A new way of measurement and recording of financial instruments

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A new way of measurement and recording of financial instruments

05.09.18

As the Australian Accounting Standards Board (AASB) has made many considerable changes and amendments to their standards this past year, it is easy to be bogged down by the details and miss what these changes actually mean for you and your business.

The introduction of the new accounting standard AASB 9 Financial Instruments came into effect for reporting periods beginning on or after 1 January 2018, significantly changes the way in which financial instruments (assets and liabilities) are classified and measured. It also provides a new set of hedge accounting rules and prescribes new principles on the impairment of financial assets.

This means that under these new rules, business may have to reclassify some of their assets, consider their business model for holding financial assets and for listed companies, how they will inform the market how these standards may affect their financial statements.

So, what’s different?

For starters, compared to its predecessor AASB 139 Financial Instruments: Recognition and Measurement, the new standard provides greater flexibility when it comes to adoption and implementation. It simplifies the classification of assets, replacing the following four categories under AASB 139 with three general categories under AASB 9:

AASB 139                                  

AASB 9

1. Fair value through profit or loss

2. Available for sale

3. Held-to- maturity

4. Loans & receivables

1. Fair value through profit or loss (FVtPL)

2. Fair value through other comprehensive income (FVtOCI)

3. Amortised cost (AC)

 

While these new categories appeared to be retained from the previous one, the main difference between them is that AASB 9 requires that an entity that designates a financial liability at FVtPL to present the portion of the change in the fair value attributable to changes in the credit risk of the liability in other comprehensive income (OCI), except when it would create an ‘accounting mismatch’.

Finally, as the hedging rules of AASB 9 are more principal based as compared to the rule based AASB 139, it will allow for increased hedging instruments and hedged items to qualify for hedge accounting.

The Impairment Model

The impairment model under AASB 139 is based on ‘incurred losses’ while under AASB 9 the impairment model is forward looking and no longer requires a credit event to have occurred before credit losses are recognised.

AASB 9 introduces an expected credit loss (ECL) impairment model that apples to financial instruments, including trade and lease receivables. It requires entities to recognise expected credit losses in respect to receivables and other financial assets not measured at FVtPL using three-stage impairment model - ‘general approach’ or the ‘simplified approach’

Under the General Approach:

  • Stage 1 – there is no significant increase in the credit risk, entities are required to provide for credit losses that result from default events ‘that are possible’ within the next 12  months.
  • Stage 2 – the credit risk has increased significantly since initial recognition; entities are required to provide for lifetime expected credit losses.
  • Stage 3 – financial assets that are assessed as being credit impaired, in addition to providing for lifetime expected credit losses, an entity is required to calculate interest on the net (impaired value) carrying amount of the instrument.

Alternatively, a Simplified Approach has been specifically introduced for circumstances where there are:

  • Trade receivables with maturities of less than 12 months
  • Other long term trade and lease receivables having maturity of longer than 12 months

 In this case, entities have a choice to either apply the general approach or the simplified approach.

Under the simplified approach, an entity considers forward-looking assumptions and information regarding expected future conditions affecting historical customer default rates. The entity does not wait until the receivable is past due before a provision is raised and will recognise ‘lifetime expected credit losses’ from the first reporting period. These are the credit losses expected over the term of the receivable and closely resembles the general doubtful debt provisioning method. Most of our clients will be using the simplified approach for their trade receivables.

Who is impacted?

Those most affected by this new standard are organisations who rely on impairments models such as Banks, Insurance Companies and those within the Financial Services industry. However, SMEs within Technology and Software, Building and Construction, Mining and Residential Real Estate should pay considerable attention to these new changes.

This article contains only an overview of the key elements of AASB 9. The implications for individual entities will depend on the nature, type and quantum of their financial assets and liabilities and the current accounting policies adopted. Should you have any questions about how these changes affect you please contact us or speak to your ESV engagement partner on 02 9283 1666. Your dedicated team will offer a practical approach to implement AASB 9.