Table of contents
1.1 Research interest & Research question
1.2 Objective of the examination
1.4 Current state of research
2 Description of the methodical approach
3 International Financial Reporting Standards
3.1 Principles of the International Financial Reporting Standards Framework
3.2 Main amendments
3.2.1 Phase I – Classification and Measurement
3.2.2 Phase II – Amortised Cost and Impairment
3.2.3 Phase III – Hedge Accounting
3.3 Valuation, classification and measurement under IFRS 9 and IAS
3.3.1 Financial Assets
3.3.2 Financial Liabilities
4 Balance Sheet and Profit-and-Loss Account 36
4.1 Asset Liability Management
4.1.1 Individual consideration of the profit-and-loss account
4.1.2 Overall view of the balance sheet
4.2 Risk Management
5 Banking products on the liability side and annual statement analysis
5.1 Deposits from customers
5.1.1 Terms and conditions
5.1.2 Influencing factors and impact factors
5.2 Deposits from banks
5.2.1 Terms and conditions
5.2.2 Influencing factors and impact factors
5.3 Own issuance
5.3.1 Terms and conditions
5.3.2 Influencing factors and impact factors
5.4 Annual statement analysis
5.4.1 Raiffeisen Bank International Aktiengesellschaft
220.127.116.11 Deposits from customers
18.104.22.168 Deposits from banks
22.214.171.124 Own issuance
5.4.2 Erste Group Bank Aktiengesellschaft
126.96.36.199 Deposits from customers
188.8.131.52 Deposits from banks
184.108.40.206 Own issuance
5.5 Summary of the main differences between RBI AG and Erste
List of abbreviations
Abbreviation Meaning / Explanation
Abbildung in dieser Leseprobe nicht enthalten
The introduction of this master thesis outlines the research interest and research question. Furthermore, the objective of the examination, the relevance and the level of research regarding the topic of IFRS 9 is described.
1.1 Research interest & Research question
Apart from applying the International Accounting Standards (IAS) 39, the execution of practical implementation of the International Financial Reporting Standards (IFRS) 9 must be finalised as of January 1st of 2018. According to the press release of the International Accounting Standards Board (IASB) in November 2009, the main objectives of IFRS 9 were divided into three phases. The first phase includes alterations regarding the classification and measurement. In contrast, phase two deals with amortised cost and impairment, whereas the third phase focuses on hedge accounting (International Accounting Standards Board 2009, 1).
This paper aims to give an overview on the relevant changes regarding IFRS 9. However, the main focus is set at the liabilities side, the classification and the measurement of financial liabilities. Although the IASB intended to create a model in order to classify financial instruments of both the asset and the liabilities side, it had to prioritise the asset side owing to the financial crisis and the demand for new regulations in 2009. Therefore, the research context considers the adjustment of the fair value option (FVO) treatment. Due to the new regulation, changes in the own credit spread or rather the creditworthiness need to be captured under the position “other comprehensive income” (OCI), which affects the net income. Unless the financial liability is designated as FVO, the subsequent measurement of the liability follows amortised cost (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2011, 35f.).
However, choosing the FVO implies that once the change in the credit spread has been recorded under the OCI, the amount is not reclassified into the profit-and-loss account (P & L). In contrast to that, a reclassification is permitted within equity e.g. a financial liability designated at FVO that is derecognised (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 15f.).
The reason for the new regulation is based on IAS 39 and the measurement of liabilities in regard to the credit spread. Although, the creditworthiness deteriorated during the financial crisis, financial institutions had to realise the increasing credit spread in the P & L as an earning and a decreasing fair value (FV) of the liability. This mixed-model approach is a reason for the volatility in P & L’s and has been revised in the course of the IFRS 9 (Becker and Wiechens 2008, 625f.; Lane and Kennedy 2015).
With the mandatory implementation of the new set of regulations 2018 onwards, the central question is as follows:
“What is the impact of IFRS 9 regarding liabilities?”
1.2 Objective of the examination
Due to the fact that IFRS 9 has been valid since the beginning of 2018, the aim of this research is to define the consequences of moving from amortised cost (AC) to FV measurement. Consequently, the valuation principles for liabilities based on IFRS 9 are described and three banking products on the liability side (deposits from customers, deposits from banks and own issuances) are evaluated. Moreover, a comparison of these banking products in terms of conditions and measurement before and after the introduction of IFRS 9 shall provide examples to determine whether applying the FVO is necessary. Therefore, the consolidated financial statements of Raiffeisen Bank International Aktiengesellschaft (RBI AG) and Erste Group Bank Aktiengesellschaft (Erste Group AG) in 2017, 2018 and the interim report of the first quarter of 2019 are examined.
The most relevant reason for the composition and introduction of the IFRS 9 is attributable to the financial crisis. Several global and domestic systemically important banks, amongst other Goldman Sachs, faced difficulties during the economic downturn. According to a “The New York Times” article published by Jenny Anderson and Landon Thomas Jr. in November 2007, Goldman Sachs was the only bank being able to forecast mortgage risk. However, Goldman Sachs continued selling risky mortgage securities to its investors in order to reduce speculative assets in their portfolio. Further, the bank decided to buy an insurance for the case of future losses. While Goldman Sachs had the highest write-downs amounting to USD 1.5 billion, it still managed to achieve a profit of USD 2.85 billion in the third quarter by selling risky mortgage securities to other banks such as Merrill Lynch, Citigroup and Morgan Stanley (Anderson and Thomas Jr. 2007).
In 2008, Ben Whitedec’s article in “The New York Times” dealt with Goldman Sachs and its quarterly loss of USD 2.1 billion. While it was able to manage the mortgage risk in 2007, Goldman Sachs did not consider the declining tendency in the global equity markets. As a result, the trading and investment business lost USD 4.36 billion and Goldman Sachs’ long-term senior debt ratings were downgraded from Aa3 to A1 by Moody’s, which led to a drastical shortening of compensations, expenses and benefits (Whitedec 2008).
Nevertheless, IFRS provides a framework for accounting and considers two characteristics, relevance and reliability and their interaction. On the one hand, an accounting department is allocated the task to deliver relevant information, which is from an investor’s point of view information concerning the near future. On the other hand, it prescribes the necessity for accounting to publish reliable information. As no precise prediction exists for the future, a distinction must exist between the use of fair value and historical costs (Blecher 2018).
Moreover, transparency and comparability of data is important for a sound banking supervision in accordance with the regulations, as IFRS is only valid for stock-listed banks in the European Union (Boissieu 2017, 86). In addition, the new regulations of IFRS also intend to simplify the comparison between European reporting standards and the United States Generally Accepted Accounting Principles (US-GAAP) (Kobialka 2017, 226). Although this paper is relevant for capital market oriented companies, it also addresses potential users such as shareholders, lenders, customers, suppliers and other stakeholders interested in the topic of IFRS 9 (Müller and Saile 2018, 17).
1.4 Current state of research
The advantages and disadvantages of the introduction of IFRS 9 are handled in various books and publications. A key reason for the mandatory applicability of IFRS 9 was the complex and detailed rules of IAS 39 regarding financial assets. In addition, the FV valuation is referred to as the result for the financial crisis. Therefore, IFRS 9 shall facilitate accounting and improve the issue of FV determination and cost accounting (Kobialka 2017, 225f.).
In an article written by Christian Blecher, the topic of FV and cost accounting is discussed. The author claims to have observed that a FV might be manipulated whereas cost accounting usually is not affected. In such cases it is difficult to evaluate whether the future turns out as favourably as forecasted (Blecher 2018).
