IFRS 9: 10 practical challenges for Treasurers
07 December 2016
With the EU having recently endorsed IFRS 9, we expect more and more companies to now start assessing the impact of the accounting standard for Financial Instruments. In our recent Treasury Talk video we explore accounting for financial instruments (IFRS 9), click here to watch. In this blog I examine the practical challenges Treasurers face during the preparation for IFRS 9.
On the whole, corporates are welcoming the hedging changes in IFRS 9. In particular:
- Hedge effectiveness testing has been made simpler with the removal of the 80-125% rule under IAS 39.
- For those hedging with options; the movement in time value is now deferred in other comprehensive income rather than creating income statement volatility.
However, having worked on IFRS 9 implementation projects with a number of clients, I thought I would share some areas that have proved challenging to help you with your own transition:
1. Whilst a lot of focus has been given to the hedging aspects of IFRS 9, it’s important to remember that there are new classification/measurement as well as impairment aspects to the standard. These will impact corporates with large portfolios of financial assets measured at amortised cost or fair value through OCI.
2. When assessing the impact of the new impairment requirements of IFRS 9, the ‘simplified’ approach or the use of practical expedients allowed by IFRS 9 may be helpful. These simplify the calculation of lifetime expected credit losses and the monitoring required to assess when, and to what extent, a significant increase in credit risk has occurred. However, for those assets with an initial maturity greater than one year (including trade and lease receivables) with a significant financing component, or not considered to be low credit risk, the more complex methods may be beneficial. Your analysis will need to consider whether you want smaller provisions but greater complexity, or simpler calculations with potentially larger lifetime provisions. Also don’t forget that intercompany loans in standalone accounts are not exempt from these requirements.
3. For those corporates with large investment portfolios and/or strategic equity investments, a significant factor influencing classification, measurement and impairment outcomes is the business model test. Failing to consider these requirements carefully can lead to undesired fair value measurement requirements or unexpected income statement outcomes. Any changes to business models and portfolio structures to minimise this impact should be effected before initial application of IFRS 9.
4. If you factor your receivables, consider the impact on the business model and whether receivables can still be held at amortised cost or fair value.
5. When hedging non-financial assets such as inventory, IFRS 9 allows you to hedge a component of the risk as long as it is separately identifiable and reliably measurable. This can be harder than it sounds. Also on transition, should you:
(a) retain the current designation, i.e. hedging the whole risk and accept potential ineffectiveness?; or
(b) re-designate a new hedge of the risk you really want to hedge but get ineffectiveness from non-zero starting fair values for the derivatives?
6. Where cross currency basis is included in the valuation of the hedging instrument (typically long dated FX forwards or cross currency interest rate swaps) this can now be excluded from the hedging relationship. However, from a practical and systems point of view this may be difficult to achieve.
7. IFRS 9 allows for hedging of net positions. On the face of it this is great news, however, the results of the hedging instrument need to be shown on a separate line in the income statement. Therefore, you can’t achieve your likely aim which was to show the positions at the hedged rate.
8. When hedging a non-financial asset such as inventory, a basis adjustment is mandatory whereby the inventory is adjusted to take into account the gain/loss on the derivative. For many companies, this will require updates to systems where the basis adjustment wasn’t previously applied.
9. When hedging movements in spot rate, for instance when hedging FX on cash flows where the timing is not exactly known, IFRS 9 now requires you to take into account discounting which was not the case with IAS 39. This may result in more ineffectiveness.
10. IFRS 9 does not allow hedges to be de-designated in a manner permitted by IAS 39 which some corporates have found to be restrictive. However careful construction and documentation of your risk management objectives and strategies can ensure that this does not cause hedge ineffectiveness or failed hedges.
So you can see that the implications are wider than just hedging, and you should start planning now to ensure you are prepared for adoption by January 2018. How far are you with your preparation? What challenges are you facing with the preparation? If you would like to discuss further on this topic please get in touch.