2.1 Debt financial assets measured at amortised cost

Financial assets that are measured at amortised cost require the use of the effective interest method and are subject to the IFRS 9 impairment rules. [IFRS 9.5.2.1, 5.2.2]. Gains and losses are recognised in profit or loss when the instrument is derecognised or impaired, as well as through the amortisation process. [IFRS 9.5.7.2]. The effective interest method of accounting is dealt with at 3 below, foreign currency retranslation is discussed at 4 below, modification of financial assets is covered at 3.8 below and impairment is addressed in Chapter 51.

2.2 Financial liabilities measured at amortised cost

Liabilities that are measured at amortised cost require the use of the effective interest method with gains or losses recognised in profit or loss when the instrument is derecognised as well as through the amortisation process. [IFRS 9.5.3.1, 5.7.2]. The effective interest method of accounting is dealt with at 3 below, foreign currency retranslation is discussed at 4 below and modification of financial liabilities is covered at 3.8 below.

2.3 Debt financial assets measured at fair value through other comprehensive income

For financial assets that are debt instruments measured at fair value through other comprehensive income (see Chapter 48 at 2.1), the International Accounting Standards Board (IASB or Board) decided that both amortised cost and fair value information are relevant because debt instruments held by entities in this measurement category are held for both the collection of contractual cash flows and the realisation of fair values. [IFRS 9.4.1.2A, BC4.150].

After initial recognition, investments in debt instruments that are classified as measured at fair value through other comprehensive income are measured at fair value in the statement of financial position (with no deduction for sale or disposal costs). The amounts recognised in profit or loss are the same as the amounts that would have been recognised in profit or loss if the investment had been recorded at amortised cost. [IFRS 9.5.7.10, 5.7.11].

Subsequent measurement of debt instruments at fair value through other comprehensive income involves the following: [IFRS 9.5.7.1(d), 5.7.10, B5.7.1A]

• impairment gains and losses (see Chapter 51) are derived using the same methodology that is applied to financial assets measured at amortised cost and are recognised in profit or loss; [IFRS 9.5.2.2, 5.5.2]
• foreign exchange gains and losses (see 4 below) are calculated based on the amortised cost of the debt instruments and are recognised in profit or loss; [IFRS 9.B5.7.2, B5.7.2A]
• interest revenue is calculated using the effective interest method (see 3 below) and is recognised in profit or loss; [IFRS 9.5.4.1]
• other fair value gains and losses are recognised in other comprehensive income; [IFRS 9.5.7.10, B5.7.1A]
• when debt instruments are modified (see 3.8 below and Chapter 51 at 8), the modification gains or losses are recognised in profit or loss;¹ [IFRS 5.4.3] and
• when the debt instruments are derecognised, the cumulative gains or losses previously recognised in other comprehensive income are reclassified (i.e. recycled) from equity to profit or loss as a reclassification adjustment. [IFRS 9.5.7.10, B5.7.1A].

It follows that the amount recognised in other comprehensive income is the difference between the total change in fair value and the amounts recognised in profit or loss (excluding any amounts received in cash, e.g. the coupon on a bond).

2.4 Financial assets and financial liabilities measured at fair value through profit or loss

After initial recognition, financial assets and financial liabilities that are classified as measured at fair value through profit or loss (including derivatives that are not designated in effective hedging relationships) are measured at fair value, with no deduction for sale or disposal costs (see Chapter 48 at 2, 4, 5.4 and 7). [IFRS 9.5.2.1, 5.3.1].

The standard helpfully points out that if the fair value of a financial asset falls below zero it becomes a financial liability (assuming it is measured at fair value). [IFRS 9.B5.2.1]. The standard does not explain what happens if the fair value of a financial liability becomes positive, but it is safe to assume that it becomes a financial asset and not a negative liability.

