4.2.1 Gains and losses by measurement category

The IASB concluded that information about the gains and losses arising on the various measurement categories of instrument is necessary to understand the financial performance of an entity's financial instruments given the different measurement bases used. Consequently, disclosure should be given of net gains or net losses arising on the following categories of instrument: [IFRS 7.20]

• financial assets or financial liabilities measured at fair value through profit or loss, showing separately those on financial assets or liabilities:
  • designated as such upon initial recognition (or subsequently when the credit risk of a financial asset is managed using a credit derivative); and
  • mandatorily measured at fair value in accordance with IFRS 9, e.g. liabilities held for trading.

  In our view, these amounts should not be shown net of funding costs if the associated financial liabilities are not classified at fair value through profit or loss.

  For financial liabilities designated at fair value through profit or loss, the amount of gain or loss recognised in other comprehensive income, i.e. relating to changes in fair value attributable to changes in credit risk (see Chapter 50 at 2.4.1), should be shown separately;

• financial assets measured at amortised cost.

  IFRS 7 requires disclosure of an analysis of the gain or loss arising from derecognition of such assets showing separately gains and losses. The reasons for derecognition should also be given. [IFRS 7.20A]. These gains and losses should also be shown separately on the face of the income statement or statement of comprehensive income (see 7.1.1 below); [IAS 1.82(aa)]

• financial liabilities measured at amortised cost;
• investments in equity instruments designated at fair value through other comprehensive income; and
• debt instruments measured at fair value through other comprehensive income, showing separately:
  • the amount of gain or loss recognised in other comprehensive income during the period; and
  • the amount reclassified upon derecognition from accumulated other comprehensive income to profit or loss for the period.

These disclosures are designed to complement the statement of financial position disclosure requirement described at 4.4.1 below. [IFRS 7.BC33].

Some entities include interest and dividend income in gains and losses on financial assets and financial liabilities held for trading and others do not. To assist users in comparing income arising from financial instruments across different entities, entities are required to disclose how the income statement amounts are determined. For example, an entity should disclose whether net gains and losses on financial assets or financial liabilities held for trading include interest and dividend income (see 4.1 above). [IFRS 7.BC34].

4.2.2 Interest income and expense

For financial assets or financial liabilities that are not measured at fair value through profit or loss, total interest income and total interest expense (calculated using the effective interest method) should be disclosed. Interest revenue for financial assets measured at amortised cost should be shown separately from interest revenue on debt instruments measured at fair value through other comprehensive income. [IFRS 7.20(b)]. This disclosure requirement is similar, but different, to the requirement to present separately on the face of the statement of comprehensive income (or income statement) interest revenue calculated using the effective interest method – see 7.1.1 below.

Financial instruments containing discretionary participation features fall within the scope of IFRS 4 – Insurance Contracts – rather than IFRS 9 (see Chapter 45 at 3.3.2 and Chapter 55 at 6) or IAS 39 for those insurers continuing to apply that standard (see Chapter 55 at 10.1). However, IFRS 7 does apply to such instruments and IFRS 4 acknowledges that the interest expense disclosed need not be calculated using the effective interest method. [IFRS 4.35(d)]. When IFRS 17 – Insurance Contracts – is applied, such contracts would only rarely be within the scope of IFRS 7 (see Chapter 45 at 3.3.2).

Similarly, lease liabilities and finance lease receivables are within the scope of IFRS 7 (see Chapter 45 at 3.2) but are not accounted for using the effective interest method. There is no equivalent acknowledgement in IFRS 16 – Leases – or IFRS 9 that the disclosure of interest income and interest expense should be made on the basis of the finance cost and finance revenue recognised under the relevant standard for leases. However, this seems little more than an oversight and we consider it appropriate to include in the disclosure the amounts actually recognised rather than amounts calculated in accordance with the effective interest method.

4.2.3 Fee income and expense

Entities should disclose fee income and expense (excluding amounts included in the effective interest rate calculation) arising from: [IFRS 7.20(c)]

• financial assets or financial liabilities that are not measured at fair value through profit or loss; and
• trust and other fiduciary activities that result in the holding or investing of assets on behalf of individuals, trusts, retirement benefit plans, and other institutions.

This information is said to indicate the level of such activities and help users to estimate possible future income of the entity. [IFRS 7.BC35].

4.3.1 The risk management strategy

An entity should explain its risk management strategy for each risk category of risk exposures that it decides to hedge and for which hedge accounting is applied. This explanation should enable users of financial statements to evaluate, for example: [IFRS 7.22A]

• how each risk arises;
• how each risk is managed.

  This includes whether the entity hedges an item in its entirety for all risks or hedges a risk component (or components) of an item and why; and

• the extent of risk exposures that are managed.

To meet these requirements, the information should include, but is not limited to, a description of: [IFRS 7.22B]

• the hedging instruments that are used (and how they are used) to hedge risk exposures;
• how the economic relationship between the hedged item and the hedging instrument is determined for the purpose of assessing hedge effectiveness;
• how the hedge ratio is established; and
• the sources of hedge ineffectiveness.

When a specific risk component is designated as a hedged item, qualitative or quantitative information should be provided about: [IFRS 7.22C]

• how the risk component that is designated as the hedged item was determined, including a description of the nature of the relationship between the risk component and the item as a whole; and
• how the risk component relates to the item in its entirety. For example, the designated risk component may historically have covered on average 80% of the changes in fair value of the item as a whole.

This information could include a description of whether the risk component is contractually specified, and if not, how the entity determined that the non-contractually specified risk component is separately identifiable and reliably measurable.

The following example shows how an entity might present some of this information.

Disclosures about an entity's risk management strategy are an important cornerstone of the new hedge accounting model, as they provide the link between an entity's risk management activities and how they affect the financial statements.

4.3.2 The amount, timing and uncertainty of future cash flows

For most hedge relationships, quantitative information should be disclosed by risk category that allows the evaluation of the terms and conditions of the hedging instruments and how they affect the amount, timing and uncertainty of future cash flows. [IFRS 7.23A]. This should include a breakdown disclosing: [IFRS 7.23B]

• the profile of the timing of the hedging instrument's nominal amount; and
• if applicable, its average price or rate (e.g. strike or forward prices).

This requirement applies to cash flow hedges, fair value hedges, and hedges of a net investment, and meeting this requirement with concise information could prove challenging where an entity's use of hedge accounting is extensive. The following example shows how an entity might present some of this information.

Different information should be given where a dynamic hedging process is used. A dynamic process may be used in which both the exposure and the hedging instruments used to manage that exposure remain the same for only short periods of time because both the hedging instrument and the hedged item frequently change and the hedging relationship is frequently reset (or discontinued and restarted). This might occur, for example, when hedging the interest rate risk of an open portfolio of debt instruments. In these situations, the following should be disclosed: [IFRS 7.23C]

• information about what the ultimate risk management strategy is in relation to those hedging relationships;
• a description of how the risk management strategy is reflected by using hedge accounting and designating those particular hedging relationships; and
• an indication of how frequently the hedging relationships are discontinued and restarted as part of the process in relation to those hedging relationships.

When the volume of hedging relationships in a dynamic process is unrepresentative of normal volumes during the period (i.e. the volume at the reporting date does not reflect the volumes during the period) that fact should be disclosed along with the reason volumes are believed to be unrepresentative. [IFRS 7.24D].

For all hedges, a description of the sources of hedge ineffectiveness that are expected to affect the hedging relationship during its term should be disclosed by risk category. [IFRS 7.23D]. If other sources of hedge ineffectiveness emerge in a hedging relationship, those sources should be disclosed by risk category along with an explanation of the resulting hedge ineffectiveness. [IFRS 7.23E].

For cash flow hedges, a description of any forecast transaction for which hedge accounting had been used in the previous period, but which is no longer expected to occur, should be disclosed. [IFRS 7.23F].

Originally the IASB had proposed that entities should disclose the total volume of risk the entity managed, irrespective of whether the entity actually hedges the full exposure. However, they were persuaded by many constituents saying this could result in disclosure of commercially sensitive information and did not to carry this requirement forward to the final standard. [IFRS 7.BC35U, BC35W, BC35X].

4.3.3 The effects of hedge accounting on financial position and performance

The following amounts related to designated hedging instruments should be disclosed:

• the carrying amount of the hedging instruments, presenting financial assets separately from financial liabilities;
• the line item in the statement of financial position that includes the hedging instrument;
• the change in fair value of the hedging instrument used as the basis for recognising hedge ineffectiveness for the period; and
• the nominal amounts (including quantities such as tonnes or cubic metres) of the hedging instruments.

This information should be given in a tabular format, separately by risk category and for fair value hedges, cash flow hedges and hedges of a net investment in a foreign operation, [IFRS 7.24A], and the implementation guidance suggests it might be given in the following format. [IFRS 7.IG13C].

The following amounts related to hedged items should be disclosed:

• for fair value hedges:
  • the carrying amount of the hedged item recognised in the statement of financial position, presenting assets separately from liabilities;
  • the accumulated amount of adjustments to the hedged item included in its carrying amount, again presenting assets separately from liabilities;
  • the line item in the statement of financial position that includes the hedged item;
  • the change in value of the hedged item used as the basis for recognising hedge ineffectiveness for the period; and
  • the accumulated amount of adjustments to hedged financial instruments measured at amortised cost that have ceased to be adjusted for hedging gains and losses and which remain in the statement of financial position;
• for cash flow hedges and hedges of a net investment in a foreign operation:
  • the change in value of the hedged item used as the basis for recognising hedge ineffectiveness for the period;
  • the balances in the cash flow hedge reserve and the foreign currency translation reserve for continuing hedges; and
  • the balances remaining in the cash flow hedge reserve and the foreign currency translation reserve from any hedging relationships for which hedge accounting is no longer applied.

This information should be given in a tabular format, separately by risk category, [IFRS 7.24B], and the implementation guidance suggests it might be given in the following format. [IFRS 7.IG13D].

The following amounts affecting the statement of comprehensive income should be disclosed:

• for fair value hedges:
  • hedge ineffectiveness, i.e. the difference between the hedging gains or losses of the hedging instrument and the hedged item, recognised in profit or loss (or other comprehensive income for hedges of an equity instrument for which changes in fair value are presented in other comprehensive income); and
  • the line item in the statement of comprehensive income that includes the recognised hedge ineffectiveness;
• for cash flow hedges and hedges of a net investment in a foreign operation:
  • hedging gains or losses that were recognised in other comprehensive income in the reporting period;
  • hedge ineffectiveness recognised in profit or loss;
  • the line item in the statement of comprehensive income that includes the recognised hedge ineffectiveness;
  • the amount reclassified from the cash flow hedge reserve or the foreign currency translation reserve into profit or loss as a reclassification adjustment, differentiating in the case of cash flow hedges between:
    • amounts for which hedge accounting had previously been used, but for which the hedged future cash flows are no longer expected to occur; and
    • amounts that have been transferred because the hedged item has affected profit or loss;
  • the line item in the statement of comprehensive income that includes the reclassification adjustment; and
  • for hedges of net positions, the hedging gains or losses recognised in a separate line item in the statement of comprehensive income.

This information should be given in a tabular format, separately by risk category, [IFRS 7.24C], and the implementation guidance suggests it might be given in the following format. [IFRS 7.IG13E].

The following example shows another way an entity might present this information.

IAS 1 requires the presentation of a reconciliation of each component of equity and an analysis of other comprehensive income (see 7.2 and 7.3 below). The level of information given in the reconciliation and analysis should: [IFRS 7.24E]

• differentiate between hedging gains or losses recognised in other comprehensive income and amounts reclassified to profit or loss, separately for:
  • cash flow hedges for which the hedged future cash flows are no longer expected to occur;
  • those hedges for which the hedged item has affected profit or loss; and
  • amounts related to hedged forecast transactions that subsequently result in the recognition of a non-financial asset or liability, or a hedged forecast transaction for a non-financial asset or liability becomes a firm commitment for which fair value hedge accounting is applied, that are included directly in the initial cost or other carrying amount of the asset or the liability.

    As noted at 7.2 and at 7.3 below, this adjustment should not be included within other comprehensive income. [IFRS 9.BC6.380]. Instead it should be presented within the statement of changes of equity, albeit separately from other comprehensive income;

• differentiate between amounts associated with the time value of options that hedge transaction related hedged items and those that hedge time-period related hedged items where the time value of the option is recognised initially in other comprehensive income; and
• differentiate between amounts associated with forward elements of forward contracts and the foreign currency basis spreads of financial instruments that hedge transaction related hedged items and those that hedge time-period related hedged items where those amounts are recognised initially in other comprehensive income.

