IND AS 109 Financial Instruments

BACKGROUND
IND AS 109 introduces a single classification and measurement model for financial assets, dependent on both: IND AS 109 removes the requirement to separate embedded derivatives from financial asset host contracts (it
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 The entity’s business model objective for managing financial assets instead requires a hybrid contract to be classified in its entirety at either amortised cost or fair value)
Not yet endorsed by the EU
 The contractual cash flow characteristics of financial assets
Separation of embedded derivatives has been retained for financial liabilities (subject to criteria being met)

INITIAL RECOGNITION AND MEASUREMENT (FINANCIAL ASSETS AND FINANCIAL LIABILITIES)

Initial Recognition Initial Measurement
When the entity becomes party to the At fair value, plus for those financial assets and liabilities not classified at fair value through profit or loss, directly attributable transaction costs
contractual provisions of the instrument  Fair value - is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
 Directly attributable transaction costs - incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset or financial liability
Specific quantitative disclosure requirements:


FINANCIAL ASSETS - SUBSEQUENT CLASSIFICATION AND MEASUREMENT

Financial Assets are classified as either: (1) Amortised cost (2) Fair value through profit or loss (3) Fair Value through other comprehensive income

(1) AMORTISED COST

Category classification criteria (i) BUSINESS MODEL ASSESSMENT (ii) CONTRACTUAL CASH FLOW ASSESSMENT
Both of the below conditions must be met:
Based on the overall business, not instrument-by-instrument Based on an instrument-by-instrument basis
(i) Business model objective: financial assets held in order
to collect contractual cash flows Centres on whether financial assets are held to collect contractual cash flows: Financial assets with cash flows that are solely payments of principal and
(ii) Contractual cash flow characteristics: solely payments  How the entity is run interest (SPPI) on the principal amount outstanding
of principal and interest on the principal amount  The objective of the business model as determined by key management Interest is consideration for only the time-value of money and credit risk
outstanding personnel (KMP) (per IND AS 24 Related Party Disclosures)
FOREX financial assets: assessment is made in the denomination currency
Financial assets do not have to be held to contractual maturity in order to be (i.e. FX movements are not taken into account)
Subsequent measurement deemed to be held to collect contractual cash flows, but the overall approach
 Amortised cost using the effective interest method must be consistent with ‘hold to collect’

IND AS 109 contains various illustrative examples in the application of both the (i) Business Model Assessment and (ii) Contractual Cash Flow Characteristics

(3) FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME

Equity Instruments Debt Instruments
(2) FAIR VALUE THROUGH PROFIT OR LOSS Note: Designation at initial recognition is optional and Category classification criteria
irrevocable.
Category classification criteria  meets the SPPI contractual cash flow characteristics test
Category classification criteria (see box (1)(ii) above)
 Financial assets that do not meet the amortised cost criteria  Entity holds the instrument to collect contractual cash
 Available only for investments in equity instruments
 Financial assets designated at initial recognition. The option to designate is available: flows and to sell the financial assets
(within the scope of IND AS 109) that are not held for
 If doing so eliminates, or significantly reduces, a measurement or recognition trading.
inconsistency (i.e. ‘accounting mismatch’) Subsequent measurement
Subsequent measurement  Fair value, with all gains and losses recognised in other
Note: the option to designate is irrevocable
 Fair value, with all gains and losses recognised in other comprehensive income
comprehensive income  Changes in fair value are not subsequently recycled to
Subsequent measurement
 Changes in fair value are not subsequently recycled to profit and loss.
 Fair value, with all gains and losses recognised in profit or loss profit and loss
 Dividends are recognised in profit or loss.
 IND AS 109 Financial Instruments
IMPAIRMENT OF FINANCIAL ASSETS
Scope Initial recognition

The impairment requirements are applied to: At initial recognition of the financial asset an entity recognises a loss allowance equal to 12 months expected credit losses which consist of
 Financial assets measured at amortised cost (incl. trade receivables) expected credit losses from default events possible within 12 months from the entity’s reporting date. An exception is purchased or
 Financial assets measured at fair value through OCI originated credit impaired financial assets.
 Loan commitments and financial guarantees contracts where losses are currently Subsequent measurement
accounted for under IND AS 37 Provisions, Contingent Liabilities and Contingent Assets
 Lease receivables Stage 1 2 3

The impairment model follows a three-stage approach based on changes in expected credit
losses of a financial instrument that determine 12 month expected
Impairment Lifetime expected credit loss
 the recognition of impairment, and credit loss
 the recognition of interest revenue
Effective interest on the gross carrying amount Effective interest on the net
Interest
(before deducting expected losses) (carrying) amount