Gains and losses arising from remeasuring a financial asset or financial liability at fair value should normally be recognised in profit or loss. [IFRS 9.5.7.1]. However, there is an exception for most non-derivative financial liabilities that are designated as measured at fair value through profit or loss. For these liabilities the element of the gain or loss attributable to changes in credit risk (see 2.4.1 below) should normally be recognised in other comprehensive income (with the remainder recognised in profit or loss). [IFRS 9.5.7.7, B5.7.8]. These amounts presented in other comprehensive income should not be subsequently transferred to profit or loss. However, the cumulative gain or loss may be transferred within equity. [IFRS 9.B5.7.9].

This exception does not apply to loan commitments or financial guarantee contracts, nor does it apply if it would create or enlarge an accounting mismatch in profit or loss (see 2.4.2 below). [IFRS 9.5.7.8, 5.7.9]. In these cases, all changes in the fair value of the liability (including the effects of changes in the credit risk) should be recognised in profit or loss. [IFRS 9.B5.7.8].

2.5 Investments in equity investments designated at fair value through other comprehensive income

After initial recognition, investments in equity instruments not held for trading that are designated as measured at fair value through other comprehensive income (see Chapter 48 at 2.2) should be measured at fair value, with no deduction for sale or disposal costs. With the exception of dividends received, the associated gains and losses (including any related foreign exchange component) should be recognised in other comprehensive income. These investments are not subject to impairment testing. Amounts presented in other comprehensive income should not be subsequently transferred to profit or loss, although the cumulative gain or loss may be transferred within equity. [IFRS 9.5.2.1, 5.7.5, B5.7.1, B5.7.3].

Dividends from such investments should be recognised in profit or loss when the right to receive payment is probable and can be measured reliably unless the dividend clearly represents a recovery of part of the cost of the investment (see Chapter 8 at 2.4.1.C). [IFRS 9.5.7.1A, 5.7.6, B5.7.1]. Determining when a dividend does or does not clearly represent a recovery of cost could prove somewhat judgmental in practice, especially as the standard contains no further explanatory guidance.

2.6 Unquoted equity instruments and related derivatives

IFRS 9 requires all investments in equity instruments and contracts on those instruments to be measured at fair value (see Chapter 14). However, it is recognised that in limited circumstances, cost may be an appropriate estimate of fair value. That may be the case if insufficient more recent information is available to determine fair value, or if there is a wide range of possible fair value measurements and cost represents the best estimate of fair value within that range. [IFRS 9.B5.2.3].

Such guidance was provided to alleviate some of the concerns expressed by constituents and also, to replace the cost exception that was not brought forward to IFRS 9 from IAS 39 – Financial Instruments: Recognition and Measurement, the previous standard for accounting for financial instruments. IAS 39 contained an exception from fair value measurement for investments in equity instruments (and some derivatives linked to those investments) that do not have a quoted price in an active market and whose fair value cannot be reliably measured. Those equity investments were required to be measured at cost less impairment, if any. [IFRS 9.BC5.13, BC5.16, BC5.18].

Indicators that cost might not be representative of fair value include: [IFRS 9.B5.2.4]

1. a significant change in the performance of the investee compared with budgets, plans or milestones;
2. changes in expectation that the investee's technical product milestones will be achieved;
3. a significant change in the market for the investee's equity or its products or potential products;
4. a significant change in the global economy or the economic environment in which the investee operates;
5. a significant change in the performance of comparable entities, or in the valuations implied by the overall market;
6. internal matters of the investee such as fraud, commercial disputes, litigation, changes in management or strategy; and
7. evidence from external transactions in the investee's equity, either by the investee (such as a fresh issue of equity), or by transfers of equity instruments between third parties.

This list is not intended to be exhaustive. All information about the performance and operations of the investee that becomes available after the date of initial recognition should be used and to the extent that any such relevant factors exist, they may indicate that cost might not be representative of fair value. In such cases, fair value should be estimated. [IFRS 9.B5.2.5].

For the avoidance of doubt, IFRS 9 emphasises that cost is never the best estimate of fair value for investments in quoted equity instruments (or contracts on quoted equity instruments). [IFRS 9.B5.2.6]. Also, the IASB noted that for financial institutions and investment funds, the cost of an equity investment cannot be considered representative of fair value. [IFRS 9.BC5.18].

