IFRS 9 Classification and Measurement of Financial Instruments

IFRS 9 uses the following criteria for determining the classification as of financial assets at Amortized Cost, FVOCI or FVPL categories apply: IFRS 9 Classification and Measurement of Financial Instrumen

The critical issues for classifying and measuring financial assets are whether:

  • The objective of the entity’s business model is to hold assets only to collect cash flows, or to collect cash flows and to sell (“the Business Model test”), and

  • The contractual cash flows of an asset give rise to payments on specified dates that are solely payments of principal and interest (“SPPI”) on the principal amount outstanding (“the SPPI test”). IFRS 9 Classification and Measurement of Financial Instrumen

Both of these tests have to be met in order to account for an instrument at Amortized Cost or FVOCI. In this publication, when we talk of passing or meeting one of these tests, we mean the asset can be measured at Amortized Cost or FVOCI as appropriate, assuming that the other test is met. When we talk of failing the test, we mean that the asset must be measured at FVPL.

Applying the Business Model and SPPI tests is not necessarily straightforward and their outcomes sometimes can be surprising.

Consider, for example, the following table, which illustrates how the tests can affect the classification and measurement of common types of financial assets.

Applying the Business Model and SPPI tests is not necessarily straightforward and their outcomes sometimes can be surprising. IFRS 9 Classification and Measurement of Financial Instrumen

Here is some additional guidance in the application of the Business Model and SPPI tests:

Amortised Cost or FVOCI possibleFVPL mandatory

Bank deposits repayable on demand, where interest, if payable, is at a fixed or floating market rate

Investments in common shares where the holder does not designate the asset as FVOCI

Trade receivables requiring payment only of fixed amounts on fixed dates

IFRS 9 Classification and Measurement of Financial Instrumen

IFRS 9 Classification and Measurement of Financial Instrumen

Investments in mandatorily redeemable preferred shares and puttable instruments (or instruments issued by entities having a limited life) such as mutual fund units where non-payment of dividends is not a breach of contract or the holder has no claim for a fixed amount in bankruptcy

Full recourse loans or investments in debt securities that require only fixed payments on fixed dates

Self-standing derivative financial assets such as purchased options, swaps and forward contracts

Full recourse floating rate loans requiring fixed payments on fixed dates of principal and bearing interest at a floating market rate (such as the BA rate) where the interest rate is for a period that is the same as the interest rate reset period (e.g., the interest rate is reset every three months based on the 3 month BA rate)

Floating rate loans where the interest rate is for a period that does not correspond to the interest reset period (e.g., interest is reset every 3 months based on the 6 month BA rate) and the impact on cash flows is significant

Non-recourse loans (i.e., those where recourse is limited to specific assets) where at initial recognition the lender has an economic exposure to the underlying asset’s value and cash flows that is consistent with a basic lending arrangement

Non-recourse loans where at initial recognition the lender has an economic exposure to the underlying asset’s value and cash flows greater than that of a basic lender

Trade receivables, loans and investments in debt securities, having the attributes described above but that can be prepaid, subject to meeting certain criteria

Fixed or floating rate loans including terms where payments are based on factors such as equity or commodity prices, unless the terms are not genuine or their effect is de minimis

This table will be used to further explain the mechanics of the Business Model and SPPI Tests in IFRS 9 The Business Model Test and IFRS 9 The Solely Payments of Principal and Interest Test.

Leave a Reply

Your email address will not be published. Required fields are marked *