Your document headline

However as IFRS 9 eliminates the available-for-sale (AFS) category, it also eliminates the AFS impairment rules.
Under IAS 39, measuring impairment losses on debt securities in illiquid markets based on fair value often led to reporting an impairment loss that exceeded the
credit loss that management expected.
Additionally, impairment losses on AFS equity investments cannot be reversed under IAS 39 if the fair value of the investment increases.
Under IFRS 9, debt securities that qualify for the amortized cost model are measured under that model and declines in equity investments measured at FVTPL are
recognized in profit or loss and reversed through profit or loss if the fair value increases.
PRACTICAL INSIGHT
One of the most frequent questions is whether IFRS 9 will result in more financial assets being measured at fair value. It will depend on the circumstances
of each entity in terms of the way it manages the instruments it holds, the nature of those instruments, and the classification elections it makes. One of the
most significant changes will be the ability to measure some debt instruments, for example investments in government and corporate bonds, at amortized
cost. Many available-for-sale debt instruments currently measured at fair value will qualify for amortized cost accounting.
OTHER ISSUES
Two particular types of instrument are likely to pose difficulties: nonrecourse loans and securitized debt. The Standard indicates that some financial assets may have
cash flows, which are described as principal and interest but do not in fact represent payment of such.
The example is given of nonrecourse debt where the creditor’s claim is limited to certain assets or cash flows and where the contractual cash flows arising from the
debt may not exclusively represent the payment of principal and interest—for example, they may include the time value of money and the credit risk involved.
However, the fact that a debt is nonrecourse does not necessarily mean that it cannot be classified at amortized cost. A holder of a nonrecourse instrument, in which
the lender is entitled only to repayment from specific assets or cash flows, must look through to the ring-fenced assets or cash flows to determine whether payments
arising from the contract meet the “contractual cash flow characteristics” test.
If the terms of the debt give rise to any other cash flows or limit the cash flows in a manner inconsistent with payments of principal and interest, it does not meet the
test. Thus, for example, a nonrecourse property loan in which the return earned by the lender is significantly dependent upon the performance of the secured property
may not meet the test.
IFRS 9 gives guidance in circumstances where an entity prioritizes payments to holders of multiple contractually linked instruments. Although an important
objective of the Standard was to simplify financial instrument accounting, it was not possible to find a simple way to classify contractually linked instruments that
create concentrations of credit risk, that is, the tranches of securitized debt.
The complexity arises because the junior tranches provide credit protection to the more senior tranches and the characteristics of the tranches depend on the
underlying instruments held.
The right to payments on more junior tranches depends on the issuer’s generation of sufficient cash flows to pay more senior tranches.
IFRS 9 takes a “look-through” approach to determine whether measurement at amortized cost is available.
A tranche meets the criterion if the following three conditions are met:
1. The contractual terms of the tranche being assessed have cash flow characteristics that are solely payments of principal and interest.
2. The underlying pool contains one or more instruments that have contractual cash flows that are solely payments of principal and interest, and any other
instruments either
a. Reduce the cash flow variability of other such instruments and result in cash flows that are solely payments of principal and interest (e.g., interest rate
caps and floors, credit protection) or
b. Align the cash flows of the tranches with the cash flows of the underlying pool of instruments to address differences in whether the interest rate is
fixed or floating or the currency or timing of cash flows.
3. The exposure to credit risk in the tranche is equal to, or lower than, the exposure to credit risk of the underlying pool of instruments.
IFRS 9 states that this latter condition would be met if, in all circumstances in which the underlying pool of instruments loses 50% as a result of credit losses, the
tranche would lose 50% or less.
If any instrument in the underlying pool does not meet the above conditions or if the pool can change in a way that would not meet these conditions, then the
tranche cannot use amortized cost.
Facts
CASE STUDY 4
Exel is a special-purpose entity, which has issued two tranches of debt which are linked by contract. The first tranche has a value of $8 million and the
second tranche is valued at $4 million. The second tranche is subordinated to the first tranche and receives distributions after payments to the first tranche.
Exel has loans of $12 million, which are carried at amortized cost. The contractual terms of the first tranche only give rise to payments of principal and
interest.
Required