Final version of IFRS 9 Financial Instruments. Impacts for non-financial corporates using SAP Financial Consolidation starter kit for IFRS

Transcription

1 Final version of IFRS 9 Financial Instruments Impacts for non-financial corporates using SAP Financial Consolidation starter kit for IFRS November 2014

2 TABLE OF CONTENTS INTRODUCTION... 3 BRIEF OVERVIEW OF IFRS Classification and measurement... 4 Impairment... 6 Hedge accounting... 8 WHAT CHANGES FOR NON-FINANCIAL CORPORATES?...11 Classification and measurement...11 Impairment...12 Hedge accounting...12 Amendments to IAS IMPACTS ON SAP FINANCIAL CONSOLIDATION STARTER KIT...14 CONCLUSION...15 APPENDIX 1- IMPAIRMENT AND FVTOCI...16

3 Introduction In July 2014, the IASB (International Accounting Standards Board) published the fourth and final version of IFRS 9 Financial Instruments. This is the conclusion of a major project started in 2002 as part of the Norwalk Agreement between the IASB and US Financial Accounting Standards Board (FASB) to reform financial instruments accounting. The project had been divided into three phases in order to allow a step by step approach. Once a phase was completed, the corresponding chapters were created in IFRS 9 and withdrawn from IAS 39 Financial Instruments: Recognition and Measurement. Phase I: classification and measurement First chapters of IFRS 9 were issued in November 2009, regarding solely the classification and measurement of financial assets. Additional provisions regarding the classification and measurement of financial liabilities were added in October Final amendments have been introduced in the last version of July Phase II: impairment A new impairment model has been added in the final version of July 2014 that replaces the complex and multiple impairment models existing in IAS 39. Phase III: hedge accounting Issued in November 2013, chapters relating to hedge accounting have not been modified in the final version of IFRS 9. The IASB has worked closely with the FASB throughout the development of IFRS 9. However, they could not come to an agreement on a converged solution. IFRS 9 is effective for annual periods beginning on or after 1 January Earlier application is permitted. This document firstly presents a brief overview of IFRS 9. It then focuses on the main changes non-financial corporates will have to face when adopting IFRS 9. The last part is dedicated to the expected impacts on the SAP Financial Consolidation starter kit for IFRS. IFRS 9 as issued in July 2014 is now complete Effective from 1 January 2018 No convergence with US GAAP Final version of IFRS 9 (Financial Instruments) I 3

4 Brief overview of IFRS 9 Though simpler than IAS39, IFRS 9 remains a long and complex standard. In this document we limit our analysis to the requirements that may have an impact on the consolidation software configuration. Classification and measurement Classification based on cash flows characteristics and business model Three categories: amortized cost, fair value through profit or loss, fair value through other comprehensive income Financial assets IFRS 9 applies one classification approach for all types of financial assets, including those that contain embedded derivatives, based on two criteria: the contractual cash flow characteristics of the financial asset, and the company s business model for managing the financial assets. This process can be illustrated as follows 1 : Firstly, it should be determined whether contractual cash flows are solely payments of principal and interest (SPPI). IFRS 9 now provides more guidance to appreciate whether this criteria is met. In particular, it has been clarified that interest can comprise a return not only for the time value of money and credit risk but also for other components such as a return for liquidity risk, amounts to cover expenses and a profit margin. Financial assets that do not meet the SPPI criteria should be measured at fair value through profit or loss (FVTPL). 1 From: IFRS 9 Financial Instruments, Project Summary, July 2014 published by the IFRS Foundation Final version of IFRS 9 (Financial Instruments) I 4

