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The following are indicators of when cost might not be representative of fair value for unquoted equity instruments:
1. A significant change in the performance of the investee company compared with the budget plan or milestone
2. Changes in expectation that technical milestones will be achieved
3. A significant change in the market for the investee company or its products or potential products
Facts
CASE STUDY 1
Amber is a start-up company and Light holds all of the share capital of the entity. Light wishes to value the financial asset at cost as there is very little
information about value of the investment.
Required
Can the investment in Amber be valued at cost?
Solution
As Amber is a start-up company, performance even in accordance with original plans may lead to a significant increase in value as uncertainty over the
future is removed. This means that even if there are no significant changes in performance over plan, cost may not be an appropriate estimate of fair value.
RECLASSIFICATION
The classification of an instrument is determined on initial recognition, and reclassifications are only permitted on the change of an entity’s business model and are
expected to occur only infrequently.
If an instrument is reclassified from amortized cost to fair value, it should be measured at fair value on that date with any difference between the carrying amount
and fair value recognized in a separate line in the income statement. If an instrument is reclassified from fair value to amortized cost, the fair value of the instrument on
the date of reclassification becomes its new carrying amount.
An example of where reclassification from amortized cost to fair value might be required would be when an entity decides to close its mortgage business, is no
longer accepting new business, and is actively marketing its mortgage portfolio for sale.
When a reclassification is required it is applied from the first day of the first reporting period following the change in business model.
Example of change in business model allowing reclassification
An entity has a portfolio of commercial loans that it holds to sell in the short term. The entity acquires a company that manages commercial loans and has a
business model that holds the loans to collect the contractual cash flows. The portfolio of commercial loans is no longer for sale, and the portfolio is now
managed together with the acquired commercial loans and all are held to collect the contractual cash flows.
Examples of change in business model not allowing reclassification
1. A change in intention related to specific financial assets even in circumstances of significant changes in market conditions
2. A temporary disappearance of a particular market for financial assets
3. A transfer of financial assets between existing business models
If the entity reclassifies financial assets in accordance with IFRS 9, the entity is required to disclose the date of reclassification and the amount reclassified into or out
of each category. In addition, a detailed explanation of the change in business model and a qualitative description has to be shown.
Facts
CASE STUDY 2
Garby wishes to reclassify its financial assets and does not understand the implications of IFRS 9. The entity wishes to reclassify and immediately use the
new classifications in its financial statements.
Required
Advise Garby on the procedures for reclassification.