IFRS 9

Financial Instruments
Compiled by: Murtaza Quaid, ACA
 TOPIC OVERVIEW

IAS 32 - Financial Instruments: IFRS 9 - Financial Instruments:

Presentation Recognition and measurement

 Definitions  Classification
 Financial instrument  Financial asset
 Financial asset  Financial liability
 Financial liability  Measurement
 Equity instrument  Reclassification
 Derivative  Modification / Restructuring
 Debt v/s equity  Regular way transaction
 Compound financial instrument  Impairment
 Treasury shares  Derivatives
 Offsetting  Embedded derivatives
 Hedge accounting
 Derecognition
 TOPIC OVERVIEW

IFRS 7 – Financial Instruments:

IFRS 13 – Fair value measurement
Disclosures

 Disclosure requirement  Framework for fair value

Measurement
 Applies across IFRS

Connected IASs and IFRICs

 IAS 21: The Effects of Changes in Foreign Exchange Rates

 IFRIC 16: Hedges of a Net Investment in a Foreign Operation
 IFRIC 19: Extinguishing Financial Liabilities with Equity
Instruments
 DEFINITIONS
A “financial instrument” is a contract that gives rise to both:
Financial  A financial asset of one entity; and
Instrument  A financial liability or equity instrument of another entity.

A “financial asset” is any asset that is:

 Cash; or
 An equity instrument of another entity; or
Financial Asset  A contractual right to receive cash or another financial asset from
another entity; or
 A contractual right to exchange financial assets or financial liabilities with
another entity under conditions that are potentially favourable to the
entity.

A “financial liability” is any liability that is :

 A contractual obligation to deliver cash or another financial asset to
another entity; or
Financial Liability  A contractual obligation to exchange financial assets or financial liabilities
with another entity under conditions that are potentially unfavourable
to the entity.

An “equity instrument” is any contract that evidences a residual interest in

Equity the assets of an entity after deducting all of its liabilities. Examples include
equity shares and equity share options issued by an entity.
 DEFINITIONS

Financial Instrument

Financial Asset Financial Liability Equity

Examples include: Examples include: Examples include:

 Cash in hand or at bank;  Trade Payables;  Ordinary
 Investment in equity shares;  Bank loan; shares issued;
 Receivables; and
 Debentures
 Investment in debentures; issued;  Irredeemable
preference
 Investment in redeemable preference  Redeemable
shares issued.
shares; and preference shares
 Favorable forward currency contracts. issued; and
 Unfavorable
forward currency
contracts.
 DEFINITIONS
 Some financial instruments have the legal form of equity but
are, in substance, liabilities. For example, an issuer (company)
has contractual obligation to deliver cash in case of redeemable
Substance over preference shares.
form  Therefore, dividend on redeemable preference shares is treated
as finance cost in profit or loss while dividend on ordinary
shares is presented in statement of changes in equity.

RECOGNITION
 An entity shall recognize a financial asset or a financial
liability in its statement of financial position, when,
and only when, the entity becomes party to the
contractual provisions of the financial instrument.
 CLASSIFICATION OF FINANCIAL INSTRUMENT

Financial Instrument

Financial Asset Financial Liability Equity

1. Amortized cost No Classification

Debt Investment Equity Investment
2. Fair value
1. Amortized cost 1. Fair value through PL
through OCI
2. Fair value
through OCI 2. Fair value
through PL
3. Fair value
through PL
 CLASSIFICATION OF FINANCIAL ASSET

Is the business model’s Yes

Is the asset an equity No Are the asset’s contractual Yes
objective to hold to
investment? cash flows solely principal
collect contractual cash
and interest?
flows?
Yes
Yes No No
Is it held for trading?
Is the business model’s
No objective achieved both
No
Has the entity elected the by collecting contractual
No cash flows and by selling
OCI option at initial
recognition (irrevocable)? financial assets?

Yes Yes
Debt
Equity Equity Debt Debt
Investment
Investment Investment Investment Investment
Amortized
FVOCI FVPL FVPL FVOCI
Cost
 KEY TERMS

Effective Interest  The effective interest rate method is a method used in the calculation of the
amortized cost of a financial asset / liability and the allocation & recognition of
Rate Method
the interest revenue (expense) in P/L over the period.

 The effective interest rate is the internal rate of return (IRR) that exactly
Effective Interest discounts the future cash flows to the amount initially recognized for the
Rate financial asset or financial liability. Thus, it results in a net present value of zero.
 It is the IRR of all cash flows associated with lending or borrowing.

 A coupon is the annual interest paid on a bond, expressed as a percentage of

Coupon Rate the face value and paid from issue date until maturity. Coupons are usually
referred to in terms of the coupon rate.

 The amount at which the financial

asset or financial liability is measured
at initial recognition
 minus the principal repayments,
Amortized Costs  plus or minus the cumulative
amortization using the effective
interest method of any difference
between that initial amount and
the maturity amount.
 KEY TERMS
 Transaction costs are incremental costs that are directly
attributable to the acquisition, issue or disposal of a financial
instrument. Examples of transaction costs are: fees and
commissions paid to agents, advisers, brokers and dealers; levies
by regulatory agencies and securities exchanges; transfer taxes
Transaction and duties; credit assessment fees; registration charges and
Costs similar costs.
 An incremental cost is one that would not have been incurred if
the entity had not acquired, issued or disposed of financial
instrument.
 Examples of costs that do not qualify as transaction costs are
financing costs, internal administration costs and holding costs.

 The fair value of debt reflects

the price at which the debt
Fair Value of instrument would transact
between market participants,
Debt Instrument
in an orderly transaction at
the measurement date
 EQUITY INVESTMENT AT FAIR VALUE THROUGH OCI

Equity instrument can be classified and measured at FVTOCI if:

 The equity instrument is not held for trading; and
Classification  The entity has elected an irrevocable choice for this designation
upon initial recognition of the asset (i.e. subsequent
reclassification is not allowed).

 Equity investment at FVTOCI is initially measured at fair value

plus transaction costs.
 Equity investment at FVTOCI is subsequently measured at fair
value.
 Subsequent changes in the fair value of the equity instrument
Accounting are recognised in OCI and accumulated in fair value reserve.
Treatment  Dividend earned is recognized in P/L.
 Foreign exchange gains and losses are recognized in OCI.
 On disposal of the investment, the fair value reserve is not
recycled to P/L. However, it can be transferred between
reserves within equity (i.e. from FV reserve to retained
earnings).
 EQUITY INVESTMENT AT FAIR VALUE THROUGH P/L

Equity instrument is classified and measured at FVTPL if:

 The equity instrument is held for trading; or
Classification
 The entity has not elected to classify the equity investment as at
FVTOCI.

 Equity investment at FVTPL is initially measured at fair value.

 Transaction costs are immediately recognised in P/L.
 Equity investment at FVTPL is subsequently measured at fair
Accounting value.
Treatment  Subsequent changes in the fair value of the equity instrument
are recognised in P/L.
 Dividend is recognized in P/L.
 Foreign exchange gains and losses are recognized in P/L.
 DEBT INVESTMENT AT AMORTIZED COST
A debt instrument that meets the following two conditions must be measured
at amortized cost unless the asset is designated at FVTPL under the fair value
option (see exception):
 ‘Hold-to-collect’ business model test: The asset is held within a business
Classification model whose objective is to hold the financial asset in order to collect
contractual cash flows (i.e. no intention to trade in the instruments); and
 ‘SPPI’ contractual cash flow characteristics test: The contractual terms of the
financial asset give rise to cash flows that are solely payments of principal
and interest (SPPI) on the principal amount outstanding on a specified date.

