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The distinction between the two models is based on the business model of each entity and a requirement to assess whether the cash flows of the instrument are only principal and interest.
The business model approach is fundamental to the standard and is an attempt to align the accounting with the way in which management uses its assets in its business whilst also looking at the characteristics of the business. The contractual cash flow characteristics test is whether 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.
All recognised financial assets that are currently in the scope of IAS 39 will be measured at either amortised cost or fair value. The standard contains only the two primary measurement categories for financial assets unlike IAS 39 where there were multiple measurement categories. Thus the existing IAS 39 categories of held to maturity, loans and receivables and available-for-sale are eliminated along with the tainting provisions of the standard.
A debt instrument e. An investment in a convertible loan note would not qualify for measurement at amortised cost because of the inclusion of the conversion option, which is not deemed to represent payments of principal and interest. This criterion will permit amortised cost measurement when the cash flows on a loan are entirely fixed such as a fixed interest rate loan or where interest is floating or a combination of fixed and floating interest rates.
IFRS 9 contains an option to classify financial assets that meet the amortised cost criteria as at FVTPL if doing so eliminates or reduces an accounting mismatch.
An example of this may be where an entity holds a fixed rate loan receivable that it hedges with an interest rate swap that swaps the fixed rates for floating rates. Measuring the loan asset at amortised cost would create a measurement mismatch, as the interest rate swap would be held at FVTPL. In this case the loan receivable could be designated at FVTPL under the fair value option to reduce the accounting mismatch that arises from measuring the loan at amortised cost.
All equity investments within the scope of IFRS 9 are to be measured in the statement of financial position at fair value with the default recognition of gains and losses in profit or loss. Only if the equity investment is not held for trading can an irrevocable election be made at initial recognition to measure it at fair value through other comprehensive income FVTOCI with only dividend income recognised in profit or loss. The amounts recognised in OCI are not recycled to profit or loss on disposal of the investment although they may be reclassified in equity.
The standard eliminates the exemption allowing some unquoted equity instruments and related derivative assets to be measured at cost. However, it includes guidance on the rare circumstances where the cost of such an instrument may be appropriate estimate of fair value. An example of where reclassification from amortised cost to fair value might be required would be when an entity decides to close its mortgage business, no longer accepting new business, and is actively marketing its mortgage portfolio for sale.
When a reclassification is required it is applied from the first day of the first reporting period following the change in business model. All derivatives within the scope of IFRS 9 are required to be measured at fair value. Consequently, embedded derivatives that would have been separately accounted for at FVTPL under IAS 39 because they were not closely related to the financial asset host will no longer be separated.
Instead, the contractual cash flows of the financial asset are assessed as a whole and are measured at FVTPL if any of its cash flows do not represent payments of principal and interest. One of the most significant changes will be the ability to measure some debt instruments, for example investments in government and corporate bonds at amortised cost. Many available-for-sale debt instruments currently measured at fair value will qualify for amortised cost accounting.
Many loans and receivables and held-to-maturity investments will continue to be measured at amortised cost but some will have to be measured instead at FVTPL. For example some instruments, such as cash-collateralised debt obligations, that may under IAS 39 have been measured entirely at amortised cost or as available-for-sale will more likely be measured at FVTPL. IFRS 9 may result in more financial assets being measured at fair value. It will depend on the circumstances of each entity in terms of the way it manages the instruments it holds, the nature of those instruments and the classification elections it makes.
Assets that are currently classified as held-to-maturity are likely to continue to be measured at amortised cost as they are held to collect the contractual cash flows and often give rise to only payments of principal and interest. IFRS 9 does not directly address impairment. Under IAS 39 measuring impairment losses on debt securities in illiquid markets based on fair value often led to reporting an impairment loss that exceeded the credit loss that management expected.
Additionally, impairment losses on AFS equity investments cannot be reversed within the income statement section of the statement of comprehensive income under IAS 39 if the fair value of the investment increases. Under IFRS 9, debt securities that qualify for the amortised cost model are measured under that model and declines in equity investments measured at FVTPL are recognised in profit or loss and reversed through profit or loss if the fair value increases.