New standard - Financial instruments

IFRS 9 will bring profound change to financial instrument accounting: financial asset impairment calculated on an expected loss basis, some easing of hedge accounting rules, and fewer categories for assets. Banks and other financial institutions are most affected, but specific areas can have a big impact on corporates as well. IFRS 9 is mandatory for financial periods beginning on or after 1 January, 2018.

IFRS 9

IFRS 9 Financial Instruments brings fundamental change to financial instrument accounting as it replaces IAS 39 Financial Instruments: Recognition and Measurement. There are a number of decisions and choices to be made at transition to the new standard but some good news: hedge accounting rules have been eased. Banks and financial institutions are most affected but corporates need to consider the new requirements as well.

Our guidance on IFRS 9 follows the three main aspects of the standard: classification and measurement of financial assets, applying the expected credit loss model to financial assets, and hedge accounting.

Classification and measurement

IFRS 9 replaces the multiple classification and measurement models in the previous standard. Classification is now driven by a combination of how a company manages its financial assets ("business model test") and the characteristics of their contractual cash flow ("cash flow test"). This will result in financial assets being measured at either amortised cost or fair value, with fair value changes recorded in profit or loss, or taken to other comprehensive income (OCI). Some flexibility exists under IFRS 9 for companies to make an irrevocable election to take fair value changes on equity instruments to OCI, helping to remove income statement volatility.

There is limited changes to accounting for financial liabilities under IFRS 9. The main impact will be accounting for modifications to financial liabilities that do not result in derecognition. A gain or loss should be recognised in profit or loss on modification, which may be a different policy for recognising gains and losses under IAS 39.

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Impairment

Under the new standard, impairment losses should be recognised using the expected credit loss (ECL) model. This involves a three-stage approach in which financial assets move through the three stages as their credit quality changes. The stage dictates how a company measures impairment losses and applies the effective interest rate method. A simplified approach is permitted for financial assets that don't have a significant financing component (eg. trade receivables) and for lease receivables. On initial recognition, companies will record a day-1 loss equal to the 12 month ECL (or lifetime ECL for trade receivables), unless the assets are considered credit impaired.

The new model is expected to lead to higher provisions and earlier recognition of impairment provisions.

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Hedging

Under the new hedging requirements, a company will be able to align its hedge accounting more closely with its risk management practices. As a general rule, it will be easier to apply hedge accounting. The bright line 80-125% retrospective hedge effectiveness test has been replaced with an economic relationship effectiveness test. Under the new hedging rules, there are a number of hedged items that can now be designated, such as risk components of non-financial items. Opportunities also exist to reduce hedge ineffectiveness when hedging with FX forwards and options. Companies will however be required to make additional disclosures around their hedging activities.

In contrast to the changes introduced for classification and measurement and impairment, which are applied retrospectively on adoption of IFRS 9, the new hedging requirements are mostly applied prospectively.

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Industry impacts

Financial instruments are used across all industries so all companies need to consider the impact of IFRS 9. Some industries, though, will be much more affected than others. For example, banks and other financial institutions will be most affected by the new impairment requirements.

The publications below look at some of the potential issues to consider and likely areas of change for banks and corporate entities.

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Contact us

Regina Fikkers

Regina Fikkers

Accounting and Regulatory Leader, PwC Australia

Tel: +61 (2) 8266 8350

Paul Brunner

Paul Brunner

Partner - Capital Markets, Accounting Advisory and Structuring, PwC Australia

Tel: +61 2 8266 4664

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