2.7 Reclassifications of financial assets

In certain situations, financial assets classified as measured at fair value through profit or loss should be reclassified as measured at amortised cost and vice versa. The situations in which a reclassification might arise are considered in more detail in Chapter 48 at 9.

The reclassification should be applied prospectively from the reclassification date which is defined as ‘the first day of the first reporting period following the change in business model that results in an entity reclassifying financial assets’. [IFRS 9.5.6.1, Appendix A].

Accordingly, any previously recognised gains, losses (including impairment gains and losses) or interest should not be restated. [IFRS 9.5.6.1]. For example, when a financial asset is reclassified so that it is measured at fair value, its fair value is determined at the reclassification date. Any gain or loss arising from a difference between the previous carrying amount and fair value should be recognised in profit or loss of the current period without restating prior periods. [IFRS 9.5.6.2]. Moreover, when a financial asset is reclassified so that it is measured at amortised cost, its fair value at the reclassification date becomes its new gross carrying amount. [IFRS 9.5.6.3]. The effective interest rate is determined on the basis of the fair value of the asset at the date of reclassification. [IFRS 9.B5.6.2].

2.8 Financial guarantees and commitments to provide a loan at a below‑market interest rate

Financial guarantees issued and commitments made to provide a loan at a below-market interest rate should be measured on initial recognition at their (negative) fair value and subsequently at the higher of:

• the amount of the loss allowance determined in accordance with the impairment requirements of IFRS 9 (see Chapter 51); and
• the amount initially recognised less, when appropriate, the cumulative amount of income recognised in accordance with the principles of IFRS 15 – Revenue from Contracts with Customers (see Chapters 27 to 32).

This assumes that the instrument is not classified at fair value through profit or loss (in which case the requirements considered at 2.4 above apply) and, in the case of a financial guarantee contract, does not arise from a failed derecognition transaction (see 2.9.3 below). [IFRS 9.4.2.1(a), 9.4.2.1(c), 4.2.1(d)].

Normal loan commitments issued at market interest rates are excluded from the scope of IFRS 9 except for impairment and derecognition. [IFRS 9.2.1(g), 2.3]. Unlike loan commitments provided at below-market interest rates, normal loan commitments are not subject to the ‘higher of’ test for subsequent measurement (see Chapter 51 at 11). [IFRS 9.2.3(c), 4.2.1(d)].

For financial guarantees, there were discussions by the ITG on whether future premiums to be received affect the measurement of the expected credit loss (ECL) allowance and this is discussed further at Chapter 51 at 1.5 and 11. In November 2018 the IFRS Interpretations Committee (IFRIC or Committee) discussed whether the cash flows expected, in general, from a financial guarantee contract or any other credit enhancement can be included in the measurement of expected credit losses (see Chapter 51 at 5.8.1).

2.9 Exceptions to the general principles

3.1 Effective interest rate (EIR)

When calculating the EIR, an entity should estimate the expected cash flows by considering all the contractual terms of the financial instrument (e.g. prepayment, extension, call and similar options). The calculation includes all fees and points paid or received between parties to the contract that are an integral part of the EIR, transaction costs, and all other premiums or discounts. [IFRS 9 Appendix A]. Except for purchased or originated financial assets that are credit-impaired on initial recognition, ECLs are not considered in the calculation of the EIR. This is because the recognition of ECLs is decoupled from the recognition of interest revenue (see Chapter 51 at 3.1). [IFRS 9 Appendix A, BCZ5.67].

Guidance related to what fees should and should not be considered integral is also included in IFRS 9. Fees that are an integral part of the EIR of a financial instrument are treated as an adjustment to the EIR, unless the financial instrument is measured at fair value, with the change in fair value being recognised in profit or loss. In those cases, the fees are recognised as revenue or expense when the instrument is initially recognised. [IFRS 9.B5.4.1]. However, the recognition of day 1 profits for the difference between the transaction price and the initial fair value on initial recognition is restricted to situations where the fair value is based on a quoted price in an active market for an identical asset or liability (i.e. a Level 1 input) or based on a valuation technique that uses only data from observable markets. (See Chapter 49 at 3.3).

