IFRS 9 Financial Instruments - Bank of Thailand · 5 Dr. Th. Goswin International Accounting...

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IFRS 9

Financial Instruments

Part 5c:

2Dr. Th. Goswin International Accounting Standards

Designated to replace IAS 32 and IAS 39

Response to the financial crisis:

Beginning of crisis in August 2008, decrease of marketvalues of securitized financial instruments (e.g. ABS),increasing consumption of Equity Capital

Request by G20 to contribute to limit impact of crisisthrough change of accounting procedures

Amendment to IAS 39: If FV Instruments are not intendedto be traded on short view, reclassification may beallowed, values “frozen” on 01.10.2008

Decision taken to “reconstruct” regulation on FinancialInstruments and to summarize in one standard: IFRS 9

IFRS 9: Financial instruments

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Situation at the peak of the crisis (I):


Asset Liability

Credit Derivative: 100 Equity: 50

Cash: 50 Liabilities: 100


Situation at the peak of the crisis (II):


Asset Liability

Credit Derivative: 100Loss on M.V.: -20New M.V.: 80

Equity: 50Retained earnings -20Total Equity: 30


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Solution to “solve” the crisis (III):


Asset Liability

„Frozen“ value of CD 80 „Frozen“ Equity: 30



IFRS 9 originally issued in November 2009, reissued inOctober 2010, intended to be applicable originally from01.01.2013 onwards, new date of application now 01.01.2018

IFRS 9 consisting of 3 parts (improvements):

Classification and Measurement

Amortized cost and impairment

Hedge Accounting

Greatest improvement is, that “expected loss model” nowacceptable

Clear procedure defined with steps of implementation


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New regulation on classification: Classification according to IAS 39: Rule based Complex and difficult to apply Multiple impairment models Own credit gains and losses recognized in profit or loss for

fair value option liabilities (not applicable in the EU) Complicated reclassification rules

Classification according to IFRS 9: Principle based Based on business model and nature of cash flow One impairment model Own credit gains and losses presented in OCI for FVO

liabilities Business model driven reclassification



New regulation on classification:

Consecutive measurement depends on the intended use ofthe financial instrument: The business model

Target of the investment is to keep the asset in order togenerate consecutive and regular cash-flow

Contract details of the asset lead to payment flows at fixedmoments in time, these flows consist of coupon paymentand repayment of principals only.

Both conditions have to be fulfilled simultaneously


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Financial Assets

Business Model Test

Measurement according to

amortized cost

Measurement according to Fair Value

Recognition of coupon in I.S.

Recognition of F.V. change in I.S.



Instrument within the scope of IFRS 9

Contractual cash flows are solely principal and interest?

Held to collect contractual cash flows only?

Fair value Option?

Amortized cost Fair value through profit and loss (Presentation option for equity investments to

present fair value changes in OCI)

Held to collect contractual cash flows and for sale?

Fair value Option?

Fair value through OCI

no

no

no

yes

yes yes

no

yes

no

yes yes no

other standard

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In detail: DEBT INSTRUMENTS

Classification is made at the time, when financialinstrument is recognized the first time

Financial instrument can be measured at amortized cost(net of any write-down for impairment), if the two followingconditions are met:

Business model test: Objective of entity’s businessmodel is to collect contractual cash-flow rather than tosell the instrument prior to its contractual maturity torealize fair value changes

Cash-flow characteristics test: Contractual terms ofasset give rise on specified dates to cash-flows thatconsist of repayment of principal and interest onamount outstanding




What is a business model?

Refers to how an entity manages its financial assets inorder to generate cash-flows, selling financial assets orboth

Business model should be determined on a level thatreflects how financial assets are managed to achieve aparticular business objective (i.e. what do we want toachieve?)

Business model can be observed through activities, thatan entity undertakes to achieve business objective. Sono evaluation on individual level (no assertion) butobjective facts to be considered


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What is a business model?

Objective facts:

Business plans

Compensation for managers (i.e. bonus plans)

Amount and frequency of general sales activities

Past sales activities and expectations about future salesactivity

Having some sale activity is not necessarily inconsistentwith the business model

Same with sales as a result of (e.g.) an increase of creditrisk

If sales are more than insignificant, entity, must assess,how these sales are in consistency with business model.




