THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA ICAN

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA (ICAN) IFRS 9 – Requirements, Transition and Application By Jamiu Olakisan B. Sc, ACS, ACA, FCCA

Content Ø The accounting and financial reporting requirement of IFRS 9 Ø From IAS 39 to IFRS 9: the major changes Ø Managing the impact of IFRS 9 adoption Ø Recommendations for parties in the financial reporting supply chain IFRS 9 Financial Instruments 2

Introduction – IASB issues IFRS 9 Ø On 24 July 2014, the International Accounting Standards Board (IASB) issued the final version of IFRS 9, bringing together all three phases of the financial instruments project Classification and measurement Impairment (expected credit losses) Hedge accounting Accounting for dynamic risk management (macro hedging) is not included and forms a separate project Ø IFRS 9 is effective for annual periods beginning on or after 1 January 2018, with early application permitted IFRS 9 Financial Instruments Page 3

Classification and measurement

IFRS 9 classification and measurement model – main changes from IAS 39 Financial instruments in the scope of IFRS 9 Financial assets Financial liabilities New classification criteria New presentation: ‘own credit’ related FV changes in OCI (for liabilities under the FVO) New categories that use OCI IFRS 9 Financial Instruments Page 5

The new classification and measurement model for financial assets Debt (including hybrid contracts) Derivatives Equity ‘Contractual cash flow characteristics’ test (at instrument level) Pass Fail Held for trading? ‘Business model’ test (at an aggregate level) 1 Hold-to-collect contractual cash flows 2 BM with objective that 3 results in collecting contractual cash flows and selling financial assets Conditional fair value option (FVO) elected? No Amortised cost Fail Neither (1) nor (2) Yes No FVOCI option elected ? Yes No FVOCI (with recycling) FVTPL IFRS 9 Financial Instruments FVOCI (no recycling) Page 6

FVOCI measurement category Ø Examples of business models likely to result in OCI Liquidity buffers subject to significant churning Liquidity buffers for everyday liquidity needs Assets to fund insurance liabilities Ø FVOCI mechanics Fair value gains and losses of the asset are recorded in OCI Cumulative gains and losses recycled to P&L upon derecognition ECLs are derived using the same model as amortised cost instruments and are recorded in P&L with offseting entry in OCI Interest income is calculated using effective interest method and recorded in P&L IFRS 9 Financial Instruments Page 7

Expected credit losses (ECL)

Scope and variation of the expected credit loss model Scope of ECL requirements General approach Simplified approach IFRS 9 Financial Instruments Trade receivables that do not contain a significant financing component Trade receivables that contain a significant financing component Policy election at entity level Other debt financial assets measured at AC or at FVOCI Loan commitments and financial guarantee contracts not accounted for at FVPL IFRS 15 Revenue from Contracts with Customers Contract assets that do not contain a significant financing component Contract assets that contain a significant financing component Policy election at entity level IAS 17 Leases Lease receivables Policy election at entity level IFRS 9 Financial Instruments Page 9

Expected credit loss model – general approach Stage 1 Loss allowance updated at each reporting date Lifetime ECL criterion Stage 3 Stage 2 Lifetime ECL 12 -month ECL (credit losses that result from default events that are possible within the next 12 -months) Credit risk has increased significantly since initial recognition (whether on an individual or collective basis) + Credit-impaired Interest revenue recognised Effective Interest Rate (EIR) on gross carrying amount EIR on amortised cost (gross carrying amount less loss allowance) Change in credit risk since initial recognition Improvement Deterioration Page 10 IFRS 9 Financial Instruments

General approach - simplifications and presumptions for assessing deterioration ‘Low’ credit risk – equivalent to ‘investment grade’ Assessing significant increases in credit risk 30 days past due ‘backstop’ Assessment on a collective basis or at counterparty level Page 11 IFRS 9 Financial Instruments Use change in 12 -month risk as approximation for change in lifetime risk Set transfer threshold by determining maximum initial credit risk

General approach – significant increase in credit risk at portfolio level ► Bottom-up approach Common borrower characteristics ► ► ► Regions LTV Scoring Sub-portfolios Region A Region B LTV<50% 1 2 Region C 50%<LTV<80% 3 4 Region D ► ► 5 ► House prices (e. g. falling house prices) Interest-rate (e. g. interest rate rise) Unemployment GDP Top-down approach No individual identification Marginal impact of macroeconomic changes? Page 12 % of loans IFRS 9 Financial Instruments 100%<LTV 80%<LTV<100% Forward-looking information ► Region E 6 7 8

Simplified approach and purchased or originated credit-impaired assets ► Simplified approach ► ► ► Purchased or originated credit -impaired assets Page 13 ► Scope: contract assets, trade receivables and lease receivables Loss allowance based on lifetime ECL No tracking of changes in credit risk Scope: financial assets that are credit-impaired on purchase or origination ECL on initial recognition reflected in creditadjusted EIR (no ‘day one’ 12 -month ECL) Loss allowance based on subsequent changes in lifetime ECL IFRS 9 Financial Instruments