On grounds of the previously mentioned, IFRS 9 aim to simplify accounting rules and enable comparison between others. In addition, subsequent measurement has also been facilitated as IAS 39 allowed for various valuation procedures and an undefined number of input parameters, while IFRS 9 have specified formulae, enabling verifiability (Kirsten 2016, 195f.).
However, the previously conducted research shows different outcomes regarding the FV treatment. According to an essay written by Klaus Becker and Gero Wiechens, financial institutions were able to take advantage of the FVO due to increasing credit spreads in 2017. Nevertheless, there is still a vast variety of spreads, e.g. funding spread or credit default swap spread, which leaves room for flexibility and the lack of comparability. An additional matter discussed in the essay is the interaction between an increasing credit spread and a decreasing FV which does not have an effect on the asset side but on the equity (Becker and Wiechens 2008, 627ff.).
Another research conducted by Wei Wu, Nicole Thibodeau and Robert Couch aimed to evaluate if the usage of the FVO favoured adverse selection during the financial crisis. The results showed that mainly companies exposed to financial problems were opting for the FV approach in order to achieve income despite rising credit spreads (Wu, Thibodeau and Couch 2016, 474).
In contrast to that, the descriptive study from Felix Schneider and Duc Hung Tran provided a completely opposite result. The study focuses on European banks from 2006 to 2010 and indicates that the FVO does not come along with high credit spreads but rather shows lower bid-ask spreads compared to banks not using the FVO. Even though the FVO does not influence the level of transparency, it is also mentioned that the paper is only descriptive and the identification of effects solely regarding the FVO are difficult (Schneider and Tran 2015, 1007f.).
Furthermore, a study of Brian Bratten, Monika Causholli and Urooj Khan discusses the usage of the FV and the relevance of the OCI. The findings indicate that the OCI based on the FV supports the estimation of earnings for the time horizon of one to two years. Moreover, the FV approach delivers information in order to meet reporting standards (Bratten, Causholli and Khan 2016, 310).
However, Dominic Detzen’s paper criticises the OCI as the interpretation relies on the utilisation of standard setters. In addition, the OCI is seen as a position for volatility and lacks definition and guidance which might favour going against the regulations (Detzen 2016, 777f.).
2 Description of the methodical approach
The method design includes three points. To begin with, the consolidated financial statements of 2017, 2018 and the interim report for the first quarter of 2019 from RBI AG and Erste Group AG are analysed and compared to each other regarding the classification and measurement of liabilities. In addition to that, the measurement and the treatment of the three banking products before and after the introduction of the new regulations are compared to the results of RBI AG and Erste Group AG. This indicates that a concrete example is evaluated from a theoretical point of view and afterwards compared to the results from the annual statements of banks. Therefore, following contents of the consolidated financial statements are illustrated:
- statement of comprehensive income
- statement of financial position
- statement of financial position according to the measurement categories
- composition of each liability
- breakdown of maturities
As IFRS 9 is mandatory since 2018, it is reasonable to assume that publications of consolidated financial statements meet the requirements of IFRS 9.
3 International Financial Reporting Standards 9
As companies tend to increase international presence through opening subsidiaries abroad, the demand to refinance the business occurs throughout capital markets. In order to facilitate globalisation, financial statements need to be transparent and comparable, resulting in time and cost reduction. Furthermore, the banking sector benefits from standard guidelines as it obtains funds but also lends loans to private customers and businesses. However, it is important to point out that financial accounting depends on national, international and European standards. The IFRS and the accounting method, which is defined by the European Union in 2005, is obligatory for capital market oriented companies (PricewaterhouseCoopers Aktiengesellschaft Wirtschafts-prüfungsgesellschaft 2017a, 177f. and 181).
3.1 Principles of the International Financial Reporting Standards Framework
In general, the system of IFRS is split into the framework, the standards including IFRS and IAS, the interpretation of the International Financial Reporting Interpretations Committee (IFRIC) and the Standard Interpretations Committee (SIC). This chapter focuses on the framework and reflects the theoretical input of the financial accounting standards (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 295 and 297).
The principles of the IFRS framework are described in the IAS 1 and focuses on the presentation of financial statements. This chapter highlights the most relevant principles such as:
- the fair presentation and compliance with IFRS,
- the going concern principle,
- the accrual basis of accounting,
- the materiality and the aggregation,
- the offsetting,
- the frequency of reporting and
- the comparative information (Müller and Saile 2018, 14).
First of all, IAS 1.15-24 aims for a fair presentation and compliance with IFRS, which is also considered as true-and-fair-view-principle. This fair presentation is relevant for the financial position, financial performance and cash flows. However, this generally described standard further requires to apply the accounting policies, changes in accounting, estimates and errors set in the IFRS 8 (Müller and Saile 2018, 14).
Secondly, the framework sets in IAS 1.25-26 the going concern principle leading managers to make assumptions about the future development of the business at least for the next twelve months starting from the latest reporting period. However, if a company intends to dissolve its business the principle is ineffective (Müller and Saile 2018, 19).
Furthermore, the accrual basis of accounting in IAS 1.27-28 is of relevance for assets, liabilities, equity and income and expenses. Therefore, this principle sets the definitions and requirements for the categorisation (Müller and Saile 2018, 20). In addition, materiality and aggregation considers relevant information for accounting and the merge of similar items based on the materiality. Nevertheless, this principle shown in IAS 1.29-31 is not allowing for covering up unfavourable conditions in order to manipulate financial statements (Müller and Saile 2018, 15f.).
Regarding the items, IAS 1.32-35 prescribe that assets cannot net liabilities out which as well applies to income and expenses. While certain exceptions for offsetting made by IFRS might exist, materiality plays an important role insofar as it allows for aggregation of similar items, for instance gains and losses resulting from currency conversion (Müller and Saile 2018, 23).
The framework requests a company to publish financial statements at least yearly according to IAS 1.36-37 (Müller and Saile 2018, 23). Further, IAS 1.38-44 focus on comparative information. In this case, it requires to include figures and other relevant information of the previous reporting period into the financial statement. Whereas these are the minimum comparative information, further details are provided for additional comparative information as well as for change in accounting policy, retrospective restatement or reclassification (Institut der Wirtschaftsprüfer 2018, 231).
Finally, IAS 1.45-46 are also of relevance with regards to the comparative information concerning the presentation of financial statements. As a result, the presentation of financial statements shall be consistent and thereby facilitate the comparability of previous reporting periods (Müller and Saile 2018, 22).
3.2 Main amendments
With the financial crisis the IASB faced the demand for a review of the existing standards, especially IAS 39 regarding the recognition and measurement of financial instruments. The process started with the “IAS 39 Replacement Project” in November 2008 with the main focus at enabling comparability of financial statements under IFRS and reduce complexity for the accounting of financial instruments (Sagerschnig 2016, 3).
However, the initial version of IAS 39 which is known as interim standard, was published in 1999 by the International Accounting Standards Committee (IASC). Even before the financial crisis, IAS 39 was considered as a complex issue and the IASB and the Financial Accounting Standards Board (FASB) released a “Memorandum of Understanding” which aimed at establishing generally valid accounting standards for the capital markets. As a result, the consultation paper “Reducing Complexity in Reporting Financial Instruments” was rolled out by the IASB and FASB in March 2008 (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2011, 3f.).
In addition to the comparability and reduction of complexity, a further aim of IFRS 9 is to follow a principle-based model instead of a rule-based model for classifying financial instruments. Furthermore, the business model and the contractual cash flows are considered. Regarding the changes for impairments, expected losses are included allowing to improve the quality of risk management. Finally, inconsistencies between risk management and hedge accounting are removed (Sagerschnig 2016, 3).
Due to the length and the various contents of the project, the IASB decided to split the topics in the following three phases: classification and measurement, amortised cost and impairment and hedge accounting (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 2).
