3.4 Transition from IAS 39 to IFRS 9
4 min read•august 7, 2024
replaced , bringing big changes to how banks handle financial instruments. The transition involved new rules for classifying assets, measuring impairment, and applying hedge accounting. These changes aimed to improve financial reporting and align it more closely with .
Moving to IFRS 9 wasn't easy. Banks had to choose between full or a modified approach. They also faced new disclosure requirements and had to analyze the impact on their financial statements. The shift affected everything from balance sheets to regulatory capital ratios.
Transition Approaches
Retrospective Application and Modified Retrospective Approach
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- Retrospective application requires entities to apply IFRS 9 as if it had always been in effect
- Involves restating comparative periods and adjusting opening retained earnings
- Can be complex and time-consuming, especially for entities with long-term financial instruments
- allows entities to apply IFRS 9 from the date of initial application
- is not restated, reducing the burden of transition
- Cumulative effect of applying IFRS 9 is recognized as an adjustment to opening retained earnings (or other component of equity) at the date of initial application
Comparative Information
- Entities are not required to restate comparative information for prior periods
- Can choose to restate if, and only if, it is possible without the use of hindsight
- If comparative information is not restated, additional disclosures are required in the year of initial application
- Disclosures should enable users to understand the impact of transitioning to IFRS 9
- Entities should provide an explanation of the reasons for any differences between the closing IAS 39 and opening IFRS 9 carrying amounts
Accounting Changes
Classification and Measurement Changes
- IFRS 9 introduces new categories for
- , fair value through other comprehensive income (FVOCI), and fair value through profit or loss (FVTPL)
- Classification is based on the entity's business model for managing the financial assets and the contractual cash flow characteristics
- Business model assessment determines whether financial assets are held to collect contractual cash flows, to sell, or both
- Contractual cash flow characteristics test (SPPI test) assesses whether the contractual terms give rise to cash flows that are solely payments of principal and interest
- Changes in classification and measurement may result in reclassifications and remeasurements of financial assets
Impairment Methodology Changes
- IFRS 9 replaces the incurred loss model under IAS 39 with an (ECL) model
- requires entities to recognize expected credit losses from when financial instruments are first recognized
- Three-stage approach to measuring ECLs:
- Stage 1: for financial instruments with no significant increase in credit risk since initial recognition
- Stage 2: for financial instruments with a significant increase in credit risk since initial recognition
- Stage 3: Lifetime ECLs for
- Transition to the ECL model may result in an increase in impairment allowances and greater volatility in profit or loss
Hedge Accounting Adjustments
- IFRS 9 aligns hedge accounting more closely with risk management practices
- Introduces a more principles-based approach, removing some of the rule-based restrictions in IAS 39
- Changes to hedge accounting include:
- Expanded eligibility of hedging instruments and hedged items
- Removal of the 80-125% effectiveness threshold, replaced by an
- Enhanced disclosure requirements about an entity's risk management strategy, hedging activities, and the impact of hedging on the financial statements
- Entities may need to reassess existing hedging relationships and documentation to ensure compliance with IFRS 9
Reporting Requirements
Disclosure Requirements
- IFRS 9 introduces extensive new disclosure requirements, particularly in relation to:
- Classification and measurement of financial instruments
- Impairment of financial assets, including the inputs, assumptions, and techniques used to measure ECLs
- Hedge accounting, including an entity's risk management strategy and the effectiveness of hedging relationships
- Entities should provide both to enable users to understand the impact of IFRS 9
Transition Date Reporting
- Entities should disclose the date of initial application of IFRS 9 and the nature of the change in accounting policy
- For each class of financial assets and , entities should disclose:
- The original measurement category and carrying amount under IAS 39
- The new measurement category and carrying amount under IFRS 9
- The amount of any financial assets and liabilities that have been reclassified
- Reconciliations between the closing IAS 39 and opening IFRS 9 carrying amounts should be provided
Impact Analysis
- Entities should assess the impact of transitioning to IFRS 9 on their financial statements
- Impact on classification and measurement of financial instruments
- Changes in impairment allowances and provisions
- Effect on hedge accounting relationships and effectiveness
- Quantitative should be performed to determine the expected adjustments to opening retained earnings (or other components of equity)
- Entities should engage with stakeholders (investors, regulators, analysts) to communicate the expected impact of IFRS 9 and any significant changes to key performance indicators or regulatory capital ratios
Key Terms to Review (31)
12-month ECLs: 12-month Expected Credit Losses (ECLs) refer to the estimate of credit losses on financial instruments over the next 12 months. This concept is crucial under IFRS 9, as it replaces the incurred loss model from IAS 39, emphasizing a forward-looking approach to assessing credit risk. The recognition of 12-month ECLs allows entities to better anticipate potential losses from default events, reflecting changes in credit risk more effectively.
Amortized cost: Amortized cost is a method used to value financial instruments by gradually reducing the initial cost of an asset over time through periodic payments or adjustments. This approach reflects the time value of money, as it accounts for the principal and interest associated with the asset, providing a more accurate representation of its current value. The amortized cost method plays a significant role in how financial instruments are classified and measured, particularly when transitioning from older accounting standards to newer ones.