What business model qualifies for fair value through othercomprehensive income (FVOCI)?

Here, business objective is both to collect contractualcash flows and selling financial assets

In comparison to model, based on contractual cash-flows (etc.), this model typically has greater frequencyand volume of sales

Typical objectives:

Manage liquidity

Maintain particular interest yield profile

Match duration of financial liabilities to duration of assetsthey are funding


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What are the characteristics of a contractual cash flow?

In general, contractual cash flows are solely payments ofprincipal and interest (SPPI)

Only financial assets with such cash flows are eligible foramortized cost or FVOCI)

Clarification: interest can comprise not only for time value ofmany and credit risk

But

Return for liquidity risk, amounts to cover expenses, profitmargin

As long as consistency with a basic lending arrangement isgiven (for instance: if contractual cash flows include a returnfor equity price risk, this is not in accordance with SPPI)





Basic element of identifying SPPI is „Time Value ofMoney“, which determines the contractual payment ofinterest (and alike elements)

Example: Fixed interest rate (i.e. 10% p.a.) or variableinterest rate (i.e. index, 3 month Libor). In that case timevalue of money is calculated on that time. However,tenors may be concluded, where determination ofinterest rate (i.e. coupon) differs from usualpreconditions of interest rate fixing (e.g. 3 month Libor,re-fixed every week)


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In this case, individual assessment, if FI fulfill the cashflow characteristics and if the cash flow representsSPPI.

Objective is to determine, if cash flow differssignificantly from cash flow with unmodified time valueof money element

In cases of doubt: Precondition of contractual cash flowis not given, valuation according to amortized cost notpossible





Example:

Pre-payable financial asset to have contractual cash flowsthat are SPPI (FX bond, bond with an add on). Testing ofcontractual lending arrangement is given

Regulated interest rates, set by government, notrepresenting time value of money, acceptable as SPPI aslong they do not introduce risk or volatility, that isinconsistent with a basic lending arrangement


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All other debt instruments, which do not pass the two testshave to be measured by Fair Value through profit and loss

Transaction costs are part of the Fair Value at first timerecognition

Amortization of transaction costs until maturity via effectiveinterest method

Fair Value option:

An entity can voluntarily measure a debt instrument by FairValue, if otherwise an “accounting mismatch” would occur

In this case, transaction costs are to be expensedimmediately via profit and loss



In detail: EQUITY INSTRUMENTS

All Equity instruments to be measured at fair value thoughprofit and loss

Transaction costs to be expensed immediately via profit andloss

No “cost exception” for unquoted equities:

IAS 39 has an exception for investments in unquoted equityinstruments (and some related derivatives). The exceptionrequires that these instruments be measured at cost (lessimpairment) if fair value cannot be determined reliably.


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In detail: EQUITY INSTRUMENTS

“Other comprehensive income option”: If equity investment isnot held for trading, entity can make irrevocable decision atinitial recognition to measure it at “fair value through othercomprehensive income”

Dividend income recognized in profit and loss

FV changes recognized in Equity via “other comprehensiveincome”



Treatment of Financial Liabilities according to IFRS 9

Similar to IAS 39, two categories of liabilities exist:

Fair value through profit or loss (FVTPL): Liabilities held withthe intention (and possibility) of trading (i.e. callable bond)

Amortized cost (AC): Liabilities, which are paid back atmaturity (other liabilities)

Fair Value Option: Entity can voluntarily measure accordingto Fair Value, if

By doing so an “accounting mismatch” is avoided (or)

The liability is part of a group of liabilities and/or assets,which are (risk-) managed as an appropriate investmentstrategy and supervised by key management personnel.


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Financial Liabilities


amortized cost


Other Liabilities Trading Liabilities

No impact on P&L Impact on P&L


In principle, the approach of IAS 39 remains unchanged.

Problem:

Approach criticized due to “artificial” creation of profits asa consequence of deterioration of own credit standing.