 Debt investment at amortized cost is initially measured at fair value plus

transaction costs.
 Debt investment at amortized cost is subsequently measured at amortized
cost.
Accounting
 Interest income is recognized in P/L using the effective interest rate.
Treatment  Foreign exchange gains and losses on the amortized cost are recognized in
P/L.
 Credit impairment losses/reversals are recognized in P/L using credit
impairment methodology.

Exception: Even if both of above requirements are met, a financial asset may be designated as
FVPL instead, if classifying at AC would have caused an accounting mismatch.
 DEBT INVESTMENT AT FAIR VALUE THROUGH OCI
A debt instrument that meets the following two conditions must be measured at fair
value through other comprehensive income (FVTOCI) unless the asset is designated
at FVTPL under the fair value option (see execption):
 ‘Hold to collect and sell’ business model test: The asset is held within a business
Classification model whose objective is achieved by both holding the financial asset in order to
collect contractual cash flows and selling the financial asset; and
 ‘SPPI’ contractual cash flow characteristics test: 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.

 Debt investment at FVTOCI is initially measured at fair value plus transaction

costs.
 Debt investment at FVTOCI is subsequently measured at fair value.
 Interest income is recognized in P/L using the effective interest rate.
 Foreign exchange gains and losses are recognized in P/L.
Accounting
 Change in the carrying amount on remeasurement to fair value is recognised in
Treatment OCI;
 Credit impairment losses/reversals are recognized in P/L using credit impairment
methodology.
 The cumulative fair value gain or loss recognised in OCI is recycled from OCI to
P/L when the related financial asset is derecognised.

Exception: Even if both of above requirements are met, a financial asset may be designated as
FVPL instead, if classifying at FVOCI would have caused an accounting mismatch.
 DEBT INVESTMENT AT FAIR VALUE THROUGH P/L
Fair value through profit or loss (FVTPL) is the residual category in
IFRS 9. A debt instrument must be measured at fair value through
Classification profit or loss unless it is measured at amortized cost or at fair
value through other comprehensive income.

 Debt investment at FVTPL is initially measured at fair value.

 Transaction costs are immediately recognised in P/L.
 Debt investment at FVTPL is subsequently measured at fair
value.
Accounting  Subsequent changes in the fair value of the debt instrument are
Treatment recognised in P/L.
 Interest income is recognized in profit or loss using the
effective interest rate.
 Foreign exchange gains and losses are recognized in profit or
loss.
 ACCOUNTING TREATMENT - FINANCIAL ASSET

Debt Debt
Equity Investment Equity Investment Debt Investment
Accounting Treatment Investment Investment
FVOCI FVPL Amortized Cost
FVPL FVOCI

Initial measurement Fair value + TC Fair value Fair value Fair value + TC Fair value + TC

Transaction cost Capitalized Expensed out Expensed out Capitalized Capitalized

Subs. measurement Fair value Fair value Fair value Fair value Amortized cost

Δ in fair value OCI P/L P/L OCI Not applicable

Impairment Not applicable Not applicable Not applicable P/L P/L

FCY gain / (loss) OCI P/L P/L P/L P/L

Dividend / Interest P/L P/L P/L (IRR) P/L (IRR) P/L (IRR)

Gain / (loss) on
P/L P/L P/L P/L P/L
derecognition

Recycling of
gain/(loss) to P/L on Not allowed Not applicable Not applicable Allowed Not applicable
derecognition
CLASSIFICATION OF FINANCIAL LIABILITY

Yes
Is the liability a derivative or financial
liability that is held for trading?
No
Yes
Is it designated under the fair value option?

No

Financial Liability Financial Liability

Amortized Cost FVPL
 FINANCIAL LIABILITY AT AMORTIZED COST
At initial recognition, financial liability is classified and measured
at amortized cost unless either:
 The financial liability is a derivative or held for trading and is
Classification therefore required to be measured at FVTPL; or
 The entity elects to measure the financial liability at FVTPL to
eliminate accounting mismatch.

 Trade payables;
 Loan payables with standard interest rates (such as a
Examples benchmark rate plus a margin);
 Bank borrowings.

 Financial liability at amortized cost is initially measured at fair

value less transaction costs.
 Financial liability at amortized cost is subsequently measured at
Accounting amortized cost.
Treatment  Interest exchange is recognized in P/L using the effective
interest rate.
 Foreign exchange gains and losses on the amortized cost are
recognized in P/L.
 FINANCIAL LIABILITY AT FAIR VALUE THROUGH P/L
At initial recognition, financial liability may be classified and measured at fair value
through profit (FVPL) only if:
Classification  the financial liability is a derivative or held for trading; or
 the entity elects to measure the financial liability at FVTPL to eliminate accounting
mismatch.

 Interest rate swaps

 Commodity futures/option contracts
Examples  Foreign exchange future/option contracts
 Convertible note liabilities designated at FVTP;L
 Contingent consideration payable that arises from one or more business combinations.

 Financial liability at FVTPL is initially measured at fair value.

 Transaction costs are immediately recognised in P/L.
 Financial liability at FVTPL is subsequently measured at fair value.
 Interest exchange is recognized in P/L using the effective interest rate.
 Foreign exchange gains and losses are recognized in profit or loss.
Accounting
 Change in the carrying amount on remeasurement to fair value is recognised in P/L.
Treatment However, change in fair value that relate to the change in the entity’s own credit status
is recognized in OCI (instead of P/L).
 On derecognition of the financial liability, the cumulative change in fair value arising
from change in entity’s own credit status is required to remain in OCI and is not
recycled to P/L. However, IFRS 9 permits entities to transfer the amount between
reserves within equity (i.e. between the FVOCI reserve and retained earnings).
 ACCOUNTING TREATMENT - FINANCIAL LIABILITY

Accounting Financial Liability Financial Liability

Treatment Amortized Cost FVPL

Initial measurement Fair value – TC Fair value

Transaction cost Capitalized Expensed out

Subs. measurement Amortized cost Fair value

P/L (except Δ in fair value

Δ in fair value Not applicable
due to Δ in credit risk – OCI)

FCY gain / (loss) P/L P/L

Interest Expense P/L (IRR) P/L (IRR)

 EQUITY
An equity instrument is defined as any contract that evidences a residual
Definition interest in the assets of an entity after deducting all of its liabilities.

 Equity instruments are initially measured at fair value less any transaction
costs. In many legal jurisdictions when equity shares are issued they are
recorded at a nominal value, with the excess consideration received
recorded in a share premium account and the issue costs being written off
against the share premium.
 Transaction costs of an equity transaction shall be accounted for as a
Accounting deduction from equity.
Treatment  Distributions to holders of an equity instrument (i.e. Dividend) shall be
recognised by the entity directly in equity.
 Changes in the fair value of an equity instrument are not recognised in the
financial statements.
 Redemptions or re-financings of equity instruments are recognised as
changes in equity.

 If an entity reacquires its own equity instruments, those instruments

(‘treasury shares’) shall be deducted from equity.