5 For financial assets that meet the SPPI criteria the second question relates to the entity s business model. Three business models have been identified depending on their objectives: 1) The objective is to hold assets in order to collect contractual cash flows only For most non-financial corporates, trade receivables will fall into this category. Such assets are measured at amortized cost. 2) The objective is achieved by both collecting contractual cash flows and selling assets Compared to the previous business model, this one will typically involve greater frequency and volume of sales of financial assets. This business model is usual for banks and insurance companies but may also exist in non-financial corporates. For example, a company may manage the overall return of long-term debt instruments by collecting the contractual cash flows and selling assets to reinvest and get a higher return in order to fund capital expenditure in the short to medium term. Such financial assets are measured at fair value through other comprehensive income (FVTOCI). This is a new category introduced in the last version of IFRS 9. The amounts that are recognized in profit or loss are the same as the amounts that would have been recognized in profit or loss if the financial asset had been measured at amortized cost. It means that interest revenue, exchange gains and losses and impairment gains or losses are recognized in profit or loss whereas other changes in the carrying amount are recognized in OCI. Where the financial asset is derecognized, the cumulative gain or loss recognized in OCI is reclassified to profit or loss. 3) Any other objective Any financial assets that are not held in one of the two business models mentioned above are measured at fair value through profit or loss. In addition to these rules, two options are available: Fair value through other comprehensive income for investments in equity instruments that are not held for trading. If this election is made, all fair value changes, excluding dividends, are recognized through OCI without any further recycling to profit or loss (where the investment is sold for example) Fair value through profit or loss for any financial asset if doing so eliminates or significantly reduces a measurement or recognition inconsistency (accounting mismatch). In both cases, the option is irrevocable and should be made at initial recognition. Financial liabilities Most financial liabilities are measured at amortized cost. The fair value option still exists where particular criteria are met. Reclassification Reclassification from one category to another is possible for financial assets when and only when an entity changes its business model for managing such assets. Such changes are expected to be very infrequent. Reclassification is prohibited for financial liabilities. Practical consequences are listed below. From amortized cost to FVTPL: fair value measured at the reclassification date, any gain or loss arising from a difference between the previous amortized cost and fair value is recognized in profit or loss Final version of IFRS 9 (Financial Instruments) I 5

6 From amortized cost to FVTOCI: fair value measured at the reclassification date, any gain or loss arising from a difference between the previous amortized cost and fair value is recognized in OCI From FVTPL to amortized cost: fair value at the reclassification date becomes the new carrying amount From FVTPL to FVTOCI: the financial asset continues to be measured at fair value From FVTOCI to amortized cost: the financial asset is reclassified at its fair value at the reclassification date; the cumulative gain or loss previously recognized in OCI is removed from equity and adjusted against the fair value of the financial asset at the reclassification date. As a result, the financial asset is measured at the reclassification date as if it had always been measured at amortized cost. This adjustment affects OCI but does not affect profit or loss and therefore is not a reclassification adjustment. From FVTOCI to FVTPL: the financial asset continues to be measured at fair value, the cumulative gain or loss previously recognized in OCI is reclassified from equity to profit or loss as a reclassification adjustment at the reclassification date. Impairment A new impairment model based on expected losses (rather than incurred losses) Applies to all financial assets measured at amortized cost or at FVTOCI When addressing the impairment requirements, the main questions are: which financial assets are concerned? (scope) when should an impairment loss be recognized? (stages) how to measure the loss allowance? Scope The impairment model applies to financial assets measured at amortized cost or at FVTOCI. For those measured at FVTOCI, the loss allowance should be recognized in OCI and should not reduce the carrying amount in the statement of financial position. It means that the impairment loss is recognized in profit or loss by transferring part of the changes in fair value from OCI. This journal entry ensures that the carrying amount in the statement of financial position always reflects the fair value at the reporting date (see an example from IFRS 9 Implementation Guidance presented in appendix 1). Final version of IFRS 9 (Financial Instruments) I 6

