Summary and Overview of new IFRS 9 on Financial instruments - covering valuation models, the impairment approach for trade receivables, and hedge accounting examples

1. Financial Instruments
– IFRS 9
SUMMARY OVERVIEW

2. Overview
• IFRS 9 – effective periods commencing January 1st 2018 – necessary period for
transition phases and implementation prior to this date.
• IFRS 9 impacts across 3 distinct areas in relation to financial instruments:
1. Classification & Measurement
• Use of amortised cost / FVOCI / FVTPL* based on analysis of business model for holding financial
assets
2. Hedge Accounting
• Criteria for hedge accounting relaxed
• Less prescriptive – based upon whether hedge accounting would reflect the economics of the hedge
3. Impairment of financial assets
• A key issue for many companies
• Implementation of “expected credit loss” model
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FVOCI : Fair value in other comprehensive income
FVTPL : Fair value through profit and loss

3. Overview
• Alternative models for financial assets:
1. Amortised cost
• Interest at effective yield in P&L
• No recognition of fair value changes
2. FVOCI
• Interest at effective yield in P&L
• Fair value changes in Other Comprehensive Income
3. FVTPL
• Interest & Fair value changes in P&L
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FVOCI : Fair value in other comprehensive income
FVTPL : Fair value through profit and loss

4. Valuation Model - Assets
1. Amortised cost
• Unless designated FVTPL, use where:
I. Business model is to hold assets to collect contractual cash flows
II. Contractual cashflows are on specified dates and are solely principle & interest
2. FVOCI – 2 scenarios
I. Business model asset held to collect contractual cash flows, and for sale.
II. Irrevocable designation option for equities
3. FVTPL
I. Residual Value
II. May designate if reduces or eliminates accounting mismatch
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FVOCI : Fair value in other comprehensive income
FVTPL : Fair value through profit and loss

5. Impairment – the IFRS 9 approach
• Based on expected credit losses (ECL)
• Different measures of impairment dependent upon which “stage” of credit deterioration has been
reached
• ECLs re-assessed at each reporting date in the light of new information.
1. Performing
1. Recognise 12 month ECL – entire lifetime ECL weighted by the probability that default will occur in the
next 12 months.
2. Interest is effective interest rate (EIR) on gross carrying amount
2. Underperforming
1. Recognise lifetime ECL – the ECL that results from all possible default events over the expected life of
the instrument (e.g. 30 days overdue becomes underperforming)
2. Interest is effective interest rate (EIR) on gross carrying amount
3. Non-performing
1. Recognise lifetime ECL – the ECL that result from all possible default events over the expected life of
the instrument.
2. Interest is effective interest rate (EIR) on NET carrying amount
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6. Impairment – Trade Receivables
• The rules are relaxed forTrade Receivables, that do not constitute financing transactions.
• IFRS9 permits lifetime expected credit losses to be provided for from initial recognition
• E.g. based upon past experience and current conditions
• IfTrade Receivables have a financing component a policy choice can be made between
this and the normal model.
• The advantage of this is that no need to assess whether there has been a significant
increase in credit risk since initial recognition.
• Impact upon existing processes and procedures:
• Many entities estimate credit losses using a provision matrix
• To date trade receivables are grouped based on different customer bases and different historical
loss patterns (geographical region, product type, customer rating, type of customer etc)
• To comply with IFRS9 entities could adjust the historical provision rates on their trade
receivables to reflect the relevant information about current conditions and reasonable and
supportable forecasts about the future.
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7. Example: Trade receivable impairment
• A company has an expected loss provision based historical performance and days
overdue at an expected loss rate:
• 0 days overdue 0.5%
• 30 days overdue 5%
• 90 days overdue 25%
• It is possible for the expected loss rates to increase/decrease depending upon the general
economic conditions – however assuming they remain the same:
• At the outset of a sale for £100,000 an impairment allowance of £500 will be posted
• If the balance remains outstanding after 3o days then an additional £4,500 will be posted
• If the balance remains outstanding after 90 days then an additional £20,000 will be posted
• Is this the return of the general bad debt provision?A tax allowable deduction, not based upon
individual customers performance but a general expected loss rate.
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8. Example: Hedge Accounting
• A company enters into forward contracts to minimize the risk that may arise between
the order, purchase and sale of goods purchased from the USA.
• Upon raising the order for $100,000 of goods a forward contract is entered into at 1.30/£
(£76,923), the goods are delivered and the invoice is entered into the system using the
forward contract rate – payment is not due for 60 days.
• At the end of month 1 the exchange rate has moved to 1.25/£ - so $100,000 is now worth
£80,000 – the invoice debt has increased, there is a loss on the revaluation of the creditor
but at the same time the forward contract now has an asset value.
1. Revaluation of supplier invoice:
• Dr. P&L – operating income (foreign exchange) £,3077
• Cr. BS – Payables (creditors) £3,077
2. Valuation of hedging contract:
• Dr. BS – Derivatives assets/liabilities £3,077
• Cr. P&L – Finance cost – change in fair value of derivative £3,077
• As can be readily apparent there is no impact upon the overall operating income of the business, but the
position at the month end reflects the current exchange rate (if a forward contract was not in place) and
the positive impact of the forward contract.
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9. Further guidance and information
• Resources:
• https://www.pwc.com/gx/en/services/audit-assurance/ifrs-reporting/financial-
instruments-ifrs-9.html
• https://www.iasplus.com/en/standards/ifrs/ifrs9
• Contact
• E-mail: arm-fdsolutions@outlook.com
• LinkedIn: https://www.linkedin.com/in/tonymason-arm-interim-fd-cfo
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