IFRS 9 Classification and Measurement Presentation by: CPA Stephen Obock March 2018

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1 IFRS 9 Classification and Measurement Presentation by: CPA Stephen Obock March 2018 Uphold public interest

2 IFRS 9 Classification and Measurement

3 Classification and Similar categories: FVTPL Amortised cost FVOCI measurement IFRS 9 IAS 39 FVTPL Loans and receivables/htm* AFS* *Significant changes in criteria for classifying assets. FVTPL Fair value through profit or loss FVOCI Fair value through other comprehensive income HTM Held to maturity AFS Available for sale

4 IFRS 9 Equity and derivative financial asset classification Derivative Equity Instrument Yes Yes Held for trading? Election not available for: No No OCI option elected? Yes a) Investment in subsidiaries at FVTPL b) Venture capital organisations at FVTPL FVTPL FVOCI Irrevocable Changes in fair value presented in OCI Dividends generally recognised in P&L No reclassification of gains and losses into P&L on disposal and no impairment recognised in P&L

5 IFRS 9 Debt instruments classification Debt instrument No Are the asset s contractual cash flows solely payments of principal and interest (SPPI)? Yes Is the business model s objective to hold to collect contractual cash flows? FVTPL No Is the business model s objective both to collect contractual cash flows and to sell? Yes No Yes FVOCI Amortised cost

6 How classification can change between IAS 39 and IFRS 9 (debt instruments) Debt Instrument FVTPL (trading book) FVTPL (designated) Available-for-sale Loans and receivables FVTPL FVOCI Amortised cost * Held-to-maturity

Change: gain or loss on a financial liability designated at FVTPL attributable to

7 Financial liabilities Financial liability measurement categories IFRS 9 retains almost all of the existing requirements from IAS 39. Change: gain or loss on a financial liability designated at FVTPL attributable to changes in own credit risk generally presented in OCI with remaining change in fair value presented in profit or loss.

8 The SPPI criterion Cash flows represent, on specified dates, solely payments of principal and interest on the principal amount outstanding Consistent with a basic lending arrangement Definition Principal Interest Fair value of financial asset on initial recognition Consideration for: the time value of money; and credit risk associated with the principal amount Can also include consideration for: other basic lending risks (such as liquidity risk) and costs (such as administrative costs); and a profit margin

9 Types of Business Models Held-to-collect contractual cash flows Matter of fact Financial assets held to collect contractual cash flows over the life of the instrument. Need not hold all instruments until maturity. Amortised cost * Selling assets is incidental to business model objective. Held both to collect contractual cash flows and to sell Both collecting contractual cash flows and selling financial assets are integral to achieving objective of business model. Typically involves greater frequency and value of sales compared to held to collect model. FVOCI* Other business models Models that do not meet the above criteria. FVTPL ** Judgements * Subject to meeting SPPI criterion and the fair value option ** SPPI criterion is irrelevant (all in this category would be measured at FVTPL)

10 Leverage Leverage increases the variability of the contractual cash flows such that they do not have the economic characteristics of interest Leverage SPPI Examples of financial assets which include leverage are: stand-alone options forward contracts swaps CPI-linked interest rates Thus such financial assets which have a leveraged return cannot be measured at amortised cost or FVOCI

11 Measurement of Financial Assets Measurement category P&L Amortised cost All gains and losses - OCI Presentation of gains/losses same as under IAS 39? Debt investments at FVOCI Interest, impairment losses, foreign exchange gains and losses, gain or loss on disposal Other gains and losses Equity investments at FVOCI Dividends (unless clearly represents recovery of part of cost of investment) FVTPL All gains and losses - Fair value gains and losses

12 Effective interest rate Effective interest rate (EIR) is the rate that exactly discounts the estimated future cash payments or receipts through the expected life of the financial instrument to: The gross carrying amount of the financial asset; or The amortised cost of the financial liability Consider the following when calculating EIR: Calculated at initial recognition IN All contractual terms (ie: prepayment, call and similar options) OUT Expected credit losses What about floating-rate financial instruments? IFRS 9 does not specify how to calculate EIR when the instrument has a floating interest rate. Under IAS 39, two approaches were developed which will not change under IFRS 9. The approaches are: Approach 1: Based on the actual benchmark interest rate that was set for the relevant period Approach 2: Taking into account expectations of future interest rates, and changes in these expectations

13 Calculating amortised cost minus plus or minus equals Financial assets Amount initially recognised Principal repayments Financial liabilities Cumulative amortisation, using EIR of any difference between the initial amount and the maturity amount Gross carrying amount minus equals Loss allowance Amortised cost Amortised cost (no adjustment for loss allowance) The amortised cost of a financial asset is likely to be different under IFRS 9 compared to IAS 39. This is because amortised cost is net of a loss allowance for impairment and the impairment requirements of IFRS 9 and IAS 39 are different

14 Business Model Assessment Illustration Company Z generates trade receivables that are due in 30 days after the issue of an invoice. Z manages cash collections, deals with customer queries and sends out reminders when amounts become overdue. The management focuses on monitoring the overdue status and collection teams are evaluated on the basis of the length of the cash collection period. When a receivable is overdue by 150 days and no payment plan has been agreed with a customer, Z s policy is to sell the receivable, at a significant discount, to a debt collection company and Z has no further involvement with that receivable. This happens rarely. Q: What is the business model in which trade receivables are held?