Treasury  No gain or loss shall be recognised in P/L on the purchase, sale, issue or
cancellation of an entity’s own equity instruments. Consideration paid or
Shares received shall be recognised directly in equity.
 Such treasury shares may be acquired and held by the entity or by other
members of the consolidated group.
 REGULAR WAY TRANSACTION
 A purchase or sale of a financial asset under a contract whose terms
require delivery of the asset within the time frame established
Definition generally by regulation or convention in the marketplace concerned.
 For example, trades on the Pakistan Stock Exchange are typically
settled 2 days after the date of the trade.

 An entity can choose to account for a regular way purchase / sale of

financial assets using either trade date accounting or settlement date
Accounting accounting.
policy  The same method must be applied consistently for all purchases and
sales of financial assets that are classified in the same way.

An entity must account for any change in the fair value of the asset
between the trade date and the settlement date in the same way as it
Settlement date accounts for the acquired asset. In other words any change in value:
accounting  is not recognised for assets measured at amortized cost; but
issues  is recognised in P/L or OCI as appropriate for financial assets measured
at fair value.
 REGULAR WAY TRANSACTION
The two methods differ in terms of the timing of recognition and derecognition of assets.

TRADE DATE ACCOUNTING SETTLEMENT DATE ACCOUNTING

 The trade date is the date that an  The settlement date is the date that an
entity commits itself to purchase or sell asset is delivered to or by an entity
an asset
Purchase of Financial Asset

 Asset to be received and the liability to  Asset recognised on the date it is

pay for it are recognised on the trade received by an entity.
date
Sale of Financial Asset

 Derecognition of an asset with  Derecognition of an asset and

recognition of receivable and gain or recognition of any gain or loss on
loss arising occurs on the trade date disposal on the day that it is delivered
by the entity.
 FINANCIAL LIABILITY OR EQUITY?
 The classification of financial instruments as debt versus equity is particularly
important with items that are financial liabilities or equity as the presentation of the
two items and associated financial effects are very different.
 If a financial instrument is classified as a financial liability (debt),
 It will be reported within current or non-current liabilities.
 Interest expense, dividend payments, gains and losses relating to a financial
liability are recognised in the statement of profit and loss.
 If a financial instrument is classified as equity,
 Distributions on such instruments are debited to equity and shown in the
statement of changes in equity and therefore do not affect reported profit.
 FINANCIAL LIABILITY OR EQUITY?

Stakeholder perspective
 When an entity issues a financial instrument, the entity classifies it as either a
financial liability or as equity:
 Classification as a financial liability will result in increased gearing and reduced
reported profit (as distributions are classified as finance cost).
 Classification as equity will decrease gearing and have no effect on reported
profit (as distributions are charged to equity).
 Classification therefore affects how the financial position and performance of the
entity are depicted, and subsequently, how investors and other stakeholders assess
the potential for future cash flows and risk associated with the entity.
 Getting the classification right is therefore very important. IAS 32 strives to follow a
substance-based approach (rather than legal form) to give the most realistic
presentation of items that behave like debt or equity.
 FINANCIAL LIABILITY OR EQUITY?
 A financial liability is any liability where the issuer has a contractual obligation:
 To deliver cash or another financial asset to another entity, or
 To exchange financial instruments with another entity on potentially unfavorable terms.
 An equity instrument is defined as any contract that offers the residual interest in the assets of
the company after deducting all of the liabilities.
 As set out in the definition of a financial liability, a critical feature is that there is a contractual
obligation to deliver cash (or another financial instrument) or to exchange financial assets or
liabilities in unfavorable conditions.
 Where an entity issues a share to another party, that entity is not obliged to deliver cash (or
another financial instrument) to the shareholder; the payment of dividends is at the discretion
of the entity.
 It is important that the substance of a financial instrument is considered, rather than its legal
form. Some forms of financial instruments are legally classified as equity but have the
characteristics of financial liabilities and should therefore be classified as such.
 For example, a redeemable preference shares that is required, under the terms of its issue, to
be redeemed at a specified date for a specified amount is a financial liability.
 FINANCIAL LIABILITY OR EQUITY?
 A contract resulting in the receipt or delivery of an entity’s own shares is not
automatically an equity instrument. The classification depends on the so-called ‘fixed
test’ in IAS 32.
 A contract which will be settled by the entity delivering a fixed number of its own
equity instruments in exchange for a fixed amount of cash is an equity instrument. The
reasoning behind this is that by fixing upfront the number of shares to be delivered on
settlement of the instrument in question, the holder is exposed to the upside and
downside risk of movements in the entity’s share price.
 In contrast, if the amount of cash or own equity shares to be delivered is variable,
then the contract is a financial liability. The reasoning behind this is that using a
variable number of own equity instruments to settle a contract can be similar to using
own shares as ‘currency’ to settle what in substance is a financial liability. Such a
contract does not evidence a residual interest in the entity’s net assets. Equity
classification is therefore inappropriate.
 FINANCIAL LIABILITY OR EQUITY?
 There are other factors which might result in an instrument being classified as liability:
a) Dividends are non-discretionary.
b) Redemption is at the option of the instrument holder.
c) The instrument has a limited life.
d) Redemption is triggered by a future uncertain event which is beyond the control
of both the issuer and the holder of the instrument.
 Other factors which might result in an instrument being classified as equity include the
following:
a) Dividends are discretionary.
b) The shares are non-redeemable.
c) There is no liquidation date.
 PREFERENCE SHARES: DEBT OR EQUITY?
 Preference shares are shares that are entitled to a payment of their dividend, usually a fixed
amount each year, before the ordinary shareholders can be paid any dividend or that rank
ahead of ordinary shares for any distribution of net assets in the event of a winding up of the
company.
 Preference shares include the following types:
 Redeemable preference shares are those that the entity has an obligation to buy back
(or the right to buy back) at a future date.
 Irredeemable (perpetual) preference shares are those that will not be bought back at any
time in the future.
 Convertible preference shares are those that are convertible at a future date into
another financial instrument, usually into ordinary equity shares of the entity.

Classification of Preference Shares

 Depending on their characteristics, preference shares issued by a company might be classified as:
 Financial liability of the company; or
 Equity; or
 Compound financial instrument containing elements of both financial liability and equity.
 IAS 32 states (in a guidance note) that the key factor for classifying preference shares is the
extent to which the entity is obliged to make future payments to the preference shareholders.
 PREFERENCE SHARES: DEBT OR EQUITY?

Redeemable Preference Shares

 Redemption is mandatory: Since the issuing entity will be required to redeem the
shares, there is an obligation. The shares are a financial liability.
 Redemption at the choice of the holder: Since the issuing entity does not have an
unconditional right to avoid delivering cash or another financial asset there is an
obligation. The shares are a financial liability.
 Redemption at the choice of the issuer: The issuing entity has an unconditional right
to avoid delivering cash or another financial asset there is no obligation. The shares
are equity.

