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Discuss how an investor in the two tranches should account for them in their financial statements.
Solution
An investor will have to look through to the investments of Excel, which are measured at amortized cost. The pool has at least one instrument with cash
flows of principal and interest and Exel has no other instruments. Therefore the instruments held by Exel do not have any prohibitive features. The
exposure to credit risk must be analyzed.
If the pool of loans were to lose 50%, then a loss of $6 million would arise. Of that loss $4 million would be absorbed by the second tranche, leaving $2
million to be absorbed by the first tranche. This means that the ratio of loss of tranche one would be $2 million/$8 million, that is, 25%. This is obviously
less than 50%, which means the credit risk is lower than the credit risk of the underlying pool of assets. Therefore the first tranche can use amortized cost.
Tranche two does not meet the criterion because investors in this tranche lose 100% and therefore an investor should value the investment at fair value.
Facts
CASE STUDY 5
Bage has a financial asset that was accounted for as a loan and receivable under IAS 39 but under IFRS 9 it needs to be reclassified as FVTPL. Bage
manages the asset together with an existing liability, which is accounted for at amortized cost.
Required
Bage wonders whether designating the liability at amortized cost under IFRS 9 would produce an accounting mismatch.
Solution
If at the date of the initial recognition, Bage feels that by designating the liability at FVTPL would reduce an accounting mismatch compared to measuring
the liability at amortized cost and the financial asset at FVTPL, then Bage could designate the liability at FVTPL.
EQUITY INVESTMENTS AT FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME
IFRS 9 allows an option to designate nontrading equity investments at fair value through OCI upon initial recognition. Such a designation is irrevocable. However
IFRS 9 requires that dividends received from these investments be recognized in profit or loss, unless they represent a recovery of part of the cost of investment.
Fair value changes in these investments will be recognized in OCI, without recycling of gains and losses between profit or loss and OCI, even on impairment or on
sale or disposal of the investment.
For equity investments designated at fair value through OCI, an entity needs to make several additional disclosures, including the reasons for using this presentation
alternative, the fair value of each such investment at the end of the reporting period, and dividends recognized.
EFFECTIVE DATE AND TRANSITION
The mandatory effective date for IFRS 9 will be January 1, 2013, with early adoption of Phase 1 permitted for reporting periods ending on or after December 31,
2009.
In some jurisdictions, the local authority is required to endorse the Standard before it becomes available for adoption in that jurisdiction.
IFRS 9 is required to be applied retrospectively. However, the assessment of whether instruments are to be measured at amortized cost or fair value will need to be
made for instruments on the entity’s statement of financial position, based on facts and circumstances existing as at the initial application date.
The determination of whether an instrument is “held for trading” is also made as at the initial application date. It is also possible to redesignate financial assets at fair
value through profit or loss using the fair value as at the date of initial application and to apply the new designation retrospectively.
Entities will be allowed to redesignate financial liabilities at fair value through profit or loss, even though they are not otherwise within the scope of the Standard, to
avoid measurement mismatches when there is a required change in the treatment of financial assets under IFRS 9.
Comparative figures are required to be restated. However, some transitional relief is available for early adopters.