The information in the bullets above should be disclosed separately by risk category, although this disaggregation may be provided in the notes to the financial statements. [IFRS 7.24F].

The following extract from the financial statements of Vodafone shows the type of disclosure about hedge accounting and hedge relationships that can be seen in practice. In addition to the information shown below, the table in the financial statements also includes, where relevant, the average maturity year, average foreign currency rate and average euro interest rate for each of the relevant line items.

4.3.4 Option to designate a credit exposure as measured at fair value through profit or loss

If a financial instrument, or a proportion of it, has been designated as measured at fair value through profit or loss because a credit derivative is used to manage the credit risk of that financial instrument, the following should be disclosed: [IFRS 7.24G]

• a reconciliation of each of the nominal amount and the fair value of the credit derivative at the beginning and end of the period;
• the gain or loss recognised in profit or loss on initial designation; and
• on discontinuation of measuring a financial instrument, or a proportion of it, at fair value through profit or loss, the fair value of that financial instrument that becomes the new carrying amount and the related nominal or principal amount.

  Except for providing comparative information in accordance with IAS 1, this information need not be given in subsequent periods.

4.4.1 Categories of financial assets and financial liabilities

The carrying amounts of each of the following categories of financial instrument should be disclosed, either on the face of the statement of financial position or in the notes: [IFRS 7.8]

• financial assets measured at fair value through profit or loss, showing separately:
  • those designated as such upon initial recognition; and
  • those mandatorily measured at fair value in accordance with IFRS 9;
• financial liabilities at fair value through profit or loss, showing separately:
  • those designated as such upon initial recognition; and
  • those that meet the definition of held for trading in IFRS 9;
• financial assets measured at amortised cost;
• financial liabilities measured at amortised cost; and
• financial assets measured at fair value through other comprehensive income, showing separately:
  • debt instruments held within a business model to both collect contractual cash flows from, and to sell, the assets; and
  • investments in equity instruments designated to be measured as such upon initial recognition.

The IASB concluded that such disclosure would assist users in understanding the extent to which accounting policies affect the amounts at which financial assets and financial liabilities are recognised. [IFRS 7.BC14].

Although accounted for identically, the carrying amounts of financial instruments that are classified as held for trading and those designated at fair value through profit or loss are shown separately because designation is at the discretion of the entity. [IFRS 7.BC15].

A derivative that is designated as a hedging instrument in an effective hedge relationship does not fall within any of the above categories and, strictly, is not required to be included in these disclosures. Disclosure requirements for hedges are set out at 4.3 above.

4.4.2 Financial liabilities designated at fair value through profit or loss

Where a (non-derivative) financial liability has been designated at fair value through profit or loss, i.e. it is not classified as held for trading, the amount of change during the period and cumulatively (i.e. since initial recognition) in its fair value that is attributable to changes in credit risk should be disclosed. This disclosure should be provided for financial liabilities where the change is recognised in other comprehensive income (see Chapter 50 at 2.4.1) and it should also be provided for financial liabilities where the change is recognised in profit or loss because recognising it in other comprehensive income would create or enlarge an accounting mismatch within profit or loss (see Chapter 50 at 2.4.2). [IFRS 7.10(a), 10A(a)].

Further, if the disclosure is not considered to represent faithfully the change in the fair value of the financial liability attributable to changes in credit risk, the reasons for reaching this conclusion and the factors believed to be relevant should also be disclosed. [IFRS 7.11(b)].

The IASB concluded that the difference between the carrying amount of such a liability and the amount the entity would be contractually required to pay at maturity to the holder of the obligation should also be disclosed. This disclosure is also required for liabilities where the change in fair value attributable to credit risk is recognised in other comprehensive income and for those where the change is recognised in profit or loss. [IFRS 7.10(b), 10A(b)]. The fair value may differ significantly from the settlement amount, particularly for liabilities with a long duration when the entity has experienced a significant deterioration in creditworthiness subsequent to issuance and the IASB concluded that knowledge of this difference would be useful. Also, the settlement amount is important to some financial statement users, particularly creditors. [IFRS 7.BC22].

Where changes in the fair value of a financial liability attributable to credit risk are recognised in other comprehensive income, any transfers of the cumulative gain or loss within equity should be disclosed, including the reason for such transfers. [IFRS 7.10(c)]. Also, if such a financial liability is derecognised during the period, the amount (if any) presented in other comprehensive income that was realised at derecognition should be disclosed. [IFRS 7.10(d)].

A detailed description of the methods used to calculate the changes in fair value attributable to changes in credit risk should be given, including an explanation of why the method is appropriate. This disclosure is required irrespective of whether those changes are recognised in other comprehensive income or in profit or loss, [IFRS 7.11(a)].

Entities should also provide a detailed description of the methodology or methodologies used to determine whether presenting changes in the fair value of a liability attributable to credit risk in other comprehensive income would create or enlarge an accounting mismatch in profit or loss (see Chapter 50 at 2.4.2). Where an entity is required to present such changes in profit or loss, this disclosure should include a detailed description of the economic relationship between the financial liability and other financial instrument(s) measured at fair value through profit or loss that are expected to offset those changes. [IFRS 7.11(c)].

4.4.3 Financial assets designated as measured at fair value through profit or loss

Additional disclosure requirements apply to financial assets (or groups of such assets) that are designated at fair value through profit or loss if they would otherwise be measured at fair value through other comprehensive income or at amortised cost, namely: [IFRS 7.9]

• the maximum exposure to credit risk (see 5.3.3 below) at the reporting date of the financial asset (or group of financial assets);
• the amount by which any related credit derivatives or similar instruments mitigate that maximum exposure to credit risk;
• the amount of change during the period and cumulatively (i.e. since initial recognition) in the fair value of the financial assets (or group of financial assets) that is attributable to changes in credit risk (see below); and
• the amount of change in the fair value of any related credit derivative or similar instrument that has occurred during the period and cumulatively since the financial asset was designated.

Calculating the change in fair value attributable to changes in credit risk is approached in much the same way as for financial liabilities (see 4.4.2 above). It may be determined either as the amount of change in fair value that is not attributable to changes in market conditions that give rise to market risk or by using an alternative method that more faithfully represents the amount of change in its fair value that is attributable to changes in credit risk. [IFRS 7.9].

A detailed description of the chosen method(s), including an explanation of why the method is appropriate should be disclosed. If the disclosure is not considered to represent faithfully the change in the fair value of the financial asset attributable to changes in credit risk, the reasons for reaching this conclusion and the factors believed to be relevant should be disclosed. [IFRS 7.11].

4.4.4 Investments in equity instruments designated at fair value through other comprehensive income

Where investments in equity instruments have been designated to be measured at fair value through other comprehensive income (see Chapter 48 at 2.2 and 8), the following should be disclosed: [IFRS 7.11A]

• which investments in equity instruments have been designated to be measured at fair value through other comprehensive income;
• the reasons for using this presentation alternative;
• the fair value of each such investment at the end of the reporting period;

  This requirement, applying as it does to each such investment, may be onerous if an entity makes significant use of the fair value through other comprehensive income option. However, the concept of materiality does apply to disclosures, therefore this information could be provided separately only for those investments that are themselves material whilst aggregated disclosures may suffice for immaterial items;

• dividends recognised during the period, showing separately those related to investments derecognised during the reporting period and those related to investments held at the end of the reporting period; and
• any transfers of the cumulative gain or loss within equity during the period, including the reason for such transfers.

Where such investments are derecognised during the reporting period, the following should also be disclosed: [IFRS 7.11B]

• the reasons for disposing of the investments;
• the fair value of the investments at the date of derecognition; and
• the cumulative gain or loss on disposal.

4.4.5 Reclassification

The circumstances in which financial assets should or may be reclassified from one category to another in response to a change in an entity's business model are discussed in Chapter 48 at 9. If, in the current or previous reporting periods, any such reclassifications have occurred, the following should be disclosed: [IFRS 7.12B]

• the date of reclassification;
• a detailed explanation of the change in business model and a qualitative description of its effect on the entity's financial statements; and
• the amount reclassified into and out of each category.

For assets previously measured at fair value through profit or loss that are reclassified so that they are measured at amortised cost or at fair value through other comprehensive income, the following information should be disclosed in each reporting period following reclassification until derecognition: [IFRS 7.12C]

• the effective interest rate determined on the date of reclassification; and
• the interest income or expense recognised.

Where financial assets previously measured at fair value through other comprehensive income have been reclassified since the last annual reporting date so that they are measured at amortised cost, the following should be disclosed:

• the fair value of the financial assets at the end of the reporting period; and
• the fair value gain or loss that would have been recognised in profit or loss during the reporting period if the financial assets had not been reclassified.

The same information should be given where financial assets previously measured at fair value through profit or loss have been reclassified since the last annual reporting date so that they are measured at amortised cost or at fair value through other comprehensive income. [IFRS 7.12D].

4.4.6 Collateral

Where an entity has pledged financial assets as collateral for liabilities or contingent liabilities it should disclose the carrying amount of those assets and the terms and conditions relating to its pledge. This also applies to transfers of non-cash collateral where the transferee has the right, by contract or custom, to sell or repledge the collateral (see Chapter 52 at 5.5.2). [IFRS 7.14].

When an entity holds collateral (of financial or non-financial assets) and is permitted to sell or repledge the collateral in the absence of default by the owner of the collateral, it should disclose: [IFRS 7.15]

• the fair value of the collateral held;
• the fair value of any such collateral sold or repledged, and whether the entity has an obligation to return it; and
• the terms and conditions associated with its use of the collateral.

Although some respondents to the exposure draft that preceded IFRS 7 (ED 7) argued for an exemption from this disclosure in cases where it is impracticable to obtain the fair value of the collateral held, the IASB concluded that it is reasonable to expect an entity to know the fair value of collateral that it holds and can sell even where there is no default. [IFRS 7.BC25].

4.4.7 Compound financial instruments with multiple embedded derivatives

Where an instrument has been issued that contains both a liability and an equity component and the instrument has multiple embedded derivatives whose values are interdependent, such as a callable convertible debt instrument (see Chapter 47 at 6.4.2), the existence of these features should be disclosed. [IFRS 7.17]. Accordingly, the impact on the amounts reported as liabilities and equity will be highlighted, something the IASB sees as important given the acknowledged arbitrary nature of the allocation under IAS 32 of the joint value attributable to this interdependence. [IFRS 7.BC31].

4.4.8 Defaults and breaches of loans payable

Loans payable are defined as ‘financial liabilities other than short-term trade payables on normal credit terms.’ [IFRS 7 Appendix A]. It is considered that disclosures about defaults and breaches of loans payable and other loan agreements provide relevant information about the entity's creditworthiness and its prospects of obtaining future loans. [IFRS 7.BC32].

Accordingly, for any loans payable recognised at the reporting date, an entity is required to disclose: [IFRS 7.18]

• details of any defaults during the period of principal, interest, sinking fund, or redemption terms;
• the carrying amount of the loans payable in default at the reporting date; and
• whether the default was remedied, or the terms of the loans payable were renegotiated, before the financial statements were authorised for issue.

If, during the period, there were breaches of loan agreement terms other than those described above, the same information should be disclosed if those breaches permitted the lender to demand accelerated repayment (unless the breaches were remedied, or the terms of the loan were renegotiated, on or before the reporting date). [IFRS 7.19].

It is noted that any defaults or breaches may affect the classification of the liability as current or non-current in accordance with IAS 1 (see Chapter 3 at 3.1.4). [IFRS 7.IG12].

4.4.9 Interests in associates and joint ventures accounted for in accordance with IFRS 9

IAS 28 – Investments in Associates and Joint Ventures – allows an interest in an associate or a joint venture held by a venture capital or similar organisation to be measured at fair value through profit or loss in accordance with IFRS 9 (see Chapter 11 at 5.3). In these circumstances, IFRS 12 – Disclosure of Interests in Other Entities – contains additional disclosure requirements, over and above those in IFRS 7, which are dealt with in Chapter 13 at 2.2.3.D and 5.

