IFRS 9 Financial Instruments: Measurement

As a general rule, financial assets and financial liabilities are initially recognised at fair value plus or minus directly attributable transaction costs. For items carried at FVTPL (classification of financial assets and liabilities is discussed below), transaction costs are immediately expensed (IFRS 9.5.1.1).

The fair value of a financial instrument at initial recognition normally is, but not always, the transaction price. Fair value measurements are covered in detail in IFRS 13.

As an exception to the general rule described above, trade receivables are initially recognised according to IFRS 15 provisions, i.e. at their transaction price and possibly taking significant financing component into account (IFRS 9.5.1.3).

IFRS 9 limits the possibility of immediate recognition of so-called ‘day 1 gains/losses’ to financial instruments with a quoted market price or with fair value based on a valuation technique that uses only data from observable markets (Level 1 input as per IFRS 13 terminology). For other instruments, the difference between fair value and transaction price is recognised in the carrying amount but the recognition of gains/losses is deferred. After initial recognition, that deferred difference is recognised as a gain or loss only to the extent that it arises from a change in a factor (including time) that market participants would take into account when pricing the asset or liability (IFRS 9.B5.1.2A). It is not clear how exactly the deferred difference should be recognised as a gain/loss. Basis for conclusions to IAS 39 stated that straight-line amortisation may be an appropriate method in some cases, it will not be appropriate in others (IAS 39.BC222(v)(ii)). IFRS 9 is silent on this matter, therefore whenever reasonable, straight-line amortisation can be used.

If part of the consideration given or received is for something other than the financial instrument, an entity shall measure the fair value of the financial instrument. IFRS 9 gives an example of a long-term loan or receivable that carries no interest, which should be measured at fair value measured as the present value of all future cash receipts discounted using the prevailing market rate(s) of interest for a similar instrument. Any additional amount lent should be accounted for according to its substance under other applicable IFRS (IFRS 9.B5.1.1).

Below-market interest rate loans are not rare among entities under common control. Therefore, strictly speaking, the difference between the fair value of such loan and the proceeds should be recognised as an increase in investment in subsidiary (in separate financial statements of the parent) and an equity contribution (in separate financial statements of the subsidiary).

A below-market interest rate loan may also be an example of a government grant. If an entity receives such a loan, it should be recognised at fair value using the market rate of interest, with the difference treated as a government grant and accounted for under IAS 20.

Another example is given by IFRS 9 and concerns an off-market interest rate loan with a compensating upfront fee (IFRS 9.B5.1.2).

As noted above, transaction costs are included in the carrying amount of a financial asset or a financial liability unless they are classified to FVTPL measurement category (IFRS 9.5.1.1). Accounting implications of recognition of transaction costs are discussed in paragraph IFRS 9 IG.E.1.1.

Transaction costs are defined as incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset or financial liability. An incremental cost is one that would not have been incurred if the entity had not acquired, issued or disposed of the financial instrument (IFRS 9.Appendix A). Transaction costs include fees and commission paid to agents (including employees acting as selling agents), advisers, brokers and dealers, levies by regulatory agencies and security exchanges, and transfer taxes and duties. Transaction costs do not include debt premiums or discounts, financing costs or internal administrative or holding costs (IFRS 9.B5.4.8).

Subsequent measurement of financial assets and financial liabilities depends on their classification, which is discussed above. The table below summarises the subsequent measurement for each category and more discussion follows:

Classification and measurement of financial assets under IFRS 9
Classification and measurement of financial assets under IFRS 9

Note that fair value measurements are covered in IFRS 13.

Assets measured at amortised cost are accounted for using the effective interest method with interest income recognised in P/L. These assets are also subject to impairment losses recognised in P/L (IFRS 9.5.2.2) and foreign currency translation with gains/losses recognised in P/L as well (IFRS 9.B5.7.2).

Amortised cost and effective interest method are discussed below in detail with excel examples given in a separate section below.

As debt instruments are monetary items, general IAS 21 provisions apply. Firstly, the amortised cost is determined in the foreign currency in which the item is denominated. Then, the foreign currency amount is translated into the functional currency and any foreign gains/losses are recognised in P/L (IFRS 9.B5.7.2; IFRS 9 IG.E.3.4).

Hedge accounting is discussed on a separate page.