Therefore this approach still not applicable within EU

IFRS 9 offers improvement of treatment of liabilities:

Amount of profit, which is attributable to marketmovements to be recognized in Income Statement

Amount of profit, which is attributable to deterioration ofown credit standing to be recognized as “othercomprehensive income”


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Reclassification:

For Financial Assets reclassification is required betweenFVTPL and AC (and vice versa), if and only if the entity’sbusiness model objective for its financial assets changes

In this case the previous model does not apply any more

If reclassification is decided (appropriate), it must be donefrom reclassification date. No restating of previous gains,losses or interest

No limitation of reclassifications considered

However: Reclassification is a significant event andexpected to be uncommon




Financial Assets

Business Model Test


amortized cost


Reclassification

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Reclassification:

Users of financial statement must be provided withsufficient information to understand and evaluate thereclassification

Especially how the cash flows on financial assets areexpected to be realized

IFRS 7 requires disclosures about reclassifications:

Amount of financial assets moved out and into differentcategories

Detailed explanation of the change in business model and itseffect on income statement(s)



De-recognition: ASSETS

1st step: Determine whether asset under consideration is an

Entire asset

Specially identified cash-flows from an asset (e.g. pre-maturerepayment of a loan)

Fully proportionate share of a cash-flow (pro rata, e.g. regularrepayment of proportion of loan, mortgage, etc)

2nd step: Determine, whether the asset has been transferredand if so, whether the asset is subsequently eligible for de-recognition:

Entity has transferred the contractual rights to receivecash-flows


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2nd step:

Entity has retained the contractual rights to receive cash-flows, but has assumed a contractual obligation to passthese cash-flows to someone else under an arrangementthat meets the following conditions:

Entity has no obligation to pay amounts unless it collectsequivalent amounts on original asset (e.g. sale of an option onsecondary market)

Entity is prohibited from selling or pledging the original asset(e.g. a loan/mortgage)

The entity has obligation to remit those cash-flows withoutmaterial delay (e.g. factoring)




3rd step: Determination whether risk out of investment aretransferred as well.

Substantial transfer of risks: Full de-recognition of asset

Retaining of risks: De-recognition of asset precluded

No full retaining and no full transfer of risks (“in-between-case”): Determination of control of risks

Entity does not control: De-recognition may be appropriate(IAS 39 requires provision, IFRS 9 does not mention)

Entity still controls risk: Recognition of the asset to the extentof ongoing involvement in the asset


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De-recognition of Fundamental Financial Assets

Transfer of rights

Transfer of risks

Transfer of control

De-recognition Recognition insofar further involvement

De-recognition, maybe provision to be created

Recognition

no

yes

yes

no

no yes


De-recognition: LIABILITIES:

Financial liability to be removed from balance sheet, whenand only when it is extinguished

Obligation specified in the contract is either discharged orcancelled or expires (e.g. Option)

If there was an exchange between existing borrower andlender of debt instrument with substantially different terms,or if there was a substantial modification of the terms ofexisting liability, the previous liability is de-recognized and anew liability is recognized

Gain and loss of the exchange to be considered directly andimmediately in the income statement.


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Derivatives:

All derivatives, including those unquoted, are measured afair value

Fair Value changes are recognized in profit and loss,unless the entity has decided to classify the derivative as ahedging instrument, Requirements of IAS 39 to apply

If fair value not available, best estimates to be applied (i.e.certified valuers, Option price models)

Transaction costs to be expensed immediately via incomestatement



Embedded Derivatives:

Hybrid contract, which is a combination of derivativeelement with non-derivative host

Consequence: Cash-flow not entirely applicable tobusiness model and cash-flow characteristics test, havingstrong elements of “stand-alone-derivative”.

Derivative, which is attached to an other financialinstrument and is contractually transferable independentlyto third party is not an embedded derivative, but a separatefinancial instrument, to be accounted separately

No risk attachment/risk separation testing required (as inIAS 39)


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Embedded Derivatives:

Embedded derivatives, that under IAS 39 would beaccounted separately, due to different risk structure (notclosely related), will not be separated any more

Categorization into FVTPL of the entire instrument, even ifonly a part of contractual cash-flow do not representpayment of interest and repayment of principal (e.g.convertible bond)



