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Accounting Standards Update Part III: AASB 9 (Financial Instruments)

Commencement Date: Reporting periods commencing on or after 1st January 2018

AASB 9 is applicable to the following businesses:

What is a financial instrument?
A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. Examples of financial assets include:

Examples of financial liabilities include:

Main implications of the new standard
AASB 9 Financial Instruments brings change to financial instrument accounting because it replaces AASB 139 Financial Instruments: Recognition and Measurement. Changes to this standard will impact the following four key areas:

  1. Classification and measurement of financial assets
  2. Impairment
  3. Hedge accounting
  4. Disclosure 

Classification and measurement
The former classifications (i.e., under AASB 139 Financial Instruments: Recognition and Measurement) were:

  1. Loans and receivables
  2. Held to maturity
  3. Available-for-sale
  4. Fair value through profit or loss

The two new classifications (i.e., under AASB 9) are:

  1. Amortised cost (using the effective interest rate method)
  2. Fair value through profit or loss

Which method do I use to value a financial instrument?

The new standard is based on the concept that financial assets should be classified and measured at fair value, with changes in fair value recognised in profit and loss as they arise (“FVPL”), unless restrictive criteria are met for classifying and measuring the asset at either Amortised Cost or Fair Value Through Other Comprehensive Income (“FVOCI”).An entity may make an irrevocable election at initial recognition for particular investments in equity instruments that would otherwise be measured at fair value through profit or loss to present subsequent changes in fair value in other comprehensive income. Unlisted equity instruments are expected to be measured at fair value under AASB 9. Where a quoted market price is not available, other methods such as discounted cash flows, earnings multiples, or similar recent sales should be used to value equity. Unlisted equity instruments should only be measured at cost in very rare circumstances.The following remain largely unchanged under AASB 9: 

Impairment - Applying the expected credit loss model to financial assets
The new model introduced by AASB 9 is an ‘expected credit loss model’, which recognises potential losses based on past, present, and forward-looking information. The approach of the new model is similar to the calculation and recognition of the general provision for doubtful debts. The model applies to debt instruments measured at amortised cost or FVOCI, such as lease receivables, trade receivables, and contract assets.
AASB 9 contains the following three approaches to assessing impairment:

  1. The simplified approach
  2. The general approach
  3. The purchased or originated credit-impaired approach

Simplified approach – applied to most trade receivables
This approach requires the recognition of lifetime expected credit losses based on forward-looking assumptions and information regarding expected future conditions affecting historical customer default rates. This approach may require grouping receivables into various customer segments based on similar loss patterns (e.g. by geography, product type, customer rating, or type of collateral).

General approach - applied to most loans and debt securities

Under this approach, expected credit losses ought to be recognised in two stages. 

  1. For credit exposures with no significant increase in credit risk since initial recognition (i.e., ‘good’ exposures), entities are required to provide for credit losses that result from default events ‘that are possible’ within the next 12-months. 
  2. For those credit exposures with a significant increase in credit risk since initial recognition, a loss allowance is required for credit losses expected over the remaining life of the exposure, irrespective of the timing of the default.

A critical issue is determining when a financial asset has a significant increase in credit risk. One indicator of an increase in credit risk is if payments are overdue by more than 30 days. The standard provides further guidance.

The purchased or originated credit-impaired approach
The fair value at initial recognition of purchased or originated credit-impaired receivables already considers lifetime expected losses. At each reporting date, the entity updates its estimated cash flows and adjusts the loss allowance accordingly.Under each of the above approaches, the loss allowance reduces the carrying amount of the financial asset, rather than recognising an impairment loss as a separate ‘provision’ against the gross value of a receivable.

Although the core principles and purpose of hedge accounting have not changed, AASB 9 simplifies it. For the sake of this article, though, we will refrain from elaborating on this simplification.

Transition to the New Standard
AASB 9 contains a general requirement that the Standard be applied retrospectively. However, AASB 9 does permit preparers to adjust retained earnings on the date of initial application rather than restate comparatives. Ashfords foresees this being the preferred approach for most. Various other special transition provisions apply, also.

AASB 9 includes a number of significant disclosure requirements in the first year of adoption. Some of these are outlined below.For each class of financial asset and liability, the following should be disclosed:

For financial assets and liabilities reclassified to amortised cost and, in the case of financial assets, reclassified from FVTPL to FVOCI:

Ashfords can advise you on how AASB 9 will directly impact your business’ financial statements and provide resources to ensure you comply with the new standard. Contact Ashfords on (03) 9551 2822 to arrange a meeting to discuss how this standard will impact your business.

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