IFRS 9 Financial Instruments is the standard in International Financial Reporting Standards that governs how an entity accounts for financial assets and financial liabilities. It has three main parts: classification and measurement, impairment based on expected credit losses, and hedge accounting. It also carries forward the rules on when a financial instrument is recognised and removed from the statement of financial position.
The International Accounting Standards Board issued the standard in stages and completed it in July 2014. It has applied since 1 January 2018, replacing IAS 39. The replacement was prompted by the 2008 financial crisis, when the earlier standard was criticised for being complex and for recognising loan losses too late. IFRS 9 affects banks most, but applies to any entity holding receivables, loans, investments or derivatives. Presentation of instruments as debt or equity remains under IAS 32.
Classification and measurement
A financial asset is classified on initial recognition by two tests. The business model test asks how the entity manages the asset to generate cash flows. The contractual cash flow test asks whether the cash flows are solely payments of principal and interest on the principal outstanding, as they are for an ordinary loan or bond.
- Amortised cost. A debt instrument that passes the cash flow test and is held to collect contractual cash flows is measured using amortised cost accounting and the effective interest rate method.
- Fair value through other comprehensive income. A debt instrument that passes the cash flow test and is held both to collect cash flows and to sell is carried at fair value, with value changes held in equity and recycled to profit or loss on sale.
- Fair value through profit or loss. All other assets, including derivatives, most fund units and instruments with features such as leverage or links to equity prices, are measured at fair value with changes in profit or loss.
Equity investments are measured at fair value through profit or loss, unless the entity irrevocably elects at the outset to present value changes in other comprehensive income, in which case gains are never recycled. Reclassification of assets is permitted only when the business model changes.
Most financial liabilities are measured at amortised cost. Where a liability is designated at fair value, the part of the value change caused by the entity's own credit risk is presented in other comprehensive income, so that a deterioration in an entity's credit standing does not produce a profit.
Impairment
IFRS 9 replaced the incurred loss approach with an expected credit loss model that applies to assets at amortised cost, debt instruments at fair value through other comprehensive income, lease receivables, contract assets, loan commitments and financial guarantees. An allowance is recognised from the first reporting date, without waiting for evidence of loss. The model has three stages, described under staging under IFRS 9.
In stage 1 the allowance equals the losses expected from defaults possible within the next twelve months. If there has been a significant increase in credit risk since initial recognition, the asset moves to stage 2 and the allowance covers losses expected over its whole life. There is a rebuttable presumption that this has occurred when payments are more than 30 days past due. Stage 3 covers credit-impaired assets, for which lifetime losses are recognised and interest is calculated on the net amount. Estimates must be unbiased and probability-weighted and must reflect reasonable and supportable information about past events, current conditions and forecasts. For trade receivables without a significant financing component, a simplified approach always uses lifetime losses.
Hedge accounting
The hedge accounting chapter aligns the accounting more closely with risk management. The types of hedge are unchanged: the fair value hedge, the cash flow hedge and the hedge of a net investment in a foreign operation. More items may be designated, including risk components of non-financial items and net positions. The earlier numerical effectiveness test was replaced by a requirement that an economic relationship exists between the hedged item and the hedging instrument. Entities were given a choice to continue the hedge accounting rules of IAS 39, and a separate project on dynamic risk management of interest rate portfolios is continuing. General background is given under hedge accounting.
Effects and later amendments
On adoption, most banks reported higher allowances than under the old rules, and bank regulators introduced transitional arrangements for the effect on regulatory capital. Because allowances respond to forecasts, they rose sharply in early 2020 and were partly released later, which renewed debate about whether the model amplifies economic cycles. The model depends on estimates of probability of default and loss severity and on judgement about staging, which makes comparison between banks difficult.
Amendments in 2019 and 2020 provided relief for hedges and contract changes affected by the reform of interest rate benchmarks. Amendments issued in 2024, effective from 2026, address the settlement of liabilities through electronic payment systems and the assessment of loans with features linked to environmental or social targets. The US equivalent for credit losses requires lifetime expected losses for all assets from the start and has no staging. The mechanics of recording allowances are covered under impairment accounting, and an embedded derivative in a financial asset is no longer separated but assessed with its host as a whole.