Measurement of expected credit losses Numerator: Cash shortfalls ► Expected credit losses Present value of all cash shortfalls over the remaining life, discounted at the original EIR ► ► Denominator: Discount rate ► ► ► Page 14 March 2021 The period over which to estimate ECL: maximum contractual period (for revolving credit facilities, this extends beyond contractual period) Probability-weighted outcomes: possibility that a credit loss occurs, no matter how low that possibility is Reasonable and supportable information: reasonably available information about the past, current and future forecasts Discounting period: from cash flows date to reporting date Assets: EIR or approximate (if credit-impaired on initial recognition, then use credit-adjusted EIR) Commitments and guarantees: EIR of resulting asset (if not determinable, then use current rate representing risk of the cash flows) IFRS 9 Financial Instruments

Hedge accounting

Hedge accounting: snapshot of key differences Requirement IAS 39 IFRS 9 Financial items All items ► Risk component as eligible hedged item ► 80%-125% test ü X ► Retrospective effectiveness testing ü X ► Quantitative effectiveness test ü Depends ► Qualitative effectiveness test X Depends ► Special accounting for ‘costs of hedging’ X ü ► Rebalancing of hedge ratio X ü ► Dedesignation if ineffective, but risk management objective unchanged ü X Page 16 March 2021 IFRS 9 Financial Instruments

How to achieve hedge accounting Define risk management (RM) strategy and objective Identify eligible hedged item(s) and eligible hedging instrument(s) No Yes 1) Is there an economic relationship between hedged item and hedging instrument? Yes 2) Does effect of credit risk dominate fair value changes? No To avoid ineffectiveness the ratio may need to differ from the one used in RM Page 17 March 2021 Base hedge ratio on the actual quantities used for risk management Yes 3) Does hedge ratio reflect an imbalance that would create hedge ineffectiveness? No Formal designation and documentation IFRS 9 Financial Instruments

Effective date and transition

Effective date and transition – early application choices Under IFRS 9 (2009, 2010, 2013) Under IFRS 9 (2014) IFRS 9 (2009) Or Final version of IFRS 9 (2014) IFRS 9 (2009) and IFRS 9 (2010) Or Includes accounting policy choice to apply IAS 39 for hedge accounting IFRS 9 (2009), IFRS 9 (2010) and IFRS 9 (2013) Or Or Own credit requirements ► ► ► Own credit requirements IFRS 9 is effective for annual periods beginning on or after 1 January 2018, with early application permitted Early application of previous versions of IFRS 9 (2009, 2010, 2013) is permitted if date of initial application is before 1 February 2015 Retrospective application, but restatement of comparatives not required Page 19 March 2021 IFRS 9 Financial Instruments

From IAS 39 to IFRS 9: Major changes Ø Change in classification of financial assets Ø IAS 39 classifications: HTM, FVTPL, L&R and AFS Ø IFRS 9 measurement bases: FVTPL, Amortised Cost (AC), FVTOCI for equity instrument without recycling and FVTOCI for debt instruments with recycling Ø No tainting rule applicable to financial assets measured at amortised cost similar to HTM under IAS 39 Ø Embedded derivatives – No requirement to separate embedded derivative from financial instrument host under IFRS 9. Ø IFRS 9 uses expected loss model instead of incurred loss model of IAS 39 for impairment of financial assets Ø 80%-125% test of effectiveness in hedge accounting removed under IFRS 9 Ø Retrospective effectiveness testing in hedge accounting removed under IFRS 9 Financial Instruments 20

Managing the impact of IFRS 9 adoption Ø Mandatory application date of pushed to 1 January 2018 to: Provide sufficient time for entities to develop systems and processes Gather historical data in order to make the calculations. Ø Closer alignment of credit risk management systems and financial reporting functions to IFRS 9 requirements Ø Adopting the IFRS 9 Expected Credit Loss (ECL) requirements will require significant effort and investment for many entities, in particular, banks and insurers. Ø Financial and non-financial institutions alike need to start planning an initial assessment of the likely impact of the new IFRS 9 ECL requirements to manage a successful transition and implementation. Ø Financial institutions need to fully understand the complex interactions between the IFRS 9 and regulatory capital requirements in relation to credit losses. Ø In many cases, it is expected that the new IFRS 9 ECL requirements will result in a reduction in the regulatory capital of financial institutions. IFRS 9 Financial Instruments 21

Recommendations for parties in the financial reporting supply chain Ø Ø Knowledge is key Be proactive System changes Process changes IFRS 9 Financial Instruments 22

Thank You

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Contact Jamiu Olakisan jamiu. olakisan @ng. ey. com 08035621311