Impairment of financial assets is discussed on a separate page.

Amortised cost is the amount at which the financial asset or financial liability is measured at initial recognition minus the principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount and, for financial assets, adjusted for any loss allowance (IFRS 9.Appendix A).

Effective interest method is the method that is used in the calculation of the amortised cost of a financial asset or a financial liability and in the allocation and recognition of the interest revenue or interest expense in P/L over the relevant period (IFRS 9.Appendix A). For financial assets, this is calculated by applying effective interest rate to gross carrying amount of a financial asset except for credit-impaired financial assets (IFRS 9.5.4.1).

Effective interest rate (‘EIR’) is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial asset or financial liability to the gross carrying amount of a financial asset or to the amortised cost of a financial liability. Gross carrying amount is the amortised cost of a financial asset before adjusting for any loss allowance (IFRS 9.Appendix A). The treatment of loss allowance is different for credit-impaired financial assets which is covered below.

Illustration of application of amortised cost and effective interest method is presented below:

Example: illustration of application of amortised cost and effective interest method

Entity A purchases a bond on a stock exchange for $900. All the relevant data for this example is presented below:

Face value: $1,000
Transaction price (incl. coupon accrued to date): $900
Transaction fee: $10
Coupon: 5%, that is $50 (calculated on face value, fixed and paid annually on 31 December)
Acquisition date: 20X1-05-01
Redemption date: 20X5-12-31

Based on the data above, Entity A is able to prepare a schedule for cash flows and calculate the effective interest rate (‘EIR’) as presented below. EIR can be calculated using spreadsheet function. In MS Excel, this can be done using XIRR function.

All calculations presented in this example are available for download in an excel file.

For the acquired bond, relevant cash flows as listed below give the EIR at 7.8%:

datecash flow
20X1-05-01(900)
20X1-05-01(10)
20X1-12-3150
20X2-12-3150
20X3-12-3150
20X4-12-3150
20X5-12-3150
20X5-12-311,000
EIR7.8%

When EIR is calculated, Entity A is able to calculate interest income for each year. The accounting schedule for this bond is as follows:

Note: you can scroll the table horizontally if it doesn’t fit your screen

yearacquisition date/
opening balance
interest in P/Lcash flowclosing balance
31 Dec
20X191047(50)907
20X290771(50)928
20X392872(50)950
20X495074(50)974
20X597476(1,050)-


When calculating the effective interest rate (‘EIR’), an entity estimates the expected cash flows by considering all the contractual terms of the financial instrument (for example, prepayment, extension, call and similar options), but generally does not consider the expected credit losses (IFRS 9.BCZ5.67).

As we can see from the above, EIR is based on estimated cash flows and there is a presumption that the cash flows and the expected life of a group of similar financial instruments can be estimated reliably. However, in those rare cases when it is not possible to reliably estimate the cash flows or the expected life of a financial instrument (or group of financial instruments), the entity uses the contractual cash flows over the full contractual term of the financial instrument (or group of financial instruments) (IFRS 9.Appendix A).

When the estimates of cash flows are revised, for reasons other than changes in estimates of expected credit losses, the gross carrying amount of the financial asset or amortised cost of a financial liability is adjusted to reflect actual and revised estimated contractual cash flows. The entity recalculates the gross carrying amount of the financial asset or amortised cost of the financial liability as the present value of the estimated future contractual cash flows that are discounted at the financial instrument’s original effective interest rate. As a result, a one-off gain or loss is recognised in P/L (IFRS 9.B5.4.6). Example of this accounting treatment is presented below. Different approach applies to credit-impaired assets.

Example: revision of cash flows in amortised cost calculation

Starting data for this example is identical as in this example. Entity A calculated EIR at 7.8% and prepared an accounting schedule for the acquired bond as follows:

Note: you can scroll the table horizontally if it doesn’t fit your screen

yearacquisition date/
opening balance
interest in P/Lcash flowclosing balance
31 Dec
20X191047(50)907
20X290771(50)928
20X392872(50)950
20X495074(50)974
20X597476(1,050)-

Let’s now assume that on 1 January 20X4, the issuer of this bond exercises a right to redeem the bond one year before its maturity, i.e. on 31 December 20X4 instead of 31 December 20X5. As we can see in the accounting schedule above, the amortised cost of this bond amounts to $950 on 1 January 20X4 (the date when Entity A makes revisions to expected cash flows). Entity A now expects to receive $1,050 on 31 December 20X4, which gives a present value of $974 ($1,050 discounted at original EIR of 7.8%). Therefore, Entity A increases the amortised cost of acquired bond by $24 and recognises a one-off gain in P/L (IFRS 9.B5.4.6). The accounting schedule for the bond, which takes into account revision made to cash flows, is now as follows. Notice the additional column with one-off gain on revision.