3.2.1 Phase I – Classification and Measurement
Phase one discusses the classification and measurement of financial assets and liabilities. To begin with, the initial recognition is described in IFRS 220.127.116.11 and states that a financial asset or liability is solely recorded if a contracting party of the financial instrument exists. In addition, the paragraph refers to the standards in IFRS which set the classification and measurement of financial assets and liabilities (Sagerschnig 2016, 4).
In regard to financial assets, two main adjustments are made: the establishment of the business model and the contractual cash flow. To begin with, the business model is assessed on an aggregated level. As a result, the aim of a group of financial assets is of relevance instead of considering the objective of a single financial asset. Furthermore, it is required to assess the business model itself which can be deemed as a discretionary decision as any relevant fact or circumstance needs to be considered e.g. evaluating the efficiency of business model or risks affecting the business model and financial instruments. In addition, the contractual cash flows are introduced for the classification of financial instruments. Within the business model, three approaches for the contractual cash flows are distinguished: amounts allocated to the revenue resulting from contractual cash flows of financial assets held, selling financial assets to achieve contractual cash flows and a combination of the first and second approach (Deloitte & Touche GmbH Wirtschafts-prüfungsgesellschaft 2014, 6).
Consequently, a financial instrument is categorised in line with the business model and the contractual cash flow. While IAS 39 offered four classification categories, IFRS 18.104.22.168 allow only for two or alternatively for three classification categories depending on the interpretation. However, this paper considers three classification categories for financial assets which are AC, fair value through other comprehensive income (FVOCI) and fair value through profit and loss (FVTPL) (Deloitte & Touche GmbH Wirtschaftsprüfungs-gesellschaft 2011, 9). Consequently, IAS 39.45 and its classification categories fair value through profit or loss, held to maturity (HTM), loans and receivables (L&R) as well as available for sale (AFS) are adapted or called off (Müller and Saile 2018, 145).
With regard to the measurement of financial assets, IFRS 22.214.171.124 set the measurement at AC for financial assets based on two conditions. First of all, the business model aims to achieve contractual cash flows by holding assets and secondly, the contractual term is of relevance for the dates when payments of the principal and interest are paid on the principal amount outstanding. Due to the definition, equity instruments and resulting dividend payments are excluded from this measurement. Furthermore, the measurement at AC requests that both the business model and the contractual cash flow criteria are met. In case a criterion is not met according to the standard, the measurement is at FVTPL in line with IFRS 126.96.36.199 (Deloitte & Touche GmbH Wirtschaftsprüfungs-gesellschaft 2011, 10).
Apart from that, if the business model aims to achieve revenues from the contractual cash flows of assets held and intends to sell assets, the financial asset is measured at FVOCI. The prerequisite, however, is that the contractual term of the dates when payments of the principal and interest are paid on the principal amount outstanding is fulfilled. This method is equivalent to the contractual cash flow of financial assets measured at AC (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 8).
With reference to the business model, financial assets that are initially held for the purpose of generating contractual cash flows may be sold occasionally. This does not require the adaption of the business model but rather depends on the available information considered for the initial categorisation. Should such sales be regularly conducted, resulting in a considerable amount and lacking an appropriate explanation for frequent execution, a reconsideration of the business model is advisable (Deloitte & Touche GmbH Wirtschaftsprüfungs-gesellschaft 2014, 6f.).
In comparison to that, a business model that intends to hold and sell financial assets in order to receive contractual cash flows is not demanded to review previously conducted sales. The reason for defining such a business model comply with guidelines dealing with liquidity or interest income (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 8f.).
With regard to the business model, there is another approach to collect, focusing on financial instruments intended for dealing e.g. holding a financial asset and selling it after a time where the possibility exists to achieve profit. Most likely these transactions are settled on a short-term basis but also a derivative can be used. Consequently, financial assets or liabilities are measured at FVTPL (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 8).
Additionally, the contractual cash flow condition and its specifications impact the measurement of a financial asset. As described, the contractual terms define a date at which payments of the principal and interest are paid on the principal amount outstanding. This definition is valid for cash flows generated from basic lending arrangements. The two relevant components for the contractual cash flow are the notional amount and interest. The notional amount is measured for initial recognition at FV. However, a redemption which leads to a decrease in the notional amount is not influencing the contractual cash flow condition. Considering the interest, it solely compensates for the time value of the money, the default risk which occurs from the principal amount outstanding and the costs resulting from basic lending arrangements e.g. administration costs or margins (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 9f.).
Nevertheless, there are a few features to consider in order to assure that the contractual cash flow condition is fulfilled. In regard to the time value of the money, the interest rate might have an effect if interest is set for a year but the fixing is carried out monthly. Deciding on the significance and a possible modification of the time value of the money is conducted by a qualitative or respectively quantitative analysis. Assuming that the difference between the actual and the unmodified cash flows for the reporting period and the remaining time is considerable, the measurement follows neither AC nor FVOCI but FVTPL (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 10).
In addition to the time value of the money, the amount and the date of the payments might change. Therefore, the contractual cash flow must be reviewed unless it solely includes payments of the principal and interest paid on the principal amount outstanding. Assuming a premature resignation exists, the contractual cash flow is valid if the FV of the right of cancellation is insignificant at the point of taking the asset. Therefore, a prematurity compensation payment is acceptable (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 11).
In terms of significance, the contractual cash flow is also fulfilled considering contractual terms which are characterised as “de minimis” and “not genuine”. “De minimis” result in a small effect, whereas “not genuine” illustrates that the contractual term is not “de minimis” but the probability of occurrence is very unlikely (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 11).
Another aspect to consider is the contractually linked instrument. While the business model follows IFRS 9, the contractual cash flow includes further criteria which have to be fulfilled in terms of the reallocation of credit risk. In case the conditions are met, the financial instrument is measured at AC; otherwise at FV affecting the P & L (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2011, 20).
Nevertheless, even if the business model and contractual cash flow are set at AC, it is still possible to switch to FV. This is only allowed under the condition of an accounting mismatch, or with other words, that financial assets might be measured at AC while financial liabilities are measured at FV. However, the switch to the FVO is solely permitted at initial recognition and is non-reversible (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2011, 25f.).
Besides the FVO, the FVOCI is allowed to be exercised for equity instruments since the contractual cash flow condition is not met. Unless the option is exercised, the measurement is at FV. As a result, changes in the FV are recorded in the OCI instead of the P & L. Nevertheless, an equity instrument is permitted to be designated as FVOCI if no trading purpose exists (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 13).
The switch from FV to FVOCI is conform with the requirements of the FVO. In this case, the FVOCI is only allowed at the initial recognition and this option right cannot be reversed. However, dividends must be recorded in the P & L (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2011, 31).
In regard to embedded derivatives, IFRS 9 do not demand for a separation of the derivative from the host contract if the financial asset is connected to the contract (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2011, 34). Finally, if the business model changes, the financial asset must be reclassified. The reclassification is conducted prospectively and thereby leads to a new business model for the reporting period on the date of the reclassification (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 14).
Besides the classification and measurement of financial assets, the focus is set on financial liabilities which are also affected by the alterations within phase one. While the IASB initially aimed to develop a symmetrical model for the classification of financial assets and liabilities, the priority has been redirected on financial assets owing to the financial crisis in 2008. Nevertheless, the issue of classifying financial liabilities started in 2010 (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2011, 35).
In comparison to financial assets, the amount of changes for financial liabilities is less significant and most parts of IAS 39 are still valid in IFRS 9. The classification and measurement is either at AC or FVTPL (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 15).