Irredeemable Non-cumulative Preference Shares

 It should be treated as equity, because the entity has no obligation to the
shareholders that the shareholders have any right to enforce.
 COMPOUND FINANCIAL INSTRUMENT
 A compound financial instrument is one that contains both a liability component and an equity component.
It is a non-derivative financial instrument that contains two component:
 Financial liability - Issuer’s contractual obligation to pay cash (i.e. principal and interest)
 Equity instrument - A embedded option to convert the loan into equity shares of the issuer.
 An example of a compound instrument is a convertible bond. The company issues a bond that can be
converted into equity in the future or redeemed for cash. Initially, it is a liability, but it has a call option on
the company’s equity embedded within it.
 Typically, a convertible bond pays a rate of interest that is lower than the market rate for a non-convertible
bond (a ‘straight bond’) with the same risk profile. This is because the terms of the conversion normally
allow the bondholder to convert the bond into shares at a rate that is lower than the market price.
 On initial recognition, compound financial instrument are required to be split into liability component and
equity component as follow:
Fair value of the instrument as a whole [i.e. proceeds from the issue of bond] XXXX
Less. Fair value of the liability component
[PV of contractually determined future cash flows (i.e. interest payments and
(XXX)
the redemption value) discounted @ market interest rate applicable to
comparable instrument but without conversion option]
Equity component (Residual amount) XXXX

 The split is made on initial recognition of the instruments and is not subsequently revised due to change in
interest rate, share price or possibility of exercise of conversion option.
 Transaction / issue cost on compound financial instrument will be allocated to each component on pro-rata
basis of initially recognized amounts of equity and liability.
 COMPOUND FINANCIAL INSTRUMENT

If Conversion is Exercised IF Conversion is NOT Exercised

 Derecognize the liability and recognize it as  Derecognize the liability as follow:

equity as follow:
Debit: Financial Liability XXXX
Debit: Financial Liability XXXX Credit: Cash / Bank XXXX
Credit: Share capital + premium XXXX
 Early repurchase: Allocate the
 The original equity component remains as consideration paid and transaction costs for
equity (may be transferred within equity) early repurchase to the liability and equity
components in the same manner that is used
 Early conversion: If favorable conversion in original allocation of the proceeds
ratio is offered for early conversion, the fair received by the entity when the convertible
value of additional shares given under the instrument was issued. Any gain or loss is
revised terms is recognized as loss in P/L. recognized as follows:
 Gain or loss relating to liability
component is recognized in P/L; and
 Consideration relating to equity
component is recognized in equity.
 MODIFICATION / RESTRUCTUIRNG OF FINANCIAL ASSET
 For modifications that do not result in derecognition, recalculate present value of
modified cash flows using original effective interest rate. Any difference between
this recalculated amount and existing carrying amount is recognised in P/L as a
modification gain / loss.
Present value of modification future cashflow at original IRR XXXX
Carrying amount of Financial Asset
(XXX)
(i.e. Present value of existing cashflow at original IRR)
Modification Gain / (Loss) XX / (XX)

 Any modification fee paid/received is recognized as a part of the carrying amount

of modified financial asset, and are amortized over remaining term of modified
financial asset (new IRR would be calculated to amortize the modification fee).
MODIFICATION / RESTRUCTUIRNG OF FINANCIAL LIABILITY
 Where lender and borrower agree to revise the terms for an existing loan, for example
change in timing of payment (restructuring) the liability, change in rate of interest, waiving
part of the loan etc., the financial liability is said to be modified to restructured.
 The accounting treatment for a modification depends on whether the terms of the loan
after the modification are substantially different from those of the original loan or not.
 The terms are substantially different if the discounted present value of the cash flows under
the new terms, including any fees paid net of any fees received and discounted using the
original effective interest rate, is at least 10% different from the discounted present value of
the remaining cash flows of the original financial liability.

On the Modification Date

- Present Value of modified cashflows @ original IRR XXXX
Add. Modification fee paid (if any) XXXX
Less. Modification fee received (if any) (XXX)

XXXX
% Change
Carrying amount of Financial Liability XXXX
(i.e. Present Value of existing cashflows @ original IRR)
MODIFICATION / RESTRUCTURING OF FINANCIAL LIABILITY

Modification % ≥ 10% Modification % < 10%

Modification with substantially different Modification with terms that are not
terms substantially different

Extinguishment Accounting Modification Accounting

 Do not derecognize the original liability.
 Derecognize the original liability  Recalculate amortized cost of modified
 Record any modification fee paid / received financial liability by discounting modified
in P/L. contractual cash flows using original EIR.
 Recognize new liability at its fair value, with  Any difference between this recalculated
any gain / (loss) in P/L. amount and existing carrying value is
 The new liability is recognised at its FV in recognized as modification gain/(loss) in P/L.
accordance with the normal rules of  Any modification fee paid / received is
recognition of financial instruments. This is adjusted against the carrying amount of
found by discounting the revised future modified financial liability, and are
payments at the market rate of interest that amortized over remaining term of modified
applies to such cash flows. financial liability (new IRR would be
calculated to amortize the modification fee).
MODIFICATION / RESTRUCTUIRNG OF FINANCIAL LIABILITY
Modification with substantially Modification with terms that are not
different terms substantially different
Extinguishment Accounting Modification Accounting

 If the new terms are identified as a  If the new terms are not substantially
substantial modification, the original different, do not recognize the
loan is extinguished and a new original liability. Recalculate present
financial liability is recognised in its value of the modified cash flows
place with any gain or loss recognised discounted at original effective
in P/L . Any costs or fees incurred are interest rate. Any difference between
recognised as part of the gain or loss this recalculated amount and existing
on the extinguishment. carrying value is recognized as
modification gain/(loss) in P/L.
 The new liability is recognised at its
fair value in accordance with the  Any modification fee paid / received
normal rules of recognition of is adjusted against the carrying
financial instruments. This is found by amount of modified financial liability,
discounting the revised future and are amortized over remaining
payments at the market rate of term of modified financial liability
interest that applies to such cash (new IRR would be calculated to
flows. amortize the modification fee).
 IMPAIRMENT OF FINANCIAL ASSETS

Overview of the New Impairment Model

 “IAS 36: Impairment of assets” operates an incurred loss model. This means that impairment
is recognised only when an event has occurred which has caused a fall in the recoverable
amount as compared to carrying amount of an asset.
 However, IFRS 9 uses a forward-looking impairment model based on expected losses.
Under this model future expected credit losses are recognised. Anticipating credit losses is a
prudent approach, meaning it is less likely that assets will be over-stated. Users of the
financial statements are also provided with timely information, because they are warned
about potential impairment issues before actual defaults have occurred.
 The rules look complex because they have been drafted to provide guidance to banks and
similar financial institutions on the recognition of credit losses on loans made. However,
there is a simplified regime that applies to other financial assets as specified in the standard
(such as trade receivables and lease receivables).
 EXPECTED LOSS MODEL
Key Definitions

 Credit loss
The difference between all contractual cash flows that are due to an entity in accordance
with the contract and all the cash flows that the entity expects to receive (i.e. all cash
shortfalls), discounted at the original effective interest rate.
 Expected credit losses
The weighted average of credit losses with the respective risks of a default occurring as the
weights.
 Lifetime expected credit losses
The expected credit losses that result from all possible default events over the expected life of
a financial instrument.
 12-month expected credit losses
The portion of lifetime expected credit losses that represent the expected credit losses that
result from default events on a financial instrument that are possible within the 12 months
after the reporting date.
They are calculated by multiplying the probability of default in the next 12 months by the
present value of the lifetime expected credit losses that would result from the default
 EXPECTED LOSS MODEL
IFRS 9 establishes a three-stage impairment model, based on whether there has been a significant
increase in the credit risk of a financial asset since its initial recognition. These three-stages then
determine the amount of impairment to be recognised as expected credit losses (ECL) at each
reporting date as well as the amount of interest revenue to be recorded in future periods:
Stage 1: Credit risk has not increased significantly since initial recognition
Recognise 12 months ECL, and recognise interest on a gross basis
Stage 2: Credit risk has increased significantly since initial recognition
Recognise lifetime ECL, and recognise interest on a gross basis;
Stage 3: Financial asset is credit impaired.
The financial asset is written down to its estimated recoverable amount. Recognise
lifetime ECL, and present interest on a net basis (i.e. on the gross carrying amount less
credit allowance).
 EXPECTED LOSS MODEL

