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IFRS 9 is an International Financial Reporting Standard (IFRS) published by the International Accounting Standards Board (IASB). It addresses the accounting for financial instruments. It contains three main topics: classification and measurement of financial instruments, impairment of financial assets and hedge accounting. The standard came into force on 1 January 2018, replacing the earlier IFRS for financial instruments, IAS 39.
IFRS 9 began as a joint project between IASB and the Financial Accounting Standards Board (FASB), which promulgates accounting standards in the United States. The boards published a joint discussion paper in March 2008 proposing an eventual goal of reporting all financial instruments at fair value, with all changes in fair value reported in net income (FASB) or profit and loss (IASB). [1] Due to the 2007–2008 financial crisis, the boards revised their accounting standards for financial instruments to address perceived deficiencies which were believed to have contributed to the magnitude of the crisis. [2]
The boards disagreed on several important issues, and also took different approaches to developing the new financial instruments standard. [3] FASB attempted to develop a comprehensive standard that would address classification and measurement, impairment and hedge accounting at the same time, and issued an exposure draft of a standard addressing all three components in 2010. [4] [3] In contrast, the IASB attempted to develop the new standard in phases, releasing each component of the new standard separately. [3] [5] In 2009, IASB issued the first portion of IFRS, covering classification and measurement of financial assets. [5] [6] This was intended to replace the asset classification and measurement sections of IAS 39, but not supersede other sections of IAS 39. [5] [6] In 2010, IASB issued another portion of IFRS 9, primarily covering classification and measurement of financial liabilities and also addressing aspects of applying fair value option and bifurcating embedded derivatives. [7] [8]
Certain elements of IFRS 9 as issued were criticized by some key IASB constituents. The model for classifying debt instrument assets permitted only two approaches, fair value with all changes in fair value reported in profit and loss (FVPL), or amortized cost. [9] This represented a significant deviation from FASB decisions, which would also have a category of fair value with certain changes in fair value reported in other comprehensive income (FVOCI). [3] In addition to creating significant divergence with FASB, the lack of a FVOCI category would have been inconsistent with the accounting model being developed by the IASB for insurance contracts. [9] [10] [3] There were also concerns that the criteria for qualifying for the amortized cost category were overly stringent and would force many financial instruments to be reported at fair value even though they could be appropriately accounted for at amortized cost. [9] To address these concerns, IASB issued an exposure draft in 2012 proposing limited amendments to the classification and measurement of financial instruments. [9]
Meanwhile, IASB and FASB worked together to develop a model for impairment of financial assets. IASB issued an exposure draft proposing an impairment model in 2013. [11] FASB decided to propose an alternative impairment model. [11] IASB was also developing its hedge accounting model independently of FASB, and issued that portion of the IFRS 9 standard in 2013. [12] The final IFRS 9 standard, including hedge accounting, impairment, and the amended classification and measurement guidance, was issued on 24 July 2014. [13]
Early evidence on the market reaction to the IFRS 9 in Europe suggests overall a positive response to the IFRS 9, although heterogeneities across countries exist. [14]
As amended, IFRS 9 had four possible classification categories for financial assets, including a FVOCI classification for debt instruments. [10] The classification is dependent on two tests, a contractual cash flow test (named SPPI as Solely Payments of Principal and Interest) and a business model assessment. [10] [15] Unless the asset meets the requirements of both tests, it is measured at fair value with all changes in fair value reporting in profit and loss (FVPL). [10] In order to meet the contractual cash flow test, the cash flows from the instrument must consist of only principal and interest. [10] Among the amendments to classification and measurement made in the 2014 update, de minimis and "non-genuine" features can be disregarded from the test, meaning that a de minimis feature would not preclude an instrument from being reported at amortized cost or FVOCI. [10] However, equity instruments, derivatives and instruments that contain other than de minimis embedded derivatives would have to be reported at FVPL. [10]
If the asset passes the contractual cash flows test, the business model assessment determines how the instrument is classified. If the instrument is being held to collect contractual cash flows, i.e., it is not expected to be sold, it is classified as amortized cost. [10] If the business model for the instrument is to both collect contractual cash flows and potentially sell the asset, it is reported at FVOCI. [10] [15] For a FVOCI asset, the amortized cost basis is used to determine profit and loss, but the asset is reported at fair value on the balance sheet, with the difference between amortized cost and fair value reported in other comprehensive income. [15] For any other business model, such as holding the asset for trading, the asset is reported at FVPL. [10]
IFRS 9 retained most of the measurement guidance for liabilities from IAS 39, meaning most financial liabilities are held at amortized cost, [10] the only change relating to liabilities that utilize the fair value option. [10] For those liabilities, the change in fair value related to the entity's own credit standing is reported in other comprehensive income rather than profit and loss. [10]
IFRS 9 retained the concept of fair value option from IAS 39, but revised the criteria for financial assets. [10] [15] Under a fair value option, an asset or liability that would otherwise be reported at amortized cost or FVOCI can use FVPL instead. IFRS 9 also incorporated a FVOCI option for certain equity instruments that are not held for trading. [10] Under this option, the instrument is reported at FVOCI similar to FVOCI for debt. However, this version of FVOCI does not permit "recycling." [10] Whereas when debt instruments using FVOCI are sold, the gain or loss on sale is "recycled" from other comprehensive income to profit and loss, [15] for FVOCI equities the gain or loss is never reported in profit and loss, but rather remains in other comprehensive income.
