Instruments-Classification. Measurement and Impairment. Credibility. Professionalism. AccountAbility

Transcription

1 IFRS IFRS 139 Fair Financial Value Instruments-Classification Measurement and Impairment Credibility. Professionalism. AccountAbility

2 Agenda Adoption permutations Scope of the standard Definitions Classification of financial assets Classification of financial liabilities Impairment

3 Practical implications - adoption Until the effective date of IFRS 9 (2014) the following permutations of IFRS 9 and IAS 39 are possible Apply only IAS 39 Apply IAS 39 and early adopt the own credit risk presentation of IFRS 9 Applying only IFRS 9 (2009) Applying IFRS 9 (2009) and early adopting the own credit risk presentation of IFRS 9 (2010) Applying IFRS 9 (2010) Applying IFRS 9 (2013), but electing to apply IAS 39 for all hedge accounting Applying IFRS 9 (2013), including the new general hedging model Applying IFRS 9 (2014) but electing to apply IAS 39 for all hedge accounting, and Applying IFRS 9 (2014), including the general hedging of IFRS 9 (2013)

4 Scope of IFRS 9 IAS 32 provides a definition of the term financial instrument and also defines the relates concepts of financial assets, financial liability and equity instruments; IAS 32 provides guidance on whether a financial instrument is considered a financial asset, financial liability or an equity instrument IFRS 9 provides recognition and measurement requirements for financial assets and financial liabilities; IFRS 7 requires entities to provide disclosures that enable users of their financial statements to evaluate the significance of financial instruments for the entity s financial position and performance The measurement of fair value of financial instruments and disclosures about fair value are addressed by IFRS13

5 Definitions A Financial Instrument is any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity; A financial asset is any asset that is cash, a contractual right to receive cash or another asset; or To exchange financial assets or liabilities under potentially favourable conditions; An equity instrument of another entity; or A derivative...

6 Definitions Financial liability is defined as a contractual obligation; To deliver cash or another financial asset to another entity; or To exchange financial instruments under potentially unfavourable conditions; or A contract that will or may be settled in the entity s own equity instrument... An equity instrument is any contract that evidences the residual interest in the assets of an entity after deducting all its liabilities

7 Classification of financial assets On initial recognition, a financial asset is classified into one of three primary measurement categories; Amortised cost Fair value through OCI (FVOCI); or Fair value through profit and loss (FVTPL)

8 Financial assets measured at amortized cost A financial asset is measured at amortised cost on if it meets both of the following conditions; The asset is held within a business model whose objective is to hold assets to collect contractual cash flows (held to collect business model); and The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding (the SPPI criterion)

9 Financial assets measured at FVOCI and at FVTPL A debt instrument is measured at FVOCI only if it meets the following conditions; The asset is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets; and The contractual terms of the financial asset meet the SPPI criterion (IFRS A) All other financial assets i.e. Financial assets that do not meet the criteria for classification as subsequently measured at either amortised cost or FVOCI are classified as subsequently measured at fair value, with changes in fair value recognised in profit or loss.

10 Financial assets measured at FVOCI and at FVTPL In addition, an entity has the option on initial recognition to irrevocably designate a financial assets as at FVTPL if doing so eliminates or reduces a measurement inconsistency i.e. accounting mismatch At initial recognition of an equity investment that is not held for trading, an entity may irrevocably elect to present in other comprehensive income (OCI) subsequent changes in its fair value. IFRS 9 retains the existing requirements in IAS 39 for the classification of financial liabilities

11 The SPPI Criterion To determine whether a financial asset should be classified as measured at amortised cost or FVOCI an entity assess whether the cash flows from the financial asset represent, on specified dates solely payments of principal and interest on the principal amount outstanding If this is not met the instrument is always measured at FVTPL unless it is an equity instrument for which an entity applies the OCI election

12 Business model assessment Business Model Key features Category Held to collect Objective is to hold assets to collect contractual cash flows Sales are incidental to the objective of the model Model involves lowest level of sales in comparison to the other models Amortised cost Both Held to collect and for sale Both collecting contractual cash flows and sales are integral to achieving the objective of the business model This typically has more sales (in frequency and volume) than the held to collect business model FVOCI

