July 25, 2019
The global credit crunch/financial crises that began in 2008 and the recession that followed were largely blamed on the complex financial assets and liabilities introduced to the markets whose credit risks were not effectively captured by the financial reporting framework for financial instrument at the time (International Accounting Standard 39). The process to change this standard began immediately in 2009, with further amendments in 2010 and 2013. The new standard, International Financial Reporting Standards (IFRS) 9, was finally issued on July 1, 2014. The effective date for the new standard was then set at January 1, 2018 to give enough room for companies and businesses to study and assess the potential impact of the new standard on their statement of financial position (SOFP).
IFRS 9 is a response to criticisms that IAS 39 is too complex, inconsistent with the way entities manage their businesses risks and defers the recognition of credit losses on loans and receivables until too late in the credit cycle. The new standard brought major changes in the areas of classification and measurement of financial assets and liabilities, impairment of financial assets, hedging transactions and disclosure requirements.
This article explores some of the changes introduced by the new standard in accounting for financial assets and possible tax implications.
Classification and Measurement
Financial assets includes cash, investment in equity and contractual right to receive cash or another financial asset from another entity. Some examples of financial assets include trade receivables, loan receivables, equity investment, bond investments, fixed deposits, investments in treasury bills and commercial papers among others.
IAS 39 classified financial assets into four categories. These are Fair Value Through Profit Or Loss (FVTPL), Loan Receivable (LR), Held To Maturity (HTM) Assets and Available For Sales (AFS) Assets. FVTPL financial assets were assets held for trading on short-term basis or have been designated as such by management. All types of derivative investments were also classified as FVTPL. LR relates to financial assets brought about through the provision of money goods or services. Such assets must have fixed or determinable payment patterns, not traded in an active market and are usually fixed at maturity. HTM financial assets are similar to LR except that the holder intends to hold the investment to maturity and they may be traded in active market. AFS financial assets are those that could not be classified into the other three categories.
IAS 39 further provided that FVTPL and AFS financial assets should always be measured at fair value, while LR and HTM financial assets were to be measured at amortized costs using the effective interest method. The effective interest method uses the effective interest rate to allocate the amortized cost of the financial asset and allocate the interest income over the tenor of the asset. The effective interest rate is the rate that exactly discounts estimated future cash receipts through the expected life of the financial instrument to the net carrying amount of the financial asset.