Fees that are an integral part of the EIR of a financial instrument include:

• origination fees received on the creation or acquisition of a financial asset. Such fees may include compensation for activities such as evaluating the borrower's financial condition, evaluating and recording guarantees, collateral and other security arrangements, negotiating the terms of the instrument, preparing and processing documents and closing the transaction. These fees are an integral part of generating an involvement with the resulting financial instrument;
• commitment fees received to originate a loan when the loan commitment is not measured at fair value through profit or loss and it is probable that the entity will enter into a specific lending arrangement. These fees are regarded as compensation for an ongoing involvement with the acquisition of a financial instrument. If the commitment expires without the entity making the loan, the fee is recognised as revenue on expiry; and
• origination fees paid on issuing financial liabilities measured at amortised cost. These fees are an integral part of generating an involvement with a financial liability. An entity distinguishes fees and costs that are an integral part of the EIR for the financial liability from origination fees and transaction costs relating to the right to provide services, such as investment management services. [IFRS 9.B5.4.2].

Fees that are not an integral part of the EIR of a financial instrument and are accounted for in accordance with IFRS 15 include:

• fees charged for servicing a loan;
• commitment fees to originate a loan when the loan commitment is not measured at fair value through profit or loss and it is unlikely that a specific lending arrangement will be entered into; and
• loan syndication fees received to arrange a loan and the entity does not retain part of the loan package for itself (or retains a part at the same EIR for comparable risk as other participants). [IFRS 9.B5.4.3].

For a purchased or originated credit-impaired financial asset (see Chapter 51 at 3.3), the credit-adjusted EIR is applied when calculating the interest revenue and it is the rate that exactly discounts the estimated future cash payments or receipts through the expected life of the financial asset to the amortised cost of a financial asset. An entity is required to include the initial ECLs in the estimated cash flows when calculating the credit-adjusted EIR for such assets. [IFRS 9.5.4.1, B5.4.7, Appendix A].

However, this does not mean that a credit-adjusted EIR should be applied solely because the financial asset has high credit risk at initial recognition. The application guidance explains that a financial asset is only considered credit‑impaired at initial recognition when the credit risk is very high or, in the case of a purchase, it is acquired at a deep discount. [IFRS 9.B5.4.7].

It is important to note that the EIR is normally based on estimated, not contractual, cash flows and there is a presumption that the cash flows and the expected life of a group of similar financial instruments can be estimated reliably. However, in those rare cases when it is not possible to estimate reliably the cash flows or the expected life of a financial instrument (or group of instruments), the contractual cash flows over the full contractual term of the financial instrument (or group of instruments) should be used. [IFRS 9 Appendix A].

When applying the effective interest method, an entity generally amortises any fees, points paid or received, transaction costs and other premiums or discounts that are included in the calculation of the EIR over the expected life of the financial instrument. However, there may be situations when discounts or premiums are amortised over a shorter period (see 3.3 below).

For fair value hedges in which the hedged item is recorded at amortised cost, the adjustment to the hedged item arising from the application of hedge accounting is amortised to profit or loss. This adjustment is based on a recalculated EIR at the date amortisation begins (see Chapter 53 at 7.1.2).

For floating-rate financial assets and floating-rate financial liabilities, periodic re‑estimation of cash flows to reflect the movements in the market rates of interest alters the EIR. If a floating rate financial asset or a floating rate financial liability is recognised initially at an amount equal to the principal receivable or payable on maturity, re‑estimating the future interest payments normally has no significant effect on the carrying amount of the asset or the liability. [IFRS 9.B5.4.5].

