IFRS 9: Classification and Measurements

In today's fast-paced, globalizing world, things are constantly changing. And so too are the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB), both of which worked on new standards for classification and measurement of financial instruments. And now, IFRS 9 has replaced IAS 39 as the standard for classifications and measurement. Likewise, FASB also issued ASC 825 to make significant convergence with IFRS 9. Why do you think it's important to adjust accounting standards?

These new changes removed the terms _available for sale_ and _held to maturity_, which will no longer be valid. Instead, IFRS 9 promotes either measuring assets at fair value or at amortized cost (debt securities only). To determine which is appropriate, the first step is to evaluate the debt asset by asking the following two questions: Are the assets being held to collect contractual cash flows? And do the contractual cash flows consist of principal and interest payments? If the answer to both questions is "yes," then the debt asset can be recorded at amortized cost.

However, under IFRS 9 a company would also be allowed to elect the fair value through profit and loss option for a debt security to avoid balance sheet issues.

But why make the choice of equity classification irreversible?

Not quite. Objectivity would allow companies the ability to change their accounting procedures.

Yes! IFRS is intended to promote consistency in the classification of investments so forecasts and predictions can be made with confidence.

Incorrect. IFRS 9 is intended to help investors analyze financial statements with confidence. Companies' using their own discretion would undermine this.

For reclassification under IFRS 9, only debt securities are permitted to be reclassified. No equity reclassification is allowed. So SunLife can only reclassify its bonds. For debt security reclassification, the objective for holding the financial asset must have changed in a way that really changes operations. Once SunLife believes a material change has occurred, it makes a forward-looking accounting change. Why would IFRS only require SunLife to make a forward-looking change?

Exactly! When the financial statements were filed, the documents were accurate because SunLife intended to honor the classification. So, IFRS doesn't allow historical revisions because company could potentially take the classification decision lightly. When SunLife changes from amortized cost to fair value profit and loss recognition, it realizes a gain or loss of the difference between the current fair value and the amortized value. If the situation is reversed, the current fair value on the balance sheet becomes the new amortized cost going forward.

No. Just because the revision would lead to lower income doesn't mean IFRS wouldn't allow historical revisions.

No. If SunLife made a materially significant error on numerous financial statements, it could be forced to refile those documents, so the quantity of statement's isn't a good reason for blocking historical revisions.

So in SunLife's case, if it chooses the fair value route, it must weigh the potential increase in net income versus the potential consistency of other comprehensive income. That's because other comprehensive income isn't included in the net income calculation. But SunLife could also use derivatives to hedge market and interest-rate exposure and help smooth out any earnings volatility. If it goes the derivatives route, IFRS 9 says that the derivatives must be measured at fair value through the profit and loss statement (unless derivatives are used for hedging). Embedded derivatives are not separated from a hybrid security if the security falls under the guidelines, meaning the whole asset is measured at fair value through profit or loss. So SunLife's hedging derivatives would be recognized in other comprehensive income.

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Of course! In fact, all three are correct.

If the cash flows are contractual, and if the payments consist of principal and interest, amortized cost is the available choice. But fair value through profit and loss helps companies match assets and liabilities to avoid a significant duration issue. Take, for example, SunLife insurance Co., which most likely uses bonds to help fund operations. If the company's life insurance book of business changes by, say, increasing the number of policies that expire after a certain time period, then it will want to change its asset mix as well. For equity holdings under IFRS 9, SunLife can choose either fair value through profit or loss, or fair value through other comprehensive income, with the choice being irrevocable. If equity investments are held for trading, then SunLife must recognize gains and losses through profit and loss. If SunLife uses the fair value through other comprehensive income (OCI), only dividend income is recognized in profit and loss and the rules for reclassifying gains and losses recognized in OCI differ for debt and equity.

Why do you think this would be allowed?

Incorrect.

Correct!

To help address relevant issues and promote comparability and consistency across bonds, stocks, and derivatives, the IFRS board drafted IFRS 9, a set of new rules that were adopted on 1 January 2018.

To address new issues

To ensure consistency

To promote comparability

To promote discretion

To promote objectivity

To promote consistency

The revision could lead to lower income

The historical statements are accurate as intended

The revision could impact numerous financial statements

Because the assets held are contractual obligations

Because fair value through profit and loss helps avoid asset and liability mismatches

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