The Federation of Accounting Professions (FAP) announced a new standard on accounting for financial instruments, TFRS 9, which application will be effective date on 1 January 2020.
The new TFRS 9 is based on IFRS 9 issued by The International Accounting Standard Board which fundamentally rewrites the accounting rules for financial instruments. It introduces a new approach for financial asset classification; a more forward-looking expected loss model; and major new requirements on hedge accounting.
While TFRS 9 mandatory effective date has been deferred to 1 January 2020 which seems to be a long way off, companies should use this period to start evaluating the impact of this new Standard now, in addition to the impact on reported results, which may require many businesses to collect and analyse additional data and implement changes to systems.
Classification and measurement
TFRS 9 requires classification of financial assets into one of the measurement categories depending on the financial asset being held whether it is debt or equity in nature.
Investments in debt type financial assets
Debt type financial assets generally include receivables, originated and purchased loans and debt securities where the entity receives principal on redemption and/or interest during the tenure of the instrument. On initial recognition TFRS 9 requires all such financial assets (including those that contain embedded derivative features) to be classified into one of two primary measurement categories i.e. fair value or amortised cost.
TFRS 9 defines business model in relation to how financial assets are managed and the extent to which cash flows will result from collecting contractual cash flows, selling financial assets or both. It defines two business models as:
- a ‘hold to collect’ business model i.e. a business model whose objective is to hold the financial asset in order to collect contractual cash flows
- a ‘hold to collect and sell’ business model i.e. a business model in which assets are managed to achieve a particular objective by both collecting contractual cash flows and selling financial assets
The ‘business model test’ is not relevant to derivative financial assets and investments in equities which are classified at fair value as the instruments do meet the ‘cash flow characteristics test’
The contractual cash flow characteristics test is the second of the two tests that determine the classification of a financial asset. In order to make the test, the contractual terms of the financial asset must give rise on specified dates to cash flows that are solely payments of principal and interest.
Investments in equity type financial instruments
Investments in equity instruments will generally be measured at fair value, except for non-publicly traded equity instruments, where a company may elect to irrevocably present changes in fair value in Other Comprehensive Income (OCI).
The new impairment model under TFRS 9 replaces the ‘incurred loss’ model with an ‘expected credit loss’ model, which means that a loss event will no longer need to occur before an impairment reserve is recognised.
TFRS 9 outlines a ‘three-stage’ model for impairment based on changes in credit quality since initial recognition.
The new model applies to debt instruments recognised on-balance sheet, such as loans or bonds instruments classified as measured at amortised cost or FVOCI and certain loan commitments and guarantees.
Under the new model, a credit loss arises as soon as a company buys or originates a loan or receivable – a so-called ‘day one loss’. Recognition of impairment therefore no longer depends on the company first identifying a credit loss event. Instead an entity always estimates an ‘expected loss’ considering a broader range of information, including:
- past events, such as experience of historical losses for similar financial instruments
- current conditions
- reasonable and supportable forecasts that affect the expected collectability of the future cash flows of the financial instrument.
The standard also prescribes a simplified model for trade receivables, contract assets and lease receivables which recognise a loss allowance at an amount equal to lifetime expected credit losses.
The advantage of using the simplified approach is that an entity is not required to determine whether credit risk has increased significantly since initial recognition.
As TFRS 9 is effective for accounting periods beginning on or after 1 January 2020, there are number of actions to be taken now in order to implement the requirements for the current financial year. In particular, following actions should be undertaken:
- studying the classification and measurement requirements and evaluating how the information will be accumulated
- engaging with auditors and business advisers now
- creating and maintaining buy-in from senior management within organisation for the project
- compiling information about existing instruments in order to gauge the Standard’s impact
- considering whether to adopt any of the classification options available on initial recognition of the Standard
- reviewing loan covenants and other agreements that incorporate financial ratios and metrics, such as compensation arrangements, that could be affected by the new Standard
- communicating what is happening and how it affects the entity
- monitoring progress towards interim and final milestones and intervene where required.
Above all be clear on the impact of the Standard and be sure to tailor disclosures to entity’s specific circumstances.
How can we help?
Grant Thornton’s team comprises financial reporting, and industry experts, each having several years of hands-on practical experience across GAAPs and sectors. Our professionals uniquely combine their technical expertise with the intuition, insight and confidence gained from their extensive practical experience to develop a systematic, reliable, efficient and scalable reporting framework for converging to the new standard.
This entails a careful and well-documented evaluation (and suitable modifications) of the financial reporting process, in order to achieve an optimal balance between transparency, consistency, accuracy, reliability and speed, while also controlling costs.
- Contract reviews under TFRS 9.
- Identify areas of impact under TFRS 9 and documentation of such impact assessment.
- Analyse and report on expected impact on processes, systems, controls, taxes, and KPIs.
- Draft accounting position papers for all identified
- differences under TFRS 9
- Design templates and working notes for mathematical
- computations of transition adjustments.
- Update business process and policy manuals.
- Prepare computation of adjustments as of transition date to TFRS 9
- Conduct a series of workshops and trainings for supporting the implementation
- Draft the additional disclosures required under TFRS 9.
- Provide input on changes to systems and processes to generate information for sustainable financial reporting.
- Provide regular updates on evolving changes in the accounting literature that are likely to have an effect on an ongoing basis.