27-Oct-17

6. Measurement
Financial Assets + Financial Liabilities:
INITIAL MEASUREMENT

I. FA + FL at FVTPL II. Other FA + FL

Fair value Fair value Transaction

Costs
Trade receivables with no significant financing component Transaction price (IFRS 15)

Fair value = 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
FA at fair value

Fair value If transaction price for FA

CASH
includes something other
Difference to PL (or as applicable)

6. Measurement
Financial Assets + Financial Liabilities:
INITIAL MEASUREMENT

I. FA + FL at FVTPL II. Other FA + FL

Initial
Measurement:
Fair value Fair value Transaction
Costs
Subsequent Fair value
Measurement: Amortized cost
FAIR VALUE through P/L FAIR VALUE through P/L
Equity instruments Debt instruments
Profit or Loss; OCI-not OCI - reclassified
FV gains / losses Gain/loss on FL reclassified to
Foreign exchange attributable to P/L P/L (effective Profit or loss
credit risk – interest
Impairment - FA P/L method) P/L (effective
sometimes to OCI
Interest, dividends interest rate)

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6. Measurement
Amortized cost & effective interest method

Amortized cost Effective interest method Effective interest rate

= amount on initial recognition = method of calculating the = discounts estimated future

- principal repayments amortized cost cash payments or receipts
+/- cumulative amortization of Δ +allocating the interest income through the expected life
- write-down of impairment / expense over the relevant period to the net carrying amount
=1A C b/f x 8.02% =AC c/f = AC b/f+interest income – CF
AC b/f 20X2 = AC c/f 20X1
Example: Year Cash flow Ammortized Interest Amortized
Cash flows:
cost b/f income cost c/f
Face value: 1000 20X1 -900 900 Expected / contractual
Coupon: 5% 20X2 50 900 72 922 Include incurred credit
Bond 20X3 50 922 74 946 losses / expected losses
Maturity: 20X5
20X4 50 946 76 972
Purchase price: 900 20X5 1050 972 78 0 Over expected or shorter
on 1 January 20X2 period
8.02%

Effective interest rate

6. Measurement

Amortized cost & effective interest method

Revisions to estimated cash flows:

Change in payment schedule

Revised carrying amount of FI

Present value of estimated future cash flows at original effective interest rate

Fair value hedge => revised effective interest rate

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6. Measurement

Amortized cost & effective interest method

Floating rate instruments: LIBOR 12M + 0.5%

Is FI initially recognized at amount repayable on maturity?

YES NO

Interest payments on accrual basis Accrued interest Credit downgrade

Amortize discount Amortize discount

over the period to the over the period to
next re-pricing date the maturity

6. Measurement
Financial Assets + Financial Liabilities:
SUBSEQUENT MEASUREMENT

I. FA + FL at FVTPL II. Other FA + FL

Initial
Measurement:
Fair value Fair value Transaction
Costs
Subsequent Fair value
Measurement: Amortized cost
FAIR VALUE through P/L FAIR VALUE through OCI
Equity instruments Debt instruments
Profit or Loss; OCI-not OCI - reclassified
FV gains / losses Gain/loss on FL reclassified to
Foreign exchange attributable to P/L P/L (effective Profit or loss
credit risk – interest
Impairment - FA P/L method) P/L (effective
sometimes to OCI
Interest, dividends interest rate)

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6. Measurement
Financial Assets + Financial Liabilities:
SUBSEQUENT MEASUREMENT

I. FA + FL at FVTPL II. Other FA + FL

Initial
Measurement:
Fair value Fair value Transaction
Costs
Subsequent Fair value
Measurement: Amortized cost
FAIR VALUE through P/L FAIR VALUE through OCI
Equity instruments Debt instruments
Profit or Loss; OCI-not OCI -
FV gains / losses Gain/loss on FL reclassified to reclassified
Foreign exchange attributable to P/L P/L (effective Profit or loss
credit risk – interest
Impairment - FA
P/L method) P/L (effective
sometimes to
Interest, dividends interest rate)
OCI

6. Measurement
Financial Liabilities
at Fair Value through Profit or Loss

Gain / Loss for the period

Resulting from credit risk Other gain / loss

Other comprehensive income  If accounting mismatch => Profit or loss

= the risk that one party to a financial instrument will cause a financial loss
for the other party by failing to discharge the obligation

Credit risk

Instrument-specific component of IRR: IRR Benchmark % Instrument-

specific
component of IRR

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8. Derivatives

Derivatives

= a financial instrument or other contract with all three of the following characteristics:
1. Its value changes in response to the change in an underlying variable
Specified interest rate
Financial instrument price
Interest rate swap Commodity price
Notional amount Underlying variable Foreign exchange rate
Equity forward Index of prices / rates
Credit rating/credit index