4.5.1 General disclosure requirements

The IASB sees the disclosure of information about the fair value of financial assets and liabilities as being an important requirement. It is explained in the following terms:

‘Many entities use fair value information internally in determining their overall financial position and in making decisions about individual financial instruments. It is also relevant to many decisions made by users of financial statements because, in many circumstances, it reflects the judgement of the financial markets about the present value of expected future cash flows relating to an instrument. Fair value information permits comparisons of financial instruments having substantially the same economic characteristics, regardless of why they are held and when and by whom they were issued or acquired. Fair values provide a neutral basis for assessing management's stewardship by indicating the effects of its decisions to buy, sell or hold financial assets and to incur, maintain or discharge financial liabilities.’

Therefore, when financial assets or liabilities are not measured on a fair value basis, information on fair values should be given by way of supplementary disclosures to assist users in comparing entities on a consistent basis. [IFRS 7.BC36].

More specifically, except as set out below, the fair value of each class of financial assets and liabilities should be disclosed in a way that permits comparison with the corresponding carrying amounts. [IFRS 7.25]. In providing this disclosure, instruments should be offset only to the extent that their related carrying amounts are also offset in the statement of financial position. [IFRS 7.26]. IFRS 13 contains guidance on determining fair values and includes more extensive disclosure requirements about the fair values disclosed. These are discussed in Chapter 14 at 20.

Pragmatically, disclosure of fair values is not required for instruments whose carrying amount reasonably approximates their fair value, for example short-term trade receivables and payables. [IFRS 7.29(a)]. Where an entity has material amounts of longer term receivables or payables the carrying amount will often not represent a reasonable approximation of fair value and in such cases the use of this concession will not be appropriate.

As set out in Chapter 45 at 3.3.2 some instruments within the scope of IFRS 4 (normally life insurance policies) contain a discretionary participation feature. If the fair value of that feature cannot be reliably measured, disclosures of fair value are not required. [IFRS 7.29(c)]. However, additional disclosures should be given to assist users of the financial statements in making their own judgements about the extent of possible differences between the carrying amount of such contracts and their fair value. In particular, the following should be disclosed: [IFRS 7.30]

• the fact that fair value has not been disclosed because it cannot be reliably measured;
• a description of the instruments, their carrying amount, and an explanation of why fair value cannot be measured reliably;
• information about the market for the instruments;
• information about whether and how the entity intends to dispose of the instruments; and
• for instruments whose fair value previously could not be reliably measured that are derecognised:
  • that fact;
  • their carrying amount at the time of derecognition; and
  • the amount of gain or loss recognised.

When IFRS 17 is applied such contracts would only rarely be within the scope of IFRS 7 (see Chapter 45 at 3.3.2) and consequently these requirements are deleted from the standard.

When IFRS 16 is applied, disclosure need not be given of the fair value of lease liabilities. [IFRS 7.29(d)]. IFRS 16 is effective for periods commencing on or after 1 January 2019 (see 8 below).

4.5.2 Day 1 profits

In certain situations there will be a difference between the transaction price for a financial asset or financial liability and the fair value that would be determined at that date in accordance with IFRS 13 (commonly known as a day 1 profit). [IFRS 7.28]. As set out in Chapter 49 at 3.3, an entity should not recognise a day 1 profit on initial recognition of the financial instrument if the fair value is neither evidenced by a quoted price in an active market for an identical asset or liability (known as a Level 1 input) nor based on a valuation technique that uses only data from observable markets. Instead, the difference will be recognised in profit or loss in subsequent periods in accordance with IFRS 9 and the entity's accounting policy. [IFRS 7.IG14].

Where such a difference exists, IFRS 7 requires disclosure, by class of financial instrument, of: [IFRS 7.28]

• the accounting policy for recognising that difference in profit or loss to reflect a change in factors (including time) that market participants would take into account when setting a price for the financial instrument;
• the aggregate difference yet to be recognised in profit or loss at the beginning and end of the period and a reconciliation of changes in the amount of this difference; and
• why it was concluded that the transaction price was not the best evidence of fair value, including a description of the evidence that supports the fair value.

In other words, disclosure is required of the profits an entity might think it has made but which it is prohibited from recognising, at least for the time being. This disclosure is illustrated in the following example based on the implementation guidance. It is rather curious in that it illustrates a day 1 loss, not profit.

UBS discloses the following information about recognition of day 1 profits.

4.6.1 Acquired receivables

Some constituents were concerned that prohibiting the use of an allowance account when accounting for acquired receivables at fair value (see Chapter 49 at 3.3.4) could make it impossible to determine the contractual cash flows due on those assets and the amount of those cash flows not expected to be collected. They asked for additional disclosure to help in assessing considerations of credit quality used in estimating those fair values, including expectations about receivables that will be uncollectible. [IFRS 3.BC258]. Consequently, the IASB decided to require the following disclosures to be made about such assets acquired in a business combination:

• fair value of the receivables;
• gross contractual amounts receivable; and
• the best estimate at the acquisition date of the contractual cash flows not expected to be collected.

This information should be provided by major class of receivable, such as loans, direct finance leases and any other class of receivables. [IFRS 3.B64(h)].

Although these requirements will produce some of the information users need to evaluate the credit quality of receivables acquired, the IASB acknowledged that it may not provide all such information. However, this is seen as an interim measure and the IASB will monitor a related FASB project with a view to improving the disclosure requirements in the future, [IFRS 3.BC260], although it is not clear when such a project might be completed.

4.6.2 Contingent consideration and indemnification assets

The following information about contingent consideration arrangements and indemnification assets (see Chapter 45 at 3.7.1 and 3.12 respectively) should be given: [IFRS 3.B64(g)]

• the amount recognised as at the acquisition date;
• a description of the arrangement and the basis for determining the amount of the payment; and
• an estimate of the range of outcomes (undiscounted) or, if a range cannot be estimated, that fact and the reasons why a range cannot be estimated.

  If the maximum amount of the payment is unlimited, that fact should be disclosed.

These are requirements of IFRS 3 and apply irrespective of whether such items meet the definition of a financial instrument (which they normally will).

5.3.1 Scope and objectives

The objective of these disclosures is to enable users to understand the effect of credit risk on the amount, timing and uncertainty of future cash flows. To achieve this objective, the disclosures should provide: [IFRS 7.35B]

• information about the entity's credit risk management practices and how they relate to the recognition and measurement of expected credit losses, including the methods, assumptions and information used to measure those losses (see 5.3.2 below);
• quantitative and qualitative information that allows users of financial statements to evaluate the amounts in the financial statements arising from expected credit losses, including changes in the amount of those losses and the reasons for those changes (see 5.3.3 below); and
• information about the entity's credit risk exposure, i.e. the credit risk inherent in its financial assets and commitments to extend credit, including significant credit risk concentrations (see 5.3.4 below).

An entity will need to determine how much detail to disclose, how much emphasis to place on different aspects of the disclosure requirements, the appropriate level of aggregation or disaggregation and whether additional explanations are necessary to evaluate the quantitative information disclosed. [IFRS 7.35D]. If the disclosures provided are insufficient to meet the objectives above, additional information that is necessary to meet those objectives should be disclosed. [IFRS 7.35E].

To avoid duplication, IFRS 7 allows this information to be incorporated by cross-reference from the financial statements to some other statement that is available to users of the financial statements on the same terms and at the same time, such as a management commentary or risk report. Without the information incorporated by cross-reference, the financial statements are incomplete. [IFRS 7.35C].

A number of the disclosures about credit risk are required to be given by class (see 3.3 above). In determining these classes, financial instruments in the same class should reflect shared economic characteristics with respect to credit risk. A lender, for example, might determine that residential mortgages, unsecured consumer loans and commercial loans each have different economic characteristics. [IFRS 7.IG21].

Unless otherwise stated, the disclosure requirements set out at 5.3.2 to 5.3.4 below are applicable only to financial instruments to which the impairment requirements in IFRS 9 are applied. [IFRS 7.35A].

5.3.2 Credit risk management practices

An entity should explain its credit risk management practices and how they relate to the recognition and measurement of expected credit losses. To meet this objective it should disclose information that enables users to understand and evaluate: [IFRS 7.35F]

• how it has determined whether the credit risk of financial instruments has increased significantly since initial recognition, including if and how:
  • financial instruments are considered to have low credit risk, including the classes of financial instruments to which it applies; and
  • the presumption that there have been significant increases in credit risk since initial recognition when financial assets are more than 30 days past due has been rebutted;
• its definitions of default, including the reasons for selecting those definitions. This may include: [IFRS 7.B8A]
  • the qualitative and quantitative factors considered in defining default;
  • whether different definitions have been applied to different types of financial instruments; and
  • assumptions about the cure rate, i.e. the number of financial assets that return to a performing status, after a default has occurred on the financial asset;
• how the instruments were grouped if expected credit losses were measured on a collective basis;
• how it has determined that financial assets are credit-impaired; and
• its write-off policy, including the indicators that there is no reasonable expectation of recovery and information about the policy for financial assets that are written-off but are still subject to enforcement activity.

  An asset (or portion thereof) should be written off only if there is no reasonable expectation of recovery; [IFRS 9.5.4.4] and

• how the requirements for the modification of contractual cash flows of financial instruments have been applied, including how the entity:
  • determines whether the credit risk on a financial asset that has been modified while the loss allowance was measured at an amount equal to lifetime expected credit losses has improved to the extent that the loss allowance reverts to being measured at an amount equal to 12‑month expected credit losses; and
  • monitors the extent to which the loss allowance on financial assets meeting the criteria in the previous bullet is subsequently remeasured at an amount equal to lifetime expected credit losses.

    Quantitative information that will assist users in understanding the subsequent increase in credit risk of modified financial assets may include information about modified financial assets meeting the criteria above for which the loss allowance has reverted to being measured at an amount equal to lifetime expected credit losses, i.e. a deterioration rate. [IFRS 7.B8B]. Including qualitative information can also be a useful way of meeting this disclosure requirement.

An entity should also explain the inputs, assumptions and estimation techniques used to apply the impairment requirements of IFRS 9. For this purpose it should disclose: [IFRS 7.35G]

• the basis of inputs and assumptions and the estimation techniques used to:
  • measure 12‑month and lifetime expected credit losses;
  • determine whether the credit risk of financial instruments has increased significantly since initial recognition; and
  • determine whether a financial asset is credit-impaired.

    This may include information obtained from internal historical information or rating reports and assumptions about the expected life of financial instruments and the timing of the sale of collateral [IFRS 7.B8C] or information about the estimated maximum period considered when determining estimated credit losses in respect of revolving credit facilities;⁴

• how forward-looking information has been incorporated into the determination of expected credit losses, including the use of macroeconomic information. Where relevant this will include information about the use of multiple economic scenarios in determining those expected credit losses (see Chapter 51, particularly at 5.6).

  In rare circumstances, there may be relevant forward-looking information that cannot be incorporated into the determination of significant increases in credit risk or the measurement of expected credit losses because of a lack of reasonable and supportable information. In such cases disclosures should be made that are consistent with the objective in IFRS 7, i.e. to enable users of the financial statements to understand the credit risk to which the entity is exposed;⁵ and

• changes in estimation techniques or significant assumptions made during the reporting period and the reasons for those changes.

5.3.3 Quantitative and qualitative information about amounts arising from expected credit losses

An entity should explain the changes in the loss allowance and reasons for those changes by presenting a reconciliation of the opening balance to the closing balance. This should be given in a table for each relevant class of financial instruments, showing separately the changes during the period for: [IFRS 7.35H]

• the loss allowance measured at an amount equal to 12‑month expected credit losses;
• the loss allowance measured at an amount equal to lifetime expected credit losses for:
  • financial instruments for which credit risk has increased significantly since initial recognition but that are not credit-impaired financial assets;
  • financial assets that are credit-impaired at the reporting date (but were not credit-impaired when purchased or originated); and
  • trade receivables, contract assets or lease receivables for which the loss allowance is measured using a simplified approach based on lifetime expected credit losses; and
• financial assets (or, potentially, loan commitments or financial guarantee contracts – see Chapter 51 at 11) that were credit-impaired when purchased or originated.

  The total amount of undiscounted expected credit losses on initial recognition of any such assets during the reporting period should also be disclosed.