7 Stages As soon as a financial instrument is originated or 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 (stage 1, as illustrated 2 ). 12-month expected credit losses are a portion of lifetime expected credit losses. It is not the expected cash shortfalls over the next twelve months instead, it is the effect of the entire credit loss on an asset weighted by the probability that this loss will occur in the next 12 months. If the credit risk increases significantly and the resulting credit quality is not considered to be low credit risk (stage 2), full lifetime expected credit losses are recognized. Assessment of significant increases in credit risk may be done on a collective basis, for example, on a group or sub-group of financial instruments. Regardless of the way in which an entity assesses significant increases in credit risk, there is a rebuttable presumption that the credit risk on a financial asset has increased significantly since initial recognition when contractual payments are more than 30 days past due. If the credit risk of a financial asset increases to the point that is considered credit-impaired (stage 3), interest revenue is calculated based on the amortized cost (ie the gross carrying amount adjusted for the loss allowance). Financial assets in this stage will generally be individually assessed. Measurement Credit losses are the present value of all cash shortfalls. Expected credit losses are an estimate of credit losses over the life of the financial instrument. When measuring expected credit losses, an entity should consider: the probability-weighted outcome: expected credit losses should represent neither a best or worst-case scenario. Rather, the estimate should reflect the possibility that a credit loss occurs and the possibility that no credit loss occurs the time value of money: expected credit losses should be discounted to the reporting date reasonable and supportable information that is available without undue cost or effort. An entity should recognize in profit or loss, as an impairment gain or loss, the amount of expected credit losses (or reversal) that is required to adjust the loss allowance at the reporting date to the amount that is required to be recognized in accordance with this standard. 2 From: IFRS 9 Financial Instruments, Project Summary, July 2014 published by the IFRS Foundation Final version of IFRS 9 (Financial Instruments) I 7

8 Simplified approach Full lifetime expected credit losses should be recognized for trade receivables or contract assets that do not contain a significant financing component. For trade receivables or contract assets that constitute a financing transaction, as well as for lease receivables, there is an accounting policy choice to apply the full impairment model or to measure loss allowance equal to lifetime expected losses. Hedge accounting Principle-based criteria to qualify for hedge accounting Three types of hedging relationships: fair value hedge, cash flow hedge and hedge of a net investment in a foreign operation To keep it simple, hedge accounting allows for offsetting P&L effects of both hedging instrument and hedged item in the same accounting period. Only hedging relationships that meet the qualifying criteria listed in IFRS 9 can benefit from hedge accounting. There are three types of hedging relationships: fair value hedge: a hedge of the exposure to changes in fair value of a recognized asset or liability or an unrecognized firm commitment that is attributable to a particular risk and could affect profit or loss example: interest rate swap hedging a fixed rate borrowing cash flow hedge: a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated with a recognized asset or liability or a highly probable forecast transaction, and could affect profit or loss example: interest rate swap hedging a variable rate borrowing hedge of a net investment in a foreign operation as defined in IAS21 Fair value hedges As long as a fair value hedge meets the qualifying criteria, the hedging relationship should be accounted for as follows: the gain or loss on the hedging instrument should be recognized in profit or loss (or OCI if the hedged item is an equity instrument for which an entity has elected to present changes in fair value in OCI) the hedging gain or loss on the hedged item should be recognized in profit or loss even though the hedged item is a financial asset measured at FVTOCI. However, if the hedged item is an equity instrument for which an entity has elected to present changes in fair value in OCI, those amounts should remain in OCI. When a hedged item is an unrecognized firm commitment, the cumulative change in fair value of the hedged item subsequent to its designation is recognized as an asset or a liability with a corresponding gain or loss recognized in profit or loss. When a hedged item is a firm commitment to acquire an asset or a liability, the initial carrying amount of the asset or the liability that results from the entity meeting the firm commitment is adjusted to include the cumulative change in the fair value of the hedged item that was recognized in the statement of financial position. Final version of IFRS 9 (Financial Instruments) I 8