2. No initial investment/initial net investment smaller than would be required for other types of
contracts with expected similar response to changes in market factors

Recognize derivatives in the financial statements (even if initial cost close to 0)

3. Settled at a future date

8. Derivatives

Foreign currency forward

= agreement between two parties to exchange a fixed amount of 1 currency for a fixed
amount of another currency at a future date

NOW: Sells goods for 20 mil. EUR,

€ payment expected in 9 months $ Enters into forward contract to sell
20 mil. EUR for 1.28 USD/EUR in 9 months

EU US
Bank
customer producer
Pays 20 mil. EUR

AFTER 9 MONTHS: Receives 20 ml. EUR Receives 25.6 mil. USD

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8. Derivatives

Interest rate swap

= agreement between two parties to exchange interest rate cash flows based on
specified notional amount from a fixed rate to a floating rate (or vice versa)
Issues bonds: face value = 10 mil. EUR Enters into interest rate swap:
NOW: annual coupon LIBOR 12m+0.5%
Notional amount: 10 mil. EUR
Pay: 1.5% fixed
Receive: LIBOR 12m+0.5%

EU
Investors Bank
company
Pays interest of
1.5%

Pays interest of LIBOR 12m+0.5% Receives interest of LIBOR 12m+0.5%

AFTER 1 YEAR:

If LIBOR = 1.2% => - 170 000 + 170 000 - 150 000 = - 150 000
If LIBOR = 0.8% => - 130 000 + 130 000 - 150 000 = - 150 000

8. Derivatives

Interest rate swap:

Valuation

EU company
Floating leg of IRS
Fixed leg of IRS
Receives Pays

~ ~~
interest of interest
LIBOR 12m PLAIN VANILLA SWAP of 1.5%
+0.5%

Bank

FV of Interest rate swap Floating leg of IRS Fixed leg of IRS

~ ~~

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8. Derivatives

Interest rate swap:

Valuation

FV of Interest rate swap Floating leg of IRS Fixed leg of IRS

1. Expected future cash flows

~ ~~
=> Swap cash flows = Floating rate bond Floating rate bond

2. Discount rate => always priced at face value => present value
on an interest payment date of fixed payments
Implied zero-coupon
yields / LIBOR curves
= −
-Use zero-coupon bond prices +
-”bootstrapping” from full-coupon bonds
- Complex swaps: implied forward rates

8. Derivatives

Embedded derivatives

Hybrid instrument Non-derivative host contract Embedded derivative

Contract outside scope Financial Financial Foreign currency forward

of IFRS 9 liability asset Interest rate floor / cap

Extension/prepayment option
e.g. Lease contract e.g. Bond issued e.g. Bond acquired Payments linked to indices

Purchase contract with

payments in foreign currency Purchase Foreign currency forward

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8. Derivatives

Embedded derivatives

Hybrid instrument Non-derivative host contract Embedded derivative

Contract outside scope Financial Financial Foreign currency forward

of IFRS 9 liability asset Interest rate floor / cap

Extension/prepayment option
e.g. Lease contract e.g. Bond issued e.g. Bond acquired Payments linked to indices

Loan with interest of LIBOR

+0.5% with min. interest of 1% Loan Interest rate floor

8. Derivatives

Embedded derivatives

Hybrid instrument Non-derivative host contract Embedded derivative

Contract outside scope Financial Financial Foreign currency forward

of IFRS 9 liability asset Interest rate floor / cap

Extension/prepayment option
e.g. Lease contract e.g. Bond issued e.g. Bond acquired Payments linked to indices

Government bond with interest Government Inflation-linked interest

payments of 3x CPI bond payments

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8. Derivatives

Embedded derivatives

Hybrid instrument Non-derivative host contract Embedded derivative

Contract outside scope Financial Financial

of IFRS 9 liability asset

In IAS 39: You

SEPARATE if: DO NOT SEPARATE
need to separate!