In addition, it may be necessary to provide a narrative explanation of the changes in the loss allowance during the period. This narrative explanation may include an analysis of the reasons for changes in the loss allowance during the period, including: [IFRS 7.B8D]

• the portfolio composition;
• the volume of financial instruments purchased or originated; and
• the severity of the expected credit losses.

For loan commitments and financial guarantee contracts the loss allowance is recognised as a provision. Information about changes in the loss allowance for financial assets should be shown separately from those for loan commitments and financial guarantee contracts. However, if a financial instrument includes both a loan (i.e. financial asset) and an undrawn loan commitment (i.e. loan commitment) component and the expected credit losses on the loan commitment component cannot be separately identified from those on the financial asset component, the expected credit losses on the loan commitment should be recognised together with the loss allowance for the financial asset. To the extent that the combined expected credit losses exceed the gross carrying amount of the financial asset, the expected credit losses should be recognised as a provision. [IFRS 7.B8E].

An explanation should also be provided of how significant changes in the gross carrying amount of financial instruments during the period contributed to changes in the loss allowance. This information should be provided separately for each class of financial instruments for which loss allowances are analysed (see above). It should also include relevant qualitative and quantitative information. Examples of changes in the gross carrying amount of financial instruments that contribute to changes in the loss allowance may include: [IFRS 7.35I]

• changes because of financial instruments originated or acquired during the reporting period;
• the modification of contractual cash flows on financial assets that do not result in a derecognition of those financial assets;
• changes because of financial instruments that were derecognised, including those that were written-off during the reporting period; and
• changes arising from the measurement of the loss allowance moving from 12‑month expected credit losses to lifetime losses (or vice versa).

The information disclosed should provide an understanding of the nature and effect of modifications of contractual cash flows on financial assets that have not resulted in derecognition as well as the effect of such modifications on the measurement of expected credit losses. The following information should therefore be given: [IFRS 7.35J]

• the amortised cost before the modification and the net modification gain or loss recognised for financial assets for which the contractual cash flows have been modified during the reporting period while they had a loss allowance based on lifetime expected credit losses; and
• the gross carrying amount at the end of the reporting period of financial assets that have been modified since initial recognition at a time when the loss allowance was based on lifetime expected credit losses and for which the loss allowance has changed during the reporting period to an amount equal to 12‑month expected credit losses.

These requirements apply to all modifications whether they are as a result of credit related or other commercial reasons. However, if an entity has the ability to separately identify different types of modifications and considers that the separate disclosure of these items is relevant to achieving the overall objective of the disclosures in this section, the entity could provide this additional detail as part of the disclosure.⁶

The following example illustrates how this information might be presented. [IFRS 7.IG20B].

To provide an understanding of the effect of collateral and other credit enhancements on the amounts arising from expected credit losses, the following should be disclosed by class of financial instrument: [IFRS 7.35K]

• the amount that best represents the maximum exposure to credit risk at the end of the reporting period without taking account of any collateral held or other credit enhancements (e.g. netting agreements that do not qualify for offset in accordance with IAS 32);
• a narrative description of collateral held as security and other credit enhancements, including:
  • a description of the nature and quality of the collateral held;
  • an explanation of any significant changes in the quality of that collateral or credit enhancements as a result of deterioration or changes in the entity's collateral policies during the reporting period; and
  • information about financial instruments for which a loss allowance has not been recognised because of the collateral.

  This might include information about: [IFRS 7.B8G]

  • the main types of collateral held as security and other credit enhancements, examples of the latter being guarantees, credit derivatives and netting agreements that do not qualify for offset in accordance with IAS 32;
  • the volume of collateral held and other credit enhancements and its significance in terms of the loss allowance;
  • the policies and processes for valuing and managing collateral and other credit enhancements;
  • the main types of counterparties to collateral and other credit enhancements and their creditworthiness; and
  • information about risk concentrations within the collateral and other credit enhancements; and
• quantitative information about the collateral held as security and other credit enhancements, e.g. quantification of the extent to which collateral and other credit enhancements mitigate credit risk, on financial assets that are credit-impaired at the reporting date.

Disclosure of information about the fair value of collateral and other credit enhancements is not required, nor is a quantification of the exact value of the collateral included in the calculation of expected credit losses (i.e. the loss given default). [IFRS 7.B8F]. Further, these requirements do not apply to lease receivables. [IFRS 7.35A(b)].

For a financial asset, the maximum exposure to credit risk is typically the gross carrying amount, net of any amounts offset in accordance with IAS 32 and any impairment losses recognised in accordance with IFRS 9. [IFRS 7.B9]. Activities that give rise to credit risk and the associated maximum exposure to credit risk include, but are not limited to: [IFRS 7.B10]

• granting loans to customers and placing deposits with other entities. In these cases, the maximum exposure to credit risk is the carrying amount of the related financial assets;
• entering into derivative contracts, e.g. foreign exchange contracts, interest rate swaps and purchased credit derivatives. When the resulting asset is measured at fair value, the maximum exposure to credit risk at the reporting date will equal the carrying amount;
• granting financial guarantees. In this case, the maximum exposure to credit risk is the maximum amount the entity could have to pay if the guarantee is called on, which may be significantly greater than the amount recognised as a liability; and
• making a loan commitment that is irrevocable over the life of the facility or is revocable only in response to a material adverse change. If the issuer cannot settle the loan commitment net in cash or another financial instrument, the maximum credit exposure is the full amount of the commitment. This is because it is uncertain whether the amount of any undrawn portion may be drawn upon in the future. This may be significantly greater than the amount recognised as a liability.

The contractual amount outstanding on financial assets that were written off during the reporting period and which are still subject to enforcement activity should be disclosed. [IFRS 7.35L].

5.3.4 Credit risk exposure

Users should be able to assess an entity's credit risk exposure and understand its significant credit risk concentrations. Therefore, an entity should disclose, by ‘credit risk rating grades’ (see below), the gross carrying amount of financial assets and the exposure to credit risk on loan commitments and financial guarantee contracts. This information should be provided separately for financial instruments: [IFRS 7.35M]

• for which the loss allowance is measured at an amount equal to 12‑month expected credit losses;
• for which the loss allowance is measured at an amount equal to lifetime expected credit losses and that are:
  • financial instruments for which credit risk has increased significantly since initial recognition but are not credit-impaired financial assets;
  • financial assets that are credit-impaired at the reporting date (but were not credit-impaired when purchased or originated); and
  • trade receivables, contract assets or lease receivables for which the loss allowances are measured using a simplified approach based on lifetime expected credit losses. Information for these assets may be based on a provision matrix; [IFRS 7.35N] and
• that are financial assets (or, potentially, loan commitments or financial guarantee contracts – see Chapter 51 at 11) that were credit-impaired when purchased or originated.

These disclosures should distinguish between financial instruments for which the loss allowance is equal to 12‑month or lifetime expected credit losses even where the maturity of a financial instrument is twelve months or less in spite of the fact that the loss allowance should be the same under either approach.⁷

The following examples illustrate how this information might be presented. [IFRS 7.IG20C, 20D].

Credit risk rating grades are defined as ratings of credit risk based on the risk of a default occurring on the financial instrument. [IFRS 7 Appendix A]. The number of credit risk rating grades used to disclose the information above should be consistent with the number that the entity reports to key management personnel for credit risk management purposes. If past due information is the only borrower-specific information available and past due information is used to assess whether credit risk has increased significantly since initial recognition, an analysis by past due status should be provided for that class of financial assets. [IFRS 7.B8I].

When expected credit losses are measured on a collective basis, it may not be possible to allocate the gross carrying amount of individual financial assets or the exposure to credit risk on loan commitments and financial guarantee contracts to the credit risk rating grades for which lifetime expected credit losses are recognised. In that case, the disclosure requirement above should be applied to those financial instruments that can be directly allocated to a credit risk rating grade and separate disclosure should be given of the gross carrying amount of financial instruments for which lifetime expected credit losses have been measured on a collective basis. [IFRS 7.B8J].

A concentration of credit risk exists when a number of counterparties are located in a geographical region or are engaged in similar activities and have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. Information should be provided to enable users to understand whether there are groups or portfolios of financial instruments with particular features that could affect a large portion of that group of financial instruments, such as concentration to particular risks. This could include, for example, loan-to-value groupings, geographical, industry or issuer-type concentrations. [IFRS 7.B8H].

For financial instruments within the scope of IFRS 7 to which the impairment requirements in IFRS 9 are not applied, disclosure should be given by class of instrument of the amount that best represents the entity's maximum exposure to credit risk at the reporting date (see 5.3.3 above). The amount disclosed should not take account of any collateral held or other credit enhancements (e.g. netting agreements that do not qualify for offset in accordance with IAS 32). This disclosure is not required for financial instruments whose carrying amount best represents this amount, [IFRS 7.36(a)], but will be required, for example, for written credit default swaps measured at fair value through profit or loss.

Entities should also provide, by class of financial instrument to which the impairment requirements in IFRS 9 are not applied, a description of collateral held as security and of other credit enhancements, and their financial effect (e.g. a quantification of the extent to which collateral and other credit enhancements mitigate credit risk) in respect of the amount that best represents the maximum exposure to credit risk. This applies irrespective of whether the maximum exposure to credit risk is disclosed separately or is represented by the carrying amount of a financial instrument. [IFRS 7.36(b)]. The requirement may be met by disclosing: [IFRS 7.IG22]

• the policies and processes for valuing and managing collateral and other credit enhancements obtained;
• a description of the main types of collateral and other credit enhancements (examples of the latter being guarantees and credit derivatives, as well as netting agreements that do not qualify for offset in accordance with IAS 32);
• the main types of counterparties to collateral and other credit enhancements and their creditworthiness; and
• information about risk concentrations within the collateral or other credit enhancements.

Whilst the standard suggests this information should, or at least could, involve disclosure of quantitative information, the implementation guidance implies more discursive disclosures might suffice in some cases. Therefore entities will need to make a judgement based on their own specific circumstances.

5.3.5 Collateral and other credit enhancements obtained

When an entity obtains financial or non-financial assets during the period by taking possession of collateral it holds as security, or calling on other credit enhancements such as guarantees, and these assets meet the recognition criteria in other standards, it should disclose for such assets held at the reporting date: [IFRS 7.38]

• the nature and carrying amount of the assets; and
• when the assets are not readily convertible into cash, its policies for disposing of such assets or for using them in its operations.

This disclosure is intended to provide information about the frequency of such activities and the entity's ability to obtain and realise the value of the collateral. [IFRS 7.BC56].

5.3.6 Credit risk: illustrative disclosures

The following example illustrates what some of the disclosures about credit risk and loss allowances for one class of a bank's lending might look like. In preparing this example the following approach has been taken:

• although not explicitly required by IFRS 7, in order to provide relevant qualitative and quantitative information (see 5.3.3 above) and in line with the examples to the standard:
  • a reconciliation of movements in the gross carrying amounts in a tabular format has been provided; and
  • loans that are assessed on a specific basis and those assessed collectively have been shown separately;
• IFRS 7 does not require disclosure of the proportion of stage 2 loans that are 30 days past due, but this is regarded as useful information by users and has therefore been included;
• in order to avoid excessive detail only the net effect of using multiple scenarios has been provided rather than providing details of the scenarios and their weightings; and
• in practice the various parameters used are unlikely to be independent and, in line with the EDTF's recommendations (see 9.2 below), sensitivity to only one parameter has been disclosed.

The following extract from the financial statements of Volkswagen shows the type of disclosure addressing credit risk that can be seen in practice.

5.4.1 Information provided to key management

As set out at 5.2 above, an entity should disclose summary quantitative data about its exposure to risk on the basis of the information provided internally to key management personnel and IFRS 7 emphasises that this requirement applies to liquidity risk too. [IFRS 7.B10A, BC58A(b)].

Entities should provide an explanation of how the data disclosed are determined. If the outflows of cash (or other financial assets) included in the data could occur significantly earlier than indicated, that fact should be stated and quantitative information should be provided to enable users of the financial statements to evaluate the extent of this risk, unless that information is included in the contractual maturity analyses (see 5.4.2 below). Similar information should be given if the outflows of cash (or other financial assets) could be for significantly different amounts than those indicated in the data. This might be required, for example, if a derivative is included in the data on a net settlement basis, but the counterparty has the option of requiring gross settlement. [IFRS 7.B10A].

