AS 39 is used for an in-depth analysis and dictation of the principles that measure financial assets and liabilities. It also recognizes what contractors would use for the transactions involving assets that are otherwise not financial. IAS 39 for financial instruments came to be as a result of the international accounting standards board. Ideally, a financial instrument is identified when a contracting party becomes allied to the provisions of the instrument at a given time. The IAS 39 comes into play as a measuring factor for the value of such an instrument. It classifies the instrument into the respective a category that is dependent upon what kind of instrument it is. The value and cost are then measured as per the category. It recognizes investments that are done at a fair value and determines what the fair value includes. The aspect of profit and loss plays a prominent role in the determination of the value of an investment. The control that it has over profit and loss, liabilities and assets enable it to measure and recognize the amount of debt that a party has.
IFRS 9 was introduced on the 24th of July in 2009. It serves as an effective replacement for IAS 39 and covers a number of issues. Introduced to solve the crisis in the financial world, it has made a number of notable improvements to what the former was doing. The functions that it has are embroidered on what IAS 39 was doing, but only on a larger scale. The improvements have been made in the classification and measurement of financial assets and liabilities in the sense that there has been the incorporation of the aspect of the expected loss. In this sense, economic entities are better equipped to foresee and sort the losses that may be encountered. One of the sure ways that IFRS 9 does so is through an impairment assessment financial model for assets. What happens is that it helps in the recording of losses that are foreseen and those that happen. IAS 39 had not embraced such a model that proves to be more efficient in handling the issue of losses. One of the functions or rather improvements that have been most notable of IFRS 9 is hedge accounting. Hedge accounting is responsible for hedge strategies that are essential for business entities.
The IFRS 9 works coherently with the firms to ensure that hedge accounting is used to its full effectiveness and potential. The improvement also came in through the disclosure of information to users regarding their finances, something that hedge accounting propels. Furthermore, it works through the proper delivery of information that is accrued to risk management. Risk management in business firms is more of a necessity and requires detailed information. Without the information on risk management, commercial entities are likely to incur many losses. The lack of such ability by the former is the reason for the famous financial crisis. Proper use of hedge accounting is the solution for the provision of the information needed for risk management. Therefore, IFRS 9 is mandatory for the proper execution of hedge accounting. It uses a highly endorsed model level for hedge accounting that enables it to be effective in the delivery of the issue of risk management. There are financial institutions that are too complex to figure out and require a high model for their measurement. What happened was that there were changes that were substantially made in the aspect of hedge accounting testing had a positive impact on the measurement of financial entities. One way the above is realized is through the use of an objective-based mode of testing. It is a way in which the relationship between the hedged item and an instrument is primarily focused. The relationship is a purely economic one and gives attention to the issue of credit risk.
In addition, it identifies the risks and measures them for non-financial instruments after they are classified accordingly. The work it does not just involve those things that are financial, but works for the delivery of other aspects of the business entity that are not financial. IFRS 9 recognizes that all aspects are responsible for the generation of either profit or loss, which is inclusive of all the costs that are used in hedging and measurement. Therefore, through its rigorous procedures, it covers all the financial things that a business entity can undergo. The changes that were brought about by hedging accounting in regard to costs are calculated in relation to the fair value in commercial entities. In this case, the changes that are experienced in fair value in an entity do not affect instruments, but are rather directly geared to profit and loss that has the same value as the costs of the transaction. Therefore, instead of the usual scenario of instruments being exclusively viewed in a financial scope, they are seen as the cause of the costs of hedging. What this does is it achieves totality in the measurement of profit and loss because all costs are considered. As a result, it provides big businesses such as banks with the proper estimation of the costs in which they are involved.
As a replacement of the IAS 39, IFRS 9 is here to simplify how things were done and adequately measure the aspects of profit and loss. The overall objective that the IASB body had can be identified in the introduction of AFRS is to improve the information available in finance through use of better disclosure. Such information is what would help in the measurement of risk and solve the financial crisis that most businesses experienced at the time. As a result of such replacement, business entities were asked to give a report on the credit and loss of any investments or lending of money in which they partake. They were required and given permission to use all the information that could be deemed relevant to the measurement of loss or profits. Such information would be ideal for an updated report of the financial activities in entities. The information was admissible of the past and included all the history that entities could gather on the transactions that they were involved in. The difference with what IAS 39 was doing can be traced in how it was basing conclusions on current information only. Besides, the replacement was paramount in giving ideas and estimating the loss for the future, something that was devoid of the former. Impairment losses in the case of the latter can now be measured based on all the previous activities. Prior to that, measurement was solely premised on an incurred immediate loss. An entity’s history is a good determinant of the likely events that will follow upon most of its transactions.
IFRS 9 replaced IAS 39 to ensure that the history is put into consideration so that more future damage can be avoided. What makes sense in all this has to do with the aspect of classification. Because of the proper classification of financial instruments, there is an effectiveness that has been witnessed in the measurement of impaired losses. The previous system left no room for the exploitation of the options that are available for the measurement of finances. The system was full of confusion because of the lack of proper and clear-cut classification of instruments in financial entities. The replacement has fully exploited the issue of classification. An example can be given where credit bonds are classified in the same category and measured by the same amount as was seen in the case of IAS 39 (Kansal, Sunil, 10). Much as credit bonds are the same, they have different amounts are accounted for in various forms of cash flow. Given the previous classification methods, it was hard to tell the difference and brought about a lot of confusion for financial entities. The new model would ensure that such cases do not occur through the proper analysis of instruments and classifying them into the different groups. Such an organized form of classification makes it easy for the measurement of instruments. Thus, the new model proves to be more effective in that sense.
