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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.
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.
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:
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 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:
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:
Above all be clear on the impact of the Standard and be sure to tailor disclosures to entity’s specific circumstances.
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.
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