The International Accounting Standards Board (IASB) has completed the final element of its comprehensive response to the financial crisis by issuing IFRS 9 Financial Instruments. The project was launched in 2008.
"The reforms introduced by IFRS 9 are much needed improvements to the reporting of financial instruments and are consistent with requests from the G20, the Financial Stability Board and others for a forward-looking approach to loan-loss provisioning," says Hans Hoogervorst, Chairman of the IASB.
Hoogervorst adds that the new standard will enhance investor confidence in banks’ balance sheets and the financial system as a whole.
The package of improvements introduced by IFRS 9 includes a logical model for classification and measurement, a single, forward-looking ‘expected loss’ impairment model and a substantially-reformed approach to hedge accounting.
Although the international deadline for companies to adopt IFRS 9 is 1 January 2018, companies can chose to adopt the new standard early. Full transition is likely to occur over a long time frame.
“We expect that planning for IFRS 9 adoption – including implementation of the new hedge accounting requirements – will be an important issue for corporate treasurers and accountants generally," says Ong Pang Thye, Head of Audit, KPMG in Singapore.
Classification and measurement
Classification determines how financial assets and financial liabilities are accounted for in financial statements and, in particular, how they are measured on an ongoing basis.
IFRS 9 introduces a logical approach for the classification of financial assets, which is driven by cash flow characteristics and the business model in which an asset is held.
This single, principle-based approach replaces existing rule-based requirements that are generally considered to be overly complex and difficult to apply.
The new model also results in a single impairment model being applied to all financial instruments, thereby removing a source of complexity associated with previous accounting requirements.
“The removal of the current ‘available-for-sale’ classification is a disappointment to investors with longer-term horizon," says Ong.
Under the fair value through other comprehensive income classification, results from equity investment recorded in other comprehensive income, for example, would not be allowed to recycle back to the income statement, even upon disposal.
“The amendment also means that the classification and measurement requirements of the new standard are at least as complex as the current IAS 39 standard that it will replace,” says Ong.
New, expected-loss impairment model
During the financial crisis, the delayed recognition of credit losses on loans (and other financial instruments) was identified as a weakness in existing accounting standards.
As part of IFRS 9, the IASB has introduced a new, expected-loss impairment model that will require more timely recognition of expected credit losses.
Specifically, the new standard requires entities to account for expected credit losses from when financial instruments are first recognised and to recognise full lifetime expected losses on a more timely basis.
The IASB has already announced its intention to create a transition resource group to support stakeholders in the transition to the new impairment requirements.
“The new standard is a step change in accounting for impairment and will give rise to new challenges for banks adopting it,” says Ong.
Ong noted that following the global financial crisis, concerns have been raised about ‘too little, too late’ provisioning for loan losses.
The new expected credit loss model aims to address these concerns, and accelerates the recognition of losses by requiring provisions to cover both already-incurred losses and some losses expected in the future.
The new standard is also likely to increase costs for banks.
Substantially-reformed model for hedge accounting
IFRS 9 introduces a substantially-reformed model for hedge accounting, with enhanced disclosures about risk management activity.
The new model represents a significant overhaul of hedge accounting that aligns the accounting treatment with risk management activities, enabling entities to better reflect these activities in their financial statements.
In addition, as a result of these changes, users of the financial statements will be provided with better information about risk management and the effect of hedge accounting on the financial statements.
Most companies with significant commodity exposure such as airlines and shipping have welcomed the revised hedge accounting revision guidelines as the revised requirement allows them to better reflect how they manage risk in their financial statements.
IFRS 9 also removes the volatility in profit or loss that was caused by changes in the credit risk of liabilities elected to be measured at fair value.
This change in accounting means that gains caused by the deterioration of an entity’s own credit risk on such liabilities are no longer recognised in profit or loss.
Early application of this improvement to financial reporting, prior to any other changes in the accounting for financial instruments, is permitted by IFRS 9.
“We had hoped that the IASB and the US FASB could have achieved a single converged solution for banks and other entities globally, but this hasn’t been possible," says KPMG's Ong.
Ong notes that having different rules under US GAAP and IFRS will mean a lack of comparability for investors between the results of banks reporting under the different frameworks, and increased costs for those banks that have to prepare figures under both accounting frameworks.
Singapore defers adoption
In Singapore, the Singapore Accounting Standards Council (ASC) has deferred the adoption of components of IFRS 9 as it was waiting for the complete standard to be issued.
For corporates in Singapore looking to adopt IFRS 9, hedge accounting principles announced earlier would be most relevant.
The revisions also provide for a more principles-based approach that aligns hedge accounting more closely with risk management, allowing more relationships to be eligible for hedge accounting.
Ong stressed that corporates should not automatically assume that the impact of the classification and measurement and impairment requirements of the new standard will be small, as it depends on the exposures they have and how they manage them.
"In many jurisdictions, companies will not be able to adopt the new standard until it is legally endorsed or permitted by regulators. Given the significance of the standard to the financial services sector, the road to endorsement may be longer and more winding than usual,” Ong said.