The initial measurement is based on amortised costs, this is the amount for which an asset or liability is initially recognised in the balance sheet less principal repayments, plus or minus the cumulative amortisation of the difference between that initial amount and the redemption amount calculated by using the effective interest method and less any write-downs (directly or through the use of a provision) arising from impairment or un-collectibility.
The second measurement basis is the fair value through other comprehensive income. IASB defines fair value in IFRS 13 as:’The price that would be received on sale of an asset or paid upon transfer of a liability in a regular transaction between market participants on the measurement date’. The changes in fair value are recognised in other comprehensive income. The IFRS 9 Framework for financial assets
The last measurement basis is the fair value through profit or loss. The definition of fair value in IFRS 13 is also effective within this measurement basis.
The classification of financial instruments affects the valuation of financial instruments for reporting purposes. Based on the requirements of IFRS 9, a framework can be created to link the classification of financial instruments to the corresponding measurement basis.
A debt instrument is a paper or electronic obligation that enables the issuing party to raise funds by promising to repay a lender in accordance with terms of a contract. Types of debt instruments include notes, bonds, debentures, certificates, mortgages, leases or other agreements between a lender and a borrower.
Spoiler: Debt instruments are subjected to two tests. First, the classification of the business model will take place. This looks at the underlying business strategy of acquiring the debt instruments. The debt instruments may be held to collect the contractual cash flows or to collect and sell the contractual cash flows. If this is the case, the SPPI test is carried out to see whether the generated cash flows are exclusively caused by principal and interest payments.
Depending on the business model, the outcome of the SPPI test and the possible use of the fair value option (Fair value PL option) debt instruments are value at fair value through other comprehensive income (including recycling to profit or loss at derecognition, see below), at amortised cost or at fair value through profit or loss. In the scope of IFRS 9, debt instruments valued at amortised costs or fair value through other comprehensive income also apply the Expected Credit Loss model.
A derivative is a financial instrument or other contract within the scope of IFRS 9 with all three of the following characteristics.
its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract (sometimes called the ‘underlying’).
it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors.
An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. The most common example of an equity instrument is, off course, shares or stock in American English.
Spoiler: Equity instruments can be measured at fair value through profit or loss or at fair value through other comprehensive income (without recycling through profit or loss, see below). The valuation method depends on whether the equity instruments are held for trading purposes or not. Held for trading results in valuation at fair value through profit or loss. If the equity instruments are not acquired for trading purposes, it is considered whether the fair value through other comprehensive income option (fair value OCI option) will be used. Here an entity can decide to choose and document one of the two fair value options (PL or OCI).
Document your decisions in your financial close file to facilitate internal review and approval and external audits.
A valuation at amortised costs or fair value through other comprehensive income will only be possible if the contractual cash flow characteristics (the SPPI-Test) show that these costs cover solely payments of principal and interest (SPPI). Establishing a distinction between ‘recycling’ and ‘without-recycling’ is important when measuring at FVOCI (see debt instrument above FVOCI with recycling and equity instruments FVOCI without recycling. Recycling means that after derecognition of a financial instrument, a reclassification of the accrued effects in OCI is required in profit or loss. The IFRS 9 Framework for financial assets The IFRS 9 Framework for financial assets The IFRS 9 Framework for financial assets