Nevertheless, IFRS 188.8.131.52 (a)-(d) list the exceptions for which the FVTPL needs to be used. First of all, it affects financial liabilities held for trading, derivatives showing a negative FV and all financial liabilities for which the FVO is exercised. Secondly, it includes financial liabilities resulting from a transmission of financial assets. Consequently, financial liabilities are measured at FVTPL in case a write-off is not possible or the liability is intended for a continuing involvement. Therefore, IFRS 184.108.40.206 and IFRS 220.127.116.11 set special arrangements regarding the measurement. The third exception are financial guarantee contracts. These contracts are measured at the higher amount for the initial recognition applying IAS 37 or IAS 18, respectively. Furthermore, the guarantor is obliged to pay a fixed amount if losses occur due to the guaranteed debt instrument. Finally, the FVTPL is applied to loan commitments set below the market interest rate. The measurement is conducted equally as for financial guarantee contracts (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2011, 36).
In regard to the FVO, the possibility to opt in is still as it was defined in IAS 39. By applying the FVO, accounting mismatches are eliminated. Further, financial assets respectively financial liabilities are grouped according to the risk strategy or investment strategy in order to analyse the development of the FV. The results are usually communicated to key positions within the company such as the management and the supervisory board (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2011, 37).
While the separation of the derivative from the host contract is not required for financial assets, financial liabilities are treated differently. Therefore, an embedded derivative is split from the host contract as under IAS 39. The separation also impacts the measurement. While the embedded derivative is measured at FVTPL, the host contract is measured at AC for which the effective interest rate method is applied (Sagerschnig 2016, 11f).
The separation of an embedded derivative and the host contract is required if one of three conditions are met. First of all, the separation is conducted for embedded derivatives that are not closely linked to the economical characteristics and risks of the host contract. Secondly, if an independent instrument shows the same contract conditions as the derivative and thirdly, if the structured product is not measured at FV (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2011, 37f.).
Additionally, the new amendments affect the FVO in regard to the financial liabilities. The relevant aspect of the FVO before the alteration is the deterioration of the own financial standing and the influence on the rating. However, this decrease would still result in an income in the P & L. In accordance with IFRS 18.104.22.168 financial liabilities measured at FV are captured in the P & L and the change in the FV occurred through the own creditworthiness is recorded under the OCI which is adjusted by equity (Sagerschnig 2016, 10).
The IASB decided to adjust the previously applied approach in order to avoid effects on the income temporarily. This was due to the fact that solely a scheduled redemption results in the rebooking of income which initially is attributable to the deterioration of the own creditworthiness. Nevertheless, this separation into the P & L and OCI is only allowed for the own creditworthiness unless an accounting mismatch evolves, otherwise all changes in the FV are recorded in the P & L. Therefore, other financial instruments measured at FVTPL are not intended for the OCI such as financial liabilities held for trading and derivatives as well as financial guarantee contracts and loan commitments (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2011, 39ff.).
Once the change in the own creditworthiness is recorded in the OCI, a reclassification to the P & L is not allowed even if the financial liability is written off. The amounts booked in the OCI may be reclassified into the equity as accumulated other comprehensive income if required instead. As the change of the own creditworthiness reflects the default risk, it is necessary to distinguish this risk from the settlement risk regarding financial assets. The default risk is the risk of the contracting party not meeting the obligations regarding the financial instrument. As a result, the other contracting party might face a loss. In contrast, the settlement risk arises if the financial liability is either linked to the financial asset through contractual terms or its value depends on the financial asset due to a ring-fencing (Deloitte & Touche GmbH Wirtschafts-prüfungsgesellschaft 2011, 39).
Furthermore, the highlight on the own creditworthiness is considered as the residual amount which cannot be traced back to market changes. Consequently, unfavourable changes in the market such as the reference interest rate, prices of financial instruments of other companies or commodity prices are booked into the P & L (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2011, 39).
In case the FV of the financial liability solely changes due to the market risk or rather the movement of the market interest rate, it is advisable to determine the residual amount caused by the own creditworthiness applying the standard approach. As a result, the credit spread is described as the FV at time zero and the contractual cash flows are considered in order to set the return from which the reference interest rate is subtracted and leads to the credit spread for the instrument. Afterwards, the contractual cash flows are divided by the sum of credit spread for the instrument and the reference interest rate resulting in the present value of the contractual cash flows. Finally, the change in the own credit spread is determined as the difference between the FV and present value of the previously calculated contractual cash flows (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2011, 39f.).
Furthermore, reporting duties are more demanding and detailed. The disclosures on financial instruments stated in IFRS 7 are adapted to the new standards of IFRS 9. The main enhancements are made for financial liabilities regarding the FV in accordance to IFRS 7.10-11. and financial assets in terms of the FVOCI. Additionally, reporting duties are widened in case if the business model changes e.g. the change regarding the timing, the amount and the occasion for the change to the new business model (Sagerschnig 2016, 12).
3.2.2 Phase II – Amortised Cost and Impairment
The second phase of IFRS 9 deals with amortised costs and impairments. The reason for the renewed standards can be traced back to the incurred loss model of the IAS 39. Due to the usage of this model, impairments for loans are only recognised if there is a triggering event. Consequently, this approach favoured the extent of the financial crisis. In order to counteract this outcome, the new impairment model called the expected credit loss model (ECL) was introduced in 2014 as a part of IFRS 9 (Sagerschnig 2016, 12f.).
The ECL is applicable for financial assets which are measured at AC and FVOCI, loan commitments and financial guarantee contracts unless the measurement is at FVTPL, lease receivables in line with IFRS 17 as well as contract assets for which IFRS 15 is used (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 16).
According to IFRS 9.B5.5.7 the previously required triggering event is not relevant anymore, consequently, the significance of the default risk is given despite changes in the creditworthiness or occurring defaults (Institut der Wirtschaftsprüfer 2018, 1793).
Moreover, the ECL implies a three-stage approach. Generally, financial instruments are categorised at stage one at the initial recognition. Furthermore, they belong to stage one if there is an internal rating. For stage one the loss allowance is determined by the 12-month expected credit loss. Further, the gross book value is required for the calculation of the interest income. However, stage two is applied if no internal rating exists for the financial instrument. Another circumstance are substantial changes in the amount due to the deterioration of creditworthiness in regard to the subsequent measurement. While the calculation of the interest income is equal to stage one, the 12-month expected credit losses are replaced by the lifetime expected credit losses. Consequently, during the remaining period of the financial instrument, the present value of the expected losses is evaluated (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 16f.; Institut der Wirtschaftsprüfer 2018, 1625; Sagerschnig 2016, 15).
Finally, if the financial instrument is significantly affected by a default risk and an objective evidence for the impairment exists, the categorisation follows stage three of the ECL for which the lifetime expected credit losses are considered. In contrast to stage one and two, the interest income is calculated on the net book value (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 17).
Additionally, the ECL is reviewed on the reporting date to assure that each financial instrument is appropriately categorised. The decisive factor for the switch between stage one and two is the probability of default (PD) for the outstanding period – also referred to as the lifetime PD. In order to distinguish between the stages, it is necessary to define the term default. While this task is assigned to the internal risk management of the company, it usually considers 90 days overdue. Additionally, a comparison between the PD at initial recognition and the PD at the reporting date is carried out to evaluate if a change in the default occurred. The extent to which it is possible, each financial instrument is evaluated separately. However, if real-time identification is not feasible, the review is carried out as a portfolio to avoid defaults in payment. Nevertheless, the above described approach is avoidable if the financial instrument is investment graded. In addition, the 12-month PD may be used if the lifetime PD is less relevant. Finally, financial instruments are transferred to stage two if contractual payments are 30 days overdue unless there is proof of insignificance (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 17f.).
