Accounting for Derivatives. Ramirez Juan

cost of the liability at each accounting date is computed as follows:

1.2.2 Effective Interest Rate Calculation – Floating Rate Debt

      IFRS 9 does not specify how the EIR is calculated for floating rate debt instruments. The EIR of a floating rate instrument changes as a result of periodic re-estimation of determinable cash flows to reflect movements in market interest rates. Two approaches can be used to calculate the EIR in a floating rate debt instrument:

      • calculation based on the actual benchmark rate that was set for the relevant period; or

      • calculation using the method employed for fixed rate debt (i.e., estimating the EIR at the beginning of each interest period taking into account the expected interest rates in each future interest period).

      When the floating rate instrument is recognised at an amount equal to the principal receivable or payable on maturity, this periodic re-estimation does not have a significant effect on its carrying amount. Therefore, for practical reasons the first approach is used, and in such cases the carrying amount is usually not adjusted at each repricing date, because the impact is generally insignificant. According to this method, the interest income for the period is calculated as follows:

      Similarly, for floating rate debt liabilities, the following method is used to calculate interest expense for the period:

      The treatment of an acquisition discount or premium on a floating rate instrument depends on the reason for that discount or premium. For example:

      • When the discount (or premium) reflects changes in market rates since the last repricing date, it is amortised to the next repricing date.

      • When the discount (or premium) results from a change in the credit spread over the floating rate as a result of a change in credit risk, it is amortised over the expected life of the instrument.

      IFRS 9 does not prescribe any specific methodology for how transaction costs should be amortised for a floating rate instrument. Any consistent methodology that would establish a reasonable basis for amortisation of the transaction costs may be used. For example, it would be reasonable to determine an amortisation schedule of the transaction costs based on the interest rate in effect at inception. In my view, this approach also could be applied for a floating rate instrument recognised at amortised cost with an embedded derivative that is not separated (e.g., a floating rate bond with a cap). Another reasonable approach would be to linearly amortise the transaction costs over the life of the instrument.

      1.3 EXAMPLES OF ACCOUNTING FOR FIXED RATE BONDS

      Suppose that an investor bought, at a discount, a fixed rate bond with the following terms:

1.3.1 Example of a Fixed Rate Bond at Amortised Cost

      Let us assume that the bond was recognised at amortised cost, and that no impairments were recognised. The calculation of the effective interest rate was performed as follows (in EUR millions):

      EIR was 5.7447 %.

      The related accounting entries were as follows:

1.3.2 Example of a Fixed Rate Bond Recognised at FVOCI

      Let us assume that the bond was recognised at FVOCI, and that no impairments were recognised. Let us assume further that the fair value of the bond on 31 December 20X0 and 31 December 20X1 was EUR 97 million and EUR 101 million, respectively. The change in the bond's clean fair at each reporting date was:

      In order to account for the bond the investor had to keep track of both the bond's amortised cost and its fair value. The bond's amortised cost profile, which was identical to that in the previous example, determined the interest expense to be recognised at each period.

      Any difference between the bond's clean fair value (i.e., excluding accrued interest) and its amortised cost was recognised in the FVOCI reserve in OCI.

      The related accounting entries were as follows:

      1.4 ACCOUNTING CATEGORIES FOR FINANCIAL LIABILITIES

1.4.1 Financial Liability Categories

      A financial liability is any liability that is a contractual obligation to deliver cash or some other financial asset to another entity or to exchange financial instruments with another entity under conditions that are potentially unfavourable.

Under IFRS 9 there are only two categories of financial liabilities (see Figure 1.5): at amortised cost and at FVTPL. The following table summarises the accounting treatment of each category of financial liabilities:

Figure 1.5 IFRS 9 financial liabilities classification categories.

      The category of financial liabilities at FVTPL has two sub-categories: liabilities held for trading and those designated to this category at their inception using the FVO. Financial liabilities classified as held for trading include:

      • financial liabilities acquired or incurred principally for the purpose of generating a short-term profit (i.e., held for trading);

      • a derivative not designated in a cash flow or net investment hedging relationship, or the ineffective part if designated;

      • obligations to deliver securities or other financial assets borrowed by a short seller;

      • financial liabilities that are part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent actual pattern of short-term profit taking.

      The following instruments are measured under specific guidance in IFRS 9:

      • financial guarantee contracts; and

      • commitments to provide a loan at a below market interest rate.

1.4.2 Partial Repurchases of Financial Liabilities

      When an entity repurchases own financial liabilities, the repurchased part is derecognised. According to IFRS 9, “if an entity repurchases a part of a financial liability, the entity shall allocate the previous carrying amount of the financial liability between the part that continues to be recognised and the part that is derecognised based on the relative fair values of those parts on the date of the repurchase. The difference between (a) the carrying amount allocated to the part derecognised and (b) the consideration paid, including any non-cash assets transferred or liabilities assumed, for the part derecognised shall be recognised in profit or loss.”

1.4.3 Changes in Credit Risk in Financial Liabilities at FVTPL

      The amount of change in the fair value of a liability designated at FVTPL under the FVO that is attributable to changes in credit risk must be presented in other comprehensive income (OCI), unless:

      • Presentation of the fair value change in respect of the liability's credit risk in OCI would create or enlarge an accounting mismatch in profit or loss. In this case, the fair value change attributable to changes in credit risk must be recognised in profit or loss. This determination is made at initial recognition of the individual liability and will not be reassessed.

      The remainder of the change in fair value is presented in profit or loss.

      To determine whether the treatment would create or enlarge an accounting mismatch, the entity must assess whether it expects the effect of the change in the liability's