IFRS 9: Financial instruments
Classifying financial assets, the amortised cost method, and expected credit losses on receivables.
ACCA exams this helps with: FR Financial Reporting SBR Strategic Business Reporting See the ACCA map
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What it is: IFRS 9 is the standard for financial instruments. These are contracts about money, such as loans, bonds, shares held in other companies, and amounts customers owe (receivables).
What it covers: (1) Whether each item is shown at cost or at market value (fair value). (2) How interest on a loan is spread over its life. (3) How much to set aside now for money that may never be paid (the expected credit loss).
Important: The loss is estimated before a customer fails to pay, not after.
Example. A business is owed £100,000 by customers. Past records show about 2% is never paid. Allowance = £100,000 × 2% = £2,000. This £2,000 is an expense this year.
Key words
- Financial asset
- A contract that gives a right to receive cash (or another financial asset), such as money owed by customers, a loan given, or shares held.Example: A £5,000 invoice a customer has not yet paid is a financial asset.
- Amortised cost
- A way to measure a loan or bond. Start with the amount borrowed or paid, add interest at the effective interest rate each year, and take off the payments.Example: Borrow £9,500. Interest at 5.4% is £513. Pay £400. The new balance is £9,500 + £513 − £400 = £9,613.
- Effective interest rate
- The single interest rate that spreads the total cost of a loan evenly over its life, including any fees or discount, not just the stated interest.Example: A bond pays 4% interest, but the company only received £9,500 for £10,000 of bonds. The effective rate works out as 5.4%.
- Fair value
- The price an asset would sell for (or a liability would cost to transfer) in a normal sale between willing parties on the measurement date.Example: A building bought for £500,000 would sell for £800,000 today. Its fair value is £800,000.
- Expected credit loss
- The amount a business expects to lose because some customers or borrowers will not pay. It is set aside as an allowance before they fail to pay.Example: £100,000 of receivables with an expected 2% loss rate gives an allowance of £2,000.
Learn
IFRS 9 covers financial instruments: contracts about money, such as loans, bonds, shares held in other companies, and receivables.
Which group does a financial asset go in?
Two tests decide:
- The business model: why the company holds the asset. Is it to collect the payments, to sell it, or both?
- The cash flow test (SPPI): are the payments solely payments of principal and interest? In other words, is it a simple loan, where you get back the amount lent plus interest?
| Group | When | Where gains and losses go |
|---|---|---|
| Amortised cost | Held to collect the payments, and passes SPPI | Interest goes to profit or loss, using the effective interest rate |
| Fair value through OCI (debt) | Held to collect and to sell, and passes SPPI | Value changes go to OCI. When sold, they are moved to profit or loss. |
| Fair value through OCI (shares, by choice) | Shares not held for trading, if the company chooses this at the start. It cannot change later. | Value changes go to OCI. They are never moved to profit or loss. |
| Fair value through profit or loss | Everything else, including items held for trading and derivatives | Value changes go to profit or loss |
Amortised cost and the effective interest rate (EIR)
Most loans are measured at amortised cost. The interest charged each year is the effective interest rate × the opening balance. This is not always the same as the cash interest paid (the coupon).
Example: A company borrows £10,000. The EIR is 8%. It pays £500 cash interest each year. Year 1: £10,000 + £800 − £500 = £10,300.
Expected credit losses (ECL)
IFRS 9 says you must set aside an allowance for losses you expect, before they happen.
- Stage 1: the risk has not gone up much since the start. Allow for losses expected in the next 12 months.
- Stage 2: the risk has gone up a lot. Allow for losses over the whole life of the asset.
- Stage 3: the borrower is already in trouble (credit-impaired). Allow for lifetime losses, and work out interest on the amount after the allowance.
For trade receivables there is a simpler method. Always allow for lifetime losses. Usually you use a provision matrix: a table of loss rates for how long each debt has been unpaid.
Example: £40,000 not yet due × 1% = £400. £10,000 over 90 days late × 20% = £2,000. Allowance = £2,400.
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Worked example
A loan at amortised cost. A company issues a bond with a nominal value of £10,000 and receives £9,500 after costs. It pays a 4% coupon (£400 a year). The effective interest rate is 5.4%.
| Year | Opening £ | Interest at 5.4% £ | Cash paid £ | Closing £ |
|---|---|---|---|---|
| 1 | 9,500 | 513 | (400) | 9,613 |
| 2 | 9,613 | 519 | (400) | 9,732 |
The finance cost in profit or loss is £513 in year 1, not the £400 paid. The balance grows towards £10,000, which is repaid at the end.
A provision matrix.
| Ageing band | Balance £ | Expected loss rate | Allowance £ |
|---|---|---|---|
| Current | 200,000 | 0.5% | 1,000 |
| 1–30 days overdue | 60,000 | 2% | 1,200 |
| 31–60 days overdue | 25,000 | 8% | 2,000 |
| Over 60 days overdue | 10,000 | 30% | 3,000 |
| Total | 295,000 | 7,200 |
Practice questions
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