Financial Instrument

Financial asset Financial liability Equity instrument

Fundamental Financial asset

Derivatives

Hedging Instruments

Amortized Cost

Fair Value

Plain Derivatives

Embedded Derivatives

Fair Value Hedge

Cash-flow Hedge

Hedge of a net investment in a foreign operation

Macro Hedge

Liabilities Held for Trading

Other liabilities

Plain Equity Capital

Compound Equity Instrument

Synthetic Equity Instrument

Insurance Contract

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IAS 32/39: Financial instruments (Excursion: Overview on Financial Instruments)

Financial assets

Traded at spot market Traded at forward market

Conclusion and settlement of contract at the same time

Conclusion and settlement of contract at different times

Interest Instruments

Shares (Equity Instruments)

conditional forwards

unconditional forwards

Buyer acquires right, seller accepts commitment

Buyer and seller accept commitment

- Options

-Instruments similar to Options (Caps, Floors etc.)

- Forwards

- Futures

-Swaps

- Money Market instruments

- Capital Market instruments

- Common shares

-Preferred Stock (Premium sh.)


Summary: Treatment of the different financial instruments

First time recognition in every case by Fair Value

Interest instruments: Testing of Business Model and Cash-Flow Characteristics, categorization to AC and FVTPL,application of Fair Value Option

Shares: Application of FVTPL, “Other ComprehensiveIncome Option, no “Cost Exemption” in case of absence ofprice quotation

Derivatives: Application of FVTPL, no accounting options

Hedging instruments: According to IAS 39, changes andsimplifications promised, but not disclosed so far


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Summary: Treatment of the different financial instruments

Embedded Derivatives: in general accounting procedure asa whole (as one Financial Instrument, no separationforeseen), application of FVTPL, no “cost exemption”applicable, simplification of procedures in comparison toIAS 39

Own Equity: No changes so far, IAS 39 applicable

Own liabilities: categorization into “Trading Liabilities” and“Other Liabilities”, treatment according to EFRAGproposal:

Profit, out of market movements to be recognized in IncomeStatement

Profit, attributable to deterioration of own credit standing to berecognized as “other comprehensive income”



Open issue:

Asset and Liability offsetting: US-GAAP allows theoffsetting of assets and liabilities, if there is a master-netting-agreement available: In case of default ofbankruptcy all and asset and liability contracts are nettedinto a single payable or receivable amount. IFRS does notallow this procedure

IASB and FASB were unable to agree on a compromise, asa result an amendment to IAS 32 was agreed on specialdisclosures, which allow analysts to more easily comparecredit exposure

The said amendment is still under preparation


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Impairment

IAS 32 required an impairment model, based on “incurredlosses”.

Incurred loss model assumes that all loans will be repaid,until evidence to the contrary (Loss trigger event). Only atthat point, an impaired loan (or portfolio) is written down

Basel II requires a proactive approach, creation ofprovisions and reserves for credit event.

IFRS 9 accepts now “expected loss approaches” wherebyexpected losses are recognized throughout the life of aloan/financial asset, even if it is measured at amortizedcost, recognition of a potential loss at an “earlier level”



Three stages of impairment:


Stage 1:

As soon as a financial instrument

is originated of purchased, 12

month expected credit losses are

recognized in profit or loss and a

loss allowance is established.

This serves as a proxy for the

initial expectations of credit

losses.

For financial assets, interest

revenue is calculated on the gross

carrying amount (i.e. without

adjustment for expected credit

losses.

Stage 2:

If the credit risk increases

significantly and the

resulting credit quality is not

considered to be low credit

risk, full lifetime expected

credit losses are recognized.

Lifetime expected credit

losses are only recognized,

if the credit risk increases

significantly from when the

entity originates or

purchases the financial

instrument.

Stage 3:

If the credit risk of a financial

asset increases to the point,

that it is considered credit-

impaired, interest revenue is

calculated based on the

amortized cost (i.e. the gross

carrying amount adjusted for

the loss allowance). Financial

assets in this stage will

generally be individually

assessed.

Lifetime expected credit

losses are still recognized on

these financial assets.

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12-month expected credit losses:

Portion of lifetime expected credit losses, that representthe EXPECTED credit losses, which result from defaultevents on a FINANCIAL INSTRUMENT (in general), whichare possible within the 12month after the reporting date

It is not the expected CASH shortfall over the next twelvemonth, however, it is the effect of the entire credit loss onan asset weighted by the probability that this loss willoccur in the next 12 month.