In regard to the reporting date, a financial instrument categorised into stage two is transferred to stage three due to objective evidence of impairment. A few objective evidence are for instance financial difficulties faced by the debtor, breach of agreement related to a default payment, the possibility to become insolvent or face a restructuring process. Moreover, accounts receivables, lease receivables and contract assets are automatically categorised into stage two, thereby requiring the application of the lifetime expected credit losses. While a transfer to stage three in case of an objective evidence of impairment is mandatory, downgrading to stage one is not allowed. Nevertheless, if there is an objective evidence of impairment for the financial instrument, the expected instead of the contractual cash flows are taken into account. Further, the expected loss at the initial recognition is used and changes are solely booked into the P & L for the remaining time (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 19f.).
In order to estimate the expected loss, several aspects are considered. First of all, all available information including those from the past, present and the future are relevant. The information used refers not only to the debtor but also to economic factors. Secondly, the expected cash flows are relevant for the definition of the expected loss. For the calculation of the expected loss, the present value of the expected cash flow on the one hand and the income which results from selling securities on the other hand is subtracted from the present value of the contractual cash flows. Furthermore, a scenario analysis is applied to determine the expected value. Consequently, the expected value is illustrated with or without default. In addition, the discount factor is dependent on the financial instrument. Generally, the calculation of the effective interest rate differs for fixed and variable interest rates. For fixed income instruments, the effective interest rate equals the discount rate used for the present value at initial recognition. In contrast to that, the effective interest rate for an instrument with variable interest is set by the current effective interest rate. The calculation requests parameters such as the PD, exposure at default (EAD) and the loss given default (LGD), however, credit loss rates are also considered to estimate the expected loss in regard to the 12-month expected credit losses. It is important to point out that the 12-month expected credit losses is not the loss in the next twelve months but rather corresponds to the expected loss for the outstanding time and a PD in the next twelve months (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 20f.).
3.2.3 Phase III – Hedge Accounting
Finally, the third phase of IFRS 9 discusses the topic of hedge accounting which was published in November 2013. One of the objectives is to connect hedge accounting to the risk strategy of the company. As a result, the objective set in IFRS 22.214.171.124 considers hedge accounting as a feature in the risk management and aims to manage exposures which could impact the P & L. Therefore, risk management that carries out hedges intends to illustrate the effect on the financial instruments used. Due to that, the traceability between risk management and hedge accounting has been improved (Institut der Wirtschaftsprüfer 2018, 1639; Sagerschnig 2016, 18f.).
However, hedge accounting is only permitted if the prerequisites are met. In accordance with IFRS 126.96.36.199 both a hedge instrument and hedge item must be eligible in order to generate a hedge relationship. Furthermore, a documentation of the procedure and designation of hedge instrument and hedge item is requested. Additionally, the risks which are intended be hedged, the risk management strategy and the effectiveness of the hedge must be described. In contrast to IAS 39, the focus of IFRS 9 are set on the risk management and its objective which consequently might result in the termination of a hedge relationship in case risk management is affected negatively (Institut der Wirtschaftsprüfer 2018, 1645 and 1647; Sagerschnig 2016, 19).
A further amendment in this phase is non-derivative financial instruments used as a hedge instrument under the condition that it is categorised as FVTPL. However, there is one exception in regard to non-derivative financial liabilities measured at FVTPL in accordance to IFRS 188.8.131.52. With respect to the classification and measurement in phase one, changes in the own creditworthiness are booked in the OCI whereas the residual amount is transferred into the P & L. Due to the consideration of the OCI and P & L, the financial instrument cannot be classified as hedge instrument as the change is not considered entirely in the P & L (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 22; Institut der Wirtschaftsprüfer 2018, 1641; Sagerschnig 2016, 20).
In terms of the hedged item, IFRS 9 allow to group non-derivative and derivative financial instruments as exposure. Further, IFRS 184.108.40.206 categorise recorded assets and liabilities, unrecognised firm commitments, transactions to be carried out with a high probability or net investments as hedge instrument (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 22; Institut der Wirtschaftsprüfer 2018, 1643; Sagerschnig 2016, 20).
With the introduction of IFRS 9, changes are made in regard to the hedge effectiveness. While IAS 39 requested the hedge effectiveness to be ranged between 80 % and 125 %, IFRS 220.127.116.11(c) require an economical connection between the hedge item and hedge instrument, the credit risk not to significantly affect the hedge relationship and a documentation of the hedge ratio (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2014, 22; Institut der Wirtschaftsprüfer 2018, 1645 and 1647; Sagerschnig 2016, 20).
Furthermore, if the hedge relationship shows a hedge ineffectiveness although the aim of the risk management remains unchanged, IFRS 18.104.22.168 state that the hedge ratio and the hedge relationship need to be adapted. In contrast to this approach of rebalancing in IFRS 9, IAS 39 required the termination and the correct designation of the hedge relationship (Institut der Wirtschaftsprüfer 2018, 1649; Sagerschnig 2016, 21).
With respect to the cut-off of hedge relationships, the option to voluntary discontinue the hedge relationship is not provided anymore. In fact, the hedge relationship stops if the adaption is not carried out or if there is an expiration, termination or sale in accordance with IFRS 22.214.171.124 (Institut der Wirtschaftsprüfer 2018, 1649; Sagerschnig 2016, 21).
Due to the changes, IFRS 7 and its disclosure requirements needed an enhancement. IFRS 7.21A describe relevant aspects regarding the topic of risk management strategy and risks involved. While IFRS 7.22B-22C focus on the quantitative characteristics such as the influence of hedging on future cash flows, IFRS 7.24A-24F summarise the effect of hedge accounting for the financial positions (Institut der Wirtschaftsprüfer 2018, 1485ff. and 1491ff.; Sagerschnig 2016, 22).
3.3 Valuation, classification and measurement under IFRS 9 and IAS 39
With regards to the main amendments, this paper also describes the general valuation principles as well as classification and measurement of financial instruments on the asset and liability sides. Due to the fact that IFRS 9 affect basically almost the same area of application as IAS 39 except for the changes made, this chapter provides a compromised overview of the balance sheet items. Furthermore, applying IFRS 9, IAS 32 dealing with the presentation and IFRS 7 stating the disclosure of financial instruments are of relevance for creating annual reports (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1031).
3.3.1 Financial Assets
To begin with, a financial asset is solely recorded if it is part of a contractual agreement in accordance with IFRS 126.96.36.199. For this case, IFRS 9.B3.1.2 list examples to meet this requirement. A contract evolves for instance from a legal obligation, respectively right for the owner or a firm commitment, where one party already fulfilled the contract. However, IAS 32.13 emphasise that writtenness is not requested unless an economic relationship legally exists between the parties. Regarding the date of recognition or derecognition in the financial statement, IFRS 9.B3.1.3. set for regular way purchase or sale, the option for either the trade or settlement date. Compared to that, a forward contract is recorded or booked when the contract is concluded and loans are drawn up on the settlement date (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1037ff.; Wagenhofer 2018, 193 and 502f. and 535f.).
Neither the recognition nor the derecognition changed significantly as most parts regulated in IAS 39 were transferred to IFRS 9. First of all, financial assets are only derecognised for consolidated accounts in accordance with IFRS 188.8.131.52 as the financial asset might not be derecognised but rather transferred to a sub-company, consequently, it is still within the affiliated group. In order to determine the expiration date for the right to receive cash flows, a multilevel process is introduced. Especially financial instruments are possibly split into single parts or they are bundled as portfolio leading to the complexity in the derecognition. As a result, the multilevel process defines three steps: the economical approach, the risk and reward approach and the control concept. Prior to the transfer of financial assets to third parties, it is essential to evaluate if the financial asset in total or solely parts of it are derecognised. Assuming the financial asset is partly derecognised, IFRS 184.108.40.206. prescribe for the derecognition one of three criteria to be fulfilled. As a result, the cash flows of a part of the financial asset are either generated from the financial asset directly or result by a proportional share. Moreover, the cash flows of the proportional share must be entirely traceable back to the financial asset. However, the criteria are applicable to financial assets that are grouped. Unless one of the three criteria is met, the derecognition affects the financial asset in total (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1039ff.; Wagenhofer 2018, 503).