In most cases, a floating rate will be specified as a benchmark rate, such as LIBOR, plus (or for a very highly rated borrower, less) a fixed credit spread. Hence it might be more accurate to say that the rate has a floating component and a fixed component. But it is also possible for the credit spread to be periodically reset to a market rate. Neither ‘floating-rate’ nor ‘market rates of interest’ are defined in the standard. However, the IFRIC noted in its January 2016 agenda decision on separation of an embedded floor from a floating rate host contract that the term ‘market rate of interest is linked to the concept of fair value as defined in IFRS 13 and is described in paragraph of AG64 of IAS 39 as the rate of interest for a similar instrument (similar as to currency, term, type of interest rate and other factors) with a similar credit rating’ (or the equivalent in paragraph B5.1.1 of IFRS 9).² This implies that the market rate of interest may include the credit spread appropriate for the transaction and not just the benchmark component of the rate. [IFRS 9.B5.1.1].

The application of the effective interest method to floating-rate instruments and inflation-linked debt is considered in more detail at 3.3 and 3.6 below.

As set out in Chapter 47 at 6, an issued compound financial instrument such as a convertible bond is accounted for as a financial liability component and an equity component. In accounting for the financial liability at amortised cost, the expected cash flows should be those of the liability component only and the estimate should not take account of the bond being converted.

3.2 Fixed interest rate instruments

The effective interest method is most easily applied to instruments that have fixed payments and a fixed term. The following examples, adapted from the Implementation Guidance to the standard, illustrate this. [IFRS 9.IG.B.26, IG.B.27].

Methods for determining the EIR for a given set of cash flows (as in the examples above) include simple trial and error techniques as well as more methodical iterative algorithms. Alternatively, many spreadsheet applications contain goal-seek or similar functions that can also be used to derive EIRs.

3.3 Floating interest rate instruments

For floating-rate instruments, the periodic re-estimation of cash flows to reflect the movements in the market interest rates alters the EIR. The standard goes on to explain that where a floating rate financial asset or a floating-rate financial liability is initially recognised at an amount equal to the principal receivable or repayable on maturity, re‑estimating the future interest payments normally has no significant effect on the carrying amount of the asset or the liability. [IFRS 9.B5.4.5]. This is normally interpreted to mean that entities should simply account for periodic floating-rate payments on an accrual basis in the period they are earned. An alternative treatment would consist of calculating the EIR based on a market-derived yield curve applicable for the entire life of the instrument. Applying this alternative approach, the calculated EIR is applied until estimated future cash flows are revised, at which point a new EIR is calculated based on the revised cash flow expectations and the current carrying amount. This more complicated treatment is illustrated in the following example (in which it is assumed that the instrument meets the criteria for measurement at amortised cost under IFRS 9).

Even if it is not applied widely in practice (and the effect may often not be material), such an approach seems technically correct. This was also confirmed by the IFRIC discussion on inflation-linked instruments in May 2008 (see 3.6 below).

The example below illustrates a loan which is partially fixed and partially variable.

Payments, receipts, discounts and premiums included in the effective interest method calculation are normally amortised over the expected life of the instrument and it will often be acceptable to amortise transaction costs on a straight-line basis over the life of the instrument on a basis of materiality.

However, there may be situations when discounts or premiums are amortised over a shorter period if this is the period to which the fees, points paid or received, transaction costs, premiums or discounts relate (see 3 above). This will be the case when the related variable (e.g. interest rates) to which the fees, points paid or received, transaction costs, premiums or discounts relate is repriced to market rates before the instrument's expected maturity. In such cases, the appropriate amortisation period is to the next repricing date. [IFRS 9.B5.4.4].

For example, if a premium or discount on a floating-rate instrument reflects interest that has accrued since interest was last paid, or changes in market rates since the floating interest rate was reset to market rates, it will be amortised to the next date when the interest rate is reset to market rates. This is because the premium or discount relates to the period to the next interest reset date because, at that date, the variable to which the premium or discount relates (i.e. the interest rate) is reset to market rates. If, however, the premium or discount results from a change in the credit spread over the floating-rate specified in the financial instrument, or other variables that are not reset to market rates, it is amortised over the expected life of the instrument. [IFRS 9.B5.4.4].

