IFRS 9 (Recognition, Classification and Measurement) – Class notes

RECOGNITION

An entity shall recognize a financial asset or a financial liability in its statement of financial position when
and only when the entity becomes party to the contractual provisions of the instrument. On initial
recognition the entity shall also classify financial asset or financial liability as per guidance discussed later
in this chapter.
Examples:
- Entity B transfers cash to Entity A as a collateral for a borrowing transaction. The cash is not legally
segregated from Entity A’s assets. Therefore, Entity A recognizes the cash as an asset and a payable
to Entity B, while Entity B derecognizes the cash and recognizes a receivable from Entity A.
- Assets to be acquired and liabilities to be incurred as a result of a firm commitment to purchase or
sell goods or services are generally not recognized until at least one of the parties has performed
under the agreement. For example, an entity that receives a firm order does not generally recognize
an asset (and the entity that places the order does not recognize a liability) at the time of the
commitment but, instead, delays recognition until the ordered goods or services have been shipped,
delivered or rendered.
- Planned future transactions, no matter how likely, are not assets and liabilities because the entity has
not become a party to a contract.

CLASSIFICATION OF FINANCIAL ASSETS

Financial assets which are debt instruments of other entity

An entity shall classify financial assets as subsequently measured at:

1) Amortized cost
2) Fair value through other comprehensive income
3) Fair value through profit or loss

1) Amortized cost
A financial asset shall be measured, except for 3(ii) below, at amortized cost if both of the following
conditions are met:
(i) the financial asset is held within a business model whose objective is to hold financial assets in order
to collect contractual cash flows and
(ii) 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.
Amortized cost
The amount at which the financial asset or financial liability is measured at initial recognition minus
the principal repayments, plus or minus the cumulative amortization using the effective interest
method of any difference between that initial amount and the maturity amount and, for financial
assets, adjusted for any loss allowance.

2) Fair value through OCI

A financial asset shall be measured, except for 3(ii) below, at fair value through other comprehensive
income if both of the following conditions are met:
(i) the financial asset is held within a business model whose objective is achieved by both collecting
contractual cash flows and selling financial assets and

Nasir Abbas FCA Page 1 | 5

 IFRS 9 (Recognition, Classification and Measurement) – Class notes

(ii) 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.

Business model
Any entity’s business model is determined at a level that reflects how groups of financial assets are
managed together to achieve a particular business objective. It does not depend on management’s
intentions for an individual instrument. However, an entity may have more than one business models
for managing its financial instruments. For example, an entity may hold a portfolio of investments that
it manages to collect contractual cash flows and another portfolio of investments that it manages in
order to trade to realize fair value changes.

Contractual cashflows comprise of:

Principal Interest
It is the fair value of the financial It consists of consideration for the time value of money, for the
asset at initial recognition. credit risk associated with the principal amount outstanding
during a particular period of time and for other basic lending
risks and costs, as well as a profit margin.

3) Fair value through P&L

A financial asset shall be measured at fair value through profit or loss if either:
(i) it cannot be classified as measured at amortized cost or fair value through OCI; or
(ii) an entity has, at initial recognition, irrevocably designated the financial asset as measured at fair value
through P&L if doing so eliminates or significantly reduces an accounting mismatch.

Financial assets which are equity instruments of other entity

An entity shall classify financial assets as subsequently measured at:
1) Fair value through other comprehensive income
2) Fair value through profit or loss

A financial asset shall be measured at fair value through P&L (default method) unless an entity has made
an irrevocable election, at initial recognition, for particular investments in equity instruments if these are
not held for trading to present subsequent changes in fair value in OCI.

CLASSIFICATION OF FINANCIAL LIABILITIES

An entity shall classify all financial liabilities as subsequently measured at amortized cost except for:
(a) Financial liabilities, including derivatives that are liabilities, measured at fair value through P&L
An entity may, at initial recognition, irrevocably designate a financial liability as measured at fair
value through P&L if either:
- It eliminates or significantly reduces an accounting mismatch; or
- A group of financial liabilities is managed and its performance is evaluated on a fair value basis
in accordance with a documented risk management or investment strategy.
(b) Financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or
when the continuing involvement approach applies.
(c) Financial guarantee contracts.

Nasir Abbas FCA Page 2 | 5

 IFRS 9 (Recognition, Classification and Measurement) – Class notes

(d) Commitments to provide a loan at a below-market interest rate.

(e) Contingent consideration recognized by an acquirer in a business combination.

INITIAL MEASUREMENT

Financial assets

Financial assets subsequently measured at Financial assets subsequently measured at fair

amortized cost or fair value through OCI: value at P&L:

Fair value of asset + transaction cost Fair value of asset

Financial liabilities

Financial liabilities subsequently measured at Financial liabilities subsequently measured at fair

amortized cost: value at P&L:

Fair value of liability – transaction cost Fair value of liability

Transaction costs
Incremental costs that are directly attributable to the acquisition or issue of a financial asset or financial
liability. An incremental cost is one that would not have been incurred if the entity had not acquired or
issued of the financial instrument.