Changes in Disclosures: Changes in disclosures refer to the modifications made to the information that companies are required to present in their financial statements, particularly when transitioning from one accounting standard to another. These changes aim to enhance transparency and provide more relevant information to users of financial statements. As organizations adopt new standards, such as moving from IAS 39 to IFRS 9, they must revise their disclosures to reflect new requirements, thereby improving the quality of financial reporting.
Classification and measurement: Classification and measurement refer to the processes of categorizing financial assets and liabilities based on their characteristics and determining how to value them in financial statements. These processes are crucial for ensuring consistency and comparability in financial reporting, particularly when transitioning from older standards to newer frameworks like IFRS 9.
Comparative Information: Comparative information refers to the financial data presented in a way that allows for analysis and comparison across different time periods or entities. It is essential for users to evaluate performance trends, financial position, and changes in accounting policies between different reporting periods or standards, such as when transitioning from IAS 39 to IFRS 9.
Credit-impaired financial instruments: Credit-impaired financial instruments are assets that have experienced a significant decline in credit quality, indicating that the borrower may be unable to fulfill their payment obligations. These instruments are crucial in assessing credit risk and determining the appropriate accounting treatment for expected credit losses under new financial reporting standards, particularly during the transition from IAS 39 to IFRS 9.
Data Migration: Data migration is the process of transferring data from one system or storage location to another. This can involve moving data between databases, applications, or formats and is often necessary when organizations upgrade their systems, adopt new technologies, or comply with new regulations. Understanding data migration is essential during significant transitions, especially as organizations shift from older accounting standards to more updated frameworks.
ECL Model: The ECL (Expected Credit Loss) model is a framework established under IFRS 9 to calculate the expected credit losses on financial instruments. This model represents a significant shift from the incurred loss model used in IAS 39, as it requires entities to recognize credit losses based on expectations of future losses, rather than waiting for a loss event to occur. The ECL model aims to provide a more forward-looking approach to financial reporting by incorporating a broader range of information and considerations.
Effective Date: The effective date refers to the specific date on which a new accounting standard or financial regulation is applied or becomes mandatory. This date is crucial for companies and financial institutions as it marks the beginning of their obligation to adhere to the new requirements outlined in the standard, significantly impacting financial reporting and compliance practices.
Expected Credit Loss: Expected credit loss refers to the estimate of the likelihood of a borrower defaulting on a loan, taking into account the potential loss incurred if default occurs. This concept is essential for financial institutions to assess and recognize credit risk accurately, especially in the shift from older accounting standards that did not require proactive loss recognition. It plays a crucial role in understanding credit risk, calculating provisions, and ensuring transparent financial reporting.
Financial Accounting Standards Board (FASB): The Financial Accounting Standards Board (FASB) is an independent organization that establishes and improves financial accounting and reporting standards in the United States. It plays a crucial role in developing Generally Accepted Accounting Principles (GAAP) and ensures consistency and transparency in financial reporting, impacting how entities transition between accounting standards, meet compliance requirements, and integrate non-financial information into their reports.
Financial assets: Financial assets are monetary instruments that hold value and can be traded or transferred. These include cash, stocks, bonds, and accounts receivable, which can be converted into cash or used to settle debts. Understanding financial assets is crucial in analyzing a company's financial position and performance, particularly when discussing transitions between accounting standards and how fair value measurements are disclosed.
Financial crisis impact: The financial crisis impact refers to the effects and consequences of a financial crisis on the economy, businesses, and individuals. It encompasses aspects like increased volatility in financial markets, reduced access to credit, and significant changes in regulatory environments. These impacts often necessitate reforms in accounting standards and practices, particularly in the transition from IAS 39 to IFRS 9, as organizations seek to adapt to new risk management frameworks and financial reporting requirements.
Financial Liabilities: Financial liabilities are obligations that a company has to transfer economic benefits to another entity in the future, often in the form of cash, other financial assets, or services. They can arise from various transactions, including loans, accounts payable, and bonds payable. Understanding financial liabilities is crucial for assessing a company's financial health and stability, especially during the transition from one accounting standard to another.
Global convergence of accounting standards: Global convergence of accounting standards refers to the ongoing process of harmonizing and aligning accounting principles and practices across different countries to create a unified set of standards. This movement aims to improve comparability, consistency, and transparency in financial reporting, which is increasingly important in a globalized economy where businesses operate across borders.
Hedge Accounting Adjustments: Hedge accounting adjustments are accounting practices that align the timing of recognition of gains and losses on hedging instruments with the underlying exposure they are intended to hedge. This approach reduces volatility in financial statements by ensuring that the effects of hedging transactions are reflected in the same period as the losses or gains of the hedged item, thus providing a clearer picture of a company’s financial performance and risk management strategies during the transition from IAS 39 to IFRS 9.