The following examples illustrate the requirements of applying a discount arising on acquisition of a debt instrument resulting from: (a) a credit downgrade; and (b) accrued interest.

3.4 Prepayment, call and similar options

When calculating the EIR, all contractual terms of the financial instrument, for example prepayment, call and similar options, should be factored into the estimate of expected cash flows. [IFRS 9 Appendix A]. (This assumes that the presence of such contractual terms does not cause the contractual cash flow characteristics test to fail, i.e. the contractual terms of the debt instrument give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding (see Chapter 48 at 2 and 6)). The following simple example illustrates how this principle is applied.

3.5 Perpetual debt instruments

Accounting for perpetual debt instruments is discussed in Chapter 47 at 4.7. The fact that an instrument is perpetual does not change how the gross carrying amount is calculated. The present value of the perpetual stream of future cash payments, discounted at the EIR, equals the gross carrying amount in each period. [IFRS 9.IG.B.24].

However, in cases where interest is only paid over a limited amount of time, some or all the interest payments are, from an economic perspective, repayments of the gross carrying amount, as illustrated in the following example. [IFRS 9.IG.B.25].

3.6 Inflation-linked debt instruments

As noted in Chapter 46 at 5.1.5, the issue of debt instruments whose cash flows are linked to changes in an inflation index is quite common. IFRS 9 often allows inflation-linked financial assets to be recorded at amortised cost or at fair value through other comprehensive income, as shown in Example 48.15 at 6.3.5 in Chapter 48. Entities that record these instruments at amortised cost must apply the effective interest method to determine the amount of interest to be recognised in profit or loss each period. In May 2008, the IFRIC was asked to consider a request for guidance on this issue. The key issue is whether the changes in the cash flows on inflation-linked debt are equivalent to a repricing to the market rate and, therefore, inflation-linked debt can be treated as a floating rate instrument. Three ways of applying the effective interest method that were being used in practice were included in the request. These are summarised in the following example that has been revised to reflect the requirements in IFRS 9 instead of IAS 39.⁵

In analysing the submission, it initially appeared as if the Committee staff completely rejected Method 3. The submission argued that Method 3 was justified by reference to IAS 29 – Financial Reporting in Hyperinflationary Economies. The staff concluded (quite correctly) that it was inappropriate to apply IAS 29 because that standard applies only to the financial statements of an entity whose functional currency is the currency of a hyperinflationary economy and instead the guidance in IAS 39 should be applied.

However, in their final rejection notice the Committee noted that paragraphs AG6 to AG8 of IAS 39 provide the relevant application guidance and that judgement is required to determine whether an instrument is floating-rate and within the scope of paragraph AG7 or is within the scope of paragraph AG8.⁷ Further, it was noted that IAS 39 was unclear as to whether future expectations about interest rates (and presumably, therefore, inflation) should be taken into account when applying paragraph AG7. This would appear to suggest that all three methods noted in the example would be consistent with the requirements of IAS 39 and therefore, since the requirements are unchanged, of IFRS 9.

3.7 More complex financial liabilities

Under IFRS 9, most complex financial assets are accounted for at fair value through profit or loss. The treatment of financial liabilities is, however, unchanged from that under IAS 39. The application of the effective interest method to liabilities with unusual embedded derivatives that are deemed closely related to the host, or other embedded features that are not accounted for separately, is not always straightforward or intuitive. Specifically, it is not always clear how to deal with changes in the estimated cash flows of the instrument and in any given situation one needs to assess which of the approaches set out above is more appropriate:

• the general requirements for changes in cash flows set out in paragraph B5.4.6 of IFRS 9, equivalent to the previous IAS 39 AG8 approach, assuming a fixed original EIR (see 3.4.1 above); or
• specific requirements for floating-rate instruments under paragraph B5.4.5 of IFRS 9, equivalent to the previous IAS 39 AG7 approach (see 3.3 above).

