AASB 9 FINANCIAL INSTRUMENTS (DECEMBER 2014)
AASB 9 (December 2014) represents the complete set of requirements for financial instruments and consists of seven chapters. It replaces AASB 139 ‘Financial Instruments: Recognition and Measurement’.
Chapter 1 contains the objective of AASB 9 and sets out the application criteria for adoption.
Chapter 2 represents the ‘Scope’ section and provides a list of financial instruments to which AASB 9 does not apply. This list is essentially the same as that contained in AASB 139 except that AASB 9:
• specifies that the issuer of loan commitments should apply the impairment requirements of the standard to all loan commitments, irrespective of whether such commitments are within the scope of AASB 9;
• excludes financial instruments that are within the scope of AASB 15 ‘Revenue from Contracts with Customers’, except for those that AASB 15 specifies are to be accounted for in accordance with AASB 9; and
• includes within its scope a contract to buy or sell a non-financial item that can be settled net in cash or another financial instrument, or by exchanging financial instruments as if the contract was a financial instrument that is irrevocably designated as measured at fair value through profit or loss even if it was entered into for the purpose of the receipt or delivery of the non-financial item in accordance with the entity’s expected purchase, sale or usage requirements. This designation can only be used if it eliminates or significantly reduces an accounting mismatch.
Chapter 3 deals with recognition and derecognition of financial instruments. These requirements are largely the same as in AASB 139. Additional guidance has been provided on the derecognition of financial assets.
Chapter 4 contains the guidance on the classification of financial assets and financial liabilities.
Chapter 5 contains the requirements for measurement. AASB 9 introduces new classification and measurement models for financial assets using a single approach to determine whether a financial asset, which is initially measured at fair value, is subsequently measured at either: (i) amortised cost; (ii) fair value through other comprehensive income (‘OCI’) or (iii) fair value through profit or loss.
With one exception, financial liabilities will continue to be classified and measured in accordance with the existing requirements of AASB 139, although such requirements have now been incorporated into AASB 9. The exception for accounting for financial liabilities relates to situations where a portion of a change of fair value relates to the entity’s ‘own credit risk’ where such change is required to be presented in OCI unless it would create an accounting mismatch. Entities are able to early adopt the ‘own credit risk’ requirements without adoption of AASB 9 in full (See ‘Own credit risk provisions – Early adoption’ below).
For impairment, the new requirements use an ‘expected credit loss’ (‘ECL’) model to recognise an allowance. It is therefore no longer necessary for a credit event to have occurred before credit losses are recognised. This will therefore bring forward the timing of recognising impairment losses.
Under the general principle, one of the two measurement bases will apply for impairment:
ECL shall be measured under the 12-month expected credit loss method unless the credit risk on a financial instrument has increased significantly since initial recognition or special measurement requirements apply.
Where credit risk has increased significantly since initial recognition, the lifetime expected credit loss method is adopted. The term ‘significant increase’ has not been defined by the standard for this purpose. Increases in credit risk are determined by risk of default at the reporting date with that which existed on initial recognition. As risk is measured at each reporting date, impaired assets could move between the two measurement bases.
Extensive disclosures are required, including reconciliations from opening to closing amounts of the ECL provision, assumptions and inputs, and a reconciliation on transition of the original classification categories under AASB 139 to the new classification categories in AASB 9.
Chapter 6 ‘Hedge Accounting’ supersedes the general hedge accounting requirements in AASB 139 and includes a new simpler approach to hedge accounting that is intended to more closely align hedge accounting with risk management activities undertaken by entities when hedging financial and non-financial risks. Some of the key changes from AASB 139 are as follows:
- allow hedge accounting of risk components of non-financial items provided that they are separately identifiable and measurable;
- changes in the accounting for the time value of options, the forward element of a forward contract, and foreign-currency basis spreads designated as hedging instruments; and
- modification of the requirements for effectiveness testing (including removal of the ‘bright-line’ effectiveness test that offset for hedging must be in the range 80-125%) as well as the retrospective testing.
Hedge effectiveness testing is only required on a prospective basis using a methodology based on the entity’s risk management policies. The testing can be qualitative or quantitative and ‘rebalancing’ will be required to maintain the risk management objectives. Discontinuation of hedge accounting only occurs when the qualifying criteria are not met or the risk management objectives change. If the risk management purpose is still in place, designation is prohibited. Entities previously unable to apply hedge accounting may now be able to apply it. For example, it would be possible to achieve hedge accounting on jet-fuel based on hedging the risk component, thus removing profit or loss volatility in the aviation industry.
Chapter 7 covers the effective date and transition requirements.