THREE-STAGE APPROACH

STAGE 1 STAGE 2 STAGE 3

12 month expected credit losses (gross interest) Lifetime expected credit losses (gross interest) Lifetime expected credit losses (net interest)

 Applicable when no significant increase in credit risk  Applicable in case of significant increase in credit risk  Applicable in case of credit impairment
 Entities continue to recognise 12 month expected losses that are  Recognition of lifetime expected losses  Recognition of lifetime expected losses
updated at each reporting date  Presentation of interest on gross basis  Presentation of interest on a net basis
 Presentation of interest on gross basis

PRACTICAL EXPEDIENTS SIMPLIFIED APPROACH LOAN COMMITMENTS AND

FINANCIAL GUARANTEES
30 days past due rebuttable presumption Low credit risk instruments Short term trade receivables
 The three-stage expected credit loss model also
 Rebuttable presumption that credit  Instruments that have a low risk of  Recognition of only ‘lifetime expected credit losses’ (i.e. stage 2)
applies to these off balance sheet financial
risk has increased significantly when default and the counterparties have a  Expected credit losses on trade receivables can be calculated using
commitments
contractual payments are more than strong capacity to repay (e.g. financial provision matrix (e.g. geographical region, product type, customer
 An entity considers the expected portion of a loan
30 days past due instruments that are of investment rating, collateral or trade credit insurance, or type of customer)
commitment that will be drawn down within the
 When payments are 30 days past due, grade)  Entities will need to adjust the historical provision rates to reflect
next 12 months when estimating 12 month
a financial asset is considered to be in  Instruments would remain in stage 1, relevant information about current conditions and reasonable and
expected credit losses (stage 1), and the expected
stage 2 and lifetime expected credit and only 12 month expected credit supportable forecasts about future expectations
portion of the loan commitment that will be drawn
losses would be recognised losses would be provided.
down over the remaining life the loan commitment
 An entity can rebut this presumption Long term trade receivables and lease receivables
(stage 2)
when it has reasonable and
Entities have a choice to either apply:  For loan commitments that are managed on a
supportable information available that
 the three-stage expected credit loss model; or collective basis an entity estimates expected credit
demonstrates that even if payments
 the ‘simplified approach’ where only lifetime expected credit losses losses over the period until the entity has the
are 30 days or more past due, it does
are recognised practical ability to withdraw the loan commitment
not represent a significant increase in
the credit risk of a financial instrument
 IND AS 109 Financial Instruments
FINANCIAL LIABILTIES - SUBSEQUENT CLASSIFICATION AND MEASUREMENT
Financial Liabilities are classified as either: (1) Amortised Cost (2) Fair value through profit or loss.
In addition, specific guidance exists for:
(i) Financial guarantee contracts and (ii) Commitments to provide a loan at a below market interest rate
(iii) Financial Liabilities that arise when the transfer of a financial asset either does not qualify for derecognition or where there is continuing involvement

(1) AMORTISED COST (2) FAIR VALUE THROUGH PROFIT OR LOSS (i) FINANCIAL GUARANTEE (iii) FINANCIAL LIABILITIES RESULTING
Category classification criteria Category classification criteria
CONTRACTS FROM
THE TRANSFER OF A FINANCIAL ASSET
All financial liabilities, except  Financial liabilities held for trading (ii) COMMITMENTS TO PROVIDE A
those that
Specific meet the criteria
quantitative of
disclosure  Derivative financial liabilities
requirements: (That does not qualify for derecognition)
(2), (i), and (ii). LOAN AT A BELOW MARKET
 Financial liabilities designated at initial recognition. The option to (Where there is continuing involvement)
designate is available: INTEREST RATE
Subsequent measurement  If doing so eliminates, or significantly reduces, a measurement Financial liability for the consideration received is
 Amortised cost using the Subsequent measurement (the higher of either)
or recognition inconsistency (i.e. ‘accounting mismatch’), or recognised
effective interest method  If a group of financial liabilities (or financial assets and financial (i) The amount determined in accordance with
IND AS 37 Provisions, Contingent Liabilities Subsequent measurement
liabilities) is managed, and evaluated, on a fair value basis, in
accordance with a documented risk management or investment and Contingent Assets The net carrying amount of the transferred asset and
strategy, and information about the group is provided internally (ii) The amount initially recognised, less (when associated liability is measured as either:
to KMP appropriate) cumulative amortisation  Amortised cost of the rights and obligations retained (if the
Subsequent measurement recognised in accordance with IND AS 115 transferred asset is measured at amortised cost)
Revenue from contracts with customers  The fair value of the rights and obligations retained by the
 Fair value with all gains and losses being recognised in profit or loss
entity when measured on a stand-alone basis (if the
transferred asset is measured at fair value)

EMBEDDED DERIVATIVES
Definition and description Exclusions and exemptions (i.e. not embedded derivatives)
Embedded derivatives are components of a hybrid contract (i.e. a contract that also includes a non-derivative  Non-financial variables that are specific to a party to the contract.
host), that causes some (or all) of the contractual cash flows to be modified according to a specified variable (e.g.  A derivative, attached to a financial instrument that is contractually transferable independently of that
interest rate, commodity price, foreign exchange rate, index, etc.) instrument, or, has a different counterparty from that instrument.
 Instead, this is a separate financial instrument.