• Economic characteristics not closely related Apply measurement rules to

• Separate instrument would meet the the entire hybrid contract
definition of a derivative

• Hybrid instrument not at FV through P/L

Apply measurement rules to the host contract

and to derivative separately If not possible Entire contract at FVTPL

8. Derivatives

Embedded derivatives

What is “NOT CLOSELY RELATED”? If the host is a financial instrument:

Holder does not recover

substantially all of its investment
Interest rate indices Not closely related when:

LIBOR Holder does not recover

substantially all of its investment

Cap is at/above market rate of interest

Interest rate Floor is at/below market rate of interest
IS closely related if:
floor and cap
Not leveraged

Commodity / equity Equity conversion

NOT closely related NOT closely related
linked payments feature

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8. Derivatives

Embedded derivatives

What is “NOT CLOSELY RELATED”? If the host is a contract for sale/purchase of goods/services:

It is not leveraged
Foreign currency
IS closely related if: It does not contain an option feature
derivatives
CURRENCY

CNY¥ COP$
$$$

=> the functional currency of any substantial party to the contract

=> routinely denominated in commercial transactions around the world
=> commonly used in contracts to purchase/sell non-financial items where transaction takes place

It is not leveraged
Inflation-linked
IS closely related if:
features
In appropriate economic environment

9. Hedging

What is hedging?

= designating one or more hedging instruments so that their change in fair value
is an offset to the change in fair value or cash flows of a hedged item
Hedged = asset/liability/firm commitment/ Hedging = designated derivative (or another
item forecasted future transaction that: instrument financial asset/liability) whose fair value
• exposes the entity to risk or cash flows are expected to offset
• is designated as being hedged changes in the fair value or cash flows of
a designated hedged item.
NOW:

€ Sells goods for 20 mil. EUR,

payment expected in 9 months $
Enters into forward contract to
sell20 mil. EUR for 1.28
USD/EUR in 9 months

EU US
customer producer Bank

Pays 20 mil. EUR

Receives 20 mil. EUR

AFTER 9 MONTHS: Receives 25.6 mil. USD

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9. Hedging

What is hedging?

= designating one or more hedging instruments so that their change in fair value
is an offset to the change in fair value or cash flows of a hedged item

Accounting for forward contract

Without hedge accounting With hedge accounting

Debit: Credit: Debit: Credit:

P/L-Finance expenses: Liabilities from OCI – Effective portion Liabilities from
loss on forward contract derivatives of a cash flow hedge derivatives

Debit:
P/L – Finance expenses:
ineffective portion of CF hedge

9. Hedging

Why hedge accounting?

IAS 39 = rules too strict

HEDGING STRATEGY + difficult to apply

covers
19 November 2013: IFRS 9 amended!

RISKS: IAS 39 IFRS 9

IAS 39 for Choice:

hedging, too IAS 39 or IFRS 9
for hedging

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9. Hedging

Hedge accounting?

=> Hedge accounting is OPTIONAL, not obligatory!

CONDITIONS (IAS 39):

1. The hedging relationship must be designated at its inception as a hedge.

2. The hedge is expected to be highly effective.

3. For cash flow hedges: a forecasted transaction must be highly probable + could affect
profit or loss

4. The effectiveness of the hedge can be measured reliably.

5. The hedge is assessed on an ongoing basis + effective during reporting period.

9. Hedging

Hedge accounting?

=> Hedge accounting is OPTIONAL, not obligatory!

QUALIFYING CRITERIA (IFRS 9):

1. The hedging relationship consists only of eligible hedging instruments and eligible
hedged items.
2. At the inception: formal designation and documentation of the hedging relationship:

=> Hedging instrument

=> Hedged item
HEDGING STRATEGY => Nature of risk being hedged
=> Assessment of hedging effectiveness

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9. Hedging

Hedge accounting?

=> Hedge accounting is OPTIONAL, not obligatory!

QUALIFYING CRITERIA (IFRS 9): = receivable 20 mil. EUR

3. The hedging relationship meets all the following criteria for hedge effectiveness:

=> There is an economic relationship between hedging

instrument and hedged item

=> The effect of credit risk does not dominate the value
changes from that economic relationship

Hedged
=> The hedge ratio = = receivable 20 mil. EUR
item
quantity of hedged item : quantity of hedging instrument
Hedging = forward contract
instrument to sell 20 mil. EUR

9. Hedging

Hedge accounting?

Hedging instrument Hedged item

= designated derivative (or another = asset/liability/firm commitment/

financial asset/liability) whose fair value forecasted future transaction that:
or cash flows are expected to offset • exposes the entity to risk
changes in the fair value or cash flows of • is designated as being hedged
a designated hedged item.