5.4.2 Maturity analyses

To illustrate liquidity risk, the principal minimum numerical disclosures required are: [IFRS 7.39(a), (b)]

• a maturity analysis for non-derivative financial liabilities (including issued financial guarantee contracts) that shows their remaining contractual maturities; and
• a maturity analysis for derivative financial liabilities which includes the remaining contractual maturities for those derivative financial liabilities for which contractual maturities are essential for an understanding of the timing of the cash flows.

  The contractual maturities of the following would be essential for an understanding of the timing of the cash flows: [IFRS 7.B11B]

  • an interest rate swap with a remaining maturity of five years in a cash flow hedge of a variable rate financial asset or liability; and
  • all loan commitments.

  Derivatives entered into for trading purposes that are typically settled before their contractual maturity (e.g. in response to fair value movements) are an example of the type of instrument that might not need to be included in the maturity analysis.⁸

These requirements are discussed further in the remainder of this sub-section.

Although these minimum disclosures address only financial liabilities, other aspects of IFRS 7 mean that most financial institutions will be required to disclose a maturity analysis of financial assets too (see 5.4.3 below).

5.4.3 Management of associated liquidity risk

In addition to the maturity analyses for financial liabilities, the entity should provide a description of how it manages the liquidity risk inherent in those analyses. [IFRS 7.39(c)]. These disclosures are, in effect, intended to ‘reconcile’ the maturity analyses which are prepared on a worst case scenario notion (see 5.4.2 above) with how an entity actually manages liquidity risk (see 5.4.1 above).¹³

It is emphasised that a maturity analysis of financial assets held for managing liquidity risk (e.g. financial assets that are readily saleable or expected to generate cash inflows to meet cash outflows on financial liabilities) is required if that information is necessary to enable users of financial statements to evaluate the nature and extent of the entity's liquidity risk. [IFRS 7.B11E, BC58D]. IFRS 7 does not specify the basis on which such an analysis should be provided and in practice they are often prepared on the basis of expected rather than contractual maturities as this is considered more relevant information.

Other factors that might be considered when making this disclosure include, but are not limited to, whether the entity: [IFRS 7.B11F]

• has committed borrowing facilities (e.g. commercial paper facilities) or other lines of credit (e.g. stand-by credit facilities) that it can access to meet liquidity needs;
• holds deposits at central banks to meet liquidity needs;
• has very diverse funding sources;
• has significant concentrations of liquidity risk in either its assets or its funding sources;
• has internal control processes and contingency plans for managing liquidity risk;
• has instruments that include accelerated repayment terms (e.g. on the downgrade of the entity's credit rating);
• has instruments that could require the posting of collateral (e.g. margin calls for derivatives);
• has instruments that allow the entity to choose whether it settles its financial liabilities by delivering cash (or another financial asset) or by delivering its own shares; or
• has instruments that are subject to master netting agreements.

5.4.4 Puttable financial instruments classified as equity

Certain puttable financial instruments that meet the definition of financial liabilities are classified as equity instruments (see Chapter 47 at 4.6). In spite of this classification, the IASB recognises that these instruments give rise to liquidity risk and consequently requires the following disclosures about them: [IAS 1.136A]

• summary quantitative data about the amount classified as equity;
• the entity's objectives, policies and processes for managing its obligation to repurchase or redeem the instruments when required to do so by the instrument holders, including any changes from the previous period;
• the expected cash outflow on redemption or repurchase of that class of financial instruments; and
• information about how the expected cash outflow on redemption or repurchase was determined.

5.5.1 ‘Basic’ sensitivity analysis

Except where the disclosures set out at 5.5.2 below are provided, entities should disclose: [IFRS 7.40]

• a sensitivity analysis for each type of market risk to which the entity is exposed at the reporting date, showing how profit or loss and equity would have been affected by changes in the relevant risk variable that were reasonably possible at that date.

  The sensitivity of profit or loss (which arises, for example, from instruments measured at fair value through profit or loss) should be disclosed separately from the sensitivity of equity (which arises, for example, from investments in equity instruments whose changes in fair value are presented in other comprehensive income). [IFRS 7.B27].

  The term ‘profit or loss’ is used in IAS 1 to mean profit after tax. Therefore, it might well be argued that the amounts disclosed should take account of any related tax effects, a view corroborated by the illustrative disclosures in the implementation guidance to IFRS 7 (see Example 54.13 below). However, as noted below, the application guidance suggests this requirement should (and the implementation guidance might suggest it could) be met by disclosing the impact on interest expense, a pre-tax measure of profit. Given this conflicting guidance, it is difficult to say that a pre-tax approach fails to comply with the standard and, in practice, both approaches are seen.

  Where a post-tax figure is disclosed, it will not always be straightforward to determine the related tax effects, especially for a multinational group, and it may be appropriate to use the guidance in Chapter 33 at 10 which deals with the allocation of income tax between profit or loss, other comprehensive income and equity.

  This requirement focuses exclusively on accounting sensitivity, and does not include market risk sensitivities that do not directly impact profit and loss or equity, e.g. interest rate risk arising on fixed rate financial assets held at amortised cost. In December 2008, the IASB considered encouraging entities to discuss the effect of changes in the relevant risk variable on economic value not manifest in profit and loss or equity, but decided not to;¹⁴

• the methods and assumptions used in preparing the sensitivity analysis; and
• changes from the previous period in the methods and assumptions used, and the reasons for such changes.

The standard contains a reminder of the general guidance at 3.1 above and explains that an entity should decide how it aggregates information to display the overall picture without combining information with different characteristics about exposures to risks from significantly different economic environments. For example, an entity that trades financial instruments might disclose this information separately for financial instruments held for trading and those not held for trading. Similarly, an entity would not aggregate its exposure to market risks from areas of hyperinflation with its exposure to the same market risks from areas of very low inflation. However, an entity that has exposure to only one type of market risk in only one economic environment, would not show disaggregated information. [IFRS 7.B17].

Risk variables that are relevant to disclosing market risk include, but are not limited to: [IFRS 7.IG32]

• the yield curve of market interest rates.

  It may be necessary to consider both parallel and non-parallel shifts in the yield curve;

• foreign exchange rates.

  The standard requires a sensitivity analysis to be disclosed for each currency to which an entity has significant exposure; [IFRS 7.B24]

• prices of equity instruments; and
• market prices of commodities.

When disclosing how profit or loss and equity would have been affected by changes in the relevant risk variable, there is no requirement to determine what the profit or loss for the period would have been if the relevant risk variables had been different during the reporting period. The requirement is subtly different because the effect that is disclosed assumes that a reasonably possible change in the relevant risk variable had occurred at the reporting date and had been applied to the risk exposures in existence at that date. For example, if an entity has a floating rate liability at the reporting date, the entity would disclose the effect on profit or loss (i.e. interest expense) for the current year if interest rates had varied by reasonably possible amounts. Further, this disclosure is not required for each change within a range of reasonably possible changes, only at the limits of the reasonably possible range. [IFRS 7.B18].

The following example illustrates how the amounts to be included in these disclosures in respect of a number of different instruments might be determined – for simplicity, tax effects are ignored.

Relevant risk variables for the purpose of this disclosure might include: [IFRS 7.IG33]

• prevailing market interest rates, for interest-sensitive financial instruments such as a variable-rate loan; or
• currency rates and interest rates, for foreign currency financial instruments such as foreign currency bonds.

For interest rate risk, the sensitivity analysis might show separately the effect of a change in market interest rates on:

• interest income and expense;
• other line items of profit or loss (such as trading gains and losses); and
• when applicable, equity.

An entity might disclose a sensitivity analysis for interest rate risk for each currency in which the entity has material exposures to interest rate risk. [IFRS 7.IG34].

In determining what a reasonably possible change in the relevant risk variable is, the economic environment(s) in which the entity operates and the time frame over which it is making the assessment should be considered. A reasonably possible change should not include remote or ‘worst case’ scenarios or ‘stress tests’. Moreover, if the rate of change in the underlying risk variable is stable, the chosen reasonably possible change in the risk variable need not be altered.

For example, assume that interest rates are 5 percent and an entity determines that a fluctuation in interest rates of ±50 basis points is reasonably possible. It would disclose the effect on profit or loss and equity if interest rates were to change to 4.5 percent or 5.5 percent. In the next period, interest rates have increased to 5.5 percent. The entity continues to believe that interest rates may fluctuate by ±50 basis points (i.e. that the rate of change in interest rates is stable). The entity would disclose the effect on profit or loss and equity if interest rates were to change to 5 percent or 6 percent. The entity would not be required to revise its assessment that interest rates might reasonably fluctuate by ±50 basis points, unless there is evidence that interest rates have become significantly more volatile. [IFRS 7.B19].

However, when market conditions change significantly, for example as occurred in many markets in the second half of 2008, an entity's assessment of what constitutes a reasonably possible change should be reassessed.¹⁵

The time frame over which a reasonably possible change should be assessed is defined by the period until these disclosures will next be presented. This will normally coincide with the next annual reporting period, [IFRS 7.B19], although in some jurisdictions such information may be included in interim reports.

Because the factors affecting market risk will vary according to the specific circumstances of each entity, the appropriate range to be considered in providing a sensitivity analysis of market risk will also vary for each entity and for each type of market risk. [IFRS 7.IG35].

Where an entity has exposure to other price risk, it might disclose the effect of a decrease in a specified stock market index, commodity price, or other risk variable. For example, if residual value guarantees that are financial instruments are given, the disclosure could include an increase or decrease in the value of the assets to which the guarantee applies. [IFRS 7.B25].

The following example from the implementation guidance illustrates the type of disclosure that might be provided.

The following extracts from the financial statements of Hunting illustrates how one company has addressed this disclosure requirement in respect of certain of its interest rate and foreign currency exposures.

5.5.2 Value-at-risk and similar analyses

Where an entity prepares a sensitivity analysis, such as value-at-risk, that reflects interdependencies between risk variables (e.g. interest rates and exchange rates) and uses it to manage financial risks, it may disclose that analysis in place of the information specified at 5.5.1 above. [IFRS 7.41]. If this disclosure is given, the effects on profit or loss and equity at 5.5.1 above need not be given. [IFRS 7.BC61].

In these cases the following should also be disclosed: [IFRS 7.41]

• an explanation of the method used in preparing such a sensitivity analysis, and of the main parameters and assumptions underlying the data provided; and
• an explanation of the objective of the method used and of limitations that may result in the information not fully reflecting the fair value of the assets and liabilities involved.

This applies even if such a methodology measures only the potential for loss and does not measure the potential for gain. Such an entity might comply with the disclosure requirements above by detailing the type of value-at-risk model used (e.g. whether the model relies on Monte Carlo simulations), an explanation about how the model works and the main assumptions (e.g. the holding period and confidence level). Entities might also disclose the historical observation period and weightings applied to observations within that period, an explanation of how options are dealt with in the calculations, and which volatilities and correlations (or, alternatively, Monte Carlo probability distribution simulations) are used. [IFRS 7.B20].

The basic sensitivity analysis considered at 5.5.1 above incorporates only the effects of financial instruments and other contracts within the scope of IFRS 7. In contrast, value-at-risk and similar analyses can incorporate the effects of items outside the scope of IFRS 7, for example trading inventories, own use contracts and insurance contracts. This is because the standard requires entities to disclose the analysis actually used in the management of the business which will often include such items.

It has been suggested that disclosure of potential losses due to stress conditions would be of greater use than the disclosure requirements for value-at-risk and similar methodologies that do not contemplate extraordinary market movements. However, in December 2008, the IASB noted this would be inconsistent with the ‘basic’ sensitivity analysis (see 5.5.1 above) and decided not to add such a requirement to IFRS 7.¹⁶

BP provides the following market risk disclosures which includes the value-at-risk limit it uses to manage that risk.

5.5.3 Other market risk disclosures

When the sensitivity analyses discussed at 5.5.1 and 5.5.2 above are unrepresentative of a risk inherent in a financial instrument, that fact should be disclosed together with the reason for believing the sensitivity analyses are unrepresentative. [IFRS 7.42].

This can occur when the year-end exposure does not reflect the exposure during the year [IFRS 7.42] or a financial instrument contains terms and conditions whose effects are not apparent from the sensitivity analysis, e.g. options that remain out of (or in) the money for the chosen change in the risk variable. [IFRS 7.IG37(a)]. Additional disclosures in this second case might include:

• the terms and conditions of the financial instrument (e.g. the options);
• the effect on profit or loss if the term or condition were met (i.e. if the options were exercised); and
• a description of how the risk is hedged.

