IFRS 9 Financial Instruments FIA Technical Workshop Saturday

IFRS 9 Financial Instruments FIA Technical Workshop Saturday 24 th June 2017 Korolevu, FIJI 1

Acknowledgements This presentation is based on various documents including § IFRS 9, published by IASB § IFRS 9 Project Summary (July 2014) published by IASB § Get Ready for IFRS 9, Issue 1 and 2 published by Grant Thornton For further information and queries, please contact nacanieli. rika@usp. ac. fj 2

Objective IFRS 9 establishes principles for the financial reporting of financial assets and financial liabilities that will 1. present relevant and useful information 2. to users of financial statements 3. for assessing an entity’s future cash flows in terms of a) amounts b) timing c) uncertainty IFRS is effective for reporting periods beginning on or after 1 January 2018 3

Background 1. Replaces IAS 39 § and previous versions of IFRS 9 2. Responds to GFC. Interested parties including G 20 highlighted areas in need of consideration a) timeliness of recognising expected credit losses b) complexity of multiple impairment models c) Accounting for own credit risk 3. Based on over 1, 000 comment letters from stakeholders and hundreds of meetings with users, preparers and others § 6 EDs, 1 supplementary document, 1 DP 4

Accompanying Videos In this video, IASB member Sue Lloyd provides an overview of IFRS 9 In this video, Sylvia M explains the main features of IFRS 9 http: //www. ifrs. org/news-andevents/2016/02/19 -from-incurred-to -expected-two-years-to-go/ https: //www. youtube. com/watch? v =m. WGctejm. SZk 9 minutes 20 minutes 5

Presentation Summary Part 1 2 3 Topic Classification & Measurement Impairment Hedge Accounting 6

Part 1 Classification and Measurement 7

Main Changes 1. Classify financial assets on the basis of a) the business model within which they are held; & b) their contractual cash flow characteristics 2. New category of financial assets § Fair Value through Other Comprehensive Income (FVTOCI) 3. For financial liabilities § ignore effect of changes in credit risk § unless the liability is held for trading 8

Comparison of IAS 39 vs IFRS 9 IAS 39 Rule based Complex and difficult to apply Multiple impairment models For FVO liabilities, own credit gains and losses are recognised in profit or loss Complicated reclassification rules IFRS 9 Principle based Classification based on business model and nature of cash flows One impairment model For FVO liabilities, own credit gains and losses are presented in OCI Business-model driven reclassification 9

Classification of Financial Assets IFRS 9 applies one classification approach for all types of financial assets § classified and measured according to two criteria 1. The entity’s business model for managing financial assets 2. The contractual cash flow characteristics of the financial asset Does not depend on management’s intentions for an individual instrument § Should be based on a higher level of aggregation. 10

Business Model How an entity manages its financial assets in order to generate cash flows by 1 Collecting contractual cash flows 2 Collecting contractual cash flows and selling financial assets e. g. trade receivables, loans and debt securities held to maturity e. g. liquidity portfolio, assets held by an insurer to back insurance liabilities 3 Other e. g. trading portfolios, assets managed on a fair value basis 11

Business Model This is typically observed through the activities that an entity undertakes to achieve its business objectives. Consider objective information such as 1. How performance is evaluated and reported to the entity’s KMP 2. How managers of the business are compensated e. g. fair value or contractual cash flows 3. The risks affecting performance of the business model and how those risks are managed 4. Amount and frequency of sales activity 12

Option 1 Amortised Cost Measurement Objective of the business model § To collect contractual cash flows only Consider past sales information and expectations about future sales activity § May include some sales activity 1. Infrequent and insignificant 2. Sales resulting from an increase in credit risk 13

Option 2 FVTOCI Measurement Objective of the business model Achieved by both 1. Collecting contractual cash flows; and 2. Selling financial assets § Involves greater frequency and volume of sales Possible objectives of the business model 1. Manage liquidity 2. Maintain a particular interest yield profile 3. Match the duration of financial liabilities to the duration of the assets they are funding 14