It is also not the credit losses on assets, that are forecastedto actually default in the next 12 month

If an entity can identify such assets (or a portfolio), theseare recognized in LIFETIME EXCPECTEDCREDIT LOSS


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12 month expected credit loss: Expected risk, “acceptable”

damage calculated statistically out of past events

Example: about 600 credit events with different rate of repayment/default50 enterprises created 0% default70 enterprises created 0.25% default95 enterprises created 0.5% default

…..

1 enterprise created 4.75% default0 enterprise created 5% default and more

Average loss of credit: 1%i.e. 1% of all credits default

1% expected risk, part of calculation of credit cost

Loss-rate

Number of cases creating loss

rel. Freqeuncy of cases

weighted loss

0,00% 50 0,0% 0,0%0,25% 70 11,2% 0,0%0,50% 95 15,2% 0,1%0,75% 100 16,1% 0,1%1,00% 90 14,4% 0,1%1,25% 80 12,8% 0,2%1,50% 70 11,2% 0,2%1,75% 50 8,0% 0,1%2,00% 30 4,8% 0,1%2,25% 20 3,2% 0,1%2,50% 10 1,6% 0,0%2,75% 5 0,8% 0,0%3,00% 3 0,5% 0,0%3,25% 2 0,3% 0,0%3,50% 1 0,2% 0,00%3,75% 1 0,2% 0,00%4,00% 1 0,2% 0,00%4,25% 1 0,2% 0,00%4,50% 1 0,2% 0,00%4,75% 1 0,2% 0,00%5,00% 0 0,0% 0,00%

Over 5% 0 0,0% 0,00%


Dr. Th. Goswin International Accounting Standards

Expected loss = Σ (loss * frequency of loss)= Σ weighted loss

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12 month expected credit loss:

Example: Investment in interest rate swap

Consideration of counterparty risk

Calculation of credit value adjustment at the beginning of swap arrangement



0

9

16

2124 25 24

21

16

9

00

‐9

‐16

‐21‐24 ‐25 ‐24

‐21

‐16

‐9

0

‐30

‐20

‐10

0

10

20

30

0 1 2 3 4 5 6 7 8 9 10

EPE

ENE

Periodpotential exposures Credit Spread credit charges with 50% probability Discount Factor

Cash valueEPE ENE counterparty own counterparty own difference 4,00%

0 0 0 0,80% 0,40% 0,000 0,000 0,000 1,000 0,0001 9 -9 0,90% 0,45% 0,041 -0,020 0,020 0,962 0,0192 16 -16 1,00% 0,50% 0,080 -0,040 0,040 0,925 0,0373 21 -21 1,00% 0,50% 0,105 -0,053 0,053 0,889 0,0474 24 -24 1,00% 0,50% 0,120 -0,060 0,060 0,855 0,0515 25 -25 1,00% 0,50% 0,125 -0,063 0,063 0,822 0,0516 24 -24 1,00% 0,50% 0,120 -0,060 0,060 0,790 0,0477 21 -21 1,00% 0,50% 0,105 -0,053 0,053 0,760 0,0408 16 -16 1,00% 0,50% 0,080 -0,040 0,040 0,731 0,0299 9 -9 1,00% 0,50% 0,045 -0,023 0,023 0,703 0,016

10 0 0 1,00% 0,50% 0,000 0,000 0,000 0,676 0,000

explanation from yield curve from yield curve given given EPE*Cr.Sp*50% ENE*Cr.Sp*50%

Summ 0,338credit value adjustment


Lifetime expected credit losses:

Expected present value measure of losses, that arise, if aborrower defaults on his obligation throughout the life ofthe financial instrument. They are the weighted averagecredit losses, with the probability of default as the weight.

Difference to 12-month expected credit losses:

12-month expected losses are proportion of lifetime expectedlosses, limited to an expectation within 12month.

Lifetime expected credit losses consider both amount andtiming of payments, this means, that a credit loss has to berecognized eve, when the entity expects to be paid in full but ata later moment.