9 Cash flow hedges As long as a cash flow hedge meets the qualifying criteria, the hedging relationship should be accounted for as follows: (a) the separate component of equity associated with the hedged item (cash flow hedge reserve, previously hedging reserve in IAS 39) is adjusted to the lower of the following (in absolute amounts): the cumulative gain or loss on the hedging instrument the cumulative change in fair value of the hedged item (b) the portion of the gain or loss on hedging instrument that is determined to be an effective hedge (ie the portion that is offset by the change in the cash flow hedge reserve calculated in accordance with (a)) should be recognized in OCI (c) any remaining gain or loss on the hedging instrument (or any gain or loss required to balance the change in the cash flow hedge reserve calculated in accordance with a)) is hedge ineffectiveness that should be recognized in profit or loss The amount accumulated in the cash flow hedge reserve is subsequently accounted for as follows, depending on the nature of the underlying hedged transaction: If it results in the recognition of a non-financial item, the amount accumulated in equity is removed from the separate component of equity and included in the initial cost or other carrying amount of the hedged asset or liability. This accounting entry, sometimes referred to as basis adjustment, does not affect OCI of the period. The same accounting treatment applies where a hedged forecast transaction of a non-financial item subsequently becomes a firm commitment for which fair value hedge accounting is applied For any other cash flow hedges, the amount accumulated in equity is reclassified to profit or loss as a reclassification adjustment in the same period or periods during which the hedged cash flows affect profit or loss. This accounting entry does affect OCI of the period. If cash flow hedge accounting is discontinued, the amount that has been accumulated in OCI should: remain in accumulated OCI if the hedged future cash flows are still expected to occur; be immediately reclassified to profit or loss as a reclassification adjustment if the hedged future cash flows are no longer expected to occur. After discontinuation, once the hedged cash flow occurs, any amount remaining in accumulated OCI should be accounted for depending on the nature of the underlying transaction (as described above). Hedges of a net investment in a foreign operation Hedges of a net investment in a foreign operation, including a hedge of a monetary item that is accounted for as part of the net investment, should be accounted for similarly to cash flow hedges: the portion of the gain or loss on the hedging instrument that is determined to be an effective hedge is recognized in OCI and the ineffective portion is recognized in profit or loss. The cumulative gain or loss on the hedging instrument relating to the effective portion of the hedge that has been accumulated in the foreign currency translation reserve should be reclassified from equity to profit or loss as a reclassification adjustment on the disposal or the partial disposal of the foreign operation. Final version of IFRS 9 (Financial Instruments) I 9

10 Macro-hedging activities The IASB currently has a separate, active project on accounting for macro hedging activities. In this project, the IASB is exploring a new way to account for dynamic risk management of open portfolios. This project is still at an early stage of development with a Discussion Paper Accounting for Dynamic Risk Management: a Portfolio Revaluation Approach to Macro Hedging having been published in April Until the completion of the project, the IASB decided to allow an accounting policy choice to apply either the hedge accounting model in IFRS 9 or in IAS 39 in its entirety, with the additional choice to use the IAS 39 accounting for macro hedges if applying IFRS 9 hedge accounting. Final version of IFRS 9 (Financial Instruments) I 10

11 What changes for non-financial corporates? 3 categories of financial assets instead of 4 in IAS 39 No change for measurement of financial liabilities except for own credit risk (fair value option) A new impairment model based on expected losses: day-one provisions to be recognized on most financial assets subject to impairment Better alignment between hedge accounting and risk management activities More line items to be presented in the statement of profit or loss Classification and measurement Financial assets The comparison between IAS 39 and IFRS 9 regarding the classification and measurement of financial assets can be illustrated as follows: categoriesinias39 FVTPL Heldfortradingfairvalueoption HTM Held-to-maturityinvestments Loansreceivables notheldfortrading AFS Available-for-sale categoriesinifrs9 Amortizedcost FVTOCI FVTPL option FVTOCIforequityinvestments Transition from IAS 39 s classification to IFRS 9 s one is not straightforward, even though it will be far simpler for non-financial corporates than for banks or insurers: Most financial assets measured at fair value through profit or loss under IAS 39 will fall into the same category (FVTPL) under IFRS 9. Provided that they pass the SPPI criteria, held-to-maturity investments will remain measured at amortized cost as they are held to collect cash-flows. Those that fail the SPPI test will be classified in the FVTPL category. The loans and receivables that were measured at amortized cost under IAS 39 will mainly remain in the same category under IFRS 9. The available-for-sale investments form the residual category according to IAS 39. Depending on their cash flow characteristics and the business model applied, they will be split into the different categories of IFRS 9. Final version of IFRS 9 (Financial Instruments) I 11

