Understanding Financial Instruments Under IFRS 9

For accounting and financial reporting purposes, revenue recognition isn’t the only IFRS standard that matters, financial instruments under IFRS 9 carry just as much weight. Contrary to what many assume, IFRS 9 affects a wide range of accounting services in Dubai and the UAE, not just banks and financial institutions.

A UAE company can face significant changes to its financial reporting because of this standard, particularly if it holds investments, long-term loans, or non-vanilla financial assets. That said, the impact isn’t limited to complex instruments, it can equally apply to a company holding nothing more exotic than short-term trade receivables.

Possible Effects of IFRS 9 on Financial Reporting

The main practical impacts of IFRS 9 include:

1. Increased Volatility in the Income Statement

More assets may need to be measured at fair value, with changes in that fair value flowing directly through the income statement rather than sitting on the balance sheet.

2. Earlier Recognition of Impairment Losses

Under the expected credit loss model, entities must provide for potential future credit losses on loans and receivables, including trade receivables, even where recovery of the asset is highly probable. This is a meaningful shift from the “incurred loss” approach used under the previous standard.

3. New Disclosure Requirements

IFRS 9 introduces a number of additional disclosure requirements, and entities most affected may need new systems and processes just to gather the underlying data.

4. New Classification Approach

IFRS 9 sets new parameters for classifying and measuring financial assets, based on both the characteristics of the asset’s contractual cash flows and the business model the entity uses to manage it.

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What Counts as a Financial Instrument

Common examples of financial assets include:

• Cash and cash equivalents
• Investments in equity securities
• Trade receivables and other accounts receivable
• Bonds and other debt investments held
• Contract assets recognized under IFRS 15
• Loans made to other parties

Common examples of financial liabilities include:

• Trade payables
• Loans and borrowings taken on by the entity
• Bonds and other debt issued to raise financing

Ordinary shares issued by the entity are an equity instrument from the issuer’s perspective, not a financial asset or liability, though the same shares are a financial asset in the hands of the investor holding them.

Classification and Measurement of Financial Assets

Accounting services in the UAE classify financial assets into one of three categories under IFRS 9, based on the business model test and the cash flow characteristics test.

The SPPI Test

Before assets can be classified, IFRS 9 requires checking whether the contractual cash flows are Solely Payments of Principal and Interest, commonly shortened to the SPPI test. Principal is the fair value of the asset at initial recognition. Interest is compensation for the time value of money and the credit risk on the outstanding principal, and can also include other basic lending risks such as liquidity risk and a reasonable profit margin. An asset only qualifies for amortized cost or FVOCI treatment if it passes this test.

#1: Amortized Cost

An asset is measured at amortized cost where the business model’s objective is to hold the asset to collect its contractual cash flows, and those contractual cash flows pass the SPPI test.

Assets in this category are subsequently measured at amortized cost using the effective interest method, net of impairment losses. Foreign currency translation gains and losses, interest income, and impairment losses are recognized in profit or loss, as are any gains or losses on derecognition.

#2: Fair Value Through Other Comprehensive Income (FVOCI)

An asset is measured at FVOCI where the business model’s objective is achieved by both collecting contractual cash flows and selling the asset, and the cash flows also pass the SPPI test. Changes in fair value are recognized in other comprehensive income rather than profit or loss, while interest income, impairment, and foreign exchange gains or losses are still recognized in profit or loss.

#3: Fair Value Through Profit or Loss (FVTPL)

Where an asset doesn’t meet the conditions for amortized cost or FVOCI, it defaults to FVTPL. This is effectively IFRS 9’s residual category. Net gains and losses, along with interest and dividend income, are all recognized in profit or loss.

