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Details on Recognition and derecognition IFRS 9

Recognition and derecognition IFRS 9

Recognition and derecognition IFRS 9: Derecognition of financial assets

The basic premise for the derecognition model in IFRS 9 (carried over from IAS 39) is to determine whether the asset under consideration for derecognition is: [IFRS 9, paragraph 3.2.2]

  • an asset in its entirety or
  • specifically identified cash flows from an asset (or a group of similar financial assets) or
  • a fully proportionate (pro rata) share of the cash flows from an asset (or a group of similar financial assets). or
  • a fully proportionate (pro rata) share of specifically identified cash flows from a financial asset (or a group of similar financial assets)

Recognition and derecognition IFRS 9: Once the asset under consideration for derecognition has been determined, an assessment is made as to whether the asset has been transferred, and if so, whether the transfer of that asset is subsequently eligible for derecognition.

An asset is transferred if either the entity has transferred the contractual rights to receive the cash flows, or the entity has retained the contractual rights to receive the cash flows from the asset, but has assumed a contractual obligation to pass those cash flows on under an arrangement that meets the following three conditions: [IFRS 9, paragraphs 3.2.4-3.2.5]

  • the entity has no obligation to pay amounts to the eventual recipient unless it collects equivalent amounts on the original asset
  • the entity is prohibited from selling or pledging the original asset (other than as security to the eventual recipient),
  • the entity has an obligation to remit those cash flows without material delay

Recognition and derecognition IFRS 9

IFRS 9 is an International Financial Reporting Standard (IFRS) promulgated by the International Accounting Standards Board (IASB). It addresses the accounting for financial instruments. It contains three main topics: classification and measurement of financial instruments, impairment of financial assets and hedge accounting. It will replace the earlier IFRS for financial instruments, IAS 39, when it becomes effective in 2018.

IFRS 9 began as a joint project with the Financial Accounting Standards Board (FASB), which promulgates accounting standards in the United States. The boards published a joint discussion paper in March 2008 proposing an eventual goal of reporting all financial instruments at fair value, with all changes in fair value reported in net income (FASB) or profit and loss (IASB).As a result of the financial crisis of 2008, the boards decided to revise their accounting standards for financial instruments to address perceived deficiencies which were believed to have contributed to the magnitude of the crisis.

The boards disagreed on several important issues, and also took different approaches to developing the new financial instruments standard. FASB attempted to develop a comprehensive standard that would address classification and measurement, impairment and hedge accounting at the same time, and issued an exposure draft of a standard addressing all three components in 2010. In contrast, the IASB attempted to develop the new standard in phases, releasing each component of the new standard separately. In 2009, IASB issued the first portion of IFRS, covering classification and measurement of financial assets. This was intended to replace the asset classification and measurement sections of IAS 39, but not supersede other sections of IAS 39. In 2010, IASB issued another portion of IFRS 9, primarily covering classification and measurement of financial liabilities and also addressing aspects of applying fair value option and bifurcating embedded derivatives.

Certain elements of IFRS 9 as issued were criticized by some key IASB constituents. The model for classifying debt instrument assets permitted only two approaches, fair value with all changes in fair value reported in profit and loss (FVPL), or amortized cost.This represented a significant deviation from FASB decisions, which would also have a category of fair value with certain changes in fair value reported in other comprehensive income (FVOCI). In addition to creating significant divergence with FASB, the lack of a FVOCI category would have been inconsistent with the accounting model being developed by the IASB for insurance contracts. There were also concerns that the criteria for qualifying for the amortized cost category were overly stringent and would force many financial instruments to be reported at fair value even though they could be appropriately accounted for at amortized cost. To address these concerns, IASB issued an exposure draft in 2012 proposing limited amendments to the classification and measurement of financial instruments.

Meanwhile, IASB and FASB worked together to develop a model for impairment of financial assets. IASB issued an exposure draft proposing an impairment model in 2013. FASB decided to propose an alternative impairment model. IASB was also developing its hedge accounting model independently of FASB, and issued that portion of the IFRS 9 standard in 2013. The final IFRS 9 standard, including hedge accounting, impairment, and the amended classification and measurement guidance, was issued on 24 July 2014.

Recognition and derecognition IFRS 9

Early evidence on the market reaction to the IFRS 9 in Europe suggests overall a positive response to the IFRS 9, although heterogeneities across countries exist.

As amended, IFRS 9 had four possible classification categories for financial assets, including a FVOCI classification for debt instruments. The classification is dependent on two tests, a contractual cash flow test (named SPPI as Solely Payments of Principal and Interest) and a business model assessment. Unless the asset meets the requirements of both tests, it is measured at fair value with all changes in fair value reporting in profit and loss (FVPL). In order to meet the contractual cash flow test, the cash flows from the instrument must consist of only principal and interest. Among the amendments to classification and measurement made in the 2014 update, de minimis and “non-genuine” features can be disregarded from the test, meaning that a de minimis feature would not preclude an instrument from being reported at amortized cost or FVOCI. However, equity instruments, derivatives and instruments that contain other than de minimis embedded derivatives would have to be reported at FVPL.

If the asset passes the contractual cash flows test, the business model assessment determines how the instrument is classified. If the instrument is being held to collect contractual cash flows, i.e., it is not expected to be sold, it is classified as amortized cost. If the business model for the instrument is to both collect contractual cash flows and potentially sell the asset, it is reported at FVOCI. For a FVOCI asset, the amortized cost basis is used to determine profit and loss, but the asset is reported at fair value on the balance sheet, with the difference between amortized cost and fair value reported in other comprehensive income. For any other business model, such as holding the asset for trading, the asset is reported at FVPL.

Recognition and derecognition IFRS 9

IFRS 9 retained most of the measurement guidance for liabilities from IAS 39, meaning most financial liabilities are held at amortized cost, the only change relating to liabilities that utilize the fair value option.For those liabilities, the change in fair value related to the entities own credit standing is reported in other comprehensive income rather than profit and loss.

IFRS 9 retained the concept of fair value option from IAS 39, but revised the criteria for financial assets.Under a fair value option, an asset or liability that would otherwise be reported at amortized cost or FVOCI can use FVPL instead. IFRS 9 also incorporated a FVOCI option for certain equity instruments that are not held for trading. Under this option, the instrument is reported at FVOCI similar to FVOCI for debt. However, this version of FVOCI does not permit “recycling.” Whereas when debt instruments using FVOCI are sold, the gain or loss on sale is “recycled” from other comprehensive income to profit and loss,for FVOCI equities the gain or loss is never reported in profit and loss, but rather remains in other comprehensive income.

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