AXCELASIA INSIGHTS Vol 2. 2018
Axcelasia is an integrated professional services group providing tax advisory, business consulting, enterprise management system applications and business process outsourcing services to public listed companies, private companies, multinational corporations and government-linked entities.
We are pleased to provide our insights on the implementation of MFRS 9 on Financial Instruments.
Malaysian Financial Reporting Standard (“MFRS”) 9 Financial Instruments - Are you ready?
Introduction to MFRS 9
As many of us are aware, MFRS 9 Financial Instruments was issued by the Malaysian Accounting Standards Board on 17 November 2014 and is effective for financial periods beginning on or after 1 January 2018 with early application permitted.
The new standard is applicable to all companies and not just financial institutions.
MFRS 9 sets the requirements for recognising and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items.
MFRS 9 replaces MFRS 139 Financial Instruments: Recognition and Measurement and is a reflection of IFRS 9 issued by the International Accounting Standards Board.
MFRS 9 introduces key changes in the following 4 areas:
a) Classification and measurement of financial assets;
b) Accounting for changes in own credit risk in financial liabilities;
c) Impairment; and
d) Hedge accounting
Nonetheless, certain principles in MFRS 139 are retained in the new standard such as the requirements on derecognition of financial assets and liabilities as well as classification and measurement of financial liabilities.
The presentation and disclosure requirements of financial instruments remain within the scope of MFRS 132 Financial Instruments: Presentation and MFRS 7 Financial Instruments: Disclosure respectively.
Revisions were also made to these standards in conjunction with the newly introduced MFRS 9.
Overview of key changes introduced by MFRS 9
a) Classification and measurement of financial assets
The two criteria applied in MFRS 9 to define the classification and measurement of financial assets are as follows:
MFRS 9 allows financial assets to be measured at amortised cost if the following criteria are met:
In a case where the financial assets meet the SPPI criteria and the business model of the entity is realised by collecting contractual cash flows and selling the financial asset, then the assets should be measured at fair value through other comprehensive income (“FVOCI”).
All other financial assets (including equity instruments and derivatives) will be measured at fair value through profit or loss (“FVTPL”).
Notwithstanding the abovementioned, an entity can always elect to classify a financial asset at FVTPL if doing so will minimise or eliminate a measurement or recognition inconsistency.
Similar to MFRS 139, MFRS 9 continues with the mixed measurement model (i.e. amortised cost, FVTPL or FVOCI) to account for financial assets. Nonetheless, the measurement basis is driven by different factors.
a) Classification and measurement of financial assets (cont’d.)
Business model assessment
It is essential to take note that it is possible to have the same type of instruments in all 3 categories of the business model depending on the model for managing the assets and thus, it does not depend on management’s intent for an instrument nor is it an accounting policy choice.
It is now moving towards how an entity is managed and information is provided to key management personnel.
b) Classification and measurement of financial liabilities
The classification and measurement of financial liabilities remain unchanged in MFRS 9 as it was in MFRS 139. The two measurement categories for financial liabilities being amortised cost and FVTPL still remains.
The amendment introduced is that MFRS 9 requires changes in fair value related to changes in own credit risk to be presented separately in OCI and not in profit or loss in the event an entity decides to measure its financial liability at FVTPL.
One of the most significant change introduced by MFRS 9 would be the impairment measurement model which is now known as the expected credit losses (“ECL”) model. It is a single impairment model to be applied for all financial instruments subject to credit risk.
Under MFRS 139, impairment was assessed differently based on how a financial asset was classified and measured which is disregarded in the new standard. MFRS 139 was also viewed and criticised as recognising impairment “too late”, as there had to be objective evidence of a credit loss event identified for an impairment to take place.
Under MFRS 9, an entity is required to estimate an expected loss which can be deemed as “day one loss”. A minimum impairment of 12-month ECL is required to be recognised at all times. There are 3 stages at which an entity will measure impairment losses at each reporting date which will be based on changes in credit quality. Impairment losses will be reversed if the credit quality improves.
The following diagram illustrates the 3 stages:
Source: The Edge Malaysia (September/2017)
Recognition of impairment considers a broader range under MFRS 9 as follows:
· Past events, for instance, experience of historical losses for similar financial instruments;
· Current conditions; and
· Reasonable and supportable forecast that affect the expected collectability of the future cash flows of the financial instrument.
Investment in equity instruments are no longer subject to impairment testing. Instead they are measured at FVTPL or FVOCI.
Measurement of the ECL model
Credit loss is the difference between the present value (“PV”) of cash flows that are due to an entity based on the contract and the PV of cash flows that the entity anticipates to collect. As ECL takes into consideration the amount and timing of payments, hence, a credit loss arises although the entity expects to be paid in full but later than the contractual due date. Probability weighted outcome and time value of money shall also be incorporated when calculating ECL.