15 Business Model Assessment: Rationale Hold to collect contractual cash flows. Management of risk Focus on collection of contractual cash flows and management of overdue status. The collection team evaluated with reference to the collection period. Sales of assets Infrequent sales in response to deterioration in credit risk are not inconsistent with the Hold to collect model.

16 Question: Classification equity/liability An entity K issues a non-redeemable preference shares with dividends only payable if interest is paid on another instrument (the linked instrument). K is required to pay interest on the linked instrument. Discuss classification of the non-redeemable instrument.

17 Question SPPI Entity Z has an instrument whose interest rate is reset to a higher rate if the debtor s net income drops below CU 100 million. Would this instrument meet the SPPI criterion? A. No. B. Yes C. It depends

18 Question: Classification equity/liability Company P has two subsidiaries, Companies B and G. G issues non-redeemable preference shares to a party (investor O) outside the group. B writes a put option on the preference shares issued by G. The put option, if it is exercised, will require B to purchase the preference shares from the holder for cash. P Put option on preference shares Subsidiary B Investor O Subsidiary G Preference shares Determine classification of the preference shares: a) G s financial statements b) P s consolidated financial statements

19 Question: Assessing the business model (factoring) An entity has a business model with the objective of providing credit to customers and immediately selling the debtors to a financial institution (i.e. recurring factoring of debtors). What is the entity s business model? A. Held-to-collect contractual cash flows B. Held both to collect contractual cash flows and to sell C. Other business model D. It depends.

20 Question: Assessing the business model (factoring) Company D originates loans for the purpose of selling them to a securitisation vehicle, which D controls and consolidates. The loans are derecognised from D's separate statement of financial position and recognised by the securitisation vehicle. On consolidation, the loans remain within the consolidated group. Determine classification of the loans: a) In D s separate financial statements b) In D s consolidated financial statements

21 Example: Long term equity investment measured at fair value Company X has an investment in an unlisted equity instrument that it holds as part of strategic investments for long term. It measures the investment at fair value. Assume the cost of the equity investment was KES100M. The fair value at year-end is KES130M and during the period Company X received dividends of KES10M. Statement of Financial Position (Current) IAS 39 treatment (New) IFRS 9 FVTPL (New) IFRS 9 FVOCI Fair value KES130M Fair value KES130M Fair value KES130M Profit or loss Dividends KES10M Dividends KES10M Fair value KES30M Dividends KES10M OCI Fair value KES30M Fair value KES30M Reclassify to profit or loss on disposal Never reclassified to profit or loss

22 FROM: Reclassification mechanics FVOCI FVTPL FVTPL Continue to measure at fair value. Reclassify accumulated OCI balance to P/L FVOCI TO: Continue to measure at fair value. Recognise subsequent changes in fair value in OCI. Fair value on reclassification date = new gross carrying amount. Calculate EIR based on new gross carrying amount. Amortised cost Derecognised accumulated OCI, with offsetting entry against fair value carrying amount. Adjusted carrying amount = amortised cost Amortised cost Fair value on reclassification date = new gross carrying amount. Calculate EIR based on new gross carrying amount.

23 Reclassification from: Reclassification mechanics Reclassification to: FVOCI FVTPL Amortised cost Remeasure at fair value, with any difference recognised in OCI Remeasure to fair value, with difference between amortised cost and fair value recognised in P/L

24 Question transaction costs Entity A incurred transaction costs when it purchased Financial Instrument B. Which classification categories in IFRS 9 will permit Entity A to capitalise the transaction costs. A. FVTPL and FVOCI B. Amortised Cost C. FVTPL D. Amortised cost and FVOCI.

25 Question SPPI Instrument A is a perpetual instrument but the issuer may call the instrument at any point in time and pay the holder the par amount plus accrued interest due. Instrument A pays a market interest rate and interest is only payable if the issuer is able to remain solvent immediately after an interest payment. Deferred interest does not accrue additional interest. Are the contractual cash flows solely payments of principal and interest? A. Yes B. No.

26 Q&A

Applying IFRS 9 Part II (Discussion) Presentation by: CPA Stephen Obock February 2018

Applying IFRS 9 Part II (Discussion) Presentation by: CPA Stephen Obock February 2018 Uphold public interest IFRS 9 Discussion and illustrations on the key changes? Presentation agenda Introduction Classification