From now until its mandatory implementation date, 1 January 2018, we are going to consider a different element of IFRS 9 Financial Instruments on a regular basis. This month we start with a look at how the accounting for equity instruments that are classified as ‘Available For Sale’ (AFS) financial assets will change.
Under IAS 39 Financial Instruments: Recognition and Measurement, the AFS category of financial assets is a default category. It captures the assets that do not meet the criteria of any of the other categories within the standard. AFS financial assets are measured at fair value with fair value gains or losses recognised in other comprehensive income (FVOCI).
In practice, the most common types of equity instruments that are classified AFS financial asset are:
- Direct equity investments that do not meet the criteria to be accounted for as an subsidiary, joint arrangement or associate, and
- Investments in unit trusts or money market funds that themselves invest in a pool of debt and equity instruments.
How will this change on adoption of IFRS 9?
IFRS 9 requires all equity investments to be measured at fair value. The default approach is for all changes in fair value to be recognised in profit or loss (FVPL). However, for equity investments that are not held for trading, entities can make an irrevocable election at initial recognition to classify the instruments at FVOCI, with all subsequent changes in fair value being recognised in other comprehensive income (OCI). This election is available for each separate investment.
Under this new FVOCI category, fair value changes are recognised in OCI while dividends are recognised in profit or loss.
Although it might appear similar to the AFS category in IAS 39, it is important to note that this is a new measurement category which is different. In particular, under the new category, on disposal of the investment the cumulative change in fair value must remain in OCI and is not recycled to profit or loss. However, entities have the ability to transfer amounts between reserves within equity (ie between the FVOCI reserve and retained earnings).
Will measurement change?
IAS 39 requires investments in equity instruments that do not have a quoted price in an active market and whose fair value cannot be reliably measured, to be measured at cost. This requirement for unquoted equity investments is not replicated in IFRS 9. Instead, all equity investments (quoted or unquoted) must be measured at fair value using the framework within IFRS 13 Fair Value Measurement.
What should we do now?
For financial assets currently classified as AFS:
- Consider whether you wish to make an irrevocable election to classify the instrument at FVOCI - if you do not make this election, the financial asset will be classified as FVPL
- Where unquoted investments in equity instruments were held at cost, consider how you will determine the fair value on the date of initial application of IFRS 9, this may require the services of a specialist valuer.
For help and advice on IFRS9 please get in touch with your usual BDO contact or Dan Taylor.
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