Initial Measurements of Financial Assets as per IAS-9. In this blog, we will discuss the initial measurement and classification of Financial Assets.
Initial Measurement:
- Financial assets are initially measured at transaction price, that is the fair value of the consideration given.
- In the case of financial assets or financial liability classified as measured at amortised cost or at fair value through other comprehensive income, transaction costs directly attributable to the acquisition are capitalised (added to the asset and deducted from the liability).
- If the asset or liability is held at fair value through profit or loss, the cost of acquisition is expensed. If an irrevocable election has been made to take gains and losses on the financial asset to other comprehensive income, the cost of acquisition should be added to the purchase cost.
- If transaction price is not equal to fair value. It should be measured initially at fair value rather than transaction price.
IFRS 9 requires that financial assets are classified as measured at either :
- Amortized cost
- Fair value through other comprehensive income
- Fair value through profit or loss
The IFRS 9 classification is made on the basis of both:
- The entity’s business model for managing the financial asstes, and
- The contractual cash flow characteristics of the financial asset.
Classification of Financial Assets:
On recognition, IFRS9 requires the financial assets to be classified as measured at either:
- Amortized cost :(The amount at which the financial asset or financial liability is measured at initial recognition minus the principal repayments, plus or minus the cumulative amortization using the effective interest method of any difference between that initial amount and the maturity amount and the financial assets, adjusted for any loss allowance)
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- The objective of the business model within which the asset is held is to hold assets to collect contractual cash flows,
- The contractual terms of the financial assets give rise on specific dates to cash flows that are solely payments of principles and interest on the principal outstanding.
- Fair value through other comprehensive income (FVTOCI)
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- The objective of the business model within which the asset is held is both collecting contractual cash flows and selling financial assets,
- The contractual terms of the financial asset give rise on specific dates to cash flows that are solely payments of principal and interest on the principal outstanding.
- Fair value through profit or loss (FVTPL)
- All other financial assets must be measured at FVTPL (the default)
Notwithstanding the above, IFRS9 allows financial assets meeting the criteria of FVTOCI to be designated, at initial recognition, as being measured at FVTPL if recognition or measurement inconsistently would otherwise arise from measuring assets or liabilities or recognising the gain or loss on them on different bases.
If the Financial Asset is an Equity Instrument:
- Equity instruments must be measured at fair value because the contractual terms associated with the investment do not entitle the holder to specific payment of interest and principal.
- Equity instruments may not be classified as measured at amortised cost, must be measured at fair value. However, if an equity instrument is not held for trading, an entity can make an irrevocable election at initial recognition to measure it at FVTOCI with only dividends recognised in profit or loss.
Subsequent Measurement of Financial Assets:
It depends on how they are classified at initial recognition
- At amortised cost→ using the effective interest method.
- At fair value through other comprehensive income→ fair value is established at each period end, and any changes in fair value are recognised in other comprehensive income.
- At fair value through profit or loss→ Fair value established at each period end and any changes in fair value is recognised in profit or loss.
* Investments whose fair value cannot be reliably measured should be measured at cost. This will only be the case in very rare circumstances.
Reclassification of Financial Assets:
- Financial assets are classified under IFRS9 when, and only when, an entity changes its business model for managing financial assets. The reclassification should be applied prospectively from the reclassification date.
- The rules only apply to investments in debt instruments as investments in equity instruments are always held at fair value and any election to measure them at fair value through other comprehensive income is an irrevocable one.
~ If a financial asset is reclassified from amortised cost to fair value →, gain or loss arising from the difference between the previous carrying amount and fair value is recognised in profit or loss.
~ If a financial asset is reclassified from fair value to amortised cost → fair value at the date of reclassification becomes the new carrying amount.
Disclaimer: The blog provided above is intended for reference purposes only. It does not imply legality or official endorsement. Spectrum assumes no responsibility for any legal implications arising from the use of the information provided.
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