IAS 39 IFRS 9 IAS 39 IFRS 9

Derivatives Derivatives Non-financial item Risk component of
only in its entirety nonfinancial item

Non-derivative in a Non-derivative at
foreign currency FVTPL
risk

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9. Hedging

Categories of Hedges

III. Hedge of a net investment

I. Fair value hedge II. Cash flow hedge
in a foreign operation

Fair value Cash flows Net investment in

a foreign operation

9. Hedging

Fair value hedge

What is it: = hedge of the exposure to changes in fair value that could affect P/L

Hedged item: Asset => fixed-rate bond

Liability => fixed-rate loan

Unrecognized firm commitment => Contract to buy oil at XY of

foreign currency

Identified portion

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9. Hedging

Fair value hedge

Accounting

Hedging instrument Hedged item

The gain / loss from => In P/L The gain / loss from =>Adjust carrying
remeasurement remeasurement attributable amount of hedged
to hedged risk item - P/L

If you hedge equity If you hedge equity

instrument at FVOCI => In OCI instrument at FVOCI => In OCI
(IFRS 9) (IFRS 9)

Unrecognized firm commitment => Cumulative change in FV as asset / liability

=> Adjust the initial cost of item

9. Hedging

Hedging: Hedge effectiveness

= the extent to which changes in the fair value or cash flows of the hedging instrument
offset the changes in the fair value or cash flows of the hedged item

Hedging instrument Hedged item Hedge effectiveness

GAIN: +100 LOSS: -100 100/100=100%

GAIN: +100 LOSS: -80 80/100=80%

WHEN? IAS 39 IFRS 9

prospectively + retrospectively prospectively

HOW?
Numerical test 80-125% Qualitative testing

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9. Hedging

Hedging: Hedge effectiveness

= the extent to which changes in the fair value or cash flows of the hedging instrument
offset the changes in the fair value or cash flows of the hedged item

Testing effectiveness Measuring ineffectiveness

Is hedge is effective? How much ineffectiveness is in the hedge?

DOLLAR OFFSET METHOD

9. Hedging

Cash flow hedge

What is it: = hedge of the exposure to variability in cash flows that could affect P/L

Hedged item: Asset => variable-rate bond

Liability => Variable-rate loan

Highly probable => Anticipated purchase of inventory

forecast transaction

Identified portion

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9. Hedging

Cash flow hedge

Accounting

Change in FV of Hedging instrument

Effective portion => In Equity (OCI) Ineffective portion => In P/L

IFRS 9: “Cash flow hedge reserve”
(reclassify to P/L)

9. Hedging

Hedging: Cash Flow hedge

MEASURING EFFECTIVENESS
Is gain/loss on hedging YES Hedge is Apply hedge
instrument < loss/gain Fully to OCI
effective accounting
on hedged item?

NO
NO
Is range 80-125% maintained? Discontinue hedge accounting

YES
Effective portion to OCI
Apply hedge accounting

Ineffective portion to P/L

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9. Hedging

Hedge of a net investment

in a foreign operation

What is it: = hedge of amount of the reporting entity’s interest in the net assets
of the foreign operation

Hedged item: Foreign operation => subsidiary, associate, joint venture, branch

In the parent’s => Carried at Cost / FV ≠Net assets => Hedge accounting
separate financial statements

In the consolidated => Carried at net assets => Hedge accounting  

financial statements

9. Hedging

Hedge of a net investment

in a foreign operation

Accounting = can be applied only to the foreign exchange differences arising between
parent’s functional currency and foreign operation’s functional currency

Similarly as

Cash flow hedge Change in FV of Hedging instrument

Effective portion => In OCI Ineffective portion => In P/L

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9. Hedging

Hedge accounting

DISCONTINTUING IAS 39 IFRS 9

The hedging instrument expires, The hedging instrument expires,

is sold, terminated or exercised is sold, terminated or exercised

WHEN? The hedge no longer meets The hedge no longer meets

criteria for hedge accounting criteria for hedge accounting

The entity revokes designation No voluntary discontinuing

HOW? PROSPECTIVELY

CF hedge of forecast transaction:

- Cumulative gain/loss stays in OCI

+ reclassified to P/L when forecast transaction affects P/L
or no longer expected

9. Hedging

Categories of Hedges

III. Hedge of a net investment

I. Fair value hedge II. Cash flow hedge
in a foreign operation

What is it: = hedge of the exposure = hedge of the exposure = hedge of a subsidiary /
to changes in fair value; to variability in cash associate / joint venture or
could affect P/L flows; could affect P/L branch whose activities are
based in a country or currency
other than that of the
reporting entity

Accounting: Hedging instrument: Hedging instrument:

=> Change in FV to P/L => Effective As cash flow hedge
(OCI) portion to OCI
Hedged item:
=> Remaining part to P/L
=> Adjust carrying
=> Reclassify “cash flow hedge
amount through P/L (OCI)
reserve” in equity

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6. Measurement

Impairment (IFRS 9)