All calculations presented in this example are available for download in an excel file.

Note: you can scroll the table horizontally if it doesn’t fit your screen

yearacquisition date/
opening balance
one-off revision
in P/L
interest in P/Lcash flowclosing balance
31 Dec
20X1910-47(50)907
20X2907-71(50)928
20X3928-72(50)950
20X49502476(1,050)-


The same approach applies to situations in which contractual cash flows of a financial asset or a financial liability are renegotiated or otherwise modified (IFRS 9.5.4.3; B5.4.6). The wording of cited paragraphs may not be clear as to whether this rule applies also financial liabilities, but this was confirmed by the IASB in 2017 and IASB intends to amend basis for conclusions to IFRS 9 so that they make it clear that when a financial liability measured at amortised cost is modified without this modification resulting in derecognition, a gain or loss should be recognised in P/L. See the example of a modification of a financial liability not resulting in derecognition.

For floating-rate instruments, periodic re-estimation of cash flows to reflect the movements in the market rates of interest alters the EIR (IFRS 9.B5.4.5). Therefore, there is no one-off gain or loss when market rates change. Example of this accounting treatment is given below.

Example: re-estimation of cash flows in floating-rate instruments

Entity A purchases a bond on a stock exchange for $1,000. All the relevant data for this example is presented below:

Face value: $1,000
Transaction price: $1,000
Transaction fee: $0
Acquired interest: $25
coupon: 5% (LIBOR + 1p.p., paid and reset annually)
acquisition date: 20X1-07-01
redemption date: 20X5-12-31

Based on estimated cash flows, Entity A calculates effective interest rate (‘EIR’) at 5.0% (see a simple example for calculating EIR). All calculations presented in this example are available for download in an excel file.

Calculation of EIR based on current LIBOR:

datecash flow
20X1-07-01(1,000)
20X1-07-01(25)
20X1-12-3150
20X2-12-3150
20X3-12-3150
20X4-12-3150
20X5-12-311,050
EIR5.0%

Note that an alternative method, where estimated cash flows are based on forward rates, is also allowed, though it is much less common in practice (IFRS 9 does not specify the approach to be used).

The initial accounting schedule for the bond is as follows:

Note: you can scroll the table horizontally if it doesn’t fit your screen

yearacquisition date/
opening balance
interest in P/Lcash flowclosing balance
31 Dec
20X11,02525(50)1,000
20X21,00050(50)1,000
20X31,00050(50)1,000
20X41,00050(50)1,000
20X51,00050(1,050)-

Let’s now assume that the annual coupon is reset to 6% on 1 January 20X4 following an increase in LIBOR. As mentioned earlier, for floating-rate instruments, revision to cash flows reflecting movements in the market rates of interest affect the EIR without any one-off gain/loss in P/L (IFRS 9.B5.4.5). Therefore, Entity A calculates new EIR on 1 January 20X4 based on annual coupon at 6%:

datecash flows
20X4-01-01(1,000)
20X4-12-3160
20X5-12-311,060
EIR6.0%

Note that the first negative cash flow shown on 20X4-01-01 is not an actual cash flow, but the amortised cost of the bond at the reset date. A negative opening value is necessary to calculate EIR in the spreadsheet.

The accounting schedule for the bond after increase in LIBOR is presented below:

Note: you can scroll the table horizontally if it doesn’t fit your screen

yearacquisition date/
opening balance
interest in P/Lcash flowclosing balance
31 Dec
20X41,00060(60)1,000
20X51,00060(1,060)-

As mentioned earlier, all calculations presented in this example are available in an excel file.

The calculation of effective interest rate includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, and includes also other transaction costs. Paragraphs IFRS 9.B5.4.2-3 give examples of fees that are, and are not, an integral part of the effective interest rate.