Consider an entity that issues a debt instrument for its par value of €10m which is repayable in ten years' time on which an annual coupon is payable comprising two elements: a fixed amount of 2.5% of the par value and a variable amount equating to 0.01% of the entity's annual revenues. The instrument is not designated at fair value through profit or loss and it is judged that the embedded feature is not a derivative as outlined in Example 46.4 at 2.1.3 in Chapter 46.

The requirements under paragraphs B5.4.5 and B5.4.6 of IFRS 9 could give rise to significantly different accounting treatments. In the latter case, the issuer would need to estimate the amount of payments to be made over the life of the bond (which will depend on its estimated revenues for the next ten years) in order to determine the EIR to be applied. Any changes to these estimates would result in a catch-up adjustment, based on the rate as estimated on origination, to profit or loss and the carrying amount of the bond which, potentially, could give rise to significant volatility. In the former case the annual coupon would simply be accrued each year and changes in estimated revenues of future periods would have no impact on the accounting treatment until the applicable year.

In 2009, the IFRIC was asked for guidance on how an issuer should account for a financial liability that contains participation rights by which the instrument holder shares in the net income and losses of the issuer. The holder receives a percentage of the issuer's net income and is allocated a proportional share of the issuer's losses. Losses are applied to the nominal value of the instrument to be repaid on maturity. Losses allocated to the holder in one period can be offset by profits in subsequent periods. The submission was asking how the issuer should account for such instruments in periods in which the issuer records a loss and allocates a portion of that loss to the participating financial instruments. Two possible views were submitted to IFRIC:

• In the first view the requirements in paragraph AG8 of IAS 39 (equivalent to paragraph B5.4.6 of IFRS 9) do not apply. Rather, the requirements for derecognition should be applied and a gain equal to the allocated loss should be recognised in the current period (with an offsetting reduction in the carrying amount of the instrument).
• In a second view, the requirements in paragraph AG8 (equivalent to paragraph B5.4.6 of IFRS 9) apply. Current period losses are one factor that the issuer would consider when it evaluates whether it needs to revise its estimated future cash flows and adjust the carrying amount of the participating financial instrument.

The IFRIC noted that paragraphs AG6 and AG8 of IAS 39 (equivalent to paragraphs B5.4.4. and B5.4.6 of IFRS 9) provide the relevant application guidance for measuring financial liabilities at amortised cost using the EIR method. The IFRIC also noted that it was inappropriate to analogise to the derecognition guidance in IAS 39 because the liability has not been extinguished. Therefore, a gain equal to the allocated loss should not be recognised in the current period. Rather, current period losses should be considered together with further expectations when the issuer evaluates the need to revise its estimated future cash flows and adjust the carrying amount of the participating financial instrument.

It should be noted that the IFRIC considered the issue without reconsidering the assumptions described in the request, namely that the financial liability (a) did not contain any embedded derivatives, (b) was measured at amortised cost using the effective interest method, and (c) did not meet the definition of a floating-rate instrument.⁸ In other words, whilst clearly indicating that the B5.4.6 approach was acceptable, it did not explicitly preclude the use of the B5.4.5 approach. In this situation, we believe that it would often be inappropriate to apply the requirements under paragraph B5.4.5 of IFRS 9, principally because the entity's revenue does not represent a floating-rate that changes to reflect movements in market rates of interest. However, as with the examples considered in 3.6 above, judgement is required to determine which approach is appropriate.⁹

There are some financial liabilities for which re-estimation of cash flows will only reflect movements in market interest rates but for which the use of B5.4.5 would, arguably, not be appropriate. An example would be an ‘inverse floater’, on which coupons are paid at a fixed-rate minus LIBOR (subject to a floor of zero).

For some financial liabilities, it might be considered appropriate to apply a combination of both the B5.4.5 and B5.4.6 approaches. An example might be, for instance, a prepayable floating-rate liability on which transaction costs have been incurred and that have been included in the EIR.

3.8 Modified financial assets and liabilities

4.1 Foreign currency instruments

The provisions of IAS 21 – The Effects of Changes in Foreign Exchange Rates – apply to transactions involving financial instruments in just the same way as they do for other transactions, although the manner in which certain hedges are accounted for can over-ride its general requirements.