IFRS 9 requires an impairment allowance against the amortized cost of financial assets held at amortized cost or FVOCI. [15] The change in this allowance is reported in profit and loss. [15] For most such assets, when the asset is acquired the impairment allowance is measured as the present value of credit losses from default events projected over the next 12 months. [15] The allowance will continue to be based on the expected losses from defaults on the receivables recognised at the balance sheet date in the next 12 months following, unless there is a significant increase in credit risk ("SICR"). [15] If there is a significant increase in credit risk, the allowance is measured as the present value of all credit losses projected for the instrument over its full lifetime. [15] If the credit risk recovers, the allowance can once again be limited to the projected credit losses over the following 12 months. [16]
An exception to the general impairment model applies to financial assets that are credit impaired when they were originally acquired. [15] For these assets, the impairment allowance is always based on the change in projected lifetime credit losses since the asset was acquired. [15]
The new impairment model is intended to address a criticism of the impairment model used during the 2007–2008 financial crisis, that it allowed companies to delay recognition of asset impairments. [2] The new model requires companies to more quickly recognize projected lifetime losses. [2] FASB elected to use a different approach to accelerating recognition of impairment losses, requiring full lifetime recognition from the time the asset is acquired, referred to as the Current Expected Credit Losses or CECL model. [17] Under both IFRS 9 and the FASB model there will be a loss, to the extent of the allowance, when most assets covered by this guidance are acquired. [18] This loss will be smaller under the IFRS 9 model, due to the 12 month limit. [18]
IFRS 9 updated the guidance for hedge accounting. The intent was to "[align] the accounting treatment with risk management activities, enabling entities to reflect better these activities in their financial statements." [2] The changes also make it more feasible for non-financial entities to use hedge accounting. [19] The changes permit more use of hedge accounting for components of instruments and groups of contracts, and ease the hedge effectiveness test; [19] see Hedge relationship (finance). They also enhance the disclosures related to hedges and risk management with a requirement to refer to a formal risk management strategy or describe it clearly in the hedge documentation. [2] [19]
International Financial Reporting Standards, commonly called IFRS, are accounting standards issued by the IFRS Foundation and the International Accounting Standards Board (IASB). They constitute a standardised way of describing the company's financial performance and position so that company financial statements are understandable and comparable across international boundaries. They are particularly relevant for companies with shares or securities publicly listed.
The historical cost of an asset at the time it is acquired or created is the value of the costs incurred in acquiring or creating the asset, comprising the consideration paid to acquire or create the asset plus transaction costs. Historical cost accounting involves reporting assets and liabilities at their historical costs, which are not updated for changes in the items' values. Consequently, the amounts reported for these balance sheet items often differ from their current economic or market values.
The Financial Accounting Standards Board (FASB) is a private standard-setting body whose primary purpose is to establish and improve Generally Accepted Accounting Principles (GAAP) within the United States in the public's interest. The Securities and Exchange Commission (SEC) designated the FASB as the organization responsible for setting accounting standards for public companies in the U.S. The FASB replaced the American Institute of Certified Public Accountants' (AICPA) Accounting Principles Board (APB) on July 1, 1973. The FASB is run by the nonprofit Financial Accounting Foundation.
Mark-to-market or fair value accounting is accounting for the "fair value" of an asset or liability based on the current market price, or the price for similar assets and liabilities, or based on another objectively assessed "fair" value. Fair value accounting has been a part of Generally Accepted Accounting Principles (GAAP) in the United States since the early 1990s. Failure to use it is viewed as the cause of the Orange County Bankruptcy, even though its use is considered to be one of the reasons for the Enron scandal and the eventual bankruptcy of the company, as well as the closure of the accounting firm Arthur Andersen.
Financial accounting is a branch of accounting concerned with the summary, analysis and reporting of financial transactions related to a business. This involves the preparation of financial statements available for public use. Stockholders, suppliers, banks, employees, government agencies, business owners, and other stakeholders are examples of people interested in receiving such information for decision making purposes.
In accounting, fair value is a rational and unbiased estimate of the potential market price of a good, service, or asset. The derivation takes into account such objective factors as the costs associated with production or replacement, market conditions and matters of supply and demand. Subjective factors may also be considered such as the risk characteristics, the cost of and return on capital, and individually perceived utility.
