Accounting Rules And Impairment Of Financial Assets - IFRS 9 Essay

Recognition of financial assets

Discuss About The Accounting Rules Impairment Of Financial Assets.

IFRS 9 is a land mark regulation in the field of financial instruments, which was brought into effect from 1^stJanuary, 2018 after years of careful planning, execution and hard work. IFRS9 Financial Instruments aims to bring about a fundamental change in the accounting of financial instruments as it aims to replace the provisions of IAS 39(Ramirez, 2015).  With respect to the new rules and regulations of the new standards, quiet a number of decisions are required to be taken with respect to the transition into the new standards of accounting. In this transition, banking sector would be the most affected sector. There are three primary aspects of this new accounting standard, which are recognition, classification and measurement of financial assets, application of expected credit loss model to the different financial assets and hedge accounting. AASB 9 has successfully imbibed all the relevant provisions of the IFRS 9 (Nobes, 2013). Whether it is concerned with recognition or measurement of the different financial assets or liabilities or the hedging related issues.

Recognition of financial assets: For the initial recognition of the different financial assets of the company, IFRS 9 states that financial assets must be recognised in the in the statement of financial position or the balance sheet of the company, when and only when, the concerned business entity becomes a party to the contractual provisions of the instrument.

Recognition of financial liabilities: According to the different provisions of the IFRS 9, financial liabilities must be recognised in the statement of the financial position or the balance sheet of the company, when and only when, the concerned business entity becomes a party to the contractual provisions of the instrument (Pwc.com, 2018).

Recognition of equities: AS per the provisions of the IFRS 9, it has been seen and identified, that at the time of initial recognition of the equity instruments, a business entity might make an unchangeable election to present in the other comprehensive income statement all the relevant and subsequent changes in the fair value or the market value of the equity instruments, while remaining within the purview of the standards of the AASB 9, which shall neither be held for trading nor for the purpose of contingent consideration as recognised and identified by any acquirer in a business combination to which AASB 3 is applicable.

For the purpose of measurement of all the financial instruments as per the different provisions of the IFRS 9, it is required that all the different financial instruments need are required to be initially measured at their fair value or minus, especially in the case of financial asset or liability not being present in their fair value because of the presence of any kind of profit or loss or any other kind of transaction costs (Pwc.com, 2018). The subsequent measurement procedures as per the different provisions of the IFRS 9, for the different kinds of financial assets and financial liabilities have been provided below:

Recognition of financial liabilities

As per IFRS 9 provisions, the measurement of all the financial assets have been divided into two classifications: those which are to be measured at their amortised cost and those which are to be measured at their fair value. When the assets are to be measured at their fair value, the profits and the losses are either identified completely in profit or loss (fair value through the process of ‘fair value through profit or loss’) or recognised or identified in the section of the other comprehensive income (through ‘fair value through comprehensive income’). In the case of the debt instruments, the business model test and the cash flow characteristics test are used for the measurement purpose.  All the other debt instruments are to measured using the fair value option and all the equity instruments are to be measured as per the fair value procedures and are to be presented in the ‘other comprehensive income’

In accordance with the measurement of the financial liabilities of IFRS 9, it has been said that, basically IFRS 9 has not brought any kind of changes in the basic accounting model for the financial liabilities under IAS 39. Two specific measurement categories continue to exist, which are FVTPL and amortised cost. The financial liabilities which have been held for trading are measured at FVTPL and all other financial liabilities are measured at amortisation cost, unless and until the fair value option has been applied. In addition to this, there is also an option to assign a financial liability as measured at fair value through profit and loss.

QBE Insurance is an insurance based company. It is Australia’s global insurer. It mainly deals in providing insurance services to Australia, America, Asia Pacific as well as Europe. Being an insurance based company, it is required to deal with financial assets and liabilities on a day to day basis. Some of the prominent financial assets of the company include, cash and cash equivalents, Investments, derivative financial instruments, trade and other receivables, current asset taxes, deferred insurance costs and many others. In the liabilities section, there are many prominent liabilities of the insurance companies. Some of the financial liabilities of the company are trade and other payables, current tax liabilities, provisions, borrowings, equity share capital. The prominent financial assets and liabilities of QBE are as follows:

(Source: Balance Sheet of QBE for 2017)

• Trade receivables: Many times, in the normal course of business, a company sells goods and services on the basis of credit, expecting the debtor to pay the amount of credit sometime in the future. The insurance companies has $4906 amount of trade receivables for the year 2017, which was $4831 in the year 2016. AS per the provisions of IFRS 9, in case of initial recognition of trade receivables, they must be recognised at their transaction price, if they do not contain a significant financing component. In the case of IFRS 9, it must be said that the company must ensure that the financial assets must be measured at its fair value, unless it is measured at amortised cost (Onali and Ginesti., 2014). As most companies in the case of the trade receivables take into account the repayment of the principle amount and the payment of interest as well as other interests which might be levied on the outstanding amounts (Pwc.com, 2018).Thus it can be said that the measurement of the trade receivables of QBE are measured through at its amortised cost.

