What Is A Financial Instrument According To IFRS 9
Being familiar with the basics of financial instruments valuation is integral for companies to complete their business valuation procedures and run a successful business.
However, it is not always easy to determine the best kind of business valuation methods except for companies that engage a professional accounting service in Malaysia.
In fact, even something as simple as “what a financial instrument is” has been debated for many years, which shows how hard these financial procedures are.
Therefore, it is important to analyze the concept of financial instruments in light of widely accepted standards, the International Financial Reporting Standards (IFRS).
What is IFRS 9?
IAS 39, Financial Instruments—Recognition and Measurement, was the previous standard that dealt with financial instruments.
However, it faced a lot of criticism for being too complicated and even inconsistent with the real-world working procedures of the corporations and the risks they faced.
For instance, its standards related to the recognition of credit losses on loans were not consistent with the actual credit cycles.
As a result, IFRS 9 was developed after comprehensive research and input from financial experts. It deals with impairment and hedging and classification and measurement of financial assets that also include financial instruments valuation.
Definition of Financial Instruments
Generally, a financial instrument is defined as a contract that gives rise to a financial asset of one entity and a financial liability of another entity.
By this definition, it can be deduced that financial instruments are principally financial assets, while financial liabilities and equity instruments are pieces of paper.
According to IFRS 9, an entity must recognize a financial asset or liability in its financial documents and statement to legally participate in the contractual provision related to the financial instrument.
Generally, when a financial instrument has to be recognized initially, the company is likely to do it on the basis of fair value. However, at later stages, different factors, such as transaction costs, also affect the financial instrument valuation procedures.
Types Of Financial Assets
There are two major types of financial assets:
- Equity Investments are typically the shares bought by a company. However, they don’t give much power to the investor to influence the company’s working procedures.
- Debt instruments are typically in the form of loan notes or bonds. They carry interest and a certain repayment schedule.
Classification of Debt Financial Instruments
Professional accounting services in Malaysia are well-familiar with the rules and regulations related to financial instruments and business valuation in Malaysia. As a result, when a company hires these services, they don’t have to worry about the complexities of the financial instruments.
Nevertheless, IFRS 9 has classified financial instruments into three major categories:
Financial instruments that are held by a business to collect contractual cash flows fall under the category of amortized costs. The business or the accounting firm managing it is responsible for recording the asset at cost and minimizing any accumulated amortization or impairment losses.
Moreover, changes in fair value should also be considered in terms of profit or loss, unless these changes are happening due to changes in credit risk.
Fair Value Through Other Comprehensive Income (FVOCI)
There are certain financial assets that an organization holds to collect contractual cash flow and sell at a later stage. These assets are classified in the FVTPL category.
Fair Value Through Profit or Loss (FVTPL)
The financial instruments classified under the FVTPL category are either meant for trading or they are selected at fair value on the basis of their initial recognition by the business.
Ultimately, the classification of a financial instrument is heavily dependent on the specific type of business model and the kind of assets it has.
Some companies can have only one type of financial instrument, while other corporations can have all types of financial instruments, so it greatly varies from company to company.
It is also important to note that if an entity changes its business model to manage financial assets differently and better, it will have to reclassify the financial assets that are affected by this remodeling process.
Being familiar with the definition and classification of financial instruments under the IFRS 9 is important because it affects businesses in many different ways. It has a significant impact on financial instrument valuation and overall business valuation in Malaysia.
Therefore, it is highly recommended that companies hire professional accounting services in Malaysia to deal with these complex financial procedures.