In accounting, amortization is a method of obtaining the expenses incurred by an intangible asset arising from a decline in value as a result of use or the passage of time. Amortization is the acquisition cost minus the residual value of an asset, calculated in a systematic manner over an asset's useful economic life. Depreciation is a corresponding concept for tangible assets.
Accounting for leases in the United States is regulated by the Financial Accounting Standards Board (FASB) by the Financial Accounting Standards Number 13, now known as Accounting Standards Codification Topic 840. These standards were effective as of January 1, 1977. The FASB completed in February 2016 a revision of the lease accounting standard, referred to as ASC 842.
Hedge accounting is an accountancy practice, the aim of which is to provide an offset to the mark-to-market movement of the derivative in the profit and loss account.
Inflation accounting comprises a range of accounting models designed to correct problems arising from historical cost accounting in the presence of high inflation and hyperinflation. For example, in countries experiencing hyperinflation the International Accounting Standards Board requires corporations to implement financial capital maintenance in units of constant purchasing power in terms of the monthly published Consumer Price Index. This does not result in capital maintenance in units of constant purchasing power since that can only be achieved in terms of a daily index.
A foreign exchange hedge is a method used by companies to eliminate or "hedge" their foreign exchange risk resulting from transactions in foreign currencies. This is done using either the cash flow hedge or the fair value method. The accounting rules for this are addressed by both the International Financial Reporting Standards (IFRS) and by the US Generally Accepted Accounting Principles as well as other national accounting standards.
IAS 39: Financial Instruments: Recognition and Measurement was an international accounting standard which outlined the requirements for the recognition and measurement of financial assets, financial liabilities, and some contracts to buy or sell non-financial items. It was released by the International Accounting Standards Board (IASB) in 2003, and was replaced in 2014 by IFRS 9, which became effective in 2018.
Constant purchasing power accounting (CPPA) is an accounting model that is an alternative to model historical cost accounting under high inflation and hyper-inflationary environments. It has been approved for use by the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB). Under this IFRS and US GAAP authorized system, financial capital maintenance is always measured in units of constant purchasing power (CPP) in terms of a Daily CPI during low inflation, high inflation, hyperinflation and deflation; i.e., during all possible economic environments. During all economic environments it can also be measured in a monetized daily indexed unit of account or in terms of a daily relatively stable foreign currency parallel rate, particularly during hyperinflation when a government refuses to publish CPI data.
Impairment of assets is the diminishing in quality, strength, amount, or value of an asset. An impairment cost must be included under expenses when the book value of an asset exceeds the recoverable amount. Fixed assets, commonly known as PPE, refers to long-lived assets such as buildings, land, machinery, and equipment; these assets are the most likely to experience impairment, which may be caused by several factors.
The role of fair value accounting in the subprime mortgage crisis of 2008 is controversial. Fair value accounting was issued as US accounting standard SFAS 157 in 2006 by the privately run Financial Accounting Standards Board (FASB)—delegated by the SEC with the task of establishing financial reporting standards. This required that tradable assets such as mortgage securities be valued according to their current market value rather than their historic cost or some future expected value. When the market for such securities became volatile and collapsed, the resulting loss of value had a major financial effect upon the institutions holding them even if they had no immediate plans to sell them.
The convergence of accounting standards refers to the goal of establishing a single set of accounting standards that will be used internationally. Convergence in some form has been taking place for several decades, and efforts today include projects that aim to reduce the differences between accounting standards.
International Accounting Standard 16 Property, Plant and Equipment or IAS 16 is an international financial reporting standard adopted by the International Accounting Standards Board (IASB). It concerns accounting for property, plant and equipment, including recognition, determination of their carrying amounts, and the depreciation charges and impairment losses to be recognised in relation to them.
IFRS 15 is an International Financial Reporting Standard (IFRS) promulgated by the International Accounting Standards Board (IASB) providing guidance on accounting for revenue from contracts with customers. It was adopted in 2014 and became effective in January 2018. It was the subject of a joint project with the Financial Accounting Standards Board (FASB), which issues accounting guidance in the United States, and the guidance is substantially similar between the two boards.
IFRS 4 is an International Financial Reporting Standard (IFRS) issued by the International Accounting Standards Board (IASB) providing guidance for the accounting of insurance contracts. The standard was issued in March 2004, and was amended in 2005 to clarify that the standard covers most financial guarantee contracts. Paragraph 35 of IFRS also applies the standard to financial instruments with discretionary participation features.
IFRS 7, titled Financial Instruments: Disclosures, is an International Financial Reporting Standard (IFRS) published by the International Accounting Standards Board (IASB). It requires entities to provide certain disclosures regarding financial instruments in their financial statements. The standard was originally issued in August 2005 and became applicable on 1 January 2007, superseding the earlier standard IAS 30, Disclosures in the Financial Statements of Banks and Similar Financial Institutions, and replacing the disclosure requirements of IAS 32, previously titled Financial Instruments: Disclosure and Presentation.