FA at amortized cost: FA at amortized cost: => Recoverable amount = Present value of

Estimated future cash flows discounted by original effective interest rate

Incurred credit loss: IAS 39 vs. Expected credit loss: IFRS 9

Assessment: Assess individually significant assets

Collective assessment No collective assessment

Collective assessment of all other assets (not assessed individually)

6. Measurement

Impairment (IFRS 9)

IFRS 9 July 2014: New rules for improvement of financial assets

General rule: (IAS 39: Impairment loss)

An entity shall recognize a Loss allowance for Expected credit losses on

 Financial assets at amortized cost; Debt securities, receivables, loans

 Financial assets at FVOCI (meeting both contractual CF test and business model test)

 Lease receivables (IAS 17)  Lease receivables (IAS 17) Not for shares =>
part of FV change

 Contract assets (IFRS 15)  Financial guarantee contracts

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6. Measurement

Impairment (IFRS 9)

Credit loss All contractual CF due in line with the contract (PV)

All CF expected to receive discounted at:

At initial recognition: OK At initial recognition: impaired

Original effective interest rate Credit-adjusted effective interest rate

(for purchased or originated credit-
impaired FA)

Expected credit loss Weighted average of credit losses with resp. risks Expected credit
loss of default as weights
< 90 days overdue => NO
default e.g. probability of
default
Credit loss Risk (as a percentage)
i i

6. Measurement

Impairment (IFRS 9)

General approach Simplified approach

3 stages of FA No stage (Lots of assessment not necessary)

Loss allowance Loss allowance = Life-time ECL

12-month ECL Life-time ECL

 All financial assets subject  Trade receivables

to impairment  Contract assets (IFRS 15)
Except for:
• Do NOT contain significant financing component
Trade receivables or
contract assets (IFRS 15) • Contain significant financing component, but
without significant financing chosen to measure loss allowance at lifetime ECL
component
 Lease receivables (IAS 17)
• If chosen to measure loss allowance at lifetime ECL

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6. Measurement

Impairment (IFRS 9): General approach

Stage 1 Stage 2 Stage 3

FA not yet impaired

Financial Asset Performing Credit risk Credit-impaired

significantly increased

12-month Lifetime expected Lifetime expected

Loss allowance expected credit credit losses credit losses
losses

Interest revenue On gross carrying On gross carrying On amortized cost

amount amount

6. Measurement

Impairment (IFRS 9): General approach

Expected credit loss = Weighted average of credit losses with resp. risks of default as weights

Lifetime ECL 12-month ECL = the portion

of lifetime ECL

= ECL resulting from all possible default events = ECL resulting from default events possible
over the expected life of a FI within 12 months after reporting date
= 95*1%+80*10%= CU 8.95 = 95*1% = CU 0.95
Risk of default in year 1: 1%; Risk of default in years 2-7: 10%; CL: 80
CL: 95 (due in year 1: 10, due later: 85)

0 1 2 3 4 5 6 7

LOAN TO ABC, CU 100, repayable after 7 years

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6. Measurement

Impairment (IFRS 9)

FA at amortized cost: => Much detailed requirements / application guidance

Historical loss rates Formula-based approaches
Banks use
Statistical methods

Recognition of Impairment loss Reversal of Impairment loss

Debit: Credit: Debit: Credit:

P/L-Impairment loss FA – Allowance account FA – Allowance account P/L-Reversal of imp. loss

The carrying amount must not exceed original amortized cost

6. Measurement

Impairment (IFRS 9): General approach

Expected credit loss = Weighted average of credit losses with resp. risks of default as weights

Lifetime ECL 12-month ECL

How to measure ECL

Measurement shall reflect:

 Unbiased and probability-weighted amount (range of possible outcomes)

 Time value of money

 Reasonable + supportable information

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6. Measurement

Impairment (IFRS 9): General approach

How to determine significant increase in credit risk

Stage 1 Assess at each reporting date Stage 2

Risk of default at the Risk of default at

Change in a risk of default
reporting date initial recognition

- If a fin. asset has LOW credit risk at the reporting date => Risk has NOT increased significantly
e.g. credit rating, external grading etc.
- If contractual payments are >30 days overdue => Risk HAS INCREASED significantly
(rebuttable)

6. Measurement

Impairment (IFRS 9): General approach

Collective vs. individual assessment

Individual assessment = Assessment of 1 financial asset

Collective assessment = Assessment of group or sub-group of financial assets

=> When not enough information to assess individually (e.g. retail loans)

=> Grouping based on shared credit risk characteristics

 Instrument type  Collateral type

 Credit risk rating  Geographical location
 Industry

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