Embedded derivatives are accounted for differently depending on whether they are within a host contract that is a financial asset or a financial liability

EMBEDDED DERIVATIVES WITHIN A EMBEDDED DERIVATIVES WITHIN A HOST CONTRACT THAT IS A FINANCIAL LIABILITY
FINANCIAL ASSET HOST CONTRACT
Subject to meeting the adjacent Criteria: to separate an embedded derivative Host contract (once embedded
criteria, the embedded derivative is: derivative is separated)
1) Economic characteristics of the embedded
The embedded derivative is not separated from  Separated from the host contract derivative and host are not closely related The (non-financial asset) host
the host contract contract is accounted for in
 Accounted for as a derivative in 2) An identical instrument (with the same
accordance with the appropriate
accordance with IND AS 109 (i.e. at terms) would meet the definition of a
Instead, the whole contract in its entirety is IND AS
fair value through profit or loss) derivative, and
accounted for as a single instrument in
accordance with the requirements of Ind AS 109. 3) The entire (hybrid) contract is not measured
at fair value through profit or loss
 INS 109 Financial Instruments
DERECOGNITION

FINANCIAL ASSETS FINANCIAL LIABILITIES

 A financial liability is derecognised only when extinguished – i.e., when the obligation specified in the
Consolidate all subsidiaries (including special purpose entities (SPEs)) contract is discharged, cancelled or it expires
 An exchange between an existing borrower and lender of debt instruments with substantially different
terms or substantial modification of the terms of an existing financial liability of part thereof is accounted
Determine whether the derecognition principles below are applied to all or part of the asset for as an extinguishment
 The difference between the carrying amount of a financial liability extinguished or transferred to a 3 rd
party and the consideration paid is recognised in profit or loss.
YES
Have the rights to the cash flows from the Derecognise
asset expired? the asset
Specific quantitative disclosure requirements:  If an entity transfers a financial asset in a transfer that qualifies for derecognition in its entirety and
retains the right to service the financial asset for a fee, it recognises either a servicing asset or liability
NO
for that servicing contract
 If, as a result of a transfer, a financial asset is derecognised, but the entity obtains a new financial asset
Has the entity transferred its rights to or assumes a new financial liability or servicing liability, the entity recognises the new financial asset,
receive the cash flows from the asset? financial liability or servicing liability at fair value
 On derecognition of a financial asset, the difference between the carrying amount and the sum of (i) the
consideration received and (ii) any cumulative gain or loss that was recognised directly in equity is
NO recognised in profit or loss.

Has the entity assumed an obligation to NO

Continue to recognise
pay the cash flows from the asset that
the asset
meets the conditions in IND AS 109 IND AS 109 paragraph 3.2.5 – where an entity retains the contractual rights to receive the cash flows of a
YES paragraph 3.2.5? financial asset, but assumes a contractual obligation to pay those cash flows to one or more entities, three
conditions need to be met before an entity can consider the additional derecognition criteria:
YES  The entity has no obligation to pay amounts to the eventual recipients unless it collects equivalent amounts
from the original asset
YES
Has the entity transferred substantially all Derecognise  The entity is prohibited by the terms of the transfer contract from selling or pledging the original asset
risks and rewards? the asset other than as security to the eventual recipients
 The entity has an obligation to remit any cash flows it collects on behalf of the eventual recipients without
material delay. The entity is not entitled to reinvest the cash flows except for the short period between
NO collection and remittance to the eventual recipients. Any interest earned thereon is remitted to the
eventual recipients
YES
Has the entity retained substantially all Continue to recognise
risks and rewards? the asset

NO

NO
Has the entity retained control of the asset? Derecognise
the asset

YES

Continue to recognise asset to the extent of the entity’s continuing involvement.

 IND AS 109 Financial Instruments
CRITERIA TO APPLY HEDGE ACCOUNTING (ALL CRITERIA MUST BE MET)
(i) Hedging Relationship (ii) Designation and Documentation (iii) All three hedge effectiveness requirements met
Must consist of: Must be formalised at the inception of the hedging relationship: (a) An economic relationship exists between the hedged item and hedging instrument
 Eligible hedging instruments  The hedging relationship (b) Credit risk does not dominate changes in value
 Eligible hedged items.  Risk management strategy and objective for undertaking the hedge (c) The hedge ratio is the is the same for both the:
 The hedged item and hedging instrument  Hedging relationship
 How hedge effectiveness will be assessed.  Quantity of the hedged item actually hedged, and the quantity of the hedging instrument used to hedge it.