12 Equity investments that are not held for trading are classified as available-for-sale under IAS 39. They are therefore measured at fair value, with changes recognized in OCI and recycled to profit or loss at derecognition (sale of the investment). Under IFRS 9, they fall into the FVTPL category, which means that they should be measured at fair value with changes recognized through profit or loss. If the option is elected, changes in fair value are recognized in OCI but, in contrast with IAS 39, without any further recycling through profit or loss. In both cases, the transition to IFRS 9 will change the way they are accounted for. Financial liabilities As regards financial liabilities, most of the requirements have been carried forward unchanged from IAS 39, meaning that most financial liabilities will continue to be measured at amortized cost. However, changes have been made to address issues related to own credit risk where the fair value option is elected. The fair value of an entity s own debt is affected by changes in the entity s credit risk (own credit). When an entity s credit quality declines, the fair value of its liabilities fall (because they are discounted using a higher interest rate), and if those liabilities are measured at fair value a gain is recognized in profit or loss under IAS 39, which is counterintuitive. To avoid this, IFRS 9 now requires the amount of the change in fair value due to changes in the entity s own credit risk to be presented in OCI. Impairment The impairment model introduced by IFRS 9 is quite different from the one existing in IAS 39. Firstly, requirements relating to impairment eliminate the threshold that was in IAS 39 for the recognition of credit losses. Under the impairment approach in IFRS 9 it is no longer necessary for a credit event to have occurred before credit losses are recognized. Instead, an entity should always account for expected credit losses and changes in those expected losses. It means that, except for limited cases, all financial assets (provided that they are subject to impairment) will carry a loss allowance. In particular, this will result in a day one loss on initial recognition of trade receivables or contract assets that arise from transactions in the scope of IFRS 15 (Revenues). The results of commercial entities with a significant amount of trade receivables will therefore be affected. Secondly, equity investments are no longer tested for impairment as they are measured either at FVTPL or FVTOCI with no further recycling to profit or loss. Lastly, IFRS 9 now requires the use of a loss allowance account whereas IAS 39 allows an entity to reduce the carrying amount of the asset directly to reflect impairment. Hedge accounting The new hedge accounting model introduced by IFRS 9 provides a better link between risk management strategy and the way it is reflected in the financial statements. IFRS 9 broadens the application of hedge accounting by allowing more hedging instruments and hedged items to qualify for hedge accounting. For example, IAS 39 allowed components of financial items to be hedged but not components of non-financial items though risk managers often hedge risk components for non-financial items (e.g. oil price component of jet fuel price exposure). IFRS 9 eliminates this distinction. Final version of IFRS 9 (Financial Instruments) I 12

13 Furthermore, the hedge effectiveness testing has been simplified including the removal of the % threshold. IFRS 9 does not change the way the three categories of hedges (fair value, cash flow and net investment in foreign operation) are accounted for, except for hedges of forecast transactions that result in the recognition of a non-financial item. IAS 39 provided an accounting policy choice to account for the amount accumulated in equity either as a basis adjustment or as a reclassification adjustment. IFRS 9 now requires that the amount accumulated in equity is included in the initial carrying amount of the hedged item (basis adjustment). Amendments to IAS 1 IFRS 9 amends IAS 1 (Presentation of Financial Statements) to require the following line items to be presented in the statement of profit or loss (or in the profit or loss section of the statement of comprehensive income): Revenue, presenting separately interest revenue calculated using the effective interest method; Gains or losses arising from the derecognition of financial assets measured at amortized cost; Impairment losses (including reversals) determined in accordance with IFRS 9; Gains or losses arising on reclassification of a financial asset out of the amortized cost category into the FVTPL category; If a financial asset is reclassified out of the FVTOCI category into the FVTPL category, any cumulative gain or loss previously recognized in OCI that is reclassified to profit or loss. Final version of IFRS 9 (Financial Instruments) I 13