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Classification Decision at a Glance

Category	Business Model Test	Cash Flow Test	Fair Value Changes Recognized In
Amortized Cost	Hold to collect contractual cash flows	Passes SPPI	N/A, measured at amortized cost
FVOCI	Hold to collect and sell	Passes SPPI	Other comprehensive income
FVTPL	Any other business model	Fails SPPI, or doesn’t fit the above	Profit or loss

Worked Example: Classifying a Corporate Bond

A Dubai company buys a corporate bond that pays fixed interest and returns the principal at maturity. Two scenarios illustrate how classification depends on intent, not just the instrument itself:

• Scenario A: The company’s treasury policy is to hold the bond to maturity and collect the coupon payments. The cash flows are fixed interest and principal only, so they pass SPPI. This bond is classified at amortized cost.
• Scenario B: The company holds a portfolio of similar bonds with a stated objective of both collecting coupons and selling bonds opportunistically to manage liquidity. The same SPPI-passing cash flows now sit within an FVOCI business model instead.

The instrument itself is identical in both cases, what changes the classification is the business model the entity actually applies to it, which is why documenting that business model matters for audit purposes.

Classification of Financial Liabilities

Financial liabilities are generally measured at amortized cost, with interest expense recognized in profit or loss using the effective interest method. A liability is measured at FVTPL instead where it is a derivative held for trading, or where the entity has designated it as such on initial recognition. For liabilities designated at FVTPL, one important exception applies: changes in fair value attributable to the entity’s own credit risk are recognized in other comprehensive income rather than profit or loss, to avoid an entity recording a gain simply because its own creditworthiness has deteriorated.

Reclassification Rules

Financial assets are not reclassified after initial recognition unless the entity changes the business model it uses to manage those assets. Where that happens, the reclassification applies prospectively, from the first reporting period following the change in business model, not retrospectively. Financial liabilities, by contrast, cannot be reclassified after initial recognition under any circumstances.

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Common Mistakes in Applying IFRS 9

• Classifying based on the instrument type alone. The same bond can sit in different categories depending on the entity’s business model, not the bond’s features by themselves.
• Underestimating expected credit losses on short-term receivables. Entities sometimes assume trade receivables are too low-risk to warrant an expected credit loss provision, even though IFRS 9 requires one regardless of how likely full recovery is.
• Not documenting the business model. Without a documented rationale, classification decisions are difficult to defend during an audit, particularly where a portfolio’s stated objective changes over time.
• Treating own credit risk gains on FVTPL liabilities as profit. These changes belong in other comprehensive income, not profit or loss.

Scope Notes

• IFRS 9 does not itself define what a financial instrument is, that definition sits in IAS 32 Presentation of Financial Instruments.
• IFRS 9 does not apply to an entity’s own issued equity instruments, such as its own issued warrants, shares, or written options on its own equity.
• IFRS 9 does apply to equity instruments issued by other entities, since these are financial assets from the holder’s perspective.
• IFRS 9 does not cover investments in subsidiaries, joint ventures, or associates, these fall under separate standards.

Frequently Asked Questions

What is the SPPI test under IFRS 9?

It’s the test used to check whether a financial asset’s contractual cash flows are Solely Payments of Principal and Interest. An asset must pass this test to qualify for amortized cost or FVOCI classification.

How many classification categories does IFRS 9 have for financial assets?

Three: amortized cost, fair value through other comprehensive income (FVOCI), and fair value through profit or loss (FVTPL).

Do trade receivables need an expected credit loss provision even if they’re low risk?

Yes. IFRS 9’s expected credit loss model requires a provision for potential future losses regardless of how likely full recovery currently appears.

Can a financial asset be reclassified after initial recognition?

Only if the entity changes the business model it uses to manage that class of assets, and the reclassification then applies prospectively from the next reporting period.

Can financial liabilities be reclassified after initial recognition?

No, financial liabilities cannot be reclassified under IFRS 9 once initially recognized.

Getting IFRS 9 Classification Right

Most IFRS 9 disputes during an audit don’t come from the standard itself, they come from a business model that was never documented clearly enough to defend the classification chosen. A corporate bond held to maturity and the same bond held for opportunistic trading look identical on paper, the only thing separating amortized cost from FVOCI or FVTPL is how the entity can actually demonstrate it manages the asset.

Best Audit Firms in Dubai can review how your financial instruments are currently classified and confirm the underlying business model documentation would hold up under audit scrutiny.