ELIGIBLE HEDGING INSTRUMENTS ELIGIBLE HEDGED ITEMS

Only those with from contracts with EXTERNAL parties of the entity (or group), that are: Eligible hedged items are reliably measurable: assets; liabilities; unrecognised firm commitment; highly probable forecast transactions;
net investment in a foreign operation. May be a single item, or a group of items (subject to additional criteria - below).
Derivatives measured at fair value Non-derivatives measured at fair value through
through profit or loss (FVTPL) profit or loss (FVTPL) HEDGES OF A GROUP OF ITEMS (ALL CRITERIA MUST BE MET)
Note: this excludes written options Note: this excludes FVTPL financial liabilities (i) All items and (and components) (iii) For group cash flow hedges: where cash flow variability is not expected to be
unless they are designated as an where fair value changes resulting from changes are eligible hedged items approximately proportional to the overall group cash flows variability, both:
offset to a purchased option in own credit risk are recognised in other
(ii) The items are managed as a group  Foreign currency is being hedged
comprehensive income (OCI)
for risk management purposes.  The reporting period, nature, and volume, in which the forecast transactions are
expected to affect profit or loss is specified.
Designation: An entity must designate a hedging instrument in full, except for:
 A proportion (e.g. 50%) of the nominal amount an entire hedging instrument (but not Designation: An entity can designate a hedged item (i) in full (ii) in part (component). If in part, only the following types of parts
part of the fair value change resulting from a portion of the time period that the (components) of hedged items can be hedged:
hedging instrument is outstanding)  One or more selected contractual cash flows
 Option contracts: separating the intrinsic value and time value, and designating only  Parts (components) of a nominal amount
the change in intrinsic value  Separately identifiable and reliably measureable changes (cash flow or fair value) that, based on the context of the market structure
 Forward contract: separating the forward element and spot element, and they relate to, are attributable to a specific risk(s)
designating only the change in the spot element
ELIGIBLE HEDGED ITEMS
HEDGING OF GROUP REBALANCING
(i) Cash flow hedge (ii) Fair value hedge
ENTITY TRANSACTIONS If the hedge ratio hedge effectiveness test Hedge of exposure to cash flow variability in cash attributable Hedge of exposure to fair value variability in an asset, liability, or
ceases to be met, but the risk to a particular risk associated with an asset, liability, or highly unrecognised firm commitment (or part thereof i.e. component),
Hedging of group entity transactions is management objective is unchanged, an probable forecast transaction (or part thereof i.e. component) attributable to a risk that could affect profit or loss
not applied in the consolidated financial entity adjusts (‘rebalances’), the hedge Recognition
statements of group entities, except for: ratio so the criteria is once again met Recognition
 Hedge effectiveness is recognised in OCI
 Gain or loss on hedging instrument: recognised in profit or loss
 Foreign currency risk on intra-group  Hedge ineffectiveness is recognised in profit or loss (unless the hedging instrument is an equity instrument measured
monetary items that are not fully  The lower of the cumulative gain or loss on the hedging at fair value through OCI, then recognised in OCI)
eliminated on consolidation DISCONTINUATION instrument or fair value in the hedged item is recognised  Gain or loss on hedged item: recognised in profit or loss (unless
 Investment entities where separately within equity (cash flow hedge reserve (CFHR)) the hedged item is an equity instrument measured at fair value
transactions between the parent Hedge accounting is discontinued only if
 For forecast transactions resulting in a non-financial asset through OCI, then recognised in OCI)
and subsidiaries measured at fair the qualifying criteria are no longer met
(after applying ‘rebalancing’). This / liability, the amount recognised in CFHR is removed and
value are not subject to elimination included in the initial cost of the non-financial asset / (iii) Hedges of a net investment in a foreign operation
adjustments including hedging instrument sale /
termination / expiration, but excluding: liability. This is not accounted for as a reclassification Hedge of an entity’s interest in the net assets of a foreign operation.
Hedging of group entity transactions is  For all other forecast transactions, the amount
 Replacement / rollovers documented in Recognition
able to be applied in separate / recognised in CFHR is reclassified to profit or loss in the
the risk management objective  Hedge effectiveness is recognised in OCI
individual financial statements of group periods when the cash flows are expected to affect profit
entities  Novations of hedging instruments  Hedge ineffectiveness is recognised in profit or loss
or loss  Upon disposal of the foreign operation, accumulated amounts in
(subject to specific criteria)
equity are reclassified to profit or loss