The CFO of a company is said to have remarked: “My accountant printed this year’s balance-sheet in colour-red.” Balance-sheets of many companies have been tainted over the last year and a half due to a combination of factors — the slowdown, bad investments and stern accounting standards.

A good portion of the damage on balance-sheets has been due to financial instruments — fixed assets can but depreciate while current assets have never appreciated. Accounting for Financial Instruments has been dictated by International Accounting Standard 39 — Financial Instruments (IAS 39).

Acknowledging its inherent limitations, the International Accounting Standards Board (IASB) has embarked on a long three-stage project to revise IAS 39 and rechristen it IFRS 9. The first stage caters to classification and measurement of financial assets while stages 2 and 3 will cater to classification and measurement of financial liabilities, impairment and hedge accounting respectively.

IFRS-9

The proposed IFRS 9 does away with the much-used classification of financial assets into four categories — Held for Trading, Available for Sale, Held to Maturity and Loans and Receivables.

Instead, financial assets are classified in one of two measurement categories. The classification is based on an assessment of the way in which the instrument is managed (the entity’s business model) and of its contractual cash-flow terms.

The category into which the asset is classified determines whether it is measured on an ongoing basis at amortised cost or fair value.

IAS 39 requires an impairment assessment for financial assets measured at fair value through other comprehensive income (OCI) as well as both classes of financial assets measured at amortised cost.

There are several different models. Some financial asset impairments cannot be reversed. In the proposed IFRS 9, as a result of the new classification model, the only financial assets subject to impairment will be instruments measured at amortised cost.

All impairments are eligible for reversal. IAS 39 had varied accounting requirements for embedded derivatives. Some hybrid contracts are measured at fair value through profit or loss in their entirety.

Others are split, with one component (the embedded derivative) being measured at fair value through profit or loss and the other component (the non-derivative host contract) being measured at amortised cost or as an executory contract using accrual accounting.

A third category of hybrid contract is accounted for either as a single contract or on a split basis, according to management’s choice. IFRS 9 attempts to solve this issue by dictating that a hybrid contract (a non-derivative host contract with an embedded derivative) with a host that is a financial asset is not separated.

Such contracts are classified in accordance with the classification criteria in their entirety. There is no change to the accounting for hybrid contracts if the host contract is a financial liability or a non-financial item. IAS 39 did not have a presentation option for strategic equity investments.

In the proposed IFRS-9, a presentation option is available for investments in equity investments that are strategic investments. If they meet the criteria, an entity may elect, at initial recognition, to record all fair value changes for such equity instruments in OCI.