In regard to IFRS 220.127.116.11 a financial asset is derecognised at the expiration of the contractual rights to cash flows. This circumstance occurs for instance if the loan is repaid, an option is abandoned or one of the three criteria is fulfilled which leads to the derecognition of a part of the financial asset. Moreover, derecognition is carried out for the transfer of contractual cash flows or the distribution of cash flows to recipients, however, the primary owner remains to hold the contractual right to receive the cash flows. The latter, however, prescribes three conditions as stated in IFRS 18.104.22.168 to be met. First, there is an obligation for the primary owner to pay the cash flows based upon the right to initially receive the cash flows. Further, allowance is provided for advance payments for a short-term. Secondly, the financial asset cannot be sold or pledged unless it is for the purpose of assuring the payments to the recipients. Finally, the entity must provide payment without delay (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1039 and 1041; Wagenhofer 2018, 504).
After conducting the economical approach, the risk and reward approach is relevant for reviewing a derecognition. Under the condition that IFRS 22.214.171.124(a) are fulfilled, consequently, the contractual right of receiving cash flows is transferred, the risk and reward approach requires examining whether risk and reward of the financial instrument are also essentially transferred in accordance with IFRS 126.96.36.199(a). Consequently, the measurement and effect on the present value of the net cash flows is carried out with risks e.g. interest rate risk, exchange risk and default risk and once without any risk factors. Thereby, it can be shown if risks impact the result using the current market interest rate. According to IFRS 188.8.131.52 a financial asset is transferred if the fluctuations resulting from the risk factors are not significant anymore. Nevertheless, the IASB does not set a predefined range for determining significance (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1041f.; Wagenhofer 2018, 504f.).
Consequently, the control concept in terms of the economic approach might be used unless the risk and reward approach indicates a finding. In case of such an occurrence, it is necessary to distinguish if the transfer of control stays with the primary owner or the recipient. In fact, if the recipient owns control, a derecognition comes into force in accordance with IFRS 9.B3.2.7, otherwise the financial asset is kept and accounted for due to a continuing involvement. However, the last approach to determine whether derecognition is feasible, is the so-called pass through test which in turn still requires the risk and reward approach. As a result, a financial asset is derecognised, not derecognised or held as continuing involvement (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1042ff.; Wagenhofer 2018, 538).
Furthermore, a financial asset, especially financial instruments, and its conditions may be adapted afterwards. Modifications are attributable to market changes e.g. the market interest rate or creditworthiness which contribute to a prolongation of the term or the forbearance of interest payments. In terms of the new standards, IFRS 9 introduced substantial and unsubstantial modifications, while the latter is not being derecognised. In accordance with IFRS 184.108.40.206(a) in connection with IFRS 9.B5.5.25 the original financial asset is derecognised and recognised as financial asset including the significant modification. However, quantitative and qualitative analyses are necessary to evaluate if the re-recognition is necessary. While the former is recommended for numerousness modifications applying a present value comparison, the latter is simpler as the result is shown clearly, for instance the arrangement to change a currency (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungs-gesellschaft 2017a, 1045ff.; Wagenhofer 2018, 503 and 573).
As already described, a financial asset is recognised according to IFRS 220.127.116.11, which also includes the topics of initial categorisation and measurement. A financial asset is categorised in regard to the business model and contractual cash flows, also called the SPPI-criterion which means “Solely Payments of Principal and Interest”. However, the decision made regarding classification and measurement is determined by the requirements of IFRS 9. In terms of the business model, three possible options exist: hold and collect, hold and sell or a third classification is provided, which is neither hold and collect nor hold and sell but can be rather considered as a business model for residuals. Nevertheless, IFRS 9.B4.1.2 define that the classification is not carried out for each financial instrument instead financial instruments are set into groups following an objective. As a result, a company might define different business models which affect all three options and include portfolios or sub-portfolios of financial instruments. In connection with the business model and its definition, IAS 24 regarding related party disclosures is of relevance due to the fact that key positions set the objectives. Moreover, it is requested to evaluate and review the business model as well as the performance and reporting of the financial instruments. This also includes risks which have to be dealt with or the compensation of managers according to IFRS 9.B4.1.2B. Further, there is an additional requirement for the business model hold to collect. As stated in IFRS 9.B4.1.2C it is required to determine frequency, amount, the time of previous sales and to estimate the development in this area for the future. It is notable that the management of financial instruments and the objective to achieve cash flows is referred to as hold and collect, while hold and sell reflects the sale of financial assets (Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft 2011, 6; PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1057f.; Wagenhofer 2018, 502 and 546f.).
Before each classification is described, it is necessary to explain the business model and the SPPI-criterion in detail. The business model hold to collect is highly oriented to hold the financial instrument until it matures. In fact, this is also a requirement for the categorisation. However, this approach differs from IAS 39 as the held-to-maturity classification requires the financial instrument to be reclassified if it is not held until it matures. In contrast to that, IFRS 9.B4.1.3 allow to hold and collect financial instruments even if it is not held until maturity. Such a circumstance might evolve from a deterioration of the creditworthiness eventually breaching the guidelines of investing set by the management (IFRS 9.B4.1.3A) or if the sale is executed close to the maturity (IFRS 9.B4.1.3B) (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1061f.; Wagenhofer 2018, 547).
However, from time to time there might be a need for unexpected sales for other reasons than the creditworthiness or the execution date. Due to that, unexpected sales for the business model hold to collect are only permitted if it is an irregular sale with even a significant amount or is a sale with an insignificant amount and executed often in accordance with IFRS 9.B4.1.3B. Those exceptions as determined in IFRS 9.B4.1.4 are for instance controlling currency or credit risk due to a stress scenario or reducing risk weighted assets to meet the requirements set in the Capital Requirements Regulation (CRR). However, IFRS 9 set no clear definition of irregular sales but usually require thresholds in regard to the frequency in practice. Nevertheless, it is reasonable to consider cases that tend to last for a long period (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1063f.; Wagenhofer 2018, 547ff.).
Furthermore, if it is neither an irregular nor an insignificant sale, it might be necessary to review the initial business model and restate errors retrospectively according to IAS 8. In contrast to that, a financial asset, a part of it or the entire portfolio is reclassified in accordance with IFRS 9.B4.4.1 under the condition that the requirements are met. Finally, sales regarding the business model hold to collect are subject to disclosure requirements as stated in IFRS 7.20A (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1065f.; Wagenhofer 2018, 68f. and 565f. and 465).
In addition to the business model hold to collect, IFRS 9.B4.1.2A also mention the business model hold to sell under the condition that all information available is considered for the classification. In line with IFRS 9.B4.1.4Aff. the management sets this business model if it aims to hold and sell financial assets in order to control liquidity on a daily basis or to adjust the maturity of financial assets to financial liabilities maximising the yield. In contrast to the business model hold to collect, hold to sell initially causes a high frequency and thus an increased amount of sales. As in the previous cases, also hold to sell is not explicitly defined in IFRS 9 regarding its threshold (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1066ff.; Wagenhofer 2018, 546 and 549ff.).
Finally, the business model for residuals as its name implies includes financial assets which are neither hold to collect nor hold to sell. As a result, the measurement is at FVTPL and is relevant for the management concerning the purchase and sale of financial assets or a portfolio in accordance with IFRS 9.B4.1.5 and IFRS 9.B4.1.6 (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1069; Wagenhofer 2018, 551f.).