Fees, premiums, discounts and similar items that are included in the calculation of the EIR are amortised over the expected life of the financial instrument, unless they relate to a shorter period. The shorter period is used when the variable to which the fees, transaction costs, premiums or discounts relate is repriced to market rates before the expected maturity of the financial instrument. For example, if a premium or discount on a floating-rate financial instrument reflects the interest that has accrued on that financial instrument since the interest was last paid, or changes in the market rates since the floating interest rate was reset to the market rates, it will be amortised to the next date when the floating interest is reset to market rates (IFRS 9.B5.4.4).

For financial instruments measured at FVTPL, fees are recognised in P/L in full when the instrument is initially recognised (IFRS 9.B5.4.1).

Purchased or originated credit-impaired financial assets are measured using credit-adjusted EIR. This means that initial ECL are included in the estimated cash flows when calculating EIR (IFRS 9.5.4.1(a);B5.4.7). More in the section on impact of expected credit losses on interest calculation.

As mentioned earlier, FVOCI category can be used for debt investments only. For these instruments (IFRS 9.5.7.10-11):

  • interest calculated using the effective interest method is recognised in P/L
  • impairment gains/losses are recognised in P/L
  • foreign exchange gains/losses (calculated based on the amortised cost) are recognised in P/L
  • fair value remeasurements, excluding impacts as above, are recognised in OCI

Interest and impairment are calculated and accounted for in exact the same way as for assets measured at amortised cost described above. Therefore the P/L impact for both categories is the same, but assets in the FVOCI with recycling category are additionally remeasured to fair value with fair value changes (excluding impacts of earned interest, impairment and foreign exchange) recognised in OCI (IFRS 9.5.7.10).

On derecognition, cumulative gains/losses recognised in OCI are reclassified to P/L as a reclassification adjustment (derecognition is discussed in a separate section below).

As debt instruments are monetary items, general IAS 21 provisions apply. Firstly, the amortised cost is determined in the foreign currency in which the item is denominated. Then, the foreign currency amount is translated into the functional currency and any foreign gains/losses are recognised in P/L even for instruments in the FVOCI category (IFRS 9.B5.7.2; IFRS 9 IG.E.3.4).

See also the illustrative example on separation of currency component for financial assets measured at FVOCI with recycling contained in paragraph IFRS 9 IG.E.3.2.

General impairment requirements are discussed on a separate page with additional aspects specific to assets at FVOCI with recycling.

As mentioned earlier, this category can be applied to equity investments only. Fair value remeasurements are recognised in OCI are not recycled to P/L subsequently (IFRS 9.5.7.5; B5.7.1).

Dividends on equity investments designated at FVOCI are still recognised in P/L (IFRS 9.5.7.6) unless the dividend clearly represents a recovery of part of the cost of the investment (IFRS9.B5.7.1). IFRS 9 contains no further guidance on determining whether a dividend clearly represents a recovery of part of the cost of the investment.

Equity investments are non-monetary items, therefore fair value gains/losses include also foreign exchange impacts and are recognised in OCI altogether (IFRS 9.B5.7.3; IFRS 9 IG.E.3.4).

Assets measured at FVOCI no recycling are not subject to impairment requirements of IFRS 9 (IFRS 9.5.5.1).

Although IFRS 9 requires all equity instruments to be measured at fair value, it acknowledges that, in limited circumstances, cost may be an appropriate estimate of fair value for unquoted equity instruments. See the discussion in paragraphs IFRS 9.B5.2.3-B5.2.6.

Liabilities measured at amortised cost are accounted for using the effective interest method with interest expense recognised in P/L. The effective interest method is covered in section on financial assets measured at amortised cost.

See the paragraph on foreign exchange gains/losses arising on assets measured at amortised cost.

As the category name implies, financial assets/ liabilities measured at fair value through profit or loss are measured, subsequent to recognition, at fair value with gains/losses arising on remeasurements recognised in P/L (IFRS 9.5.7.1). An exception relates to changes in fair value of financial liabilities designated at FVTPL which is attributable to own credit risk, which is discussed below.

