Classification of financial assets at amortised cost, at fair value through other comprehensive income (FVOCI) or at fair value through profit or loss (FVPL) is mainly based on the business model assessment and the solely payments of principal and interest (SPPI-) test.
A financial asset is classified into a measurement category at inception and is reclassified only in rare circumstances.
The classification and measurement decision tree supports a structured approach to determine whether cash flows are generated from holding the financial assets, selling the financial assets or both (business model assessment). Then the SPPI check examines all essential instrument features that are relevant for classification.
The available classification and measurement classifications are:
- Financial assets valued at amortised costs,
- Financial assets valued at fair value through other comprehensive income (FVOCI),
- Financial assets valued at fair value through profit or loss (FVPL) [IFRS 9 4.1, IFRS 9 3.1.1].
The existing categories of held-to-maturity, loans and receivables, and available-for-sale. It also removes the exception that allows certain equity investments, and derivatives linked to such investments, to be measured at cost. [IFRS 9 BZC 4.55, IFRS 9 BC5.18]
The following diagram provides an overview of the classification of financial assets into the principal measurement categories, along with the presentation and designation options under IFRS 9.
Are the asset’s contractual cash flows solely principal and interest? Note: see the SPPI Test
Business model questions Note: see business model test
FVTPL Note: Certain credit exposures can also be designated as at FVTPL if a credit derivative that is measured at FVTPL is used to manage the credit risk of all, or a part, of the exposure.
FVCOI (debt instruments) and Amortised cost Note: Subject to an entity’s irrevocable option to designate such a financial asset as at FVTPL on initial recognition if, and only if, such designation eliminates or significantly reduces a measurement or recognition inconsistency.
What type of financial assets would you like to classify: Classification of financial assets
- Debt instruments, Classification of financial assets
- Derivatives, Classification of financial assets
- Equity instruments. Classification of financial assets
Entity’s business model for managing financial assets
A very good discussion on the entity’s business model for managing financial assets, with examples, is contained in paragraphs IFRS 9 B4.1.1 to B.4.1.6.
One of the important takeaways is that if sales of financial assets are made due to an increase in the assets’ credit risk, it is not inconsistent, irrespective of their frequency and value, with a business model whose objective is to hold financial assets to collect contractual cash flows because the credit quality of financial assets is relevant to the entity’s ability to collect contractual cash flows (IFRS 9 B4.1.3A).
Additionally, sales that occur for other reasons, such as sales made to manage credit concentration risk, may also be consistent with a business model whose objective is to hold financial assets in order to collect contractual cash flows, especially if those sales are infrequent (even if significant in value) or insignificant in value both individually and in aggregate (even if frequent) (IFRS 9 B4.1.3B).
When financial assets are not held within a business model whose objective is to hold assets to collect contractual cash flows or within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets, they are measured at FVTPL. This includes, but is not limited to, financial assets held for trading (IFRS 9 B4.1.5-6).
Contractual cash flow characteristics (‘SPPI test’)
Assessment of contractual cash flow characteristics aims to determine whether these cash flows are solely payments of principal and interest on the principal amount outstanding, hence the acronym SPPI. Assets that fail this test must be measured at FVTPL.
This is because amortised cost information is presented in P/L for assets measured at amortised cost (obviously) but also for assets measured at FVOCI and, as the IASB has stated, the amortised cost measurement attribute provides relevant and useful information only for financial assets with ‘simple’ contractual cash flows (IFRS 9 BC4.158).
More complex cash flows require a valuation overlay to contractual cash flows (i.e. fair value) to ensure that the reported financial information provides useful information (IFRS 9 BC4.172). Amortised cost measurement is discussed later in this chapter.
In addition, IFRS 9 provides presentation and designation options and other specific guidance for certain financial assets, as follows.
Type of financial asset Classification of financial assets
Implications on classification
Financial assets for which designation as at FVTPL eliminates or significantly reduces an accounting mismatch
May be designated as at FVTPL
Investments in equity instruments that are not held for trading
Option to present changes in fair value in OCI
Certain credit exposures if a credit derivative that is measured at FVTPL is used to manage the credit risk of all, or a part, of the exposure
May be designated as at FVTPL
Financial assets that: Classification of financial assets
Measured under specific guidance carried forward from IAS 39, see below
Measured under specific guidance carried forward from IAS 39
Transfers that do not qualify for derecognition [IFRS 9 3.2.15]
When an entity transferred an asset, but has retained substantially all the risks and rewards, the asset is not derecognised. Instead, any proceeds received are recognised as a financial liability. In subsequent periods, an entity recognises income on the transferred asset and expense incurred on the financial liability as if they were separate financial instruments. Classification of financial assets
Note that this is not the same as continuing involvement in transferred assets covered below. Classification of financial assets
Continuing involvement in transferred assets – associated liabilities measurement [IFRS 9 3.2 17]
When an entity continues to recognise an asset to the extent of its continuing involvement, the entity also recognises an associated liability. Despite the other measurement requirements in IFRS 9, the transferred asset and the associated liability are measured on a basis that reflects the rights and obligations that the entity has retained. The associated liability is measured in such a way that the net carrying amount of the transferred asset and the associated liability is:
- the amortised cost of the rights and obligations retained by the entity, if the transferred asset is measured at amortised cost, or
- equal to the fair value of the rights and obligations retained by the entity when measured on a stand-alone basis, if the transferred asset is measured at fair value.
See also: The IFRS Foundation