Option 3 FVTPL Measurement Any financial assets not held in either of the two previous business models § Measured at fair value through profit or loss § Residual category However, at the time of initial recognition § an entity may elect to present these financial assets as FVTOCI § On grounds of relevance or to avoid an accounting mismatch 15

Reclassification of financial assets Can only be reclassified when the entity’s business model for managing them changes. § Provide disclosure required under IFRS 7 Financial Instruments: Disclosures 16

Multiple Business Models An entity can have more than one business model Example An entity holding a portfolio of mortgage loans may manage some of the loans to collect contractual cash flows while having an objective of selling other loans within the portfolio in the near term. The portfolio would be sub-divided, with § part of it being accounted for under a hold to collect business model § while the other loans are accounted for at FVTPL 17

Contractual Cash Flows Financial assets can only be measured at amortised cost or FVTOCI § if the contractual cash flows are solely payments of principal and interest (SPPI) Interest can include a return for 1. Time value of money 2. Credit risk 3. Liquidity risk 4. Amounts to cover expenses 5. Profit margin 18

Classification Flowchart Source IFRS 9 Project Summary p 9 19

Measurement Summary Cash Flows Solely payments for principal and interest Not SPPI Business Model Measurement Collect contractual cash Amortised flows only Cost Collect contractual cash FVTOCI flows & sales proceeds For either of the above, FVTPL the entity may choose … N. A. FVTPL For equity instruments FVTOCI not held for trading, the entity may choose 20

Reporting Summary Category Balance Sheet Amortised Cost less Impairment Allowance FVTPL Fair Value SOCI Presented in P&L § Interest § Impairment Losses Changes in FV presented in P&L 21

Reporting Summary Category B/Sheet SOCI Equity Fair Value § Changes in FV presented in OCI FVTOCI § Dividends recognised in P&L § No reclassification to P&L on disposal FVTOCI Fair Value § Changes in FV presented in OCI § Presented in P&L § Interest § Impairment losses § FOREX gains and losses § Cumulative FV gains/losses reclassified to P&L on derecognition/reclassification 22

Financial Liabilities 1. Mostly measured at amortised cost 2. May elect to measure financial liabilities at FVTPL if particular criteria are met § e. g. an entity can choose to measure a structured financial liability at fair value in its entirety rather than being required to account for its component parts § Changes in fair value of an entity’s own credit risk are recognized in OCI (not PNL) 23

Part 2 Impairment 24

Impairment Methodology Apply the same impairment model to all financial instruments Provide more timely information about expected credit losses 1. No longer necessary for a credit event to have occurred before credits losses are recogonised 2. An entity always accounts for expected credit losses and changes in those expected losses 3. Amount of expected credit losses is updated at each reporting date 25

Three-stage Process Source Grant Thornton Get ready for IFRS 9 p 8 26

Stage 1 12 Month Expected Credit Losses As soon as a financial instrument is originated or purchased, § 12 -month expected credit losses are recognised in profit or loss and a loss allowance is established. § Proxy for the initial expectation of credit losses. For financial assets, calculate interest revenue on the gross carrying amount § i. e. no adjustment for expected credit losses 27

Measuring Expected Credit Losses An entity should consider 1. The probability-weighted outcome § Expected credit losses should reflect the possibility that a credit loss occurs and the possibility that no loss occurs rather than a best or worst-cased scenario. 2. The time value of money § Expected credit losses should be discounted to the reporting date 3. Reasonable and supportable information that is available without undue cost or effort 28

Stage 2 Lifetime Expected Credit Losses If credit risk increases significantly and the resulting credit quality is NOT considered to be a low credit risk, § Recognise full lifetime expected credit losses. For financial assets, calculate interest revenue on the gross carrying amount § i. e. no adjustment for expected credit losses Rebuttal Presumption Credit risk on a financial asset has increased significantly since initial recognition § when contractual payments are more than 30 days past due. 29

Low Credit Risk If a financial instrument is determined to have low credit risk at reporting date § An entity may assume that the credit risk has not increased significantly since initial recognition. Credit risk is considered low if 1. the financial instrument has a low risk of default 2. The borrower has a strong capacity to meet its contractual cash flow obligations in the near term & 3. Adverse changes in conditions in the longer term may, but will not necessarily reduce the ability of the borrower to fulfil its obligations 30