For example, an entity may acquire a zero-cost interest rate collar that includes an out-of-the-money leveraged written option (e.g. the entity pays ten times the amount of the difference between a specified interest rate floor and the current market interest rate if that current rate is below the floor). The entity may regard the collar as an inexpensive economic hedge against a reasonably possible increase in interest rates. However, an unexpectedly large decrease in interest rates might trigger payments under the written option that, because of the leverage, might be significantly larger than the benefit of lower interest rates. Neither the fair value of the collar nor a sensitivity analysis based on reasonably possible changes in market variables would indicate this exposure. In this case, the entity might provide the additional information described above. [IFRS 7.IG38].

Where financial assets are illiquid, e.g. when there is a low volume of transactions in similar assets and it is difficult to find a counterparty, additional disclosures might be required, [IFRS 7.IG37(b)], for example the reasons for the lack of liquidity and how the risk is hedged. [IFRS 7.IG39].

A large holding of a financial asset that, if sold in its entirety, would be sold at a discount or premium to the quoted market price for a smaller holding could also require additional disclosure. [IFRS 7.IG37(c)]. This might include: [IFRS 7.IG40]

• the nature of the security (e.g. entity name);
• the extent of holding (e.g. 15 percent of the issued shares);
• the effect on profit or loss; and
• how the entity hedges the risk.

5.6.1 Concentrations of risk

Concentrations of risk should be disclosed if not otherwise apparent from the disclosures made to comply with the requirements set out at 5.2 to 5.5 above. [IFRS 7.34(c)]. This should include:

• a description of how management determines concentrations;
• a description of the shared characteristic that identifies each concentration (for example, counterparty, geographical area, currency or market).

  For example, the shared characteristic may refer to geographical distribution of counterparties by groups of countries, individual countries or regions within countries; [IFRS 7.IG19] and

• the amount of the risk exposure associated with all financial instruments sharing that characteristic.

Concentrations of risk arise from financial instruments that have similar characteristics and are affected similarly by changes in economic or other conditions. It is emphasised that the identification of concentrations of risk requires judgement taking into account the circumstances of the entity. [IFRS 7.B8]. For example, they may arise from:

• Industry sectors.

  If an entity's counterparties are concentrated in one or more industry sectors (such as retail or wholesale), it would disclose separately exposure to risks arising from each concentration of counterparties;

• Credit rating or other measure of credit quality.

  If an entity's counterparties are concentrated in one or more credit qualities (such as secured loans or unsecured loans) or in one or more credit ratings (such as investment grade or speculative grade), it would disclose separately exposure to risks arising from each concentration of counterparties;

• Geographical distribution.

  If an entity's counterparties are concentrated in one or more geographical markets (such as Asia or Europe), it would disclose separately exposure to risks arising from each concentration of counterparties; and

• A limited number of individual counterparties or groups of closely related counterparties.

Similar principles apply to identifying concentrations of other risks, including liquidity risk and market risk. For example, concentrations of liquidity risk may arise from the repayment terms of financial liabilities, sources of borrowing facilities or reliance on a particular market in which to realise liquid assets. Concentrations of foreign exchange risk may arise if an entity has a significant net open position in a single foreign currency, or aggregate net open positions in several currencies that tend to move together. [IFRS 7.IG18].

5.6.2 Operational risk

In developing IFRS 7, the IASB considered whether disclosure of information about operational risk should be required by the standard. However, the definition and measurement of operational risk were considered to be in their infancy and were not necessarily related to financial instruments. Also, such disclosures were believed to be more appropriately located outside the financial statements. Consequently, this issue was deferred for consideration in the management commentary project. [IFRS 7.BC65].

5.6.3 Capital disclosures

The IASB considers that the level of an entity's capital and how it is managed are important factors for users of financial statements to consider in assessing the risk profile of an entity and its ability to withstand unexpected adverse events. It might also affect an entity's ability to pay dividends. Consequently, ED 7 contained proposed disclosures about capital. [IAS 1.BC86].

However, some commentators questioned the relevance of the capital disclosures in a standard dealing with disclosures relating to financial instruments and the IASB noted that an entity's capital does not relate solely to financial instruments and, thus, they have more general relevance. Accordingly, whilst these disclosures were retained, they were included in IAS 1, rather than IFRS 7. [IAS 1.BC88]. Those disclosures required by IAS 1 are dealt with in Chapter 3 at 5.4.

6.3.1 Meaning of continuing involvement

In this context, continuing involvement arises if, as part of the transfer, the entity retains any of the contractual rights or obligations inherent in the transferred financial asset or obtains any new contractual rights or obligations relating to it. [IFRS 7.42C].

For example, a financial asset transferred subject only to either (a) a deeply out of the money put option granted to the transferee or (b) a deeply out of the money call option retained by the transferor would be derecognised. This is because substantially all the risks and rewards of ownership have been transferred. [IFRS 9.B3.2.16(g)]. However, the put or call option would constitute continuing involvement in the asset.

Similarly, a readily obtainable asset transferred subject to a call option that is neither deeply in the money nor deeply out of the money would also be derecognised. This is because the entity has neither transferred nor retained substantially all of the risks and rewards of ownership and has not retained control. [IFRS 9.B3.2.16(h)]. However, the call option would constitute continuing involvement in the asset.

The following do not constitute continuing involvement for these purposes: [IFRS 7.42C]

1. normal representations and warranties relating to fraudulent transfer and concepts of reasonableness, good faith and fair dealings that could invalidate a transfer as a result of legal action;
2. forward, option and other contracts to reacquire the transferred financial asset for which the contract price (or exercise price) is the fair value of the transferred financial asset; or
3. an arrangement whereby an entity retains the contractual rights to receive the cash flows of a financial asset but assumes a contractual obligation to pay the cash flows to one or more entities in a ‘pass-through arrangement’ (see Chapter 52 at 3.5.2).

An entity does not have a continuing involvement in a transferred financial asset if, as part of the transfer, it neither retains any of the contractual rights or obligations inherent in the transferred financial asset nor acquires any new contractual rights or obligations relating to the transferred financial asset. Also, an entity does not have continuing involvement in a transferred financial asset if it has neither an interest in the future performance of the transferred financial asset nor a responsibility under any circumstances to make payments in respect of the transferred financial asset in the future. The term ‘payment’ in this context does not include cash flows of the transferred financial asset that an entity collects and is required to remit to the transferee. [IFRS 7.B30].

When an entity transfers a financial asset, it may retain the right to service that financial asset for a fee, e.g. by entering into a servicing contract. Such a contract should be assessed in accordance with the guidance above to determine whether it gives rise to continuing involvement for the purposes of these disclosures. For example, a servicer will have continuing involvement in the transferred financial asset if the servicing fee is dependent on the amount or timing of the cash flows collected from the transferred financial asset. Similarly, the right to a fixed fee that would not be paid in full as a result of non-performance of the transferred financial asset would also represent continuing involvement. This is because the servicer has an interest in the future performance of the transferred financial asset. Any such assessment is independent of whether the fee to be received is expected to compensate the entity adequately for performing the servicing. [IFRS 7.B31].

An entity might transfer a fixed rate financial asset and at the same time enter into an interest rate swap with the transferee that has the same notional amount as the transferred asset. If payments on the swap are not conditional on payments being made on the transferred financial asset and the notional of the swap is not linked to the notional amount of the loan this would not, in our view, represent continuing involvement.

The assessment of continuing involvement in a transferred financial asset should be made at the level of the reporting entity. For example, a subsidiary may transfer to an unrelated third party a financial asset in which the parent of the subsidiary has continuing involvement. In the subsidiary's stand-alone financial statements the parent's involvement should not be included in the assessment of whether the reporting entity (the subsidiary) has continuing involvement in the transferred asset. However, in the parent's consolidated financial statements, its continuing involvement (or that of another member of the group) in a financial asset transferred by its subsidiary would be included in determining whether the group has continuing involvement in the transferred asset. [IFRS 7.B29].

Continuing involvement in a transferred financial asset may result from contractual provisions in the transfer agreement or in a separate agreement with the transferee or a third party entered into in connection with the transfer. [IFRS 7.B31]. In our view it would not encompass arrangements entered into some time after the financial asset was transferred that were not contemplated at the time of the transfer.

6.3.2 Disclosure requirements

When an entity derecognises transferred financial assets in their entirety but has continuing involvement in those assets, it should disclose, as a minimum, the following for each type of continuing involvement at each reporting date: [IFRS 7.42E]

1. the carrying amount of the assets and liabilities that are recognised in the entity's statement of financial position and represent the entity's continuing involvement in the derecognised financial assets, and the line items in which the carrying amount of those assets and liabilities are recognised;
2. the fair value of the assets and liabilities that represent the entity's continuing involvement in the derecognised financial assets;
3. the amount that best represents the entity's maximum exposure to loss from its continuing involvement in the derecognised financial assets, and information showing how the maximum exposure to loss is determined;
4. the undiscounted cash outflows that would or may be required to repurchase derecognised financial assets (e.g. the strike price in an option agreement) or other amounts payable to the transferee in respect of the transferred assets.

   If the cash outflow is variable then the amount disclosed should be based on the conditions that exist at each reporting date;

5. a maturity analysis of the undiscounted cash outflows that would or may be required to repurchase the derecognised financial assets or other amounts payable to the transferee in respect of the transferred assets, showing the remaining contractual maturities of the entity's continuing involvement.

   This analysis should distinguish between cash flows that are required to be paid (e.g. forward contracts), cash flows the entity may be required to pay (e.g. written put options) and cash flows the entity might choose to pay (e.g. purchased call options). [IFRS 7.B34].

   Entities should use judgement to determine an appropriate number of time bands in preparing the maturity analysis. For example, it might be determined that the following maturity time bands are appropriate: [IFRS 7.B35]

   1. not later than one month;
   2. later than one month and not later than three months;
   3. later than three months and not later than six months;
   4. later than six months and not later than one year;
   5. later than one year and not later than three years;
   6. later than three years and not later than five years; and
   7. more than five years.

   If there is a range of possible maturities, the cash flows should be included on the basis of the earliest date on which the entity can be required or is permitted to pay; [IFRS 7.B36] and

6. qualitative information that explains and supports the quantitative disclosures set out in (a) to (e) above.

   This should include a description of the derecognised financial assets and the nature and purpose of the continuing involvement retained after transferring those assets. It should also include a description of the risks to which an entity is exposed, including: [IFRS 7.B37]

   1. a description of how the entity manages the risk inherent in its continuing involvement in the derecognised financial assets;
   2. whether the entity is required to bear losses before other parties, and the ranking and amounts of losses borne by parties whose interests rank lower than the entity's interest in the asset (i.e. its continuing involvement in the asset); and
   3. a description of any triggers associated with obligations to provide financial support or to repurchase a transferred financial asset.

The types of continuing involvement into which these disclosures and those referred to below are analysed should be representative of the entity's exposure to risks. For example, the analysis may be given by type of financial instrument (e.g. guarantees or call options) or by type of transfer (e.g. factoring of receivables, securitisations and securities lending). [IFRS 7.B33].

If an entity has more than one type of continuing involvement in respect of a particular derecognised financial asset the information above may be aggregated and reported under one type of continuing involvement. [IFRS 7.42F].

The following example illustrates how an entity might meet the quantitative disclosure requirements in (a) to (e) above. [IFRS 7.IG40C].

In addition to the information above, the following should be disclosed for each type of continuing involvement: [IFRS 7.42G]

1. the gain or loss recognised at the date of transfer of the assets.

   Disclosure should also be given if a gain or loss on derecognition arose because the fair values of the components of the previously recognised asset (i.e. the interest in the asset derecognised and the interest retained by the entity) were different from the fair value of the previously recognised asset as a whole. In that situation, disclosure should be made of whether the fair value measurements included significant inputs that were not based on observable market data; [IFRS 7.B38]

2. income and expenses recognised, both in the reporting period and cumulatively, from the entity's continuing involvement in the derecognised financial assets (e.g. fair value changes in derivative instruments); and
3. if the total amount of proceeds from transfer activity (that qualifies for derecognition) in a reporting period is not evenly distributed throughout the reporting period (e.g. if a substantial proportion of the total amount of transfer activity takes place in the closing days of a reporting period):
   1. when the greatest transfer activity took place within that reporting period (e.g. the last five days before the end of the reporting period);
   2. the amount (e.g. related gains or losses) recognised from transfer activity in that part of the reporting period; and
   3. the total amount of proceeds from transfer activity in that part of the reporting period.