Entities must consider reasonable and supportable forward-looking information (at an individual instrument level or collective level) in addition to historical loss from past events and current conditions as at the reporting date.
With that said, there is no need to ‘foresee’ the future as entities will use forward-looking information available at the reporting date without undue cost or effort.
ECL assessment can be assessed at an individual instrument or at a collective level (on a basis of shared credit risk characteristics) if by doing so identifies significant increase in credit risk on a timely basis.
There is a simplified approach – i.e. operational simplifications available for trade receivables, contract assets and lease receivables.
The simplification requires a lifetime ECL to be recorded when the financial asset is initially recognised and disregards the requirement to calculate 12-month ECL and assess when a significant increase in credit risk takes place.
Trade receivables without significant financing components shall apply the simplified approach (i.e. lifetime ECL is recognised from initial recognition) whereas trade receivables with significant financing components as well as lease receivables have the option in accounting policy of applying either the 3-stage approach or the simplified approach. The measurement will be in accordance to the selected approach.
d) Hedge accounting
MFRS 9 has addressed some of the criticisms raised in relation to the hedge accounting requirements of MFRS 139 which was criticised for containing complex rules and not being linked to common risk management practices making it difficult to achieve.
MFRS 9 has made hedge accounting a more principle based approach. Nonetheless, the requirements of formal documentation at the inception of the hedge relationship remains.
Key changes in hedge accounting requirements:
· Testing of hedge effectiveness – Requirement to establish an economic relationship between the hedged item and hedging instrument and for the hedged ratio to be equivalent to the one the entity actually uses for risk management purposes. This departs from the requirement of MFRS 139 for the hedge to be highly effective (i.e. ranging from 80% to 125%) for prospective and retrospective test which was criticised for being stringent.
· MFRS 9 allows risk components of non-financial items to be designated as hedged items on condition that that they separately identifiable and reliably measured. This would lead to even greater hedges qualifying for hedge accounting.
Implementation concerns and challenges
The following are potential concerns and challenges of implementing MFRS 9 depending on the complexity of the financial instrument:
· Impact assessment – assessing the financial impact upon adopting MFRS 9 at initial recognition and subsequent financial periods.
· Changes to system and processes – the necessity to gather forward-looking information and data analytics in determining the credit risk of the financial assets could most likely lead to changes in the system and processes.
· Significant judgements – the involvement of significant judgements in relation to assessing the business model and ECL could lead to changes in credit management strategies.
· Reassessment of strategies – reassessment of business strategies and staff KPIs as the new standard has a direct impact on trade receivables, thus, requiring reassessment to ensure goals and objectives remain achievable.
· Stakeholder expectation – the importance of managing stakeholder expectation in relation to the new standard’s requirement and impact to the Company.
Disclosures – the requirement of greater disclosures in the financial statements upon implementing the new standard would lead to additional time taken to prepare the financial statements and in ensuring accuracy of information. It could also lead to additional statutory audit fees.
Food for thought on MFRS 9
Forward-looking information will be challenging to obtain and involves a high degree of judgement. Thus, it is essential to obtain relevant expert’s advice prior to implementing MFRS 9.
Implementation costs such as system development costs could be significant. This might be unavoidable and fundamental in order to comply with the standard’s requirement. It is important to seek advice and quotes to assess potential costs to be incurred and involve your IT department from the early stage of the implementation.
The availability of skilled resources to manage the technical requirements of the new standard. It is fundamental that the finance team has undergone relevant focused training to comply with the requirements of MFRS 9 moving forward.
Fundamental areas of MFRS 9 such as risk management, assessment of business models and ECL involves judgement. It is essential to seek advice from experts to set the right basis moving forward.
The need to review business strategies. MFRS 9 can be used as a means to review and re-align business strategies as well as business models and risk management. Companies should leverage on this opportunity to analyse their product pricing and market positioning in an increasingly competitive industry.
How can Axcelasia help you?
· A comprehensive study focusing on issues of classification, measurement, presentation and disclosures required by MFRS 9;
· Diagnostics and impact analysis inclusive of proposed restatement of opening balance adjustments;
· To provide advice and support in making appropriate decisions where MFRS 9 requires careful use of judgment;
· To advice on the implementation of models, processes, systems and changes to internal controls to capture the information necessary to apply the new guidance (if required);
· To provide a white paper documentation on the implication and impact of MFRS 9 to your Company which can be used as a form of audit evidence and documentation;
· To assist in drafting the relevant applicable disclosures for the notes to accounts; and
· To provide in-house training/ briefing specifically catered to your nature of business (if required).
Should you have any queries with regards to the above, kindly contact:
+6016 287 4041
+6012 988 0400
Inc. (LL12218) | Suite 13A.02 Level 13A | Wisma Goldhill
| 67 Jalan Raja Chulan | 50200 Kuala Lumpur.