Scope
The following financial instruments are included within the scope of the impairment requirements
in IFRS 9:
 Debt instruments measured at amortised cost;
 Debt instruments measured at fair value through other comprehensive income (FVOCI);
 Issued loan commitments (except those measured at FVTPL);
 Issued financial guarantee contracts (except those measured at FVTPL);
 Lease receivables within the scope of IFRS 16 Leases;
 Contract assets within the scope of IFRS 15 Revenue from Contracts with Customers;

XXX The impairment rules do not apply to financial assets measured at fair value through profit or
loss as subsequent measurement at fair value will already take into account any impairment.
 EXPECTED LOSS MODEL

Simplified Approach General Approach

 Compulsory application  Compulsory application

 Trade Receivable without significant  Debt instruments measured at
financing component amortized cost
 Contract Assets without significant  Debt instruments measured at fair
financing component value through other comprehensive
income (FVOCI)
 Optional application
For following financial assets, entity has  Optional application
to choose as an accounting policy to be For following financial assets, entity has
applied consistently to apply either the to choose as an accounting policy to be
“General approach” or “Simplified applied consistently to apply either the
approach” for recognising expected “General approach” or “Simplified
losses. approach” for recognising expected
 Trade Receivable with significant losses.
financing component  Trade Receivable with significant
 Contract Assets with significant financing component
financing component  Contract Assets with significant
 Lease Receivables financing component
 Lease Receivables
 EXPECTED LOSS MODEL

General Approach
 Compulsory application
 Debt instruments measured at amortised cost
 Debt instruments measured at fair value through other comprehensive income (FVOCI)
 Optional application
For following financial assets, entity has to choose as an accounting policy to be applied
consistently to apply either the “General approach” or “Simplified approach” for recognising
expected losses.
 Trade Receivable with significant financing component
 Contract Assets with significant financing component
 Lease Receivables

Measurement at Initial Recognition

 At initial recognition of a financial asset, a loss allowance equal to 12-month expected credit
losses must be recognised.
 EXPECTED LOSS MODEL - GENERAL APPROACH
Measurement at Subsequent Recognition
The expected credit loss associated with the financial asset is then reviewed at each subsequent reporting date.
The amount of expected credit loss recognised as a loss allowance depends on the extent of credit deterioration
since initial recognition.

 If there is no significant increase in credit risk, the loss allowance for that asset is remeasured to the 12
month expected credit loss as at that date.

 If there is a significant increase in credit risk the loss allowance for that asset is remeasured to the lifetime
expected credit losses as at that date. This does not mean that the financial asset is impaired. The entity still
hopes to collect amounts due but the possibility of a loss event has increased. A significant increase in
credit risk can include:
 Changes in general economic and/or market conditions (e.g. expected increase in unemployment
rates, interest rates);
 Significant changes in the operating results or financial position of the borrower;
 Changes in the amount of financial support available to an entity (e.g. from its parent);
 Expected or potential breaches of covenants;
 Expected delay in payment (Rebuttable presumption that credit risk has increased significantly when
contractual payments are more than 30 days past due).
 If there is credit impairment, the financial asset is written down to its estimated recoverable amount. The
entity accepts that not all contractual cash flows will be collected and the asset is impaired.
Future revenue recognition: Interest is recognised in the future by applying the effective rate to the new
amortized cost (after recognition of the impairment loss).
 EXPECTED LOSS MODEL - GENERAL APPROACH
Credit Impairment
 A financial asset is credit-impaired when one or more events that have a detrimental impact
on the estimated future cash flows of that financial asset have occurred. Evidence that a
financial asset is credit-impaired include (but is not limited to) observable data about the
following events:
 Significant financial difficulty of the issuer or the borrower;
 Actual breach of contract (e.g. default or delinquency in payments);
 Granting of a concession to the borrower due to the borrower’s financial difficulty;
 Probable that the borrower will enter bankruptcy or other financial re-organisation;
 Disappearance of an active market for that financial asset because of financial difficulties;
 Purchase or origination of a financial asset at a deep discount that reflects the incurred
credit losses.
 If an entity revises its estimates of receipts it must adjust the gross carrying amount of the
financial asset to reflect actual and revised estimated contractual cash flows. The financial
asset must be re measured to the present value of estimated future cash flows from the asset
discounted at the original effective rate.
 FUTURE REVENUE RECOGNITION
Interest is recognised in the future by applying the effective rate to the new amortised cost
(after the recognition of the impairment loss).
 EXPECTED LOSS MODEL - GENERAL APPROACH
Reversal of Impairment

 If an entity has measured the loss allowance at an amount equal to

lifetime expected credit losses in the previous reporting period, and
subsequently, the credit risk of the financial instrument improves, it should
revert to measuring the loss allowance at an amount equal to 12-month
expected credit losses.
 The resulting impairment gain is recognised in profit or loss.
 IMPAIRMENT OF FINANCIAL ASSETS
Measurement of Expected Credit Losses
The measurement of expected credit losses should reflect (IFRS 9: para. 5.5.17):
 An unbiased and probability-weighted amount that is determined by evaluating a
range of possible outcomes;
 The time value of money; and
 Reasonable and supportable information that is available without undue cost and
effort at the reporting date about past events, current conditions and forecasts of
future economic conditions.
 EXPECTED LOSS MODEL - GENERAL APPROACH

Loss Allowance

 Loss allowance for financial assets carried at amortised cost

Movement on the loss allowance is recognised in profit or loss.
The loss allowance balance is netted against the financial asset to which it
relates on the face of the statement of financial position. This is just for
presentation only; the loss allowance does not reduce the carrying amount
of the financial asset in the double entry system.
 Loss allowance for financial assets at fair value through OCI
Movement on the loss allowance is recognised in profit or loss but the loss
allowance balance is not netted against the financial asset to which it relates
as this is carried at fair value. The loss allowance is recognised in other
comprehensive income.
 EXPECTED LOSS MODEL - GENERAL APPROACH

Presentation
 Credit losses are treated as follows:
 EXPECTED LOSS MODEL

Simplified Approach
 Compulsory application
 Trade Receivable without significant financing component
 Contract Assets without significant financing component
 Optional application
For following financial assets, entity has to choose as an accounting policy to be
applied consistently to apply either the “General approach” or “Simplified
approach” for recognising expected losses.
 Trade Receivable with significant financing component
 Contract Assets with significant financing component
 Lease Receivables

Measurement
 A loss allowance measured as the lifetime expected credit losses is recognised.
Because the maturities will typically be 12 months or less, the credit loss for 12-
month and lifetime ECLs would be the same.
Expected credit losses on trade receivables can be calculated using provision matrix
 PURCHASED OR ORIGINATED CREDIT-IMPAIRED FINANCIAL ASSETS