Examples of transactions costs:

Include Do not include
 Fees and commission paid to agent, advisers, brokers  Debt premium and discounts
and dealers  Financing costs
 Levies by regulatory agencies and security exchanges  Internal administrative or holding costs
 Transfer taxes and duties

Important for initial measurement:

 Transaction costs for financial asset or financial liability subsequently measured at fair value
through P&L are recognized as expense when incurred.

 Transaction costs expected to be incurred on transfer or disposal of a financial instrument are not
included in the measurement of the financial instrument.

 Generally transaction price (i.e. fair value of consideration given or received) is equal to the fair
value of financial asset or financial liability at initial recognition, however, if transaction price is
different then, the difference on initial measurement shall be charged to P&L. [Fair value of an
interest free long term loan is measured as the present value of all future cash receipts discounted
using the prevailing market interest rate for a similar instrument.]

Nasir Abbas FCA Page 3 | 5

 IFRS 9 (Recognition, Classification and Measurement) – Class notes

SUBSEQUENT MEASUREMENT [IGNORING IMPAIRMENT]

Financial assets

A financial asset which is an equity instrument of another entity

Types Treatment
(i) Equity investments which - At each reporting date, the asset shall be measured at fair value.
are not held for trading and, - Fair value gain or loss shall be recognized in other comprehensive
at initial recognition, entity income.
has made irrevocable - It is a non-monetary item, therefore, as per IAS 21, its related foreign
election for this treatment exchange gain or loss shall also be recognized in OCI.
[Fair value through OCI] - Cumulative gain or loss recognized in OCI, shall not be reclassified to
profit or loss on de-recognition of the asset. However, it may be
transferred within equity e.g. retained earnings.
- Any dividend shall be recognized in P&L.
(ii) All other equity - At each reporting date, the asset shall be measured at fair value.
investments - Fair value gain or loss shall be recognized in P&L.
[Fair value through P&L] - It is non-monetary item, therefore, as per IAS 21, its related foreign
(default measurement)
exchange gain or loss shall also be recognized in P&L.
- Any dividend shall be recognized in P&L.

A financial asset which is a financial liability of another entity (e.g. loans)

Types Treatment
(i) If asset is classified as - The asset shall be measured at amortized cost using effective
measured at amortized cost interest rate method.
- Interest income using effective interest rate shall be recognized in
P&L.
- It is a monetary item, therefore, as per IAS 21 its exchange gain or
loss shall be recognized in P&L.
- Any gain or loss on derecognition shall be recognized in P&L.
(ii) If asset is classified as - At each reporting date, the asset shall be measured at fair value with
measured at fair value any gain or loss recognized in other comprehensive income.
through OCI - Interest income using effective interest rate shall be recognized in
profit or loss (i.e. same as calculated in amortized cost).
- Any foreign exchange gain/loss on amortized cost measured in
foreign currency shall be recognized in P&L.
- Cumulative fair value gain or loss, previously recognized in OCI, shall
be reclassified to profit or loss on de-recognition of the asset.

(All amounts recognized in P&L would be the same which would have
been recognized had the asset been measured at amortized cost)

Nasir Abbas FCA Page 4 | 5

 IFRS 9 (Recognition, Classification and Measurement) – Class notes

(iii) If asset is classified as - At each reporting date, the asset shall be measured at fair value with
measured at fair value any gain or loss recognized in profit or loss.
through profit or loss - It is a monetary item, therefore, as per IAS 21 its exchange gain or
loss shall be recognized in P&L.
- Actual interest received is recognized in profit or loss.

Financial liabilities

Types Treatment
(i) If liability is classified as - The liability shall be measured at amortized cost using effective
measured at amortized cost interest rate method.
(default measurement) - Interest expense using effective interest rate shall be recognized in
P&L.
- Any gain or loss on derecognition shall be recognized in P&L.
(ii) If liability is classified as - At each reporting date, the liability shall be measured at fair value.
measured at fair value - Any change in fair value attributable to change in own credit risk is
through profit or loss recognized in OCI (Amount presented in OCI shall not be
subsequently transferred to P&L, however, the entity may transfer
the cumulative gain or loss within equity e.g. retained earnings). The
remaining amount of change in the fair value of the liability shall be
presented in P&L. However, if it creates or enlarges accounting
mismatch, then entire fair value gain or loss shall be recognized in
P&L.
- Actual interest paid is recognized in profit or loss.

Estimating change in fair value of liability attributable to change in own credit risk:
Multiple methods can be used to estimate the amount of change in fair value attributable to change in
own credit risk. If the only significant relevant changes in market conditions for a liability are changes
in an observed (benchmark) interest rate, the amount of change in fair value attributable to change in
own credit risk can be estimated in following steps:
1) First find “Instrument-specific component” of IRR of the liability as
= IRR of liability at start of period (i.e. a market rate of return which is calculated using fair value of
liability and the contractual cash flows at the start of the period) LESS observed benchmark interest
rate (e.g. KIBOR) at start of period

2) Calculate the amount of change to be presented in OCI as follows:

Rs.
Fair value of liability at end of the period XXX
Present value of contractual cash flows of liability at end of year discounted at “Year (XXX)
end KIBOR + Instrument-specific component (as calculated in Step 1)”
(Gain)/Loss to be recognized in OCI XXX

Nasir Abbas FCA Page 5 | 5