13 Business model assessment Business Model Key features Category Other business models, including Trading Managing assets at fair value basis Maximising cash flows through sale The business model is neither held to collect nor held collect and for sale The collection of the contractual cash flows is incidental to the objective of the model FVTPL

14 The objective of financial statements is to provide information about the financial position, financial performance and Business cash flows of an entity that is useful to a wide range model of users in making economic decisions. assessment To determine the classification into amortised cost, FVOCI or FVTPL an entity needs to identify and assess the objective of the business model in which the asset is held. The challenge is to ensure that management is clear on their intentions when they acquire assets i.e. Held to collect (amortised cost), both held to collect and for sale (FVOCI) and other business models e.g. Trading, managing assets on a fair value basis, maximising cash flows through sale (FVTPL) The objective of the entity s model is not based on management s intentions with respect to an individual instrument, but rather it is determined at a higher level of aggregation.

15 The objective of financial statements is to provide information about the financial position, financial performance and Business cash flows of an entity that is useful to a wide range model of users in making economic decisions. assessment The assessment needs to reflect the way the entity manages its business or businesses; A single reporting entity may have more than one business model for managing its financial instruments; It may be appropriate to separate a portfolio of financial assets into sub portfolios; Judgement is required in determining the business model as there is no threshold for the frequency or significance of sales that may occur.

16 Reclassification The reclassification of financial assets is required if and only if the objective of the entity s model for managing those assets changes; Changes in the way that assets are managed within the business model e.g. increased frequency of sales will not result in the reclassification of existing assets but may result in newly acquired assets being classified differently. If an entity determines that its business model has changed in a way that is significant to its operations, then all affected assets are reclassified from the first day of the next reporting period. In order for reclassification to be appropriate, the entity cannot engage in activities consistent with its former business model after the date of change in business model. Prior periods are not restated. No reclassification of financial liabilities is allowed

17 The objective of financial statements is to provide information about the financial position, financial performance and Classification cash flows of an entity that is useful to a wide range of users in making economic of decisions. financial liabilities On initial recognition, financial liabilities are classified as subsequently measured at amortised cost, except for the following instruments; Financial liabilities at FVTPL The financial liabilities at FVTPL can be dividend into the following sub categories Financial liabilities that are held for trading (including derivatives) and Financial liabilities that on initial recognition are designated as at FVTPL

18 The objective of financial statements is to provide information about the financial position, financial performance and Financial cash flows of entity that is useful to a wide range liabilities of users in making economic decisions. held for trading These are liabilities Incurred principally for the purpose of repurchasing in the near term On initial recognition, part of the portfolio that are managed together and for which there is recent actual pattern of shortterm profit taking A derivative, except for a derivative that is designated and effective hedging instrument.

19 The objective of financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. Measurement Measurement at initial recognition - IFRS 9 generally retains IAS 39 s requirements on measurement at initial recognition. Subsequent measurement financial assets For assets classified as subsequently measured at amortised cost, interest revenue, expected credit losses and foreign exchange gains or losses are recognised in profit or loss. On derecognition, any gain or loss is recognised in profit or loss. For assets classified as subsequently measured at FVOCI, interest revenue, expected credit losses, and foreign exchange gains or losses are recognised in profit or loss. Other gains and losses on remeasurement to fair value are recognised in OCI. On derecognition, the cumulative gain or loss previously recognised in OCI is reclassified from equity to profit or loss.

20 The objective of financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. Measurement For assets classified as subsequently measured at FVTPL, all gains and losses are recognised in profit or loss. For equity investments for which subsequent changes in fair value are presented in OCI, the amounts recognised in OCI are never reclassified to profit or loss. However, dividend income on these investments is generally recognised in profit or loss. Subsequent measurement financial liabilities IFRS 9 retains almost all of the existing requirements in IAS 39 on the subsequent measurement of financial liabilities.