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Lifetime expected credit losses:

Example: Portfolio of home loans originated in a country:

Stage 1: 12-month expected credit losses are recognized for allloans on initial recognition

Stage 2: information emerges, that one region in the country isexperiencing tough economic conditions. Therefore it isexpected, that the loans in that region may be more exposed todefault. Lifetime expected credit losses are recognized forthose loans within that region additionally to the 1-monthexpected credit losses.

Stage 3: more information emerges and the entity is able toidentify some particular loans which have already defaulted orwill imminently default. Lifetime expected cedit losses continueto be recognized, but interest revenue switches to a netinterest basis.


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Lifetime expected credit loss:

Example: Investment in interest rate swap

Consideration of change of risk if an (even remote) event is triggered (e.g. change of interest rate

Calculation of credit value adjustment in course of time.



0

9

16

2124 25 24

21

16

9

00

‐9

‐16

‐21‐24 ‐25 ‐24

‐21

‐16

‐9

0

‐30

‐20

‐10

0

10

20

30

0 1 2 3 4 5 6 7 8 9 10

EPE

ENE

9

16

2124 25 24

21

16

9

0

9

0

-7

-12-15 -16 -15

-12

-7

0

-20

-15

-10

-5

0

5

10

15

20

25

30

0 1 2 3 4 5 6 7 8 9

EPE

ENE

Beginning of contract

Change of interest rate after one year

25

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Cash valueEPE ENE counterparty own counterparty own difference 4,00%

0 0 0 0,80% 0,40% 0,000 0,000 0,000 1,000 0,0001 9 -9 0,90% 0,45% 0,041 -0,020 0,020 0,962 0,0192 16 -16 1,00% 0,50% 0,080 -0,040 0,040 0,925 0,0373 21 -21 1,00% 0,50% 0,105 -0,053 0,053 0,889 0,0474 24 -24 1,00% 0,50% 0,120 -0,060 0,060 0,855 0,0515 25 -25 1,00% 0,50% 0,125 -0,063 0,063 0,822 0,0516 24 -24 1,00% 0,50% 0,120 -0,060 0,060 0,790 0,0477 21 -21 1,00% 0,50% 0,105 -0,053 0,053 0,760 0,0408 16 -16 1,00% 0,50% 0,080 -0,040 0,040 0,731 0,0299 9 -9 1,00% 0,50% 0,045 -0,023 0,023 0,703 0,016

10 0 0 1,00% 0,50% 0,000 0,000 0,000 0,676 0,000

explanation from yield curve from yield curve given given EPE*Cr.Sp*50% ENE*Cr.Sp*50%

Summ 0,338credit value adjustment


Cash valueEPE ENE counterparty own counterparty own counterparty own difference 4,00%

0 9 9 18 0 0,80% 0,40% 0,072 0,000 0,072 1,000 0,0721 16 0 16 0 0,90% 0,45% 0,072 0,000 0,072 0,962 0,0692 21 -7 21 -7 1,00% 0,50% 0,105 -0,018 0,088 0,925 0,0813 24 -12 24 -12 1,00% 0,50% 0,120 -0,030 0,090 0,889 0,0804 25 -15 25 -15 1,00% 0,50% 0,125 -0,038 0,088 0,855 0,0755 24 -16 24 -16 1,00% 0,50% 0,120 -0,040 0,080 0,822 0,0666 21 -15 21 -15 1,00% 0,50% 0,105 -0,038 0,068 0,790 0,0537 16 -12 16 -12 1,00% 0,50% 0,080 -0,030 0,050 0,760 0,0388 9 -7 9 -7 1,00% 0,50% 0,045 -0,018 0,028 0,731 0,0209 0 0 0 0 1,00% 0,50% 0,000 0,000 0,000 0,703 0,000

explanation from yield curve from yield curve from yield curve from yield curve given given EPE*Cr.Sp*50% ENE*Cr.Sp*50%

Summ 0,554

credit value adjustment


Increase in credit risk since initial recognition


Stage 1

12-month expected credit losses

Effective interest on gross carrying amount

Stage 2

Lifetime expected credit losses

Effective interest on gross carrying amount

Stage 3

Lifetime expected credit losses

Effective interest on amortized cost

Impairment recognition

Interest revenue

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Measuring expected credit losses:

Expected credit losses (in general) are an estimate of creditlosses over the life of the financial instrument

Factors to be considered:

Probability weighted outcome. Neither best case nor worstcase scenario

Estimate should reflect the possibility that credit lost occursand that no credit loss occurs

Time value of money. Expected credit loss to be discounted toreporting date

Based on reasonable and supportable information that isavailable without undue cost or effort (i.e not necessary toobtain external rating for all credit exposures)




Examples:

Discriminant analysis

Value at Risk (VAR)

Option pricing theory


µ bankrupt µ stable

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Entity required to use reasonable and supportable informationthat is available at reporting date and that includes informationabout past events, current conditions and forecasts of futureconditions

No need to use a „crystal ball“ to predict future, everythingdepends on the availability of the information. As forecast horizonincreases, quality of information decreases.

Although model should be forward looking, historical data is ananchor. Adjustment of historical data to current economic trendsis may be necessary.

IFRS 9 does not prescribe any model or method. As long asfindings and observations are justifiable, preconditions of IFRS 9fulfilled.



Assessing significant increases in credit risk:

IFRS 9 requires life expected credit losses to be recognized, whenthere are significant increases in credit risk since initialrecognition

At beginning of lifetime of credit entity assesses initialcreditworthiness of the borrower. Initial creditworthiness is takenevaluated.

If in course of time a re-valued creditworthiness shows differenceto initial expectations (i.e. if when lender is not receivingcompensation for the level of credit risk to which he is nowexposed), readjustment of expectation has to be done.

This is reflected in the income statement as a financial loss

Important: there is a significant increase of credit risk before afinancial asset becomes impaired. And this risk is alreadyreflected in the financial statement.


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Disclosure:

Explain basis for expected credit loss calculations

How credit losses and changes in credit risk are assessed

Reconciliation from opening to closing of allowance balance for12-month losses, separately from lifetime losses allowancesbalance

Balances of carrying amount from opening to closing for financialinstruments, subject to impairment

Users of financial statements must be able to understand thereasons for changes in the allowance balances (i.e. if it is causedby changes in credit risk or increased lending).

Additionally: Information on rating grades and modification ofcontractual cash flows.



Hedge accounting:

Clarification on the eligibility of financial instrumentsmanaged on a contractual cash flow basis in a fair valuehedge

Target:

Simplification of hedge accounting procedures forfair value hedges

Aligning hedge accounting more with RiskManagement and provide more useful information foranalysis

Establish a more objective-based approach to hedgeaccounting

address inconsistencies and weaknesses in existingmodel


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Hedge accounting:

Aspects considered


Hedge accounting

Objective

Hedging instruments

Discontinuation and

rebalancing

Presentation and

disclosure

Alternatives to hedge

accounting

Hedged items

Effectiveness assessment

Groups and net positions


Hedge accounting: Main questions solved in IFRS 9

(1) Definition of what financial instrument qualify for

designation as hedging instrument

(2) Definition of what items (existing or expected)

qualify as hedged items

(3) How should an entity account a hedging relationship

(4) Hedge accounting presentation and disclosures


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Hedge accounting:

(1) and (2)

Non-derivative financial assets or liabilities,measured by fair value through profit and loss(FVTPL) may be eligible as a hedging instrument (forderivatives and non-derivatives)

Non-derivative financial assets and liabilitiesmeasured not by FVTPL may lead to operationalproblems and therefore do not qualify as hedginginstruments

Non-derivative financial assets or liabilities,measured by fair value through profit and loss(FVTPL) may be eligible as a hedged item



Hedge accounting:

(1) and (2)

Derivatives qualify as a hedged item

Derivatives may qualify as hedging Instrument aswell, especially in case of covering interest rate riskand foreign currency risk

Although the two risks can be hedged with oneinstrument altogether, the board acknowledges thefact that entities often hedge these risks withdifferent instruments

However, derivatives need to be identified formallyas a hedging instrument


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Hedge accounting:

(3) Accounting procedures:

Fair value hedge: Gain and loss from re-measuringhedging instrument to be recognized as othercomprehensive income

