IFRS Global office

November 2010

IFRS in Focus
IASB issues revisions to IFRS 9 for financial
liability accounting
Contents
The Bottom Line
Introduction
The presentation of the effects of changes in a
liabilitys credit risk
The elimination of the cost exemption for
derivative liabilities
Effective date and transition

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The classification criteria for financial liabilities contained in IAS 39 move to IFRS
9 unchanged and the IAS 39 classification categories of amortised cost and fair
value through profit or loss are retained.
For a financial liability designated as at fair value through profit or loss using the
fair value option, the change in the liabilitys fair value attributable to changes
in the liabilitys credit risk is recognised directly in other comprehensive income,
unless it creates or increases an accounting mismatch.
The amount that is recognised in other comprehensive income is not recycled
when the liability is settled or extinguished.
The meaning of credit risk is clarified to distinguish credit risk from asset-specific
performance risk.
The cost exemption in IAS 39 for derivative liabilities to be settled by delivery of
unquoted equity instruments is eliminated.
The effective date of the revised Standard is 1 January 2013.

Introduction
On 28 October 2010, the IASB published a revised version of IFRS 9 Financial
Instruments. The revised Standard retains the requirements for classification and
measurement of financial assets that were published in November 2009 but adds
guidance on the classification and measurement of financial liabilities. As part of its
restructuring of IFRS 9, the IASB also copied the guidance on derecognition of
financial instruments and related implementation guidance from IAS 39 Financial
Instruments: Recognition and Measurement to IFRS 9.

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The guidance included in IFRS 9 on the classification and measurement of financial

liabilities is unchanged from the classification criteria for financial liabilities currently
contained in IAS 39. In other words, financial liabilities will continue to be measured
either wholly, or in part, at amortised cost or at fair value through profit or loss
(FVTPL). The concept of bifurcating embedded derivatives from a financial liability host
contract also remains unchanged. Financial liabilities held for trading would continue
to be measured at FVTPL, and all other financial liabilities would be measured at
amortised cost unless the fair value option is applied, using the existing criteria in
IAS 39.

However, there are two differences compared to IAS 39:

The presentation of the effects of changes in fair value attributable to a liabilitys credit risk; and
The elimination of the cost exemption for derivative liabilities to be settled by delivery of unquoted equity
instruments.
This revised guidance concludes the first phase of the IASBs comprehensive project to replace its financial
instruments standard, IAS 39. The other phases, impairment and hedge accounting, have yet to be finalised.
The presentation of the effects of changes in a liabilitys credit risk
The revised guidance about a liabilitys credit risk does not apply to all liabilities measured as at FVTPL. Financial
liabilities held for trading, such as derivative liabilities, as well as loan commitments and financial guarantee
contracts that are designated under the fair value option would continue to be measured at fair value with all
changes being recognised in profit or loss. For all other financial liabilities designated as at FVTPL using the fair value
option, the revised guidance about a liabilitys credit risk applies, requiring the amount of change in the liabilitys fair
value attributable to changes in the credit risk to be recognised in other comprehensive income (OCI) with the
remaining amount of change in fair value being recognised in profit and loss.

Observation
One of the primary factors for the Board issuing this guidance is the often cited counterintuitive result that
occurs when financial liabilities are measured at fair value. An entity experiencing credit deterioration generates
a gain in profit or loss as the fair value of the liability is reduced (potentially offsetting losses the entity may be
encountering that contribute to the credit deterioration) while improvement in creditworthiness results in
recognition of losses in profit or loss (potentially obscuring income the entity is generating that may have led to
the improvement in credit quality).

However, if recognising the changes in fair value attributable to credit risk within OCI creates or increases an
accounting mismatch, an entity would present the entire change in fair value within profit and loss. In assessing any
accounting mismatch, an entity should determine whether it expects that the effects of changes in the liabilitys
credit risk will be offset in profit or loss by a change in the fair value of another financial instrument measured at
FVTPL. Such an expectation must be based on an economic relationship between the characteristics of the liability
and the characteristics of the other financial instrument. This determination is made by the entity at initial
recognition and is not reassessed. An entity should disclose the methodology used to make its determination in the
notes to the financial statements.

