It is now more critical than ever that audit firms in Dubai
evolve their IFRS 9 models rapidly to ensure efficient governance, better pricing, an efficient internal audit process, and an outstanding customer experience. The IASB offered entities the opportunity to replace IAS 39 with an updated version of IFRS 9. In this way, financial institutions can better manage their business under financial crisis and postpone the recognition of credit losses on loans that are too late in the credit cycle.
Farahat and Co. is one of the top audit firms in Dubai, providing you with the essential tools you need to understand and adapt to the new IFRS 9 model.
What is a Financial Instrument?
A financial instrument is an agreement between two or more parties to sign up a legal document that involves any kind of monetary value, debt & equity instruments, cash & money market instruments, and derivative instruments.
IFRS 9 defines how an entity should classify and measure its financial instruments, financial liabilities, and some contracts to buy or sell non-vanilla items. Financial instruments may take up a variety of forms, especially which are contractual whilst certain liabilities that are imposed by the government aren’t considered financial instruments because they aren’t based on a contractual agreement.
A few other examples are also listed below which do not fall under the financial instruments category:
· Tax and levies
· Warranty labels
· Gold and Inventories
· Delayed revenue
· Expense paid-in-advance
What is the Fair-value option for investors?
The IFRS 9 also issues a fair-value option for contracts where non-financial items can be sold or bought by exchanging financial instruments. This help investors practice fair-value accounting to determine the value of the assets with current market value.
What is the objective of the IFRS 9 series?
The IFRS 9 Series of Financial instrument issued on 24th July 2014 includes requirements for recognition and management, hedge accounting, and impairment derecognition. This standard version replaces the IAS 39 and supersedes prior versions and is essentially effective for periods beginning after 1st January 2018.
The new IFRS 9 standard is mandatorily effective for all entities, including financial institutions to improve their financial reporting, assets, and liabilities by dealing separately in three phases.
Classification and Measurements of Financial Assets
An entity measures a financial instrument or asset either at amortized cost or at its fair value (FVOCI) or (FVPL).
All financial instruments are initially recognized as financial assets based on the entity’s business model managing the contractual cash flow at fair value plus or minus:
· The business model has held financial assets to collect contractual cash flows
· The financial asset gives rise to cash flows at stated times that are interest on outstanding amounts or payments
· If a business model achieves both collecting contractual cash flow and selling financial assets then the financial assets are measured at fair value by other comprehensive income (FVOCI)
·If none of the financial assets are held by the above-mentioned business models then the assets are classified into fair value through profit or loss (FVPL)
However, a financial asset can only be measured at Amortized or FVOCI if the criteria are met:
· The entity business model must only collect cash flows (rather than sell the asset before its contractual maturity)
· The specified dates on which the contractual cash flow of an asset gives rise to payments on (SPPI) solely payments of principal and interest, for which interest is the consideration of the time value of money, profit margin, and the credit risk linked to the principal amount outstanding within a particular period
The Impairment of Financial Instrument
IFRS 9 requires that credit losses on financial assets are measured using the early recognition Expected Credit Loss (ECL) approach as it includes both incurred losses and future expected losses as well. This is the only impairment model applied in IFRS 9 measured at amortized cost or FVOCI. Credit loss or Cashflow loss is the difference between the Present value (PV) of contractual cash and the (PV) of expected future contractual cash flow.
An entity is required to account for the impairment model on financial assets in these steps:
Step 1: A 12-month or Lifetime ECl is recognized in profit or loss and a loss allowance is made. Without deduction from ECL, interest revenue is collected.
Step 2: The ECL is measured again at each reporting date
· Unless a significant increase in credit risk occurs lifetime ECL is recognized in
profit or loss
· If the credit risk increases significantly, the ECL is remeasured
At both points, the interest revenue calculation remains the same as in Step 1.
· If the credit risk increases to such a point that they are made completely worthless
Hedge Accounting is an accountancy practice that adjusts the fair value or future cash flow that could affect the income statement in the future.
Although hedge accounting is not obligatory yet to avoid volatility in earnings it is a compulsory phase where you have to show:
· Your entity faces certain risks
· You perform strategies to cancel those risks
· How effective and efficient are these strategies are
How can Banks be impacted by IFRS 9?
Classifying the financial instruments of a bank can affect how its capital resources and requirements are calculated and create volatility in profit or loss. IFRS 9 allows a bank to swap into a new hedge accounting model which is more principle-based and more closely aligned with risk management.
However, IFRS 9 can create an impact on more than just financial institutions or banks especially those with long-term loans, or any non-vanilla financial instruments.
The ISFR 9 specifies how an entity should measure financial instruments at fair value with changes recognized in profit or loss as they arise. In order to conduct value audits smoothly, external and internal auditors need to know about IFRS 9. Also, it facilitates the smooth running of internal audit processes.
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