 A financial asset may already be credit-impaired when it is purchased. In

this case it is originally recognised as a single figure with no separate
allowance for credit losses.
 However, any subsequent changes in lifetime expected credit losses are
recognised as a separate allowance
 Interest income on such financial asset is calculated using a credit adjusted
effective interest rate. This incorporates expected lifetime credit losses at
the inception date.
 Reclassification of Financial Instruments
 Financial assets are reclassified under IFRS 9 when, and only when, an entity
changes its business model for managing financial assets.
 Such changes are expected to be very infrequent, and are determined by the entity’s
senior management as a result of external or internal changes. These changes have
to be significant to the entity’s operations and demonstrable to external parties.
Accordingly, a change in the objective of an entity’s business model will occur only
when an entity either begins or ceases to carry out an activity that is significant to its
operations – e.g. when the entity has acquired, disposed of or terminated a business
line.
 If an entity determines that its business model has changed in a way that is
significant to its operations, then it reclassifies all affected assets prospectively from
the first day of the next reporting period (i.e. reclassification date). Prior periods are
not restated i.e. there is no restatement of any previously recognised gains and
losses (including any impairment gains or losses) or interest.
 These rules only apply to investments in debt instruments as investments in equity
instruments are always held at fair value and any election to measure them at fair
value through other comprehensive income is an irrevocable one and is made at
initial recognition.
 Reclassification of financial liability is not allowed.
 Reclassification of Financial Assets & Financial Liability
 The standard provides the following examples of circumstances that are or are not
changes in the business model.

Change in business model Not a change in business model

An entity has a portfolio of commercial loans An entity changes its intention for particular
that it holds to sell in the short term. The financial assets (even in circumstances of
entity acquires a company that manages significant changes in market conditions).
commercial loans and has a business model
that holds the loans in order to collect the A particular market for financial assets
contractual cash flows. temporarily disappears.
The original portfolio of commercial loans is
Financial assets are transferred between parts
no longer for sale, and this portfolio is now
of an entity with different business models.
managed together with the acquired
commercial loans. All of the loans are held to
collect the contractual cash flows.

A financial services firm decides to shut down

its retail mortgage business. That business no
longer accepts new business and the financial
services firm is actively marketing its mortgage
loan portfolio for sale.
 MEASUREMENT ON RECLASSIFICATION OF FINANCIAL ASSETS
Reclassification to
FVPL FVOCI Amortized cost

 Fair value on the date of reclassification

 Continue to be measured at fair value. becomes the new gross carrying amount.
 Calculate new effective interest rate
FVPL

based on new carrying amount.  Calculate new effective interest rate based
on new carrying amount.
 Impairment requirements apply from
reclassification date.  Impairment requirements will apply from
reclassification date.
Reclassification from

 Remove accumulated OCI balance and

adjust it against the fair value of the asset.
 Continue to be
measured at fair Adjusted amount = amortized cost.
value.
FVOCI

 Reclassify  Loss allowance would be recognised as an

accumulated OCI adjustment to the gross carrying amount of
balance to P/L on the financial asset.
reclassification
 Effective interest rate determined at initial
date.
recognition is not adjusted as a result of
reclassification.
 Remeasure to fair value, with any
 Remeasure the difference recognised in OCI.
Amortized cost

asset to fair value

 Loss allowance would be derecognised
and derecognize
and would be recognised as an
loss allowance
accumulated impairment amount in OCI.
with any
difference  Effective interest rate determined at
recognized in P/L initial recognition is not adjusted as a
result of reclassification.
 DERIVATIVES
 A derivative is a financial instrument:
 whose value changes in response to the change in an underlying variable such as
an interest rate, commodity or security price, or index etc.;
 where the initial investment is zero or is small in relation to the value of the
underlying variable; and
 that is settled at a future date.
 Common derivatives include futures contracts, forwards, options, and swaps.
 Over the life of the derivative contract, its fair value will depend on the spot
exchange rates and the time to the end of the contract.
 A derivative can be used for hedging or speculation.
Initial measurement: All derivatives have to be initially recognized at fair value, i.e. at
consideration paid or received at inception of the contract.
Subsequent measurement: All derivatives shall be accounted for at FV through P/L
unless designated as a hedging instrument is hedge a/c relationship.
 FUTURES
 Futures is a standardized contract to buy or sell
 a particular commodity/financial item
 at a predetermined price
 at a specified time in the future.
 Futures details the quality and quantity of the underlying asset; they are
standardized to facilitate trading on a futures exchange.
 Some futures contracts may call for physical delivery of the asset, while others are
settled in cash.
 FORWARD CONTRACTS
 Forward contract is a tailor-made or customized contract to buy or sell
 a specified amount
 of a specified item (commodity or financial item)
 on a specified future date
 at a specified price agreed upon today.
 A forward contract settlement can occur on a cash or delivery basis.
 Forward contracts do not trade on a centralized exchange and are therefore
regarded as over-the-counter (OTC) instruments.
 OPTIONS
 Under option contract, the holder/buyer of the option has entered into a contract
that gives it the right but not the obligation to buy (call option) or sell (put option)
a specified amount of a specified commodity at a specified price.
 An option differs from a forward arrangement. An option not only offers its
buyer/holder the choice to exercise his rights under the contract, but also the choice
not to enforce the contract terms.
 The issuer/seller of the option must fulfil the terms of the contract, but only if the
option holder chooses to enforce them.
 The option holder has to pay a sum of money (premium) to the option seller. This
premium is paid when the option is arranged, and non-refundable if the holder later
decides not to exercise his rights under the option.
 For holder, option will only ever be recorded as an asset. Initially, atthe amount of
premium. The holder would exercise the option only if it is beneficial to do so.
Therefore it could only be an asset.
 SWAPs
 A swap is an agreement between parties to exchange cash flows related to an
underlying obligation.
 The most common type is an interest rate swap. In an IRS, two parties agree to
exchange interest payments on the same notional amount of principal, at regular
intervals over an agreed number of years.
 One party might pay interest to other party at a variable rate, and in return the
other party may pay interest on the same principal at a fixed rate.
 A swap might be an asset or liability at any particular date depending upon the
interaction between the amount to be paid and the amount to be received.
 HEDGE ACCOUNTING

Hedging
 Hedging is the process of entering into a transaction in order to reduce risk.
 Companies enter into hedging transactions (i.e. derivatives) in order to reduce
business risk.
 Where an item in the statement of financial position or future cash flow is subject
to potential fluctuations in value that could be detrimental to the business, a
hedging transaction may be entered into.
 The aim is that where the item hedged makes a financial loss, the hedging
instrument would make a gain and vice versa, reducing overall risk.
 HEDGE ACCOUNTING

Hedging - Example
 Pumpkin acquired inventories of coffee beans at 30 November 20X6 for
their fair value of $1.3 million. It is worried that the fair value will fall so
has entered into a futures contract to sell the coffee for its current fair
value in three months’ time.
 At the year ended 31 December 20X6, the fair value of the coffee is $1.2
million.
 At the reporting date:

Futures
Offset The gain on the futures
Inventories contract is $0.1M as the
NRV loss of $0.1M contract allows the holder to
sell at $0.1M more than
market value ($1.2M)
 HEDGE ACCOUNTING
 Hedge accounting provides special rules that allow the matching of the gain or
loss on the derivatives position with the loss or gain on the hedged item.
 This reduces volatility in the statement of financial position and the statement of
profit or loss, and so is very attractive to the preparers of accounts.
 Hedge accounting is optional, not obligatory.
 Under IFRS 9, hedge accounting rules can only be applied if hedging relationship
meets the following criteria:
i. Hedging relationship consists only of
 Eligible hedged items and
 Eligible hedging instruments
ii. At inception of hedge, there must be formal designation and documentation
identifying
 Risk management objective and strategy
 Eligible hedged item
 Eligible hedging instrument
 Nature of the risk being hedged.
 How hedge effectiveness will be assessed.
iii. Hedging relationship must meet hedge effectiveness requirements.
 HEDGE ACCOUNTING

Eligible Hedge Item Eligible Hedge Instrument

A hedged item is A hedging instrument is a

1) Asset or Liability,  derivative or
2) Unrecognized firm commitment,
 Non-derivative financial asset or
3) Highly probable forecast non-derivative financial liability
transaction or
4) Net investment in a foreign measured at FVTPL whose fair value
operation or cash flows are expected to offset
changes in the fair value or cash
that exposes the entity to risk of flows of a designated hedged item.
changes in fair value or future cash
flows and is designated as being For hedge accounting purposes, only
hedged. contracts with a party external to
the reporting entity (ie external to
the group or individual entity that is
being reported on) can be
designated as hedging instruments.
 HEDGE EFFECTIVENESS CRITERIA
 An entity must assess at inception and at each reporting date whether the hedge meets all of the
following hedge effectiveness criteria:
1) Economic relationship: There must be an economic relationship between hedged item & hedging
instrument i.e the hedging instrument and the hedged item have values that generally move in
the opposite direction because of the same risk, which is the hedged risk.
For example, an entity with a Rupees as functional currency might sell goods or services to
customers that use US dollars. If the entity entered into a forward contract to exchange US
dollars for Rupees on a specified future date (to coincide with the expected date of US dollar
payments by customers), changes in the fair value of that forward contract would be expected
to offset changes in the fair value of cash to be collected that is denominated in US dollars.
2) Credit risk: The effect of credit risk does not dominate the change in value from that economic
relationship i.e. the fair value changes due to credit risk should not be a significant driver of the
changes in fair value of either the hedging instrument or the hedged item.
3) Hedge ratio: Hedge ratio is the same for both the:
 Hedging relationship
 Quantity of the hedged item actually hedged, and the quantity of the hedging instrument
used to hedge it.
For example, an entity hedges 90% of the foreign exchange exposure of a financial instrument.
The hedging relationship should be designated using a hedge ratio resulting from 90% of the
foreign currency exposure and the quantity of the hedging instrument that the entity actually
uses to hedge the 90%.
 Hedge effectiveness relates to expectations and therefore the assessment of effectiveness must be
forwards-looking (prospective).
 HEDGE ACCOUNTING

Discontinuation of Hedge Accounting

 Discontinuance of hedge accounting is accounted for

prospectively.
 Hedge accounting must be discontinued if :
 Hedging relationship no longer meets the qualifying
criteria; or
 Hedging instrument is expired, sold, terminated or
exercised
 HEDGE ACCOUNTING MODELS
 Where the conditions for using hedge accounting are met,
the method of hedge accounting to be used depends on the
type of hedge.
 There are three types of hedging relationship:
1) Fair value hedges
2) Cash flow hedges; and
3) Hedges of a net investment in a foreign entity (accounted
for as a cash flow hedge).
 FAIR VALUE HEDGE
 Fair value hedge is a hedge of exposure to changes in fair value of a
recognised asset or liability or unrecognized firm commitment that is
attributable to a risk that could effect P/L.
 For example, oil held in inventory could be hedged with an oil forward
contract to hedge the exposure to a risk of a fall in oil sales prices or the
risk of a change in the fair value of a fixed rate debt owed by a company
could be hedged using an interest rate swap.

Accounting Treatment

 At the reporting date, hedging instrument and hedged item will be

measured at fair value.
 Gain / (loss) on hedge instrument and (loss) / gain on hedge item will be
recorded:
 in P/L in most cases, but
 in OCI if the hedged item is an investment in equity measured at
FVTOCI.
 CASHFLOW HEDGE
 Cash flow hedge is a hedge of exposure to variability in
future cash flows that is attributable to a particular risk
associated with a recognised asset or liability or a highly
probable forecast transaction.
 For example,
 Floating rate debt issued by a company might be hedged
using an interest rate swap to manage increases in interest
rates or
 Future US dollar sales of airline seats by a Pakistani
company might be hedged by a US$/Rs. forward
contracts to manage changes in exchange rates.
 These are hedges relating to future cash flows from interest
payments or foreign exchange receipts.
 CASHFLOW HEDGE

Accounting Treatment

 At the reporting date, hedge instrument will be re-measured to fair value.

 Effective portion of gain/ (loss) on hedge instrument is recognized in OCI (Cash Flow
Hedge Reserve –CFHR). Effective portion is the gain/ (loss) on the hedge instrument to the
extent of (loss)/ gain on hedged item.
 Ineffective portion of gain/ (loss) on hedge instrument is recognized in P/L. Ineffective
portion is the gain/ (loss) on the hedge instrument in excess of (loss)/ gain on hedged item.

Hedging
Hedge Instrument Hedge Item

Gain / (loss) on Hedge Instrument To be accounted for as per the

relevant IASs/IFRSs
Effective Portion Ineffective Portion

CFHR - OCI P/L

 CASHFLOW HEDGE

Accounting Treatment
 The amount that has been accumulated in the cash flow hedge reserve is then accounted
for as follows:
a) If a hedged forecast transaction subsequently results in the recognition of a non-
financial asset or non-financial liability, the amount shall be removed from the cash
flow reserve and be included directly in the initial cost or carrying amount of the asset
or liability.
b) For all other cash flow hedges, the amount shall be reclassified from other
comprehensive income to profit or loss in the same period(s) that the hedged
expected future cash flows affect profit or loss.
 If hedge accounting ceases for a CF hedge because forecast transaction is no longer
expected to occur, gain / (loss) deferred in OCI must be taken to P/L immediately.
 If transaction is still expected to occur but hedge relationship ceases, amounts accumulated
in equity will be retained in equity until the hedged transaction occurs.
 HEDGES OF A NET INVESTMENT IN A FOREIGN OPERATION [IFRIC 16]

 It is a hedge of an entity’s interest in the net assets of a foreign

operation.
 It can be applied only to foreign exchange differences arising between
parent’s functional currency and foreign operation’s functional currency.
 The hedging instrument may be held by any entity within the group.
 Hedge accounting of the foreign exchange risk of the net investment in a
foreign operation only applies in financial statements where the interest
in the foreign operation is included as the investing company’s share of
its net assets. This means that hedge accounting in respect of the foreign
exchange risk associated with an investment in a foreign subsidiary is
only allowed in the consolidated financial statements.
 Under IAS 21, the net assets of the foreign subsidiary are translated at the
end of each financial year, and any foreign exchange differences are
recognised in other comprehensive income (until the foreign subsidiary is
disposed of, when the cumulative profit or loss is then reclassified from
‘equity’ to profit or loss).
 HEDGES OF A NET INVESTMENT IN A FOREIGN OPERATION [IFRIC 16]

 Foreign operation: An entity that is a subsidiary, associate, joint

venture or branch of a reporting entity, the activities of which are
based or conducted in a country or currency other than those of
the reporting entity.