Consequently, the statement of financial position measurement of a foreign currency financial instrument is determined as follows:

• First, it is recorded and measured in the foreign currency in which it is denominated, whether it is carried at fair value, cost, or amortised cost.
• Second, that amount is retranslated to the entity's functional currency using the closing rate. [IAS 21.23].

Profit and loss items associated with financial instruments, e.g. dividends receivable, interest payable or receivable and impairments, are recorded at the spot rate ruling when they arise (although average rates may be used when they represent an appropriate approximation to spot rates throughout the period).

The reporting of exchange differences in profit or loss or in other comprehensive income depends on whether the instrument is a monetary item (e.g. debt instruments) or a non-monetary item (e.g. an equity investment), and whether it is designated as part of a foreign currency cash flow hedge. (This excludes the translation of foreign entities which is addressed at 4.2 below).

Foreign exchange differences arising on retranslating monetary items, including debt instruments measured at fair value through other comprehensive income, are generally recognised in profit or loss. However, those exchange differences may be recognised in other comprehensive income for instruments designated as a hedging instrument in a cash flow hedge or in a hedge of a net investment in a foreign operation (except to the extent that there is hedge ineffectiveness). Exchange differences may also be recorded in other comprehensive income for a fair value hedge of an equity instrument for which an entity has elected to present changes in fair value in other comprehensive income (see 2.5 above and Chapter 53). [IFRS 9.B5.7.2, B5.7.2A].

Any changes in the carrying amount of a non-monetary item are recognised in profit or loss or in other comprehensive income in accordance with IFRS 9. For example, for an instrument that is measured at fair value through profit or loss, all subsequent fair value changes, including the effect of foreign exchange, are recognised in profit or loss. Similarly, for an investment in an equity instrument where an entity has made an irrevocable election to present in other comprehensive income subsequent changes in the fair value of the investment, the entire change in the carrying amount, including the effect of changes in foreign currency rates, is presented in other comprehensive income. [IFRS 9.5.7.5, B5.7.3, IG.E.3.4].

In cases where some portion of the change in carrying amount is recognised in profit or loss and some in other comprehensive income, e.g. if the amortised cost of a foreign currency bond measured at fair value through other comprehensive income has increased in foreign currency (resulting in a gain in profit or loss) but its fair value has decreased in foreign currency (resulting in a loss recognised in other comprehensive income), those two components cannot be offset for the purposes of determining gains or losses that should be recognised in profit or loss or in other comprehensive income. [IFRS 9.B5.7.2‑7.2A, IG.E.3.4].

The Board developed the example below to illustrate the separation of the currency component for a financial asset that is measured at fair value through other comprehensive income in accordance with paragraph 4.1.2A of IFRS 9. To simplify the example, the Board did not reflect the need to record expected credit losses. [IFRS 9.IG.E.3.2]. A more complex illustration, including expected credit losses is included in Chapter 51 Example 51.21 at 9.2.

The treatment would be different for equity instruments measured at fair value through other comprehensive income. Under IAS 21, these are not considered monetary items and exchange differences would form part of the change in the fair value of the instrument, which would be recognised in other comprehensive income with no recycling.

4.2 Foreign entities

IFRS 9 did not amend the application of the net investment method of accounting for foreign entities set out in IAS 21 (see Chapter 15 at 6). Therefore, for the purpose of preparing its own accounts for inclusion in consolidated accounts, a foreign entity that is part of a group applies the principles at 4.1 above by reference to its own functional currency. Consequently, the treatment of gains and losses on, say, trading assets held by a foreign entity should follow the treatment in the example below, adapted from the Implementation Guidance of IFRS 9. [IFRS 9.IG.E.3.3]. Another situation where foreign exchange differences on monetary items are recognised in other comprehensive income is when the long-term debt is considered to form part of the net investment in the foreign entity.

5.1 Effective date

IFRS 9 is effective for annual periods beginning on or after 1 January 2018, although entities were permitted to apply the standard earlier.