Observation
One example discussed by the IASB during the development of this part of the project related to mortgage
funding where an accounting mismatch may arise. In that example, a mortgage bank lends to a customer and
funds the loan by selling a bond with identical terms (i.e. outstanding balance, term, currency, and repayment
terms) to that of the mortgage loan. The mortgage loan term permits borrowers to prepay their loan by retiring
their specific outstanding bond at fair value. There is a contractual linkage between the effects of changes in
credit risk of the bond and fair value changes in the mortgage loan. As a result of using the fair value option, if
the bank recognises changes in the fair value due to changes in credit risk of the bond through OCI while
recognising the full change in fair value of the loan through profit and loss, this would result in an accounting
mismatch.

The Standard provides further guidance on differentiating credit risk from asset-specific performance risk (i.e. the risk
that a single asset or a group of assets fail to perform and in doing so relieves the issuer of amounts under an
obligation that is linked to those assets). The Standard provides examples of asset-specific performance risk.

IFRS in focus

Observation
One of the examples of asset-specific performance risk provided in the Standard are notes issued by a special
purpose entity (SPE) where the assets of the SPE are legally isolated to fund the notes issued by the SPE.
Amounts are only due to the investors of the notes if the ring-fenced assets generate cash flows. If the assets
do not generate cash flows, the SPE is not obligated to pay the investors. The risk inherent in the notes is
regarded as asset-specific performance risk as the performance of the assets determines the amount of the
obligation under the liability. The difference between credit risk and asset-specific performance risk is subtle and
therefore consideration of the terms of the liability will be critical. If the amount owed under the notes does not
vary with the performance of the assets, the risk would be regarded as credit risk, not asset-specific
performance risk.

The revised guidance prohibits recycling of amounts attributable to credit risk recognised in OCI, but transfers to
other components of equity are permitted. This is relevant if an entity derecognises its financial liability prior to
maturity at an amount different from the amount contractually due. In this situation, any residual amount in OCI
may be transferred to other components of equity (e.g. retained earnings) with disclosure of the amounts
transferred and the reason for the transfer. In contrast, if an entity repaid its debt under the contractual terms at
maturity, there would be no amounts to recycle because the cumulative effect of any changes in the liabilitys credit
risk would net to zero.
The revised IFRS 9 retains the existing guidance in IFRS 7 Financial Instruments: Disclosures on how to isolate the
change in fair value of a liability attributable to credit risk. IFRS 7 permits two techniques:
1) the change in fair value not attributable to changes in market risk (such as changes in a benchmark interest rate,
the price of another entitys financial instruments, a commodity price, a foreign exchange rate, or an index of
prices or rates); or
2) an alternative method that more faithfully represents credit risk.
The method used to measure changes in fair value due to changes in credit risk should be disclosed.
The elimination of the cost exemption for derivative liabilities
The part of IFRS 9 dealing with financial assets removed the cost exemption in IAS 39 for unquoted equity
instruments and related derivative assets where fair value was not reliably determinable. When the financial assets
part of IFRS 9 was published, the cost exemption for derivative liabilities that will be settled by delivering unquoted
equity instruments whose fair value cannot be determined reliably (e.g. a written option where, on exercise, an
entity would deliver unquoted shares to the holder of the option) remained in place. However, the revised guidance
now also removes this cost exemption so that all derivatives, whether assets or liabilities, are measured at fair value.
Effective date and transition
The revised version of IFRS 9 has the same effective date as the previous version of IFRS 9, i.e., 1 January 2013.
The IASB has stated its intention to have the same effective date for all phases of the new financial instruments
standard. The revised version permits early application but if an entity elects to apply the guidance related to
classification and measurement of financial liabilities early, an entity must also apply any requirements in IFRS 9 that
have been previously finalised at the same time. Currently, this would require an entity wishing to adopt early the
guidance on financial liabilities in IFRS 9 also to adopt early the guidance on financial assets. The reason to require
application of the earlier phases is to reduce the potential for non-comparability among entities. The revised
Standard is to be applied retrospectively in accordance with IAS 8.

IFRS in focus

Key contacts

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