Classification involves the determination of the measurement of accounting instruments in entities. It is the first phase that is required in IFRS 9. In this case, the determinants for where an instrument will be placed are dependent upon the cash flow it has and business model. All of the businesses have a different genre and nature of transactions that are considered before an asset is classified under its respective category. Because of the difference in models, the cash flow is likely to be different across the businesses. What happened is that the single based approach to classification was not practical, thus leading to classification that is principle-based in financial instruments. The method removes all the complexities that were previously associated with the classification of instruments. There are very organized categories where assets and liabilities are placed, and another well-defined category that is placed for non-financial instruments. How the financial assets and liabilities are categorized into their respective groups relies heavily on the issue of measurement and their nature. For instance, the cost of the instruments and how much they accrue profit or loss is imperative in classification. Financial assets are categorized according to their fair value that is determined by how much loss of profit they incur. Moreover, things such as loans, how the assets have matured in investments and whether or not they can be sold are necessary for classification. Much of the same case applies to classification that is based on financial liabilities. The unique factor here comes in with amortized cost. The reason is that it provides room for the classification of liabilities based on whether they are fit for trading or not.
Equity investments are determined when their holder is said to be in the scope of what an issuer considers to be equity. They are given the same definition as is the case with financial most instruments in IFRS 9. The presentation plays a paramount role in their classification. Investments in equity instruments in most instances are classified according to their fair value. The fair value, like is the case with financial assets and liabilities is measured according to the profit and loss that is found after measurement. Aside from profit or loss, other income is considered when investments in equity are made. Such income is referred to as other comprehensive revenue and serves as an option for the classification of equity investments. It, however, is restricted by some factors. For instance, it does not apply to those investments or instruments that are held for potential trading. The condition would not apply to equity investments that are subject to trade for another one. In addition, when the instrument is available for liquidation, an exception is made since new obligations come from such a situation. In this case, the issuer is free to classify the equity investment as appropriate. An addition to the classification of equity investments is derivatives. The issuer has the given right to classify them under equity investments if they meet their criteria.
Debt securities are classified under the measurement of amortized costs that an instrument accrues. The situation is made possible through by the existence of a business model that allows for the gathering and collection of contractual cash flows. The situation in the above sentence is one of the determinants of the classification of debt securities. Another situation is where an asset gives rise to the dates of cash flow, and payments are made on the interest of the amount that is outstanding. When these two situations are met, they give rise to the classification of assets under debt securities. Another occurrence is when an entity opts to designate a financial asset that would have been a cause for amortized cost. The cost would have been measured in accordance with the provisions of profit and loss calculations. When such occurs, an asset can be classified under debt securities. The choice to designate an asset is not advised but is given consideration when it eradicates the possibility of a mismatch in accounting. Otherwise, designation of an asset is not highly approved.
The recognition of a financial asset or liability is done on a balance sheet that an entity prepares. Ideally, a balance sheet reflects all the transactions that are done by an entity and enables it to point out to what constitutes a financial asset or liability based on the profit or loss that is accrued. The recognition can be done when both parties have adhered to the contractual obligation that that they are given. Once classified, the instruments undergo measurements. Classification is what stirs measurements.
One of the profound merits of IFRS 9 is that banks can account for debts that have gone bad earlier than anticipated. It increases on the loan as seen in balance sheets by a significant percentage. Thus, entities spare money that will be pumped into future losses. The losses can be covered with the entities that have the opportunity of rectifying mistakes. This was not available in all the other models but is a great advantage to all loan issuers. They can assess loans that have gone bad way before the stipulated time and hence be able to avoid the loss. Being able to prepare for loss is the biggest advantage that any business possesses, and IFRS helps in realizing that. Through such anticipation, business entities such as banks incur less loss. It presents a lesser risk of losing money with no hope for any form of recovery or salvation as was the case in IAS 39.
IFRS 9 is better because it is an improved version that seeks to attract more investors into the financial business. Investors can now flock the industry because there is an assurance of the safety of their money. They are more capable of making fearless financial investment decisions that will be beneficial to the industry. The bank businesses heavily rely on investors who provide it with the necessities that they use for their growth. In fact, the famous financial crisis in businesses was propelled because investors withdrew, and potential ones were too scared to make a move. The new model, therefore, made it easy for investors to flock the industry and take it back to better heights.
The simplicity under which the model operates also makes it ideal for financial institutions top use it. It is organized and makes the work of measurement and classification simple for many commercial entities to operate.
However, it is not devoid of misgivings. The model gives a lot of power to the entities, which can be dangerous. They are too free to choose what they deem is fit and classify transaction in their accounts. With such an open method, there is room for manipulation that can be used for the wrong purposes. A good degree of control over what the companies should do is appropriate. However, the new model lacks this amount of control thus giving leeway for bad decisions that affect other people in the industry.
The implementation process has been difficult for a new model. Businesses are still rooted in the old model and would require vast resources for the new one to be effective for them. Sadly, not all of them have the resources that are needed for the full implementation of the model. The small entities, especially, have a significant challenge of implementation. It requires money and lots of training; something that they do not have.
Kansal, Sunil K. Ifrs 9 - Understanding Financial Instruments and Their Accounting. S.l.: John Wiley & Sons Inc, 2014. Print.
"IFRS 9 - a Milestone in the World of Financial Reporting - See More At: Http://economia.icaew.com/finance/august-2014/ifrs-9-financial-instruments-a-milestone-in-the-world-of-financial-reporting#sthash.sphkyiue.dpuf." Economa. 4 Aug. 2014. Web. <http://economia.icaew.com/finance/august-2014/ifrs-9-financial-instruments-a-milestone-in-the-world-of-financial-reporting>.