CFM21840 - IFRS 9: classification of financial assets: Tests
For those entities applying IFRS or FRS 101 with a period of account beginning before 1 January 2018 refer to IAS 39 for the recognition and measurement of financial instruments at CFM 21520+
To determine the classification of a financial asset between:
- Amortised Cost
- Fair Value through Other Comprehensive Income (FVTOCI); and
- Fair Value through Profit or Loss (FVTPL).
A company must apply two tests:
- The business model test; and
- The contractual cash flow test.
Business Model Test
This test refers to how a company manages the financial asset in order to generate cash flows. A company’s business model is applied at a level that reflects how groups of financial assets are managed together to achieve a particular business objective. Therefore, the test does not depend on management’s intention for an individual asset. However, a company may have multiple business models for managing its financial assets.
A company determines if the cash flows will be generated by:
- Collecting contractual cash flows;
- Selling the financial asset; or
- Both collecting contractual cash flows and from selling the financial asset.
The assessment of the company’s intention with the financial asset is not based on a ‘worst case’ or a ‘stress case’ scenario but what management reasonably expects to occur.
The business model applied to the financial asset should not be merely an assertion, but be observable through the activities of the company. A company must consider all relevant evidence such as how the performance of the financial asset is reported to management, how the risks are managed and how management is compensated (linked to fair value or cash flows).
Financial assets that are held with the intention to be sold to generate cash flows are classified as FVTPL with no need to consider the Contractual Cash Flow Test.
For all other financial assets the company must apply the second test.
Contractual Cash Flow Test
Where the business model test determines the financial asset is held for collecting contractual cash flows or a mix of collecting contractual cash flows and selling the financial asset, the company must then apply the contractual cash flow test. This test requires a company to assess the characteristics of the cash flows expected from the financial asset.
The company must assess if the cash flows are expected on specified dates and are solely payments of principal and interest (‘SPPI’) on the principal amount outstanding.
SPPI is consistent with a basic lending arrangement. In a basic lending arrangement, consideration for the time value of money and credit risk are typically the most significant elements of interest. Contractual terms that introduce exposure to risks or volatility in the contractual cash flows that is unrelated to a basic lending arrangement, such as exposure to changes in equity prices or commodity prices, do not give rise to contractual cash flows that are SPPI. Financial instruments that include options, forwards or swap contacts are examples of instruments where the cash flows would not meet the definition of SPPI.
Where a financial asset is held to collect contractual cash flows only, and these cash flows are SPPI the asset is classified as amortised cost.
Where a financial asset is held to collect contractual cash flows, these cash flows are SPPI and the company expects to sell the asset to generate further cash flows, the asset is classified as FVTOCI.
All other financial assets (those where the cash flows do not represent SPPI) are classified as FVTPL.
Summary
The table below summarises the outcome and classification of financial assets when applying the two tests described above. Note some exceptions apply as detailed below the table.
| Business Model Test | Classification - Cash Flows represent SPPI | Classification - Cash Flows do not represent SPPI |
|---|---|---|
| Collect Contractual Cash Flows | Amortised Cost | FVTPL |
| Held to Sell (held for trading) | FVTPL | FVTPL |
| Mix of Collect Contractual Cash Flows and Held to Sell | FVTOCI | FVTPL |
Note a company may, on initial recognition, make an irrevocable decision to designate a financial asset as FVTPL when doing so reduces a measurement or recognition inconsistency (sometimes referred to as an accounting mismatch).
Note a company may, on initial recognition, make an irrevocable decision to designate that the fair value movements on certain equity instruments that would otherwise be measured at FVTPL, through Other Comprehensive Income.