Changes in fair value of a financial liability designated at FVTPL attributable to changes in the credit risk of that liability are recognised in OCI and are not subsequently transferred to P/L (IFRS 9.5.7.7(a); B5.7.9). If recognition of own credit risk in OCI impact would ‘would create or enlarge an accounting mismatch in P/L’, all fair value gains/losses are recognised in P/L (IFRS 9.5.7.8). More information on accounting mismatch applicable to these requirements can be found in paragraphs IFRS 9.B5.7.5 -B5.7.7 and B5.7.10–B5.7.12 with an illustrative example in paragraph IFRS 9.B5.7.10.

Credit risk is defined by IFRS 7 as the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation (IFRS 7.Appendix A). The requirement in paragraph IFRS 9.5.7.7(a) relates to the risk that the issuer will fail to perform on that particular liability. Paragraphs IFRS 9.B5.7.13-20 contain a very good discussion on what is meant on credit risk of a liability, how it is impacted by a collateral, how it differs from asset-specific performance risk and how to determine the effects of changes in credit risk. Requirements on how to determine the effects of changes in credit risk are illustrated in illustrative example contained in paragraphs IFRS 9.IE1-IE5.

Changes in fair value of loan commitments and financial guarantee contracts designated at FVTPL are recognised in P/L in full even for impacts resulting from changes in own credit risk (IFRS 9.5.7.9).

Assets measured at FVTPL are not subject to impairment requirements of IFRS 9 (IFRS 9.5.5.1).

Financial guarantee contract is a contract that requires the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due in accordance with the original or modified terms of a debt instrument (IFRS 9.Appendix A). Financial guarantee contracts are subsequently measured by the issuer at the higher of (IFRS 9.4.2.1(c)):

  • the amount of loss allowance according to the impairment requirements of IFRS 9 and
  • the amount initially recognised less, when appropriate, the cumulative amount of income recognised under IFRS 15

The above requirements do not apply if the financial guarantee is designated at FVTPL.

Commitments to provide a loan at a below-market interest rate are subsequently measured by the issuer at the higher of (IFRS 9.4.2.1(d)):

  • the amount of loss allowance according to the impairment requirements of IFRS 9 and
  • the amount initially recognised less, when appropriate, the cumulative amount of income recognised under IFRS 15

The above requirements do not apply if the commitment is designated at FVTPL.

In some circumstances, the renegotiation or modification of the contractual cash flows of a financial asset can lead to derecognition of the existing financial asset in accordance with IFRS 9. When the modification of a financial asset results in derecognition of the existing financial asset and the subsequent recognition of the modified financial asset, the modified asset is considered a ‘new’ financial asset for the purposes of IFRS 9. Accordingly the date of the modification should be treated as the date of initial recognition of that financial asset when applying the impairment requirements to the modified financial asset. This typically means measuring the loss allowance at an amount equal to 12-month ECL until the requirements for the recognition of lifetime ECL are met. However, in some unusual circumstances following a modification that results in derecognition of the original financial asset, there may be evidence that the modified financial asset is credit-impaired at initial recognition, and thus, the financial asset should be recognised as an originated credit-impaired financial asset. This might occur, for example, in a situation in which there was a substantial modification of a distressed asset that resulted in derecognition of the original financial asset. In such a case, it may be possible for the modification to result in a new financial asset which is credit-impaired at initial recognition (IFRS 9.B5.5.25-26).

Renegotiation or modification of a financial asset may not lead to this asset being derecognised. If this is the case, a one-off modification gain/loss should be recognised in P/L calculated as the difference between gross carrying amount before and after the modification. The gross carrying amount after the modification is calculated as the present value of the estimated future cash payments or receipts through the expected life of the renegotiated or modified financial asset that are discounted at the financial asset’s original EIR (IFRS 9.5.4.3, Appendix A).

See Example 11 accompanying IFRS 9.

See other pages relating to IFRS 9:

IFRS 9 Financial Instruments: Scope and Initial Recognition

IFRS 9 Financial Instruments: Classification of Financial Assets and Financial Liabilities

IFRS 9 Financial Instruments: Derivatives and Embedded Derivatives: Definitions and Characteristics

IFRS 9 Financial Instruments: Impairment

IFRS 9 Financial Instruments: Derecognition of Financial Assets and Financial Liabilities

IFRS 9 Financial Instruments: Hedge Accounting

 


© 2018-2019 Marek Muc

Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). The information provided on this website does not constitute professional advice and should not be used as a substitute for consultation with a certified accountant.