This information should be provided for each period for which a statement of comprehensive income is presented. [IFRS 7.42G].

7.1.1 Presentation on the face of the statement of comprehensive income (or income statement)

The effects of an entity's various activities, transactions and other events (including those relating to financial instruments) differ in frequency, potential for gain or loss and predictability. Accordingly, IAS 1 explains, disclosing the components of financial performance assists in providing an understanding of the financial performance achieved and in making projections of future results. [IAS 1.86].

IAS 1 prescribes requirements for line items to be included on the face of the statement of comprehensive income (or income statement) which include:

• revenue, presenting separately interest revenue calculated using the effective interest method; [IAS 1.82(a)]

  The IFRS Interpretations Committee clarified in March 2018 that only interest on financial assets measured at amortised cost or on debt instruments measured at fair value through other comprehensive income should be included in the amount of interest revenue presented separately (subject to the effects of qualifying hedging relationships under IFRS 9). In particular, it should not include, for example, interest revenue from financial assets measured at fair value through profit or loss.¹⁷

  In March 2019 the Interpretations Committee issued an agenda decision addressing the measurement of revenue arising from the physical settlement of a contract to sell a non-financial asset when that contract is in the scope of IFRS 9 and accounted for at fair value through profit or loss. The committee concluded that any such revenue should be measured at an amount reflecting the cash price received adjusted by the fair value of the contract at the settlement date – this should equal, or at least approximate, the fair value of the non-financial item delivered at the date of delivery.¹⁸ This is illustrated in Example 54.17 below;

• gains and losses arising from the derecognition of financial assets measured at amortised cost. [IAS 1.82(aa)]. In order to determine the amount of this gain or loss, the carrying amount of the financial asset should, in principle, be updated to the date of derecognition. It should, therefore, include a revised estimate of expected credit losses determined as at the date of derecognition. However, considerations of materiality would also need to be taken into account;¹⁹

  There is no equivalent requirement to present separately gains and losses arising from derecognition of debt instruments measured at fair value through other comprehensive income. However, the amount of such gains and losses should be determined in the same way as for financial assets measured at amortised cost, i.e. by updating expected credit losses to the date of derecognition; [IFRS 9.5.7.11]

• impairment losses (including reversals of impairment losses or impairment gains) determined in accordance with IFRS 9. [IAS 1.82(ba)]. This will include losses in respect of loan commitments and financial guarantee contracts as well as financial assets.

  Some might argue this line item should also include modification gains or losses, particularly if the reason for the modification was credit-related. However, a summary of the April 2015 meeting of the Transition Resource Group for Impairment of Financial Instruments, published on the IASB's website, suggests this would not be appropriate. Instead, it says that if disclosing gains and losses from impairments and modifications on a net basis would provide relevant information (for example, if the reason for the modification was credit-related), this could be dealt with through additional disclosure in the notes.

  The summary also says that modification gains and losses should be presented separately if considered appropriate.²⁰ Consequently, another way in which a net figure could be presented on the face of the income statement involves presenting modification gains and losses (or at least those arising from credit-related events) in a separate line item that is adjacent to the one showing impairment losses and gains, together with a subtotal that includes these two amounts.

  Another view is that because modification gains and losses are determined consistently with the effective interest method, they could be presented as a component of interest revenue. However, if the amounts included were material, we would expect separate disclosure of the amounts involved;

• where a financial asset previously measured at amortised cost is reclassified so that it is measured at fair value through profit or loss, any gain or loss arising from a difference between the previous carrying amount and its fair value at the reclassification date; [IAS 1.82(ca)]
• where a financial asset previously classified at fair value through other comprehensive income is reclassified as measured at fair value through profit or loss, any cumulative gain or loss previously recognised in other comprehensive income that is reclassified to profit or loss; [IAS 1.82(cb)] and
• finance costs. [IAS 1.82(b)].

  The implementation guidance to IFRS 7 explains that this caption includes total interest expense (see 4.2.2 above) but may also include amounts associated with non-financial liabilities, for example the unwinding of the discount on long-term provisions (see Chapter 26 at 4.3.5). [IFRS 7.IG13].

  The IFRS Interpretations Committee concluded that it is not permissible to present a line item ‘net finance costs’ (or a similar term) on the face of the statement without showing the finance costs and finance revenue composing it. However, the presentation of finance revenue followed immediately by finance costs and a subtotal, e.g. ‘net finance costs’, is allowed.²¹

The demand for safe investments can sometimes result in a negative yield on very high quality financial assets (e.g. certain government bonds or reserve bank deposits). The Interpretations Committee has considered this phenomenon and in January 2015 noted that interest resulting from a negative effective interest rate on a financial asset does not meet the definition of interest revenue because it reflects a gross outflow, not a gross inflow, of economic benefits. Consequently, such expenses should not be presented as interest revenue, but in an appropriate expense classification.²² This might be a separate line item titled, for example, ‘financial expenses on liquid short term assets’ or ‘other financial expenses’ or using another appropriate description. Alternatively, it could be appropriate to include within another expense line, for example, ‘other expenses’. Similarly, we believe negative interest on financial liabilities, which will represent a form of income, should not be offset against positive interest expense.

Additional line items, headings and subtotals should be presented on the face of the statement of comprehensive income (or income statement) when such presentation is relevant to an understanding of the elements of an entity's financial performance. Factors that should be considered include materiality and the nature and function of the components of income and expenses. For example, a financial institution may amend the descriptions to provide information that is relevant to the operations of a financial institution. [IAS 1.85, 86]. This may also be relevant where an entity recognises negative interest on financial assets or financial liabilities.²³

Any additional subtotals presented should: [IAS 1.85A]

• comprise line items made up of amounts recognised and measured in accordance with IFRS;
• be presented and labelled in a manner that makes the line items that constitute the subtotal clear and understandable;
• be consistent from period to period, as required by IAS 1 (see Chapter 3 at 4.1.4); and
• not be displayed with more prominence than the subtotals and totals required in IFRS for the statement(s) presenting profit or loss and other comprehensive income.

The following items should also be disclosed on the face of the statement of comprehensive income (or income statement) as allocations of profit or loss for the period: [IAS 1.81B(a)]

• profit or loss attributable to non-controlling interests; and
• profit or loss attributable to owners of the parent.

7.1.2 Further analysis of gains and losses recognised in profit or loss

As noted at 4.2.2 above, entities are required to disclose total interest income and total interest expense, calculated using the effective interest method, for financial assets and financial liabilities that are not at fair value through profit or loss. Whilst leases are included within the scope of IFRS 7, strictly they are not accounted for using the effective interest method (although for many leases the method prescribed in IFRS 16 results in a very similar treatment). Accordingly, where material, it appears that finance income (charges) arising on leases should be disclosed separately from the interest income (expense) disclosed above. In fact, it will sometimes be appropriate to include such items within the same caption on the face of the statement of comprehensive income (or income statement) and include a sub-analysis in the notes, albeit having regard to the restrictions on what may be presented within the separate line item containing interest revenue calculated using the effective interest method – see 7.1.1 above.

Dividends classified as an expense (for example those payable to holders of redeemable preference shares) may be presented either with interest on other liabilities or as a separate item. Such items are subject to the requirements of IAS 1. In some circumstances, because of the differences between interest and dividends with respect to matters such as tax deductibility, it is desirable to disclose them separately in the statement of comprehensive income (or income statement). [IAS 32.40].

The following gains and losses reported in profit or loss should also be disclosed:

• the amount of dividends recognised from equity investments designated at fair value through other comprehensive income, showing separately the amounts arising on investments derecognised during the reporting period and those related to investments held at the end of the reporting period; [IFRS 7.11A(d)]
• changes in fair value that relate to instruments at fair value through profit or loss (see 4.2.1 above).

  Little guidance is given on disaggregating gains and losses from instruments classified as at fair value through profit or loss. For example, the components of the change in fair value of a debt instrument can include:

  • interest accruals;
  • foreign currency retranslation;
  • movements arising from changes in the issuer's credit risk; and
  • changes in market interest rates.

    An entity is neither required to disaggregate, nor prohibited from disaggregating, these components on the face of the statement of comprehensive income (or income statement) provided the minimum disclosure requirements are met (e.g. see 4.2 above) and the restrictions on what may be presented within the separate line item containing interest revenue calculated using the effective interest method are followed (see 7.1.1 above). Accordingly, in our view the interest accrual component, say, of a financial liability may be included separately within an interest expense caption or it may be included within the same caption as other components of the gain or loss such as dealing profit. As noted at 4.1 above, whatever the entity's approach, it should be explained in its accounting policies; and

• the amount of exchange differences recognised in profit or loss under IAS 21 except for those arising on financial instruments measured at fair value through profit or loss. [IAS 21.52(a)].

In IAS 1 it is explained that when items of income and expense are material, their nature and amount are required to be disclosed separately. [IAS 1.97]. Circumstances that can give rise to separate disclosure include the disposal of investments [IAS 1.98] and the early settlement of liabilities. However, gains and losses should not be reported as extraordinary items, either on the face of the statement of comprehensive income (or income statement) or in the notes. [IAS 1.87].

7.1.3 Offsetting and hedges

IAS 1 explains that income and expenses should not be offset unless required or permitted by another standard. This is because offsetting detracts from the ability of users to understand fully the transactions, other events and conditions that have occurred and to assess the entity's future cash flows (except where it reflects the substance of the transaction or other event). [IAS 1.32, 33]. It goes on to explain that gains and losses on the disposal of non-current investments (such as many debt instruments measured at fair value through other comprehensive income) are reported by deducting the carrying amount of the asset and related selling expenses from the proceeds on disposal rather than showing gross proceeds as revenue [IAS 1.34] – in the case of debt instruments measured at fair value through other comprehensive income the profit or loss on disposal will also include any gains and losses that are reclassified from equity. It also explains that gains and losses arising from groups of similar transactions should be reported on a net basis, for example gains and losses arising on financial instruments held for trading or foreign exchange differences. The individual transactions should, however, be reported separately if they are material. [IAS 1.35].

Whilst IAS 32 prescribes when financial assets and liabilities should be offset in the statement of financial position (see 7.4.1 below) it contains no guidance on when related income and expenses should be offset. However, IFRS 9 is more prescriptive, specifying the following:

• if a group of hedged items in a cash flow hedge contains no offsetting risk positions and will affect different line items in profit or loss, the gains or losses on the hedging instrument should be apportioned to the line items affected by the hedged items when reclassified to profit or loss.

  This might be the case, for example, if a group of foreign currency expense transactions are hedged for foreign currency risk and those expenses will affect, say, both distribution costs and administrative expenses.

  The basis of apportionment between line items should be systematic and rational and not result in the grossing up of net gains or losses arising from a single hedging instrument; [IFRS 9.B6.6.13, B6.6.14]

• if a group of hedged items contains offsetting risk positions, i.e. a net position is hedged and the hedged risk affects different line items in profit or loss, the gains or losses on the hedging instrument should be presented in a line separate from those affected by the hedged items. Consequently, the line item relating to the hedged item will remain unaffected by the hedge accounting. [IFRS 9.6.6.4, B6.6.13].

  This would apply, for example, to a cash flow hedge of a group of foreign currency denominated sales and expenses. The hedging gains or losses would be presented in a line item that is separate from both revenue and the relevant expense line item(s). [IFRS 9.B6.6.15].

  Another example would be a fair value hedge of a net position involving a fixed-rate asset and a fixed-rate liability. Hedge accounting would normally involve recognising the net interest accrual on the interest rate swap in profit or loss. In this case the net interest accrual should be presented in a line item separate from gross interest revenue and gross interest expense.

  This is to avoid the grossing up of net gains or losses on a single instrument into offsetting gross amounts and recognising them in different line items. [IFRS 9.B6.6.16].

These requirements imply that gains and losses from hedging instruments in other hedging relationships would be presented in the same line item that is affected by the hedged item (at least to the extent the hedge is effective) rather than being shown separately, although this is not explicitly stated in IFRS 9.