Another aspect to consider is the contractual cash flow, also considered as SPPI test. Consequently, solely the payment of principal and interest on the principal amount outstanding are conditions in order to pass the SPPI test as stated in IFRS 9.B4.1.7. Each financial instrument is examined at the initial recognition regarding the fulfilment of the SPPI test and considers possible contract terms for the future. In regard to the principal, IFRS 9.B4.1.7B describe the principal as FV of the financial asset. However, the FV also reflects changes which are traceable back to repayments. Moreover, the FV is set equal to the acquisition costs. Referring to the interest, IFRS 18.104.22.168(b) and IFRS 9.B4.1.7A list the acceptable interest components for the contractual cash flow condition. Due to the credit arrangement, the time value of the money and the resulting default risk, credit risks such as liquidity risk, administration costs and the profit margin are named as fees in terms of interest components. Moreover, further risks resulting from the credit arrangement affecting the parties are not included as interest components, for instance the risk of price changes in terms of raw materials or equity securities. The contractual cash flow condition is reviewed on an individual basis, however, the financial asset may be categorised into the business model for residuals or is designated as a FVO according to IFRS 22.214.171.124 respectively IFRS 126.96.36.199 (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1074f. and 1076 and 1079; Wagenhofer 2018, 507f. and 552).
Furthermore, the contractual cash flow condition is not affected by a financial instrument for which a functional currency is chosen (IFRS 9.B4.1.8). In addition, the exchange rate on the date of payment is applied in order to guarantee that the SPPI criterion is achieved. However, few exceptions which are not conform with the contractual cash flow condition exist. As in IFRS 9.B4.1.9 financial instruments that fail the SPPI test are those that focus on leverage, e.g. options, forward contracts or swap contracts (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1075; Wagenhofer 2018, 552).
Moreover, there are a few examples that are described shortly in regard to the SPPI requirement. For instance a debt instrument which yields a floating interest rate (IFRS 9.B4.1.11(a)) fulfils the contractual cash flow condition demanding e.g. a fee for the time value and a profit margin assuming the 3-month Euro Interbank Offered Rate (EURIBOR) and the interest rate adjustment of 3 months at a fixed maturity (IFRS 9.B4.1.13). In contrast to that, inverse floating rates breach the contractual cash flow condition. Nevertheless, a gradually growing interest unless it includes optional interest rate adjustments and interest payments in arrear are conform with the contractual cash flow. In accordance to IFRS 188.8.131.52(b) and IFRS 9.B4.1.7A zero coupon bonds are required to fulfil the SPPI criterion and provide an interest rate which is in line with the market calculated as the difference between the issuing price and amount repaid. However, as soon as the interest payment is related to the annual returns or in case the repayment of the principal is postponed or temporarily abandoned and neither principal payment nor interest is paid on, then the contractual cash flow is not met (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungs-gesellschaft 2017a, 1079ff.; Wagenhofer 2018, 508 and 552 and 554ff.).
Regarding the time value of money, it is necessary to conduct a benchmark test for the contractual cash flow condition as the time value cannot compensate risks directly in connection to financial instruments according to IFRS 9.B4.1.9B. In general, the time value is under certain conditions permitted to be modified considering the SPPI criterion. As prescribed in IFRS 9.B4.1.9B-E a modification is the monthly adjustment of the interest rate based on the 12-month-EURIBOR. While the qualitative or quantitative analysis might be advisable to determine principal and interest payments, the benchmark is another option. The approach of the benchmark test is to find a similar financial instrument equipped with the same contractual terms and default risk. Consequently, the modified contractual cash flow is permitted for use if a deviation exists between the undiscounted cash flows of the financial asset intended for classification and the financial asset used as benchmark. However, this decision is not solely influenced by the current but also the future situation. Therefore, the duration of the financial assets and probable scenarios which might affect the SPPI criterion are taken into account (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungs-gesellschaft 2017a, 1085f.; Wagenhofer 2018, 552f.).
Besides the modification of the time value, the contractual cash flows may also be adapted in regard to the conditional contractual terms, e.g. the timing and amount. The standards for this circumstance are described in IFRS 9.B4.1.10 and require the examination of the SPPI criterion before and after the adaption. Furthermore, a trigger event needs to be considered. The SPPI criterion is met for instance if the interest rate rises as the debtor fails to repay on the date settled which initially results in a default risk. In contrast to that, the increase of the interest rate related to a market index violates the SPPI criterion. However, the linkage to an inflation rate of the respective currency – e.g. the harmonised index of consumer prices – is permitted as long as no leverage is generated. Moreover, conditional contractual terms allowed are caps, floors and collars. In addition, IFRS 9.B4.1.11(b) state that an early repayment respectively the dismissal is allowed if the amount left reflects solely the payment of the principal and interest, thereby requiring a prepayment fee. This approach is reversely used for the prolongation of a contract (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1089ff. and 1093f.; Wagenhofer 2018, 553ff.).
Abbildung in dieser Leseprobe nicht enthalten
Figure 1 | Classification of financial assets under IFRS 9
(Source: PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungs-gesellschaft 2017a, 1056)
As shown in the graph above, the decision tree leads to the classification of the financial asset based on its characteristics such as the differentiation between debt instrument, derivatives and equity instruments but also in terms of business model, contractual cash flow terms as well as held for trading. IFRS 9 define three respectively four classification categories which influence the subsequent measurement of the financial asset. In accordance with IFRS 184.108.40.206(a) in connection with IFRS 9.B4.1.2C a financial asset is measured at AC based on the condition that the business model is hold to collect and the contractual cash flow condition meets the requirement of solely principal and interest payments (IFRS 220.127.116.11(b) and IFRS 9.B4.1.7). An example for this categorisation is loans and bonds (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1051f. and 1056; Wagenhofer 2018, 507f. and 547 and 552).
In contrast to that, if a financial asset belongs to the business model hold to sell (IFRS 18.104.22.168A(a) and IFRS 9.B4.1.4A) and fulfils the contractual cash flow condition (IFRS 22.214.171.124A(b) and IFRS 9.B4.1.7), then the measurement is carried out at FVOCI. In this case, the FVOCI measurement is mandatory with recycling. Therefore, changes in the FV are recorded in the OCI while other changes are booked in the P & L (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1053f.; Wagenhofer 2018, 508 and 549f. and 552).
Furthermore, an equity instrument which is not held for trading, is measured at FVOCI without recycling unless the decision is made to opt in for the FVO in accordance with IFRS 126.96.36.199. Additionally, once designated at FVOCI, the decision is irrevocable. Finally, financial assets are measured at FVTPL if neither the business model nor the contractual cash flow condition is met. Moreover, exercising the FVO, derivatives, equity instruments held for trading respectively those who are not opting in for the FVOCI option result in the measurement at FVTPL (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungs-gesellschaft 2017a, 1053f.; Wagenhofer 2018, 515).
In terms of exercising the FVO, it must be considered that this right – once designated – the decision is irrevocable and its prerequisite is the occurrence of an accounting mismatch which is consequently lessened by applying the measurement at FVTPL according to IFRS 188.8.131.52. As described in IFRS 9.B4.1.30(b) a financial asset or liability might face the same risk, e.g. interest rate risk and therefore a designation favours the offsetting (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1055; Wagenhofer 2018, 508 and 561).