• Borrowings: They refer to the different kinds of loans and kinds of financial assistance which are received by the company or the business entity for various kinds of reasons such as expansions purposes, reinvestment purposes, for introducing new products and services or for the purpose of opening new branches or any other purposes. In the case of the insurance company QBE, there is no exception for the purpose of taking different kinds of borrowings. Borrowings mainly consists of different kinds of bank loans, senior as well as subordinated debt.  As per the provisions of IFRS 9, the recognition of the financial liabilities of the company including the case of borrowings must be done taking into account the different provisions of the IFRS 9. Here in this case, the borrowings as well as the other liabilities of the companies must be initially realised and recognised, when the business entity or the concerned comes in contact with the different contractual provisions of the concerned financial liability instrument (Gebhardt, Mora and Wagenhofer., 2014).In the case of the measurement of the financial liabilities be it borrowings or any other kind of financial liabilities of the entities, the measurement must be done at their fair value.As per the new standard, the borrowings of any company, be it an insurance company or any other one, it are required to be measured at the amortised cost.

According to the report published by Price Water Coopers, a significant amount of impact would be seen in the context of the assets of the company. It is not irrelevant in the case of the insurance company QBE. From the investor’s perspective, there would be variety of changes on the assets of the company and its financial statements. Due to the measurement of all the financial assets of the company being done in their face value, the transparency if the financial statements to the investors would be improved. The new standards and provisions of the IFFRS 9 has led to the decrease in the complexity, inconsistency and mismanagement of the resources, which had been invested by the investors. If the case of the insurance company of QBE is taken, it could be seen that the all the balances of the cash and cash equivalents, investments, trade receivables, insurance costs of deferred nature, investment properties and various other assets would be done at their fair value as per the measurement provisions of the IFRS 9 (Pwc.com, 2018). For example as mentioned above, trade receivables, the investors would be able to assess the amount of credit facilities and the amount of credit sales of the company.  This would bring in improved level of transparency in the company. This would help the investors in taking a fair amount of decisions while making any kind of investment in the company.

Recognition of equities

Liabilities is one of the most important aspects of the financial statements of any company and insurance companies like QBE is no exception to this. The impact of IFRS 9 on the liabilities of any company has been very significant. In accordance with all the provisions of the IFRS 9, all the equity instruments and the other liabilities of the company must be measured at their fair values in the statement of financial position of the company and all the changes in the value of the liabilities must be duly recognised and identified in the profit and loss. This would be done for all the equities except for those which have been decided by the company or the business entity to be shown in the ‘other comprehensive income’. It helps in measuring the recognised liabilities using the methods of ‘fair value through profit and loss’ approach and the amortised cost approach. This is of immense importance to the investors (Cairns., 2012). A true and fair representation of the liabilities of the company helps in assessing the true worth and the aggregate credit worthiness of the company. It brings in accurate valuation of the liabilities of the company. In addition to this, it helps the investors in understanding the dividend payment pattern and the rate of dividend payment for the company. It is of utmost importance to the investors, to know the amount of returns expected from the company.

In the example taken above, the borrowings are also an important financial instrument upon which the investors depend a lot for the purpose of estimating the credit paying capacity of the company. The investors want to invest in those companies which has a steady cash earning capacity and which regularly pays all its dues and borrowings.

The introduction of IFRS 9 will bring about a huge impact on the financial performance of various business entities. IFRS 9 would lead to a general shift from a prescriptive to a more principle-based approach. It would lead to the changes in the way financial assets are classified, recognised and measured based on their nature and how they are managed, changes to the impairment model based on expected rather than incurred credit losses, and a move to hedge accounting guidelines that are flexible in nature. Adopting the new expected credit loss (ECL) model would need companies to consider multiple, probability weighted scenarios and various macroeconomic factors in order to apply a forward looking approach. Credit losses will now be recognized initially, from the point a loan is issued, and will be based on the expectation of losses over the life of the instrument. The necessity for augmented judgment and exposé is an opportunity for the CFOs to explain their interpretation and strategy because it creates a necessity for more perspicacity and justification of assumptions. These changes create an occasion for the treasurers and CFOs to open a dialogue with the investors about how risk is managed in a company (Bloomberg Professional Services, 2018). In this way IFRS 9 would help in bridging the gap between accounting and risk management. Along with this, it would also help in improving the overall performance of the company.

The Debt-to-Equity ratio (D/E) helps in ascertaining the proportion of the company’s assets which are being financed through debt. It is a long term solvency ratio which indicates the reliability of the long-term financial policies of the company. The Debt to equity ratio of QBE is (Total liabilities/Shareholders’ Fund), which is (34,961/8859=3.49). This suggests that the company is overly dependent on the debt instruments for the purpose of raising its capital. As per the provisions of IFRS 9, it can be said that, the classification of a financial instrument as either a liability (debt) or equity can have a momentous impact on an entity's gearing (debt-to-equity ratio) and reported earnings. It can also affect the entity's debt covenants.

References:

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