Anticipated challenges in implementing the completed IFRS 9

SUITS THE C-SUITE By Francisco Roque A. Lumbres and Jeramael P. Villaber

Business World (09/29/2014 – p.S1/4)

(Second of two parts)

IN LAST week’s column, we discussed the classification and measurement approach for debt financial assets, derivatives, and equity instruments and financial liabilities under the final and complete version of International Financial Reporting Standard (IFRS) 9 Financial Instruments issued by the International Accounting Standards Board (IASB). We also talked about the general approach of the forward-looking impairment model. In this column, we will discuss the simplifications to the general impairment approach for certain financial assets, and how hedge accounting guidelines have changed, as well as when businesses should expect to apply the new standard.

IFRS 9 provides a simplified approach for impairment for trade and lease receivables and for contract assets. Under the simplified approach, the tracking of changes in credit risk is not required unlike in the previous general approach. Instead, lifetime expected credit losses (ECL) is to be recognized at all times.

This simplified approach is required for trade and lease receivables and for contract assets that do not contain a significant financing component. However, for trade and lease receivables and for contract assets that contain a significant financing component, entities have a policy choice on whether to apply the simplified approach.

For financial assets that are credit-impaired on purchase or origination, the initial lifetime ECL would be reflected in a credit-adjusted effective interest rate (EIR), instead of recording a 12-month ECL (stage 1). Subsequently, changes in lifetime ECL due to an improvement (impairment gain) or further deterioration (impairment loss) of credit risk of the financial asset will be recognized in profit or loss.


Besides a shift to a forward-looking impairment approach, IFRS 9 also overhauls the hedge accounting requirements in IAS 39. Significant improvements were incorporated in the new standard which includes the following:

· Expansion of the range of eligible hedged items to include the hedging of aggregated and net exposures, and the hedging of risk components and layers;

· Permitting designation of non-financial instruments that are accounted for at fair value through profit or loss (FVPL) as a hedging instrument for risk components ;

· Removal of the “80% — 125%” bright line threshold in effectiveness assessment and requiring such assessment to be done only prospectively on an ongoing basis, as a minimum at each reporting date;

· Rebalancing hedge ratio if it turns out that the hedged item and hedging instrument do not move in relation to each other as expected;

· Prohibition of de-designation of a hedging relationship as long as the risk management remains unchanged and all other qualifying criteria are met; and

· Exclusion of costs of hedging such as the time value of an option, the forward element of a forward contract and any foreign currency basis spread, from the designation of a financial instrument as the hedging instrument.

These significant changes really provide a closer link between how management conducts its risk management activities in hedging its exposures, and how the effects of these activities are reflected in its financial reporting. It abolishes the previous rules-based approach on when and how an entity may avail of “hedge accounting” as a means of communicating the results of its hedging activities. Furthermore, the changes introduced include providing more useful information which would help investors and users of financial statements better understand the risk management activities of the entity and the effect of hedging activities on future cash flows.


IFRS 9 is effective for annual periods beginning on or after 1 January 2018, with early application permitted.

Before the final version of IFRS 9 was issued, three versions of this standard were already issued namely, IFRS 9 (2009) which covers the classification and measurement requirements for financial assets, IFRS 9 (2010) which incorporates the classification and measurement requirements for financial liabilities, and IFRS 9 (2013) which integrates the new hedge accounting model. Early application of these previous three versions of IFRS 9 is permitted if the date of initial application is before 1 February 2015.

The standard requires a retrospective application but restatement of comparatives is not required.


The new standard will apply to all entities that report its financial statements under IFRS. In particular, IFRS 9 will affect entities that hold financial instruments such as loans, investments in debt and equity securities, and trade and lease receivables. It is also expected that this new standard will most significantly impact banks and insurance entities due to their large exposures to financial instruments.

Entities need to begin taking action towards meeting the 2018 mandatory application date. They should start understanding the impact on the organization and plan for adopting this new standard. In particular, entities may need to perform the following:

· Understand its current business model and assess if that would be reflective of its strategic direction, so that it could maximize the benefit of a “fresh start” situation once it decides or is mandated to adopt the new standard;

· Review the present terms and conditions of its debt assets to determine whether it may satisfy the “characteristics test” and perhaps decide on the policy to be applied moving forward on what particular terms and conditions of its debt assets may be acceptable given its risk appetite;

· Evaluate the appropriate model to be used in measuring the ECL of its financial assets and determine whether data requirements are readily available;

· Revisit its risk management activities and explore appropriate hedging strategies given its risk exposures, taking into consideration the financial reporting requirements of the standard; and

· Assess whether existing systems, tools and processes are sufficient and/or scalable to capture the requirements of adopting the new standard or whether there is a need to invest in new resources.

Particularly for banks, adopting the ECL requirements in IFRS 9 will require significant effort in terms of the data to be gathered and the investment in systems and processes. There is a need to fully understand the complex interactions between IFRS 9 and regulatory capital requirements in relation to credit losses.

IFRS 9 requirements will have a far-reaching impact and will take a huge effort to implement, given its many principles, calculations and disclosure requirements. For affected entities, the time is now to plan for the final and complete IFRS 9.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co.

Francisco Roque A. Lumbres, CFA, PRM is a Partner, and Jeramael P. Villaber is an Associate Director, of SGV & Co.