Stage 3 Lifetime Expected Credit Losses If credit risk increases to the point that the financial asset is considered credit-impaired, § Recognise full lifetime expected credit losses For financial assets, calculate interest revenue on the amortised costs § i. e. gross carrying amount adjusted for the loss allowance § In general, financial assets in this stage will be individually assessed. 31

Evidence of Credit Impairment 1. The issuer or borrower faces significant financial difficulty 2. A breach of contract e. g. default of past due event 3. The lender(s), for economic or contractual reasons relating to the borrower’s financial difficulty, have granted to the borrower a concession(s) that the lender(s) would not otherwise consider 4. It is becoming probable that the borrower will enter bankruptcy or other financial reorganisation 5. The disappearance of an active market for the financial asset because of financial difficulties 32

Simplified Model Situation Trade receivables and contract assets of < or = 1 year or which don’t contain a significant financing component Trade receivables and contract assets that contain a significant financing component (in acccordance with IFRS 15) Lease receivables within the scope of IAS 17 Simplification Always recognise a loss allowance equal to lifetime expected credit losses Entities are allowed to choose the above treatment Entities may similarly choose the above treatment 33

Impairment Disclosure 1. Provide information that explains the basis for their expected credit loss calculations and § how they measure expected credit losses and § assess changes in credit risk 2. Reconcile opening to closing allowance balances § for 12 month allowances § separately from lifetime loss allowance balances 3. Reconcile opening to closing balances of the related carrying amounts § of financial instruments subject to impairment 34

Impairment Disclosure 4. Provide reconciliations in a way that enables users of financial statements to understand the reason for changes in the allowance balances § e. g. whether it is caused by changes in credit risk or increased lending 5. Provide information about § credit risk of financial assets by rating grades and § financial assets on which contractual cash flows have been modified 35

Part 3 Hedge Accounting 36

Phase 3 Main Changes 1. Align hedge accounting more closely with risk management 2. Establish a more principle-based approach to hedge accounting 3. Address inconsistencies and weaknesses in the IAS 39 hedge accounting model Entities may continue to apply hedge accounting requirements of IAS 39 § until IASB completes its project on accounting for macro hedging 37

Qualifying Items A hedged item can be a) A recognised asset or liability b) An unrecognised firm commitment c) A forecast transaction d) Net Investment in a foreign operation 1. 2. 3. 4. It can be a single item or a group of items It must be readily measurable It must be highly probable (applies to 2 & 3 above) In general, it must involve an external third party 38

Qualifying Criteria At the inception of the hedging relationship there is formal designation and documentation of 1. the hedging relationship and 2. the entity’s risk management objective and strategy for undertaking the hedge Document must include identification of 1. the hedging instrument 2. the hedged item 3. the nature of the risk being hedged 4. how the entity will assess whether the hedging relationship meets the hedge effectiveness requirements 39

Qualifying Criteria The hedging relationship must meet all of the following hedge effectiveness requirements 1. There’s an economic relationship between the hedged item and the hedging instrument 2. The effect of credit risk does not dominate the value changes that result from that economic relationship 3. The hedge ratio of the hedging relationship is the same as that resulting from the quantity of the hedged item that the entity actually hedges and the quantity of he hedging instrument that the entity uses to hedge that quantity of hedged item 40

Types of Hedging Relationships 1. Fair value hedge a hedge of the exposure to changes in the fair value of a recognised asset or liability etc. that is attributable to a particular risk and could affect profit or loss 2. Cash flow hedge a hedge of the exposure to variabiilty in cash flows that is attributable to a particular risk associated with all, or a component of, a recognised asset or liability (e. g. all or some future interest payments on variable-rate debt) or a highly probable forecast transaction , and could affect profit or loss 3. Hedge of a net investment in a foreign operation 41

IFRS 9 Financial Instruments FIA Technical Workshop Saturday 24 th June 2017 Korolevu, FIJI 42