14 Impacts on SAP Financial Consolidation starter kit Need for changes in the configuration of the starter kit Transition period (until 2018) to be handled properly Further analysis needed to know how and when the starter kit will be updated The adoption of IFRS 9 will necessarily require configuration changes in the starter kit for IFRS. It is still too early to precisely define these enhancements but the affected items will probably include: the chart of accounts, the accounting schemes (thus the category scenario), the financial statements. As regards the chart of accounts, the current starter kit is partly based on IAS 39 s classification. For example, there are two accounts dedicated to available-for-sale financial assets (one for noncurrent assets, one for current assets). These accounts will no more be used after transition to IFRS 9. Some accounting schemes will need to be changed regarding in particular measurement of financial assets (e.g. equity investments measured at FTOCI without further recycling or at FVTPL), impairment (e.g. impairment of assets measured at FVTOCI) and hedge accounting (removal of the accounting choice for hedges of forecast transactions). The financial statements will also be affected. The statement of other comprehensive income should reflect the new accounting schemes regarding measurement, impairment and hedge accounting. Particular attention should be paid to reversal journal entries that may or not be regarded as reclassification adjustments. The statement of profit or loss is affected by the amendments to IAS 1. Further analysis is still necessary to decide whether those supplementary line items should be included in the statement delivered within the starter kit. Beyond these changes, the most important issue remains the transition period, up to the mandatory effective date (2018). Until this date, some starter kit users will still refer to IAS 39 whereas others will adopt IFRS 9. Therefore, the question arises of whether a configuration compliant with both IAS 39 and IFRS 9 is worth considering. If not, the question of when the starter kit should be updated will have to be answered. Final version of IFRS 9 (Financial Instruments) I 14

15 Conclusion IFRS 9 introduces new accounting principles for financial instruments. Even though it will particularly affect banks and insurers, non-financial corporates will also face major changes: new classification and measurement principles for financial assets, new impairment model that will accelerate recognition of credit losses and a larger use of hedge accounting. As regards the starter kit for IFRS, configuration changes are necessary to comply with IFRS 9. Before defining precisely these changes, a deeper analysis will have to be carried out to consider whether a configuration compliant with both IAS 39 and IFRS 9 is possible. Indeed, the transition period up to the mandatory effective date (2018) is quite long and, until this date, some starter kit users may still apply IAS 39. In our next publication, we will get back to these questions and deliver a work plan for the starter kit update. Final version of IFRS 9 (Financial Instruments) I 15

16 Appendix 1- Impairment and FVTOCI Extract from IFRS 9 Implementation Guidance: example 13 debt instrument measured at fair value through other comprehensive income An entity purchases a debt instrument with a fair value of CU1,000 on 15 December 20X0 and measures the debt instrument at fair value through other comprehensive income. The instrument has an interest rate of 5 per cent over the contractual term of 10 years, and has a 5 per cent effective interest rate. At initial recognition the entity determines that the asset is not purchased or originated creditimpaired. Financial asset FVOCI Cash (To recognize the debt instrument measured at its fair value) Debit CU1,000 Credit CU1,000 On 31 December 20X0 (the reporting date), the fair value of the debt instrument has decreased to CU950 as a result of changes in market interest rates. The entity determines that there has not been a significant increase in credit risk since initial recognition and that expected credit losses should be measured at an amount equal to 12-month expected credit losses, which amounts to CU30. For simplicity, journal entries for the receipt of interest revenue are not provided. Impairment loss (profit or loss) Other comprehensive income (a) Financial asset FVOCI Debit CU30 CU20 Credit (To recognize 12-month expected credit losses and other fair value changes on the debt instrument) (a) The cumulative loss in other comprehensive income at the reporting date was CU20. That amount consists of the total fair value change of CU50 (ie CU1,000 CU950) offset by the change in the accumulated impairment amount representing 12-month expected credit losses that was recognized (CU30). Disclosure would be provided about the accumulated impairment amount of CU30. On 1 January 20X1, the entity decides to sell the debt instrument for CU950, which is its fair value at that date. CU50 Cash Financial asset FVOCI Loss (profit or loss) Other comprehensive income Debit CU950 CU20 Credit CU950 CU20 (To derecognize the fair value through other comprehensive income asset and recycle amounts accumulated in other comprehensive income to profit or loss) Final version of IFRS 9 (Financial Instruments) I 16

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