initial recognition.
• Interest is the return within a basic lending arrangement and typically consists of
consideration for the time value of money, and credit risk. It may also include
consideration for other basic lending risks such as liquidity risk as well as a profit
margin.

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 FINANCIAL ASSETS – DEBT
INSTRUMENTS …cont
2. Fair value through other comprehensive income
 Fair value through other comprehensive income is the classification for instruments for
which an entity has a dual business model, i.e. the business model is achieved by both
holding the financial asset to collect the contractual cash flows and through the sale of the
financial assets. The characteristics of the the contractual cash flows of instruments in this
category, must still be solely payments of principal and interest.
 The changes in fair value of FVOCI debt instruments are recognised in other
comprehensive income (OCI).
 Any interest income, foreign exchange gains/losses and impairments are recognised
immediately in profit or loss.
 Fair value changes that have been recognised in OCI are recycled to profit or loss upon
disposal of the debt

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 FINANCIAL ASSETS – DEBT
INSTRUMENTS …cont
3. Fair value through profit or loss instrument.
 Fair value through profit or loss is the classification of instruments that are held for
trading or for which the entity’s business model is to manage the financial asset on a
fair value basis i.e. to realise the asset through sales as opposed to holding the asset to
collect contractual cash flows.
 This category represents the ‘default’ or ‘residual’ category if the requirements to be
classified as amortised cost or FVOCI are not met.
 All derivatives would be classified as at FVTPL.

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 FINANCIAL ASSETS - EQUITY INSTRUMENTS
1. Fair value through profit or loss
 Equity instruments are normally measured at FVTPL.
 All derivatives would be classified as at FVTPL.

2. Fair value through other comprehensive income

 On initial recognition, an entity may make an irrevocable election (on an instrument-by-
instrument basis) to designate an equity instrument at FVOCI.
 This option only applies to instruments that are not held for trading and are not derivatives.
 Although most gains and losses on investments in equity instruments designated at FVOCI
will be recognised in OCI, dividends will normally be recognised in profit or loss (unless they
represent a recovery of part of the cost of the investment).
 Gains or losses recognised in OCI are never reclassified from equity to profit or loss.
Consequently, there is no need to review such investments for possible impairment. The
FVOCI equity reserves may however be transferred within equity i.e. to another component of
equity, if the entity so chooses.
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 FINANCIAL LIABILITIES
 remains broadly the same as under MFRS 139. Financial liabilities are measured at

1. amortised cost or
2. fair value through profit or loss (when they are held for trading).
 Financial liabilities can be designated at FVTPL if managed on a fair value basis or eliminates
or reduces an accounting mismatch
 For financial liabilities designated as at FVTPL using the fair value option, the element of
gains or losses attributable to changes in the entity’s own credit risk should normally be
recognised in OCI, with the remainder recognised in profit or loss.
 These amounts recognised in OCI are not recycled to profit or loss if the liability is ever
repurchased at a discount.

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 IMPAIRMENT
The impairment requirements under IFRS 9 are significantly different from those under IAS 39

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 IMPAIRMENT…CONT
 the application of one impairment model for all financial instruments,
including:
1. Financial assets measured at amortized cost.
2. Debt investments measured at fair value through other comprehensive
income (FVOCI).
3. Trade receivables and contract assets (as defined in IFRS 15 Revenue from
Contracts with Customers).
4. Lease receivables within the scope of IAS 17/IFRS 16 Leases.
5. Loan commitments that are not designated as at fair value through profit or
loss (FVTPL).
6. Financial guarantee contracts not designated as at FVTPL.