Financial assets are permitted in contrast to financial liabilities for reclassification. In terms of the circumstance for a reclassification, IFRS 184.108.40.206 state that financial assets are reclassified if the business model changes. Nevertheless, such a decision is to be concluded by the management and occurs if there a significant and influencing conditions. While changing the business model occurs relatively rarely, it is still possible in case the company purchases another company splitting the management of loans from hold to sell to hold to collect. Moreover, the change in the business model results from abandoning or gathering a new business segment which substantially influences the business model in accordance with IFRS 9.B4.4.1. In addition, the reclassification is only carried out after the business model has been adapted (IFRS 9.B4.4.2) (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1109ff.; Wagenhofer 2018, 510 and 565f.).
However, IFRS 9.B4.4.3 set exceptions for the reclassification. Therefore, single financial assets even if significant changes evolve, are not intended for reclassification. Furthermore, temporarily illiquid markets or a transfer within the company of a financial asset leave the business model unaffected. In fact, previously designated hedge instruments that are to be designated in terms of cash flow and net investment hedges are excluded from the business model amendment, hence also from the reclassification according to IFRS 220.127.116.11. Additionally, the change in the cash flow condition or a modification carried out regarding the contractual terms do not lead to a reclassification (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1111f.; Wagenhofer 2018, 510 and 566).
Under the assumption that a reclassification is conducted and the conditions are met, the financial asset is assigned a different category and measurement unless the FVO is exercised which results in an irrevocable designation in accordance with IFRS 18.104.22.168. The reclassification of FVTPL, FVOCI and AC leads to fewer adaptions. Beginning with FVTPL and FVOCI to be reclassified as AC, IFRS 22.214.171.124 require the FV on the day of the reclassification to be recognised as the gross book value. As a result, the difference between the gross book value and the amount to be repaid is continually amortised applying the effective interest rate. Secondly, reclassifying from FVTPL to FVOCI and vice versa does not impact the FV. Nevertheless, the profit and loss booked in the OCI is requested to be reclassified leading to the offsetting in the P & L instead of the equity. In contrast to that, reclassifying FVTPL to FVOCI requires FV changes to be booked in the OCI. Finally, reclassification from AC to FVTPL requires for the recognition the FV. Consequently, the difference between the AC and FV are booked into the P & L (IFRS 126.96.36.199). Similarly, the change from AC to FVOCI requires the difference between the AC and FV to be recorded in the OCI in accordance with IFRS 188.8.131.52 (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1113ff.; Wagenhofer 2018, 508 and 514).
Upon deciding on the classification category, the next step is the measurement in regard to the initial recognition. Generally, as applied in IAS 39, every financial asset and liability is measured at FV in accordance with IFRS 184.108.40.206. The FV is under IFRS 13.9 the price on the measurement date for market participants to sell or transfer a financial asset or liability considering that it occurs as regular transaction. Further, the price is observed on the primary or any other favourable market allowing to undertake a transaction regardless whether prices are observable or require estimation via measurement technics (IFRS 13.24). Additionally, transaction costs which occur through the purchase or sale of the financial asset or liability are added to or subtracted from the initial costs. However, this is not applicable to the classification at FVTPL both for financial assets and liabilities (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1117 and 1239.; Wagenhofer 2018, 510 and 668f.)
In terms of the transaction costs, IFRS 9 include the same content as IAS 39. As prescribed in IFRS 9.B5.4.8, transaction costs are considered as fees and commissions charged by intermediaries, consultants, agents and brokers as well as fees and taxes paid to regulators and securities market. Moreover, this paragraph also lists items which are not recognised as transaction costs such as disagio/agio, costs of financing and other costs occurring within the company in regard to management and administration (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1117f.; Wagenhofer 2018, 569).
In accordance with IFRS 9.B5.1.1 the FV is at the initial recognition equal to the transaction costs. However, the transaction costs might include costs not traceable back to the financial instruments. As a result, the FV is to be determined by the company itself. In terms of loans or accounts receivables without an interest rate, IFRS 9 set the approach for determining the FV by using similar instruments. Thus, depending on the rating of a similar instrument, the cash flows are discounted by the market interest rate also considering currency, maturity and other factors. In fact, amounts borrowed afterwards are treated as expenses (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1117f.; Wagenhofer 2018, 566).
One main difference between IAS 39 and IFRS 9 is the topic credit impairments and the measurement of financial instruments at the initial recognition. Consequently, credit impairments used to be prohibited and only intended for the subsequent measurement in IAS 39 whereas IFRS 9 allow credit impairments at the initial recognition. Furthermore, loan commitments and forward loan-contracts need to be distinguished from those loan commitments in IFRS 9.2.3. While the former is regulated in IAS 37, the latter belongs to IFRS 9. Nevertheless, loan commitments paid out are recognised using IFRS 9 (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1118f.; Wagenhofer 2018, 501f.).
Another relevant aspect for the measurement at initial recognition is securities. Due to the fact that securities are bought at different prices, the evaluation of the initial costs depends on the measurement of either the separate valuation of a security or the aggregation of a type of security. Therefore, IAS 2 which deals with inventories is applied for assessing the initial cost. The approaches used are first in – first out (FIFO), average and the classification based upon individual decisions. Using the average approach on all securities is less cumbersome and if turnover ratios are high, the average price is calculated more frequently (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungs-gesellschaft 2017a, 580f. and 1119).
Furthermore, the measurement at initial recognition is influenced by regular way contracts. When a contract is concluded, the financial instrument is recorded in the balance sheet. However, for regular way contracts a time span between the trade and settlement date is considered. Consequently, if a trade date is not equal to the settlement date, the transaction is seen as derivative but not accounted for as long as it remains a regular way contract fulfilling commercial usage in terms of the time span. In accordance with IFRS 220.127.116.11, a regular way contract is allowed to be accounted for on either the trade date or on the settlement date. However, once the decision is made, an alteration is not permitted. Nevertheless, the trade or the settlement date is decided on each classification category enabling more flexibility (IFRS 9.B3.1.3) (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1119f.; Wagenhofer 2018, 502f. and 535).
The decision made between the trade date and the settlement date impacts accounting. The trade date as described in IFRS B.3.1.5 require the buyer to record the asset and liability for the payment on the trade date. In contrast to that, the seller of the asset is requested to derecognise the asset and realise a profit or loss occurring due to the transaction as well as the recording of the receivable on the trade date. Regarding the settlement date, which is the date when the asset is delivered, the procedure is similar. Therefore, the asset is recognised on the settlement date whereas the derecognition considering profit and losses is carried out on the settlement date. However, deciding for the settlement date also results in the realisation of FV changes during the trade and settlement date. According to IFRS 9.B3.1.6, changes are booked to the P & L respectively to the OCI in regard to the classification category, whereas AC is not impacted (PricewaterhouseCoopers Aktiengesellschaft Wirtschafts-prüfungsgesellschaft 2017a, 1120f.; Wagenhofer 2018, 535f.).
The final topic described in this chapter is the subsequent measurement of financial assets. In accordance with IFRS 18.104.22.168, the subsequent measurement considers AC, FVOCI and FVTPL reflecting also the classification categories at the initial recognition. With reference to figure one (classification of financial assets), the subsequent measurement of debt instruments follows AC, FVOCI and FVTPL. In terms of FVOCI, FV changes are recorded in the OCI as part of the equity. Further, this FVOCI for debt instruments includes recycling, consequently a derecognition before maturity results in the transfer of the amount booked in the OCI into the P & L. In contrast to that, an equity instrument is permitted to opt in for the FVOCI at initial recognition as long as it is not held for trading (IFRS 22.214.171.124). The accounting approach is different to the FVOCI of the debt instrument as the FVOCI of an equity instrument is designated and not mandatory. Therefore, changes of the FV are recorded in the OCI but the amount is rather transferred to another equity position instead of recycling at derecognition (IFRS 9.B5.7.1) (PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft 2017a, 1122f.; Wagenhofer 2018, 510 and 515 and 578).