IAS 39: IAS 39, or International Accounting Standard 39, is a financial reporting standard that addresses the recognition and measurement of financial instruments, including derivatives and hedging activities. This standard sets out the rules for how companies should classify, measure, and report their financial assets and liabilities, helping to ensure transparency and consistency in financial reporting across different entities. It has a significant connection to the transition to IFRS 9, which seeks to simplify these processes and improve the overall reporting of financial instruments.
IFRS 9: IFRS 9 is an international financial reporting standard that provides guidelines for the classification, measurement, impairment, and hedge accounting of financial instruments. It was developed to enhance the transparency and consistency of financial reporting, addressing issues present in previous standards by introducing more forward-looking approaches to credit losses and clearer rules for financial asset classification.
Impact Analysis: Impact analysis is a systematic approach used to assess the potential effects of changes in accounting standards on financial statements and operations. This process is particularly important when transitioning from one set of accounting rules to another, such as from IAS 39 to IFRS 9, as it helps organizations understand how these changes will affect their financial reporting and overall financial position.
Impact on profit or loss: Impact on profit or loss refers to the effects that financial reporting changes have on a company's earnings, particularly when transitioning between accounting standards. This concept is crucial during the shift from one set of standards to another, as it can lead to significant variances in how financial performance is reported, thus influencing investor perceptions and decision-making.
Impairment Models: Impairment models are accounting frameworks used to assess whether the carrying amount of an asset exceeds its recoverable amount, leading to a potential write-down in value. These models help financial institutions determine the appropriate recognition of losses on financial assets, especially in the context of credit risk. Transitioning from previous standards to newer frameworks emphasizes a more proactive approach to recognizing impairments, allowing for timely reflection of asset values and aligning with evolving financial reporting requirements.
International Accounting Standards Board (IASB): The International Accounting Standards Board (IASB) is an independent organization that develops and establishes international financial reporting standards (IFRS) to ensure transparency, accountability, and efficiency in financial markets around the world. By creating a common set of accounting principles, the IASB aims to enhance comparability and reliability of financial statements, particularly during significant transitions like the shift from IAS 39 to IFRS 9.
Lifetime ECLs: Lifetime Expected Credit Losses (ECLs) represent the total credit losses expected over the life of a financial asset. This concept became crucial during the transition from IAS 39 to IFRS 9, as it shifts the focus from incurred losses to expected losses, requiring entities to recognize credit losses earlier and based on forward-looking information.
Modified retrospective approach: The modified retrospective approach is a method of transitioning to new accounting standards that allows entities to apply the new standard to prior periods while making adjustments only for the most recent period. This approach simplifies the adoption process by reducing the amount of historical data that needs to be restated, making it particularly useful when transitioning from older standards like IAS 39 to newer ones such as IFRS 9, or when accounting for insurance contracts under IFRS 17. It allows for a smoother shift while still providing some continuity in reporting.
Objectives-based test: An objectives-based test is an assessment approach that evaluates whether specific learning objectives have been achieved, focusing on the desired outcomes rather than the means of achieving those outcomes. This type of test helps in measuring the effectiveness of new standards, like the transition from IAS 39 to IFRS 9, by ensuring that financial instruments are classified and measured based on their intended purpose and economic characteristics.
Qualitative and Quantitative Information: Qualitative and quantitative information refers to two distinct types of data used to assess and report on financial performance and conditions. Qualitative information focuses on descriptive attributes that capture the quality of an entity's operations, such as management expertise or customer satisfaction, while quantitative information emphasizes numerical data that can be measured and analyzed statistically, like revenue figures or profit margins. Understanding the balance between these two forms of information is essential during transitions in financial reporting standards, particularly when moving from one framework to another.
Retrospective Application: Retrospective application is the process of applying a new accounting standard to prior periods as if the new standard had always been in place. This approach ensures that the financial statements reflect the current accounting policies consistently over time, making it easier for users to compare financial information across different reporting periods. It can significantly impact the way financial statements are presented and understood, especially during transitions between accounting standards.
Risk management practices: Risk management practices refer to the systematic approach organizations use to identify, assess, and mitigate risks that could impact their operations, financial performance, and reputation. These practices are crucial for navigating uncertainties in the financial services industry and are deeply intertwined with regulatory compliance and reporting requirements, especially during significant transitions in accounting standards.
System Implementation: System implementation refers to the process of executing a plan for the deployment of a new system or framework within an organization. This involves various stages including system design, configuration, testing, and training users to ensure that the system functions as intended. Successful implementation is crucial when transitioning from one financial reporting standard to another, like from IAS 39 to IFRS 9, as it can significantly impact the accuracy and reliability of financial reporting.
Transition Date: The transition date is the date when an entity begins to apply a new accounting standard, marking the shift from one standard to another. In the context of moving from IAS 39 to IFRS 9, the transition date signifies when financial institutions must start recognizing the changes in how financial instruments are classified and measured, along with the implications for reporting their financial positions and performance.
Transition Date Reporting: Transition date reporting refers to the accounting practice of recognizing and disclosing the effects of transitioning from one set of financial reporting standards to another, specifically in the context of moving from IAS 39 to IFRS 9. This reporting is crucial as it helps financial institutions and stakeholders understand how changes in standards impact financial statements, risk assessments, and overall financial health.