7.1.4 Embedded derivatives

IFRS 9 explicitly states that it does not address whether embedded derivatives should be presented separately in the statement of financial position. However, the standard is silent about the presentation in profit or loss. [IFRS 9.4.3.4]. In practice, it will depend on the nature both of the hybrid and the host whether related gains and losses are included in the same or separate captions within profit or loss.

For example, a borrowing with commodity-linked coupons that is accounted for as a simple debt host and an embedded commodity derivative might give rise to interest expense and other finance income (or expense) respectively that would often be reported in separate captions within profit or loss. Alternatively, changes in the fair value of an embedded prepayment option in a host borrowing that is accounted for separately may be included in the same caption within profit or loss as interest expense on the host debt instrument if the value of the option varies largely as a result of change in interest rates.

7.1.5 Entities whose share capital is not equity

Gains and losses related to changes in the carrying amount of a financial liability are recognised as income or expense in profit or loss even when they relate to an instrument that includes a right to the residual interest in the assets of the entity in exchange for cash or another financial asset, such as shares in mutual funds and co-operatives (see Chapter 47 at 4.6). Any gain or loss arising from the remeasurement of such an instrument (including the impact of dividends paid, where appropriate) should be presented separately on the face of the statement of comprehensive income (or income statement) when it is relevant in explaining the entity's performance. [IAS 32.41].

The following example illustrates a format for a statement of comprehensive income (or income statement) that may be used by entities such as mutual funds that do not have equity as defined in IAS 32, although other formats may be acceptable.

Although it may not be immediately clear, the final line item in this format is an expense. Therefore the entity's ‘profit or loss’ (as that term is used in IAS 1) for 2020 is €2,312 – €47 – €50 – €2,215 = €nil.

The next example illustrates a format for a statement of comprehensive income (or income statement) that may be used by entities whose share capital is not equity as defined in IAS 32 because the entity has an obligation to repay the share capital on demand, for example co-operatives, but which do have some equity (such as other reserves). Again, other formats may be acceptable.

In this example, the line item ‘Finance costs – distributions to members’ is an expense and the final line item is equivalent to ‘profit or loss’.

Corresponding statement of financial position formats for both of these examples are shown at 7.4.6 below.

7.4.1 Offsetting financial assets and financial liabilities

It is common for reporting entities to enter into offsetting arrangements with their counterparties. Offsetting arrangements allow market participants to manage counterparty credit risks, and manage liquidity risk. In particular, netting arrangements generally reduce the credit risk exposures of market participants to counterparties relative to their gross exposures. Such mechanisms also permit the management of existing market risk exposures by taking on offsetting contracts with the same counterparty rather than assuming additional counterparty risk by entering into an offsetting position with a new counterparty. Furthermore, for a regulated financial institution, position netting may also have regulatory capital implications.

IAS 1 sets out a general principle that assets and liabilities should not be offset except where such offset is permitted or required by an accounting standard or interpretation (see Chapter 3 at 4.1.5.B). [IAS 1.32]. This general prohibition on offset is due to the fact that net presentation of assets and liabilities generally does not provide a complete depiction of the assets and liabilities of an entity. In particular, offsetting obscures the existence of some assets and liabilities in the statement of financial position and it impacts key financial ratios such as gearing, and measures such as total assets or liabilities.

IAS 32 provides some exceptions to this general rule in the case of financial assets and liabilities. IAS 32 requires a financial asset and a financial liability to be offset and the net amount reported in the statement of financial position when, and only when, an entity:

1. currently has a legally enforceable right to set off the recognised amounts; and
2. intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.

These two conditions are often called the IAS 32 Offsetting Criteria. There is, however, one exception to the offsetting requirement. This exception arises when a transferred financial asset does not qualify for derecognition. In such a circumstance, the transferred asset and the associated liability must not be offset, [IAS 32.42], even if they otherwise satisfy the offsetting criteria (see Chapter 52 at 5.5.1).

IAS 32 argues that offset is appropriate in the circumstances set out in (a) and (b) above, because the entity has, in effect, a right to, or an obligation for, only a single net future cash flow and, hence, a single net financial asset or financial liability. In other circumstances, financial assets and financial liabilities are presented separately from each other, consistently with their characteristics as resources or obligations of the entity. [IAS 32.43]. Furthermore, the amount resulting from offsetting must also reflect the reporting entity's expected future cash flows from settling two or more separate financial instruments. [IAS 32.BC94].

Offset is not equivalent to derecognition, since offsetting does not result in the financial asset or the financial liability being removed from the statement of financial position, but in net presentation of a net financial asset or a net financial liability. Moreover, no gain or loss can ever arise on offset, but may arise on derecognition. [IAS 32.44].

IAS 32 acknowledges that an enforceable right to set off a financial asset and a financial liability affects the rights and obligations associated with that asset and liability and may affect an entity's exposure to credit and liquidity risk. However, such a right is not, in itself, a sufficient basis for offsetting. The entity may still realise the asset and liability separately and, in the absence of an intention to exercise the right or to settle simultaneously, the amount and timing of an entity's future cash flows are not affected. Similarly, an intention by one or both parties to settle on a net basis without the legal right to do so is not sufficient to justify offsetting because the rights and obligations associated with the individual financial asset and financial liability remain unaltered. [IAS 32.46, AG38E].

IAS 32 elaborates further on the detail of the offsetting criteria as set out in the following subsections.

7.4.2 Offsetting financial assets and financial liabilities: disclosure

This section discusses the requirements of IFRS 7 introduced by the IASB in December 2011. These requirements are similar to requirements introduced into US GAAP by the FASB at around the same time and are intended to assist users in identifying major differences between the effects of the IFRS and US GAAP offsetting requirements (without requiring a full reconciliation). [IAS 32.BC77].

7.4.3 Assets and liabilities

IAS 1 does not prescribe the order or format in which items are to be presented on the face of the statement of financial position, but states that the following items relating to financial instruments, are sufficiently different in nature or function to warrant separate presentation: [IAS 1.54, 57]

• trade and other receivables;
• cash and cash equivalents;
• other financial assets;
• trade and other payables;
• provisions; and
• other financial liabilities.

IAS 1 does not list the loss allowance in respect of financial assets measured at amortised cost as an amount to be separately presented on the face of the statement.²⁵ Rather, it is an integral part of the amortised cost measurement. [IAS 1.33]. However, additional line items, headings and subtotals should be presented on the face of the statement of financial position when the size, nature or function of an item or aggregation of similar items is such that separate presentation is relevant to an understanding of the entity's financial position. Additional line items may also be presented by disaggregating the line items noted above. [IAS 1.55, 57(a)].

Any additional subtotals presented should: [IAS 1.55A]

• comprise line items made up of amounts recognised and measured in accordance with IFRS;
• be presented and labelled in a manner that makes the line items that constitute the subtotal clear and understandable;
• be consistent from period to period, as required by IAS 1 (see Chapter 3 at 4.1.4); and
• not be displayed with more prominence than the subtotals and totals required in IFRS for the statement of financial position.

The judgement on whether additional items are presented separately should be based on an assessment of: [IAS 1.58]

• the nature and liquidity of assets;
• the function of assets within the entity; and
• the amounts, nature and timing of liabilities.

The descriptions used and the ordering of items or aggregation of similar items may be amended according to the nature of the entity and its transactions, to provide information that is relevant to an understanding of the entity's financial position. For example, a financial institution may amend the descriptions to provide information that is relevant to the operations of a financial institution. [IAS 1.57(b)]. Consequently entities need not necessarily use categorisations that are the same as the measurement categories in IFRS 9, something that was stated explicitly in IAS 39.²⁶

However, the use of different measurement bases for different classes of assets suggests that their nature or function differs and, therefore, that they should be presented as separate line items. [IAS 1.59]. For example, financial assets measured at amortised cost would normally be presented separately from debt instruments measured at fair value through other comprehensive income, particularly by a financial institution.

As noted at 7.1.4 above, IFRS 9 explicitly states that it does not address whether embedded derivatives should be presented separately in the statement of financial position. [IFRS 9.4.3.4]. Although the guidance in the previous paragraph suggests that embedded derivatives will often be presented separately on the face of the statement of financial position, this will not always be the case, e.g. for the ‘puttable instruments’ shown in Example 54.21 at 7.4.6 below, which is based on IAS 32.

Further sub-classifications of the line items presented should be disclosed, either on the face of the statement of financial position or in the notes, classified in a manner appropriate to the entity's operations. [IAS 1.77]. The detail provided in sub-classifications will depend on the size, nature and function of the amounts involved and will vary for each item. For example, receivables should be disaggregated into amounts receivable from trade customers, receivables from related parties and other amounts. Assets included within receivables that are not financial instruments, such as many prepayments, should also be shown separately. [IAS 1.78(b)].

The presentation in the statement of financial position of liabilities arising from supply-chain financing arrangements is an area where particular judgement is necessary. This issue is discussed in more detail in Chapter 52 at 6.5.

7.4.4 The distinction between current and non-current assets and liabilities

For entities presenting a statement of financial position that distinguishes between current and non-current assets and liabilities, the requirements of IAS 1 for determining whether items are classified as current or non-current are dealt with in Chapter 3 at 3.1.1 to 3.1.4. This section deals with five interpretive issues that have arisen in applying those requirements to financial instruments.

7.4.5 Equity

IAS 1 explains that the face of the statement of financial position should include line items that present the following amounts within equity: [IAS 1.54(q), (r)]

• non-controlling interests, presented within equity; and
• issued capital and reserves attributable to owners of the parent.

As for assets and liabilities, additional line items, headings and subtotals should be presented on the face of the statement of financial position when such presentation is relevant to an understanding of the entity's financial position and additional line items may also be presented by disaggregating the line items noted above. [IAS 1.55]. Further sub-classifications of the line items presented should be disclosed, either on the face of the statement of financial position or in the notes, classified in a manner appropriate to the entity's operations. [IAS 1.77]. The detail provided in the sub-classifications will depend on the size, nature and function of the amounts involved and will vary for each item. For example, equity capital and reserves should be disaggregated into various classes, such as paid-in capital, share premium and reserves. [IAS 1.78(e)]. A description of the nature and purpose of each reserve within equity should also be provided. [IAS 1.79(b)].

For each class of share capital, the following information should be disclosed, either on the face of the statement of financial position or in the notes: [IAS 1.79(a)]

• the number of shares authorised;
• the number of shares issued and fully paid, and issued but not fully paid;
• par value per share, or that the shares have no par value;
• a reconciliation of the number of shares outstanding at the beginning and at the end of the period;
• the rights, preferences and restrictions attaching to that class including restrictions on the distribution of dividends and the repayment of capital;
• shares in the entity held by the entity or by its subsidiaries (treasury shares [IAS 32.34]) or associates; and
• shares reserved for issue under options and contracts for the sale of shares, including the terms and amounts.

An entity without share capital, such as a partnership or trust, should disclose equivalent information, showing changes during the period in each category of equity interest, and the rights, preferences and restrictions attaching to each category of equity interest, [IAS 1.80], (assuming of course it has actually issued instruments that meet the definition of equity).

Where puttable financial instruments and obligations arising on liquidation (see Chapter 47 at 4.6) are reclassified between financial liabilities and equity, entities are required to disclose the amount reclassified into and out of each category and the timing and reason for that reclassification. [IAS 1.80A]. This requirement was introduced by the amendments to IAS 32 and IAS 1 dealing with the classification of puttable financial instruments and obligations arising on liquidation.

7.4.6 Entities whose share capital is not equity

Continuing Examples 50.14 and 50.15 at 7.1.5 above, the following examples illustrate corresponding statement of financial position formats that may be used by entities such as mutual funds that do not have equity as defined in IAS 32, or entities such as co-operatives whose share capital is not equity as defined in IAS 32 because the entity has an obligation to repay the share capital on demand.

As for the equivalent income statement format, it may not be immediately clear what the final line item in this format represents. It is, in fact, a liability and therefore the entity's ‘equity’ (as that term is used in IAS 1) at the end of 2020 is €92,796 – €647 – €280 – €91,869 = €nil.

The line item ‘Share capital repayable on demand’ is part of the entity's liabilities and the items within ‘Reserves’ represent its equity.

Although not required by IAS 1, an entity adopting this type of format for its statement of financial position may choose to present an analysis of movements in (or reconciliation of) total members' interests (often defined as equity plus share capital repayable on demand, perhaps adjusted for other balances with members) if this is considered to provide useful information; this would not remove the need to present a statement of changes in equity.