 Foreign Subsidiary
Investment in  Foreign Associate
Reporting Entity
 Foreign Joint Venture
 Foreign Branch Office

Net assets of foreign operation are

exposed to foreign exchange risk

Hedge of reporting entity’s interest

in Net Assets of Foreign Operation
 HEDGES OF A NET INVESTMENT IN A FOREIGN OPERATION [IFRIC 16]

 Hedge accounting of the foreign exchange risk of the net investment in a foreign
operation only applies in financial statements where the interest in the foreign
operation is included as the investing company’s share of its net assets. This
means that hedge accounting in respect of the foreign exchange risk associated
with an investment in a foreign subsidiary is only allowed in the consolidated
financial statements.
 Foreign Subsidiary Separate entity
Investment in  Foreign Associate
Reporting Entity
 Foreign Joint Venture
 Foreign Branch Office No Separate
entity

In the Reporting Entity’s Above investment at carried at

Separate Financial Statement No Hedge Accounting
Cost / Fair Value

In the Reporting Entity’s Above investment at carried at Hedge of a Net investment

Consolidated Financial Statement Net Assets in Foreign Operation
 HEDGES OF A NET INVESTMENT IN A FOREIGN OPERATION [IFRIC 16]

Accounting Treatment
 Accounting treatment for hedge instrument is same as for cash flow hedge.
 Effective portion of gain/ (loss) on hedge instrument is recognized in OCI
 Whereas ineffective portion of gain/ (loss) on hedge instrument is recognized in P/L

Reporting Entity Investment in Foreign Subsidiary (Dubai Subsidiary)

(Pakistan Company) Net Assets = 300,000 AED

Hedge Instrument In Consolidated Financial Statement

 Derivative
 Borrowing in Foreign Currency
Foreign Exchange Gain / (Loss) on Net Assets of
Gain / (loss) on Hedge Instrument Subsidiary is recognized in Other
Comprehensive Income – OCI (IAS 21)
Effective Portion Ineffective Portion

OCI P/L

 Upon disposal of foreign operation, following foreign exchange translation reserve will be reclassified to P/L:
 Cumulative translation reserve recorded on consolidation of net investment (IAS 21); &
 Cumulative effective gain / (loss) on hedging instrument (IFRS 9)
 DERECOGNITION OF FINANCIAL ASSETS
 Derecognition of a financial asset is often straightforward, as the above criteria can be implemented easily.
For example, a trade receivable should be derecognised when an entity collects payment. The collection of
payment signifies the end of any exposure to risks or any continuing involvement.

 However, financial assets may be subject to complicated transactions where some of the risks and rewards
that attach to an asset are retained but some are passed on. For example, factoring arrangement, repo
transaction etc.

 An entity shall derecognize a financial asset when:

a) the contractual rights to the cash flows from the financial asset expire; or
b) the financial asset is transferred and substantially all of the risks and rewards of ownership pass to the
transferee; or
c) the financial asset is transferred, substantially all of the risks and rewards of ownership are neither
transferred nor retained but control of the asset has been lost.

Accounting Treatment
 Step 1: Remeasure the financial asset as per the relevant classification model on the date of derecognition.

 Step 2: On derecognition of a financial asset, the difference between:

a) the carrying amount (measured at the date of derecognition) and
b) the consideration received (including any new asset obtained less any new liability assumed)
shall be recognized in Profit or Loss.
 DERECOGNITION OF FINANCIAL ASSETS

Factoring
Sell its receivable
Seller Factoring Company
Against immediate cash payment

In a factoring transaction, one party transfers the right to some receivables to another party for an
immediate cash payment. Factoring arrangements are either with recourse or without recourse.

Factoring without recourse Factoring with recourse

 In factoring with recourse, the transferor sells its
 In factoring without recourse, the transferor invoices to a factor, with the promise to buy
does not provide any guarantees about the back any uncollected invoices. The factor does
performance of the receivables. not take the risk of any uncollected invoices.
 In such case, the entity has transferred the risks The transferor has not therefore transferred fully
and rewards of ownership of asset and therefore the risks to another party.
the entity shall derecognize the receivables  In such case, the entity shall not derecognize the
against the consideration received with any gain receivable and recognize financial liability for
/ (loss) recognized in P/L. consideration received.
 DERECOGNITION OF FINANCIAL ASSETS

Repurchase Agreement

Sell a financial asset

Seller Buyer
With repurchase agreement
to buy back the asset in future

In repurchase agreement, a financial asset is sold with a simultaneous agreement to buy

it back at some future date at an agreed price.

If Repurchase is at Specified Price If Repurchase at Fair Market Price

Continue to recognize the financial asset Derecognize the financial asset and debit
and recognize the financial liability for the consideration received with any gain
cash received. / (loss) recognized in P/L.
 DERECOGNITION OF FINANCIAL LIABILITY
 A financial liability is derecognized only when extinguished i.e. when the
obligation specified in the contract is discharged or cancelled or expired.

 The difference between the carrying amount of a financial liability extinguished

or transferred to a 3rd party and the consideration paid is recognised in P/L.
EXTINGUISHING FINANCIAL LIABILITIESWITH EQUITY INSTRUMENTS
[IFRIC 19]

BACKGROUND AND SCOPE

Loan
Borrower Lender
Settlement of loan =
Equity Shares of Borrower
 Terms of a liability might be renegotiated such that the lender (creditor) accepts
equity instruments as payment instead of cash.

 IFRIC19 sets out how a borrower that issues equity instruments to extinguish all
or part of financial liability should account for the transaction.

 Following transactions are scoped out of IFRIC 19:

 Transactions with the creditor in its capacity as an existing shareholder(e.g. a

rights issue);

 Lender and borrower are controlled by the same party or parties before and
after the transaction; or

 Issue of equity shares to extinguish debt is in accordance with original terms

of financial liability (such as convertible debt).
 EXTINGUISHING FINANCIAL LIABILITIESWITH EQUITY INSTRUMENTS
[IFRIC 19]
ISSUES ADDRESSED
ISSUES CONSENSUS
Are equity instruments issued to extinguish
Issue of equity instruments is “consideration paid” to extinguish all or
financial liability considered “consideration
part of a financial liability. This leads to derecognition of the liability.
paid”?

If fair value of equity instrument issued is reliably measurable

 Equity instruments issued would be initially measured at fair value of
the issued equity instruments.
If fair value of equity instrument issued is NOT reliably measurable
How should an entity initially measure the  Equity instrument issued would be measured at fair value of the
equity instruments issued? liability extinguished.
If fair value of equity instrument issued and liability extinguished are NOT
reliably measurable
 Equity instrument issued would be measured at carrying value of the
liability extinguished.

How should the entity account for any Difference between the carrying amount of liability extinguished and
difference between the carrying amount of consideration paid must be recognised in P/L.
the liability and the equity instruments
issued? Separate line item or disclosure in the notes is required.
 EXTINGUISHING FINANCIAL LIABILITIESWITH EQUITY INSTRUMENTS
[IFRIC 19]

PART EXTINGUISHMENT – ADDITIONAL CONCERNS

 If only part of the financial liability is extinguished, entity is

required to assess whether some of the consideration paid relates
to a modification of the terms of the outstanding liability

 If some of the consideration paid relates to modification of terms

of remaining liability, the entity allocates the consideration paid
between

 Part of the liability extinguished and

 Part of the liability that remains outstanding.

and apply “modification of financial liability” rules accordingly.