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IMPAIRMENT…CONT

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 IMPAIRMENT…CONT
 The guiding principle of the expected credit loss (ECL) model is to reflect the general pattern
of deterioration or improvement in the credit quality of financial instruments.
 The amount of ECLs recognised as a loss allowance or provision depends on the extent of
credit deterioration since initial recognition.
 Under the general approach, there are two measurement bases:

1. 12-month ECLs (Stage 1), which applies to all items (from initial recognition) as long as
there is no significant deterioration in credit quality
2. Lifetime ECLs (Stages 2 and 3), which applies when a significant increase in credit risk has
occurred on an individual or collective basis

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IMPAIRMENT - GENERAL APPROACH
Impairment of financial assets is recognised in stages:
 Stage 1—as soon as a financial instrument is originated or purchased, 12-month expected
credit losses are recognised in profit or loss and a loss allowance is established. This serves as
a proxy for the initial expectations of credit losses. For financial assets, interest revenue is
calculated on the gross carrying amount (ie without deduction for expected credit losses).
 Stage 2—if the credit risk increases significantly and is not considered low, full lifetime
expected credit losses are recognised in profit or loss. The calculation of interest revenue is the
same as for Stage 1.
 Stage 3—if the credit risk of a financial asset increases to the point that it is considered credit-
impaired, interest revenue is calculated based on the amortised cost (ie the gross carrying
amount less the loss allowance). Financial assets in this stage will generally be assessed
individually. Lifetime expected credit losses are recognised on these financial assets.

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IMPAIRMENT…CONT

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 IMPAIRMENT…CONT
The simplified approach
 a policy choice for trade receivables, contract assets and lease receivables.
 Must apply for trade receivable/contract assets without significant financing component

 The simplified approach does not require the tracking of changes in credit risk, but instead
requires the recognition of lifetime ECL at all times.
 For trade receivables or contract assets that do not contain a significant financing component
(as determined in terms of the requirements of IFRS 15 Revenue from Contracts with
Customers), entities are required to apply the simplified approach.
 For trade receivables or contract assets that do contain a significant financing component, and
lease receivables, entities have a policy choice to apply the simplified approach.

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 IMPAIRMENT…CONT
Measurement of ECLs
 Credit losses are the present value of the difference between all contractual cash flows that are
due and all cash flows that the entity expects to receive (i.e., the cash shortfall).
 Expected credit losses (ECLs) are the sum of all possible credit losses, weighted based on their
probability of occurrence
 Lifetime ECL would be estimated based on the present value of all cash shortfalls over the
remaining life of the financial instrument.
 The 12-month ECL is a portion of the lifetime ECL that is associated with the probability of
default events occurring within the 12 months after the reporting date.
 ‘Default’ is not defined and the standard is clear that default is broader than failure to pay and
entities would need to consider other qualitative indicators of default (e.g., covenant breaches).
There is also a rebuttable presumption that default does not occur later than 90 days past
due.

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 IMPAIRMENT…CONT
Assessing whether there has been a significant deterioration in credit risk
 There are a number of operational simplifications and presumptions are available to help
entities assess significant increases in credit risk since initial recognition. These include:
 A rebuttable presumption that credit risk is deemed to have significantly increased if an
amount is 30 days past due.
 If a financial instrument has low credit risk (equivalent to investment grade quality), then
an entity may assume no significant increases in credit risk have occurred.

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EXAMPLE OF 12-MONTH ECLS VS. LIFETIME
ECLS
Lender A originates a 10-year loan for $1 million which equals its gross carrying amount.
Lender A determines that 25% of the gross carrying amount will be lost if the loan defaults. At
the reporting date, Lender A estimates that the loan has a probability of default of 0.5% over the
next 12 months and a lifetime probability of default of 20%. What loss allowance should be
recognized?
Assessment:
The loss allowance recognized depends on whether there has been a significant increase in
credit risk since initial recognition. This distinction determines whether the loss allowance
represents 12-month ECLs or lifetime ECLs.
 If there has not been a significant increase in credit risk since initial recognition, then the loss
allowance is based on 12-month ECLs calculated as follows: 0.5% probability of default over
the next 12 months × 25% credit loss × $1,000,000 loan = $1,250.
 If there has been a significant increase in credit risk since initial recognition, then the loss
allowance is based on lifetime ECLs calculated as follows: 20% probability of default over
lifetime × 25% credit loss × $1,000,000 loan = $50,000.

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PRESENTATION OF EXPECTED CREDIT LOSSES

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