IFRS 9 establishes principles for the financial reporting of financial assets and financial liabilities. All entities and all financial instruments are in the scope of IFRS 9 with certain exceptions listed in paragraph IFRS 9.2.1.
General rule for initial recognition of financial instruments
As a general rule, an entity recognises 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 instrument (IFRS 126.96.36.199).
Financial guarantees vs other guarantees
A financial guarantee is defined by IFRS 9 as ‘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 …’. Such financial guarantees are in the scope of IFRS 9 and are accounted for as described here. Not all contracts legally described as ‘guarantees’ are financial guarantees as defined by IFRS 9. In fact, the definition quoted above is rather narrow and includes only a payment when a debtor defaults on its due payment. See paragraph IAS 32.AG8 for further discussion.
Other ‘guarantees’ are still financial instruments as they are contractual. They may be treated under IFRS as derivatives and accounted for under IFRS 9, or as insurance contracts accounted for under IFRS 4/IFRS 17.
An insurance contract is defined in IFRS 4/17 as ‘a contract under which the issuer accepts significant insurance risk from the policyholder by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder.’ Insurance risk is any risk other than financial risk (IFRS 17 Appendix A). See paragraphs IFRS 17.B7-B16 for discussion on the distinction between insurance risk and other risks.
Therefore, if the specified uncertain future event is specific to the holder of the guarantee and will compensate it for a loss it would have suffered – such a guarantee is an insurance contract. Otherwise, such (non-financial) guarantee is treated as a derivative accounted for under IFRS 9.
Accounting for contractual guarantees under IAS 37 is incorrect as financial instruments are out of scope of IAS 37.
Receivables and payables
Unconditional receivables and payables are recognised as assets or liabilities when the entity (IFRS 9.B3.1.2(a)):
- becomes a party to the contract and
- has a legal right to receive or a legal obligation to pay cash.
Assets to be acquired and liabilities to be incurred as a result of a firm commitment to purchase or sell goods or services are generally not recognised until at least one of the parties has performed under the agreement. For example, an entity that receives a firm order does not generally recognise an asset (and the entity that places the order does not recognise a liability) at the time of the commitment but, instead, delays recognition until the ordered goods or services have been shipped, delivered or rendered (IFRS 9.B3.1.2(b)).
If a firm commitment is a derivative instrument within the scope of IFRS 9, separate provisions apply (IFRS 9.B3.1.2(b)-(d)).
Regular way purchase or sale of financial assets (trade date and settlement date)
Regular way purchase or sale is a purchase or sale of a financial asset under a contract whose terms require delivery of the asset within the time frame established generally by regulation or convention in the marketplace concerned (IFRS 9.Appendix A). This mechanism is present in nearly all major stock exchanges, where transactions are settled a few days after they are entered into. However, the policy choice discussed here applies also to private issue financial instruments (IFRS 9 IG.B.28).
IFRS 9 provides a policy choice for such transactions: they can be recognised and derecognised using trade date accounting or settlement date accounting (IFRS 188.8.131.52).
The trade date is the date that an entity commits itself to purchase or sell an asset. Trade date accounting refers to (a) the recognition of an asset to be received and the liability to pay for it on the trade date, and (b) derecognition of an asset that is sold, recognition of any gain or loss on disposal and the recognition of a receivable from the buyer for payment on the trade date. Generally, interest does not start to accrue on the asset and corresponding liability until the settlement date when title passes (IFRS 9.B3.1.5).
The settlement date is the date that an asset is delivered to or by an entity. Settlement date accounting refers to (a) the recognition of an asset on the day it is received by the entity, and (b) the derecognition of an asset and recognition of any gain or loss on disposal on the day that it is delivered by the entity. When settlement date accounting is applied, an entity accounts for any change in the fair value of the asset to be received during the period between the trade date and the settlement date in the same way as it accounts for the acquired asset (IFRS 9.B3.1.6).
Paragraphs IFRS 9 IG.D.2.1-3 contain examples illustrating application of trade date and settlement date accounting. As it can be seen, both methods give the same impact on P/L or OCI, the difference relates to the timing of recognition of the underlying financial asset only.
The same method should be applied for all purchases and sales of financial assets that are classified in the same way under IFRS 9 (IFRS 9.B3.1.3).
Irrespective of the approach adopted, the trade date should be considered the date of initial recognition for the purposes of applying the impairment requirements (IFRS 184.108.40.206).
Loan commitments are firm commitments to provide credit under pre-specified terms and conditions and are generally not recognised as they are outside the scope of IFRS 9, with the exception of certain loan commitments as specified in paragraph IFRS 9.2.3. See paragraphs IFRS 9.BCZ2.2-8 for more discussion.
However, the issuer applies impairment requirements of IFRS 9 to loan commitments (IFRS 9.2.1(g)).
General rule for initial 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 220.127.116.11).
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 18.104.22.168).
Cash collaterals are recognised by the receiving entity as cash and a corresponding liability. The transferor derecognises cash and recognises a receivable (IFRS 9.D.1.1). Cash collaterals are often non-interest-bearing and therefore their fair value if lower than transaction price. The question then arises what to do with the difference. It is a very similar issue to below-market interest rate loans described below. Namely, under paragraph IFRS 9.B5.1.1, entities need to determine what they (were) paid for other than the non-interest-bearing financial instrument. See the example below.
Example: Cash collateral paid by a contractor
On 1 January 20X1, Contractor X pays a security deposit of $3m to its Client Y to secure a contract. This deposit will be repaid after the contract ends (after 3 years), but without any interest. Current market yields for corporate bonds of issuers with a credit standing similar to Client Y amount to 3%.
Contractor X recognises the deposit at $2.75m being the present value of cash flow of $3m in three years’ time (i.e. $3m/(1.03)^3). The difference between the amount paid ($3m) and the deposit recognised ($2.75) is recognised as incremental cost of obtaining a contract. Accounting entries at initial recognition are as follows:
|Incremental costs of|
obtaining a contract
|Cash at bank||3|
Each year, incremental cost of obtaining a contract are amortised to P/L and interest is accrued on cash collateral. For example, entries after year 1 are as follows:
|Incremental costs of|
obtaining a contract
After 3 years, capitalised incremental costs of obtaining a contract will have been fully amortised to P/L and interest on cash collateral will have been recognised as interest income.
Below-market interest rate loans
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 (currency, term, etc.) with a similar credit rating. An incremental borrowing rate of the debtor will usually be a great starting point for calculation of the discount rate. Any amount lent exceeding the fair value of the loan should be accounted for according to its substance under other applicable IFRS (IFRS 9.B5.1.1). This will often mean recognition of a one-off P/L expense (lender) and income (borrower), but other scenarios are possible (see below).
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).
Day 1 gains/losses
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.
As noted above, transaction costs are included in the carrying amount of a financial asset or a financial liability unless they are classified into FVTPL measurement category (IFRS 22.214.171.124). 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).
More about financial instruments
See other pages relating to financial instruments:
Scope of IAS 32
Financial Instruments: Definitions
Derivatives and Embedded Derivatives: Definitions and Characteristics
Classification of Financial Assets and Financial Liabilities
Measurement of Financial Instruments
Amortised Cost and Effective Interest Rate
Impairment of Financial Assets
Derecognition of Financial Assets
Derecognition of Financial Liabilities
Offsetting of Financial Instruments
Financial Liabilities vs Equity
IFRS 7 Financial Instruments: Disclosures