Hedged gain or loss of hedged item to be recognizedseparately in income statement (next to gain/loss ofthe entire asset/liability, that was hedged), andafterwards recognized in other comprehensiveincome

Ineffective portion of hedging operation to be shownin income statement



Hedge accounting:


Cash flow hedge: Eligible only, if close relationbetween hedge instrument and hedged item, formaldesignation, hedge effectiveness given an more thanaccidental

Gains and losses of hedged itemto show in equity(cash flow hedge reserve), gains and losses ofhedging instrument to be shown in othercomprehensive income, if ineffective part existing, tobe shown in income statement


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Hedge accounting:


Hedge of a net investment in a foreign operation:

Gain or losses on the hedging instrument shall berecognized in other comprehensive income ifeffective, in-effective part to be shown in incomestatement

For hedging operations prior to first time applicationof IFRS 9, Cash flow hedge reserve shall betransferred to profit and loss



Hedge accounting:

(4) Disclose information about:

an entity’s risk management and how it is appliedto current risk problems

how the entity’s hedging activities may affect theamount, timing and uncertainty of its future cashflows

the effect of the hedge accounting has on theentity’s statement of financial positions (balancesheet), statement of comprehensive income(income statement) and statement of changes inequity


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Hedge accounting:

(4) Disclose information on Risk Management strategy,

explain

how risks arise

how the entity manages each risk (separately

for individual risks or the entirety of risks)

the extent of risk exposure the entity manages



Hedge accounting:

(4) Disclose information on the amount, timing anduncertainty of future cash flow

For each category of risk exposure disclosequantitative information to analyze

- type of risk exposure, which is managed

- extend of hedging to every risk exposure

- effect of hedging to every risk exposure


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Hedge accounting:

(4) Disclose information on the amount, timing anduncertainty of future cash flow, in particular:

amount or quantity (tons etc.) of risk to whichentity is exposed

amount or quantity of risk, which is hedged

how hedging changes the exposure to risk

for each category a description of sources ofhedge ineffectiveness (currently and as a futureexpectation)



Hedge accounting:

(4) Disclose of effects of hedge accounting on primary

financial statement, in tabular form, for fair value

hedge, cash-flow hedge and hedge of a net

investment (…)

- carrying amount of the hedging instruments, and

- notional amounts or other quantities (tons etc.)

related to hedging instrument


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Hedge accounting:

(4) Disclose of effects of hedge accounting on primaryfinancial statement, in tabular form, for hedged items

• For fair value hedges

• Carrying amount of accumulated gains and losseson the hedged items, presented in separate line inbalance sheet (statement of financial positions),separating assets from liabilities

• Balance remaining in balance sheet for hedges,where hedging has been discontinued



Hedge accounting:

(4) Disclose of effects of hedge accounting onprimary financial statement, in tabular form, forhedged items

• For cash flow hedges

• Balance in the cash flow hedge reserve (i.e.Equity) for continuing hedges, when there was aneffect on income statement

• Balance remaining in balance sheet for hedges,where hedging has been discontinued


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Hedge accounting:

(4) Disclose of effects of hedge accounting on primaryfinancial statement, in tabular form, for eachcategory of risk

For fair value-, cash flow-, and hedges of a netinvestment (...)

Changes in the value of the hedging instrumentrecognised in other comprehensisve income

Hedge ineffectiveness recognized in profit andloss

A description of the items, where hedgeineffectiveness is included



Hedge accounting:


• For fair value hedges

• Change of the value of the hedged item


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Hedge accounting:


For cash flow-, and hedges of a net investment (...)

For hedges of net positions the hedging gains orlosses recognized in a separate line in the incomestatement

Amount reclassified from cash flow hedge reserveto profit and loss as a reclassification adjustment

Description of the line item in the incomestatement, affected by reclassification



Hedge accounting:

(4) Disclose of effects of hedge accounting on primaryfinancial statement

A reconciliation calculation shall be given, that

Allows users to identify the different adjustments,classifications and operations, which have aneffect on balance sheet, income statement,statement of profit and loss, statement of othercomprehensive income and statement of changesof equity


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Thank you for your attention

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IFRS 9 Financial Instruments - Bank of Thailand · 5 Dr. Th. Goswin International Accounting...

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