21 Impairment The following table sets out instruments that are in and out of scope of the impairment requirements of IFRS 9. In scope Out of scope Financial assets that are debt instruments measured at amortised costs or FVOCI including loans, trade receivables and debt securities Loan commitments issued that are not measured at FVTPL Investment in equity instruments because they are either accounted for at FVTPL or FVOCI Loan commitments measured at FVTPL Other financial instruments measured at FVTPL

22 Impairment- Expected Credit Loss Concept The impairment model in IFRS 9 is an expected loss model which means that it is not necessary for a loss event to occur before an impairment loss is recognised; The model uses a dual measurement approach, under which the loss allowance is measured as either: 12-month expected credit losses; or lifetime expected credit losses. The measurement basis generally depends on whether there has been a significant increase in credit risk since initial recognition. Contrast this with IAS 39 which applies an incurred loss model i.e. The entity first assess whether there is objective evidence that impairment exists for a financial asset. If there is no objective evidence no impairment loss is recognised. Expected credit losses are a probability weighted estimate of credit losses i.e. The present value of cash short falls over the expected life of the financial instrument. For a financial asset that is credit- impaired, the expected credit losses are the difference between the asset s gross carrying amount and the present value of the estimated future cash flows

23 Impairment Determining cash shortfalls a cash shortfall is the difference between the cash flows due to the entity in accordance with the contract and the cash flows that the entity expects to receive. Because the estimation of credit losses considers the amount and the timing of payments, a cash shortfall arises even if the entity expects to be paid in full but a later than the date on which payment is contractually due. This delay gives rise to an expected credit loss, except if you expect to receive additional interest in respect of the late payment. The estimate of expected credit losses reflects an unbiased and probability weighted amount, determined by evaluating a range of possible outcomes rather than based on a bet or worst case scenario. Time value of money determine the appropriate discount rate e.g. Effective rate of interest

24 Impairment The following practices related to impairment are not acceptable under IFRS 9 Recognising a provision for losses based on a set percentage of receivable balances unless if the resulting estimates are consistent with the impairment requirements under IFRS 9 Suspending interest accruals Recognising an impairment loss in excess of the impairment requirement of IFRS 9, even if local regulations require a specific amount to be set aside If an entity wishes to identify reserves in addition to the loss allowance calculated under IFRS, it may do so by transferring amounts from retained earnings to a separate category of equity.

25 General Approach Under the general approach, impairment is measured as either 12-month expected credit losses or lifetime expected credit losses, depending on whether there has been a significant increase in credit risk since initial recognition. If a significant increase in credit risk of an instrument has occurred since initial recognition, then impairment is measured as lifetime expected credit losses.

26 12 month expected credit losses and lifetime expected credit losses. 12 month credit losses are the portion of lifetime expected credit losses that represents the expected credit losses resulting from default events on the financial instrument that are possible within 12 months after the reporting date; This means that 12 month expected credit losses represent the lifetime cash shortfalls that will result from a default occurring in the 12 months after the reporting date weighted by the probability of that default occurring; Lifetime expected credit losses are the expected credit losses that result from all possible default events over the expected life of the financial instrument; A loss allowance equivalent to a 12 month expected credit losses is recognised unless the credit risk on an instrument has increased significantly since initial recognition.

27 Impairment Definition of default IFRS 9 does not define but requires each entity to do so. The definition has to be consistent with that used for internal credit risk management purposes and has to consider qualitative factors such as breach of covenants. An entity can use a regulatory definition if it is consistent with the entity s credit risk management practices Significant increase in credit risk not defined in IFRS 9 an entity decides how to define it To be significant a larger absolute increase in the risk of default is required for an asset with a higher risk of default on initial recognition than for an asset with a lower risk of default on initial recognition

28 Impairment An entity may apply various approaches in assessing whether there is a significant increase in credit risk. Any approach used considers The change in the risk of default occurring since initial recognition The expected life of the financial instrument; and Reasonable and supportable information that is available without undue cost or efforts that may affect credit risk. Individual vs collective basis for assessment- IFRS 9 does not specify when the assessment of whether there has been a significant increase in credit risk is made on an individual or collective basis. The objective is to recognise life time credit losses for all financial instruments whether assessed on an individual or collective basis. However, for some instruments a significant increase in credit risk may not be evident on an individual instrument basis before the financial instrument becomes past due e.g. For retail loans. In such cases if more forward looking information is available on collective basis, then an entity makes the assessment on a collective basis.

