IASB issues exposure draft on Amendments to the Classification and measurement of Financial Instruments

Background

• This update is prepared in relation to the proposed amendments to the classification and measurement of Financial Instruments as per the latest exposure draft of IASB.
• The IASB, before issuing any amendments to IFRS Standards, issues consultative documents [such as Discussion Paper (DP), Exposure Draft (ED) etc.] seeking public comments from across the globe.

Proposed Amendments

The IASB proposes amendments to IFRS 9 based on the following concerns-

• Derecognition of a financial liability settled through electronic transfer – an entity is required to apply settlement date accounting when derecognizing a financial asset or a financial liability only when specified conditions are met.
• Classification of financial assets – guidance for assessing the contractual cash flow characteristics of financial assets.

Derecognition of financial liability

Notwithstanding the requirement to apply settlement date accounting, an entity is permitted to derecognize a financial liability (or a part of a financial liability)-that will be settled using an electronic payment system and to be discharged before the settlement date if, and only if, the entity has initiated the payment instruction and following conditions are met-

• the entity has no liability to cancel, stop or withdraw the payment.
• it is not practically possible for the entity to access the cash to be used for settlement as a result of the payment installment.
• the settlement risk associated with the electronic payment system is insignificant.

Settlement risk is considered low if the characteristics of the electronic payment system are such that completion of the payment instruction follows a standard predefined process and the time between initiating the payment instruction and the cash being delivered is short.

Assessment of Contractual Cash Flow characteristics of a Financial Asset

• If a financial asset contains such contractual term that could change the timing or amount of contractual cash flows (for example, if the asset can be prepaid before maturity or its term can be extended), the entity must determine whether the contractual cash flows that could arise over the life of the instrument due to that contractual term are solely payments of principal and interest on the principal amount outstanding. The entity may also need to assess the nature of any contingent event that would change the timing or amount of the contractual cash flows.
• For example, compare a financial instrument with an interest rate that is increased to a higher rate if the debtor misses a predetermined number of payments to a financial instrument with an interest rate that is reset to a higher rate if a specified equity index reaches a particular level. Following illustrations will help in giving a better understanding of the issue –

• Instrument “X” is a loan with an interest rate that is periodically adjusted by a specified number of basis points if the debtor achieves a contractually determined reduction in greenhouse gas emissions during the preceding reporting period. In this case, the occurrence of the contingent event is specific to the debtor. The contractual cash flows arising from the occurrence (or non-occurrence) of the contingent is solely dependent on the debtor’s performance and in all circumstances solely payments of principal and interest on the principal amount outstanding.
• Instrument “Y” is a loan with an interest rate that is periodically adjusted when a market-determined carbon price index reaches a contractually defined threshold. The contractual cash flows change in response to a market factor (the carbon price index), which do not come under basic lending risk and is therefore inconsistent with a basic lending arrangement.

SW Comments –

In the update, an attempt has been made to summarize the proposed amendments made by IASB in IFRS 9- Financial Instruments. The exposure draft is open for comment till 10th June.

Bijhon Bordoloi, Audit Associate, SW India