Playing with financial instruments
CORINA D. MOLINA
Just like that, we are almost done with the first half of 2018. Time really does fly and definitely has no plans of taking a pit stop. Broadly speaking, this is the only way to go – either evolve and be a better version, or be stuck in monotony. As luck would have it for accountants and finance people, this is how accounting standards roll – constantly changing and progressing.
One of the new standards required to be adopted beginning January 1, 2018 was the Philippine Financial Reporting Standard (PFRS) 9, the standard for financial instruments. This was to replace the Philippine Accounting Standard (PAS) 39, Financial Instruments – Recognition and Measurement, to lessen the complexities for measuring and calculating for credit risk losses and to ease hedging requirements, among others. With PwC IFRS Reporting Insight and PwC Inform as references, the following summary shows the basic changes to keep in mind when accounting for financial instruments.
1. Classification and measurement
The main concept underlying the new standard is the fair value classification and measurement of financial assets, with changes recognized in profit and loss, unless certain criteria are met to justify the use of amortized cost or fair value through other comprehensive income (FVOCI).
Simply put, if the company’s objective for basic loans and receivables is “hold to collect” (i.e., contractual cash flows), the measurement will be at amortized cost. While FVOCI will be used for financial assets classified as “hold to collect and sell” (e.g. debt instruments up for sale if prices are advantageous), all other loans and receivables will be measured at fair value through profit and loss (FVPL).
2. Impairment
Impairment assessment for investments in equity instruments has been eliminated because these assets can now only be measured at FVPL or FVOCI without fair value changes to profit and loss. The election of the classification by the company is irrevocable and should be made at the start of the year.
3. The ECL model
The expected credit loss (ECL) model is introduced to recognize impairment losses for loans and receivables, including short-term trade receivables. The main idea of the model is to recognize impairment losses based on the assumption that the assets will default. Both historical and forward-looking information will play a key role in calculating impairment losses.
To emphasize, PFRS 9 provides that the maximum period over which expected impairment losses should be measured is the longest contractual period where a company is exposed to credit risk.
For example, loans and receivables that are payable on demand are likely to have these scenarios – either the borrower can pay if demanded today or he simply cannot settle. If he cannot settle the due and demandable amount of receivable, the loss that will have to be recognized will be calculated using considerations such as the expected manner of recovery and the recovery period. If he can repay the receivable upon demand by reporting date, the ECL is likely to be immaterial.
4. Intercompany loans
Intercompany loans that, in substance, are a company’s investment in a subsidiary are not within the scope of PFRS 9 but rather of PAS 27, Separate Financial Statements. Note that for an intercompany loan to form part of the investment in a subsidiary, the characteristics and terms must have the effect of an equity instrument (i.e. the borrower has no contractual obligation to repay the intercompany loan).
All other intercompany loans should be assessed for impairment based on the borrower’s liquidity status and terms (short-term versus long-term).
5. Hedge accounting
PFRS 9 provides ease on the hedging requirements and a broader range of hedging instruments, as it will allow the use of any non-derivative financial asset or liability measured at FVPL. Also, PAS 39 uses a threshold of about 80-125 percent to classify the hedge as effective. Under PFRS 9, hedge effectiveness is not measured by threshold, but rather by principle-based criteria.
We have only scratched the surface of PFRS 9, and obviously, we have more digging to do. Playing with financial instruments is not everyone’s cup of tea, which is perfectly normal. However, it will never be a good enough reason to entirely miss the impact assessment process and claim that PFRS 9 will not have a significant impact on the company’s financial statements. On the contrary, because financial instruments are regulars in the financial statements, PFRS 9 will surely make an impression.
The word on the street is that we still have time. It is not yet too late to start the assessment and not miss the chance to optimize financial reports and probable efficiencies and cost savings.
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Corina D. Molina is an assurance director at Isla Lipana & Co., a member firm of the PwC network. For more information, please email markets@ph.pwc.com. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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