FINANCIAL INSTRUMENTS: CLASSIFICATION

Classification of financial assets

Under IFRS 9 Financial instruments, financial assets can be classified into four categories as follows:

• Measured at amortised cost
• Measured at fair value through profit or loss (FVTPL)

• Measured at fair value through other comprehensive income (FVTOCI)
• Measured at cost

Measured at amortised cost

This category is for financial assets that meet the following conditions:

(a) The asset is held within a business model whose objective is to hold assets in order to collect
     contractual cash flows; and

(b) The contractual terms of the financial asset give rise on specified dates to cash flows that are
     solely payments of principal and interest on the principal amount outstanding.

The two conditions above are also known as the 'business model test' and the 'cash flow test'.

In order to pass the business model test, the entity's objective must be to hold the financial asset to collect monthly or yearly payments from it, rather than to sell it to make profits.

On the other hand, in order to pass the cash flow test, the cash flows received from the financial asset must comprise payment of principal and interest and are received on specified dates.

Equity instruments such as investments in equity shares cannot be classified into this category as they do not pass the business model and cash flow tests. This is because they do not give rise to contractual cash flows. The only cash flows arising from investments in equity shares is dividends. However, an entity has no obligation to pay dividends to the shareholders. Even if so, the dividends do not constitute payments of capital and interest.

Therefore, only debt instruments such as investments in bonds and loans may qualify for this category. For instance, an entity purchases a bond with the objective of holding the financial asset until maturity. At the end of each year, the bond issuer makes payment of principal and interest to the entity until the bond is redeemed. This financial asset passes both the business model and cash flow tests.

Measured at FVTPL
This category is for financial assets that do not pass the business model and/or the cash flow test above. In other words, this is the default category for financial assets.

An entity can also make an irrevocable election to classify financial assets into this category if doing so results in more relevant information in its financial statements.

Measured at FVTOCI
This category is only for investments in equity instruments that are not held for trading (i.e. not for sale) that an entity has elected to classify them as such. Such an election is irrevocable.

For example, an entity has purchased shares in another company as trade investments and decided to keep the shares for a very long time. In this case, the financial asset can be classified as measured at FVTOCI if the entity elects to do so.

Measured at cost
This category is for investment in unquoted equity instruments that cannot be reliably measured at fair value.

As these shares are not traded on an exchange, it can sometimes be difficult to determine their fair values. As such they are simply measured at cost.

Classification of financial liabilities
Financial liabilities can be classified into two categories as follows (note that financial liabilities is still governed by IAS 39 Financial instruments: recognition and measurement):

• Measured at fair value through profit or loss (FVTPL)
• Measured at amortised cost

Measured at FVTPL
This category is for financial liabilities that are held for trading. For example, financial liabilities that are incurred with an intention to repurchase them in the near term or obligations to deliver financial assets borrowed by a short seller.

An entity can also make an irrevocable election to classify financial liabilities into this category if doing so results in more relevant information in its financial statements.

Measured at amortised cost
This is the default category for financial liabilities, i.e. financial liabilities that are not classified as measured at FVTPL are included in this category. Examples include trade payables, debt instruments issued and deposits received from customers.

The classification of financial assets and liabilities can be summarised as follows:

Financial assets 

	Classification	Characteristics
(i)	Measured at amortised cost	These are financial assets that pass the business model and cash flow tests. Equity instruments cannot be classified in this category as they do not give rise to contractual cash flows on specified dates.
(ii)	Measured FVTPL	These are financial assets that do not meet the above conditions or are elected to be classified in this category because doing so results in more relevant information. Such an election is irrevocable.
(iii)	Measured at FVTOCI	These are investments in equity instruments not held for trading that the entity has elected to be classified in this category. Such an election is irrevocable.
(iv)	Measured at cost	These are investments in unquoted equity instruments that cannot be reliably measured at fair value.

Financial liabilities

	Classification	Characteristics
(i)	Measured at FVTPL	These are financial liabilities held for trading or elected to be classified in this category because doing so results in more relevant information. Such an election is irrevocable.
(ii)	Measured at amortised cost	This category is the default category and includes trade payables, debt instruments issued and deposits received from customers.