29 Impairment Rebuttable presumption of 30 days past due-.there is a rebuttable presumption that credit risk on a financial instrument has increased significantly when payments are more than 30 days past due. However, delinquency is a lagging indicator, and a significant increase in credit risk typically occurs before an asset is past due. Therefore when information is available that is more forward looking than data about past due payments it should be considered in determining whether there is a significant increase in credit risk

30 Measurement of expected credit losses Expected credit losses are a probability- weighted estimate of credit losses over the expected life of the financial instrument Credit losses are the present value of expected cash flow shortfalls. The measurement of expected credit losses reflects An unbiased and probability weighted amount Time value of money; and Reasonable and supportable information that is available without undue cost or effort.

31 Measurement of expected credit losses A cash shortfall is the difference between the cash flows due to the entity in accordance with the contract and the cash flows that the entity expects to receive. Cash short falls are identified as follows For 12 month expected credit losses cash shortfalls that are possible in the next 12 months i.e. Not just the cash shortfalls that are expected; For lifetime expected credit losses- cash shortfalls resulting from default events that are possible over the expected life of the financial instruments. The term cash shortfalls refers to overall shortfalls against contractual terms and not just shortfalls on particular dates when cash is received or due.

32 Measurement of expected credit losses The period over which to estimate expected credit losses- the maximum period is the contractual period including any extension options over which there is exposure to credit risk on the financial instrument; Probability weighted outcome the estimate of credit losses reflects an unbiased and probability weighted amount, determined by evaluating a range of possible outcomes rather than on a best or worst case scenario. An entity is not required to identify every scenario but the estimate always reflect at least two scenarios The probability that a credit loss occurs, even if this probability is very low The probability that no credit loss occurs

33 Measurement of expected credit losses Time value of money- the estimate of expected credit losses reflects the time value of money using, the effective rate determined on initial recognition or an approximation thereof The estimates of expected credit losses are required to reflect reasonable and supportable information that is available without undue cost or effort. The information used includes Factors that are specific to the borrower; and General economic conditions. Potential data sources include Internal historical credit loss experience Credit experience of other entities

34 Measurement of expected credit losses Historical information is an important base from which to measure expected credit losses. It is adjusted on the basis of current observable data to reflect current conditions and an entity s forecast of future conditions Collateral the estimate of expected credit losses reflects the cash flows expected from collateral that are the contractual terms of the financial instrument. Irrespective of whether foreclosure is probable, the estimate of expected cash shortfalls on a collaterised asset reflects; The amount and timing of cash flows that are expected from foreclosure Cost of obtaining and selling the collateral

35 Impairment Trade Receivables Generally trade receivables that do not contain a significant financing component have a short duration typically < 12 months which means that measuring the loss allowance as lifetime expected credit loss generally does not differ from measuring it as 12-month expected credit losses Trade receivables without a significant financing component do not have a contractual interest rate and the effective rate is zero, accordingly discounting cash short falls to reflect the time value of money when measuring expected credit losses is generally not required; However further analysis is required if the receivable is renegotiated and a significant financing component included

36 How this could impact you lassification and easurement mpairment Judgements Evaluating the business model used to manage the financial assets Difficult judgements about whether loans will be received as due and, if not, how much will be recovered and when. The new model which widens the scope of these judgements relies on entities being able to make robust estimates of: expected credit losses; and the point at which there is a significant increase in credit risk Systems and processes New processes will be needed to allocate financial assets to the appropriate measurement category. The new model is likely to have a significant impact on the systems and processes of banks, insurers and other financial services entities, due to its extensive new requirements for data and calculations.

37 How this could impact you Impact on capital Judgements The way in which an entity classifies financial assets could affect the way its capital resources and capital requirements are calculated. This may affect banks and other financial services entities that have to comply with the Basel capital requirements or other national capital adequacy requirements Systems and processes The new standard may have a significant impact on the way financial assets are classified and measured, resulting in changes in volatility within profit or loss and equity, which in turn are likely to impact key performance indicators (KPIs).

38 How this could impact you Judgements The initial application of the new model may result in a large negative impact on equity for banks and, potentially, insurance and other financial services entities. Systems and processes The new model is likely to introduce new volatility because: credit losses will be recognised for all financial assets in the scope of the new model rather than only for those assets for which losses have been incurred; external data used as inputs may be volatile e.g. ratings, credit spreads and predictions about future conditions; and any move from a 12-month to a lifetime expected credit loss measurement and vice versa may result in a big change in the loss allowance.