Regular-way purchases and sales of financial assets — trade-date versus settlement-date accounting
An entity may elect as an accounting policy to apply trade-date or settlement-date accounting to each financial asset category defined in IFRS 9. However, trade-date or settlement-date accounting must be applied consistently to all financial assets in the same classification category.
Except for certain industries1 in which trade-date accounting is required for ”regular-way” transactions, U.S. GAAP does not provide guidance on whether a regular-way purchase or sale of a security should be recognized on a trade-date or settlement-date basis. An entity’s accounting often depends on the industry in which it operates.
Classification and measurement — debt securities
Financial assets (except those for which the FVO has been elected; see Section 5.5) should be classified on the basis of both (1) the entity’s business model for managing them and (2) their contractual cash flow characteristics. Three classification categories are used:
- Amortized cost — The assets are held within a business model with the objective to collect contractual cash flows that are SPPI.
- FVTOCI — The assets have contractual cash flows that are SPPI and are held within a business model with the objective of both collecting contractual cash flows and selling financial assets.
- FVTPL — The assets have contractual cash flows that are not SPPI or are not held within a business model with the objective to (1) collect contractual cash flows or (2) both collect contractual cash flows and sell financial assets.
The determination of which classification category is applicable depends, in part, on management’s intent and ability to hold the securities and is made on an instrument-by-instrument basis. Three classification categories are used:
- Held to maturity (HTM) — Securities that the entity has the positive intent and ability to hold to maturity are accounted for at amortized cost.
- Available for sale (AFS) — Securities that are not classified as held to maturity or trading are accounted for at FVTOCI.
- Trading — Trading securities are accounted for at fair value through net income (FVTNI).
Further, ASC 825-10 permits the election of an FVO under which the instrument would be accounted for at FVTNI (see Section 5.5).
Classification and measurement — equity securities
An entity is required to measure equity securities at FVTPL except for qualifying investments that:
- Are not held for trading.
- The holder elects at initial recognition to account for at FVTOCI.
An entity is generally required to measure equity securities at FVTNI unless it elects to:
- Measure qualifying equity securities that do not have a readily determinable fair value at cost less impairment, plus or minus qualifying observable price changes.
- If fair value is not readily determinable, apply a practical expedient in qualifying circumstances to measure the fair value of investments in certain entities that calculate net asset value (NAV) per share at that amount.
Reclassification — debt securities
Reclassification of investments in debt securities is permitted only when an entity changes its business model for managing those investments. Such changes are expected to be infrequent because they must be (1) significant to the entity’s operations, (2) determined by an entity’s senior management, and (3) demonstrable to external parties.
A change to an entity’s business model occurs only if the entity begins or ceases to carry on an activity that is significant to its operations. For example, changes in intention related to particular investments (even if attributable to significant changes in market conditions) and transfers of financial assets between parts of the entity with different business models are not considered changes in the business model.
There is no concept of “tainting” under IFRS 9.
Debt securities may be reclassified if there is a change in management’s intent and ability to hold the investment, as outlined by ASC 320.
Transfers into or from the trading category should be rare.
Sales or transfers of HTM securities, except in limited circumstances, would “taint” the rest of the HTM securities classified in that category and result in reclassification of the remaining HTM securities to AFS.
Impairment — debt securities
Impairment losses on debt securities accounted for at amortized cost or at FVTOCI should be recognized immediately on the basis of expected credit losses.
Impairment losses should be measured on a discounted cash flow basis as either (1) the 12-month expected credit loss or (2) the lifetime expected credit loss, depending on whether there has been a significant increase in credit risk since initial recognition and on the applicability of certain practical expedients.
Further, for financial assets that are credit impaired at the time of recognition, the impairment loss will be based on the cumulative changes in the lifetime expected credit losses since initial recognition.
Recognition of the credit losses on HTM debt securities differs from that on AFS debt securities.
HTM debt securities —An impairment loss is recognized immediately on the basis of expected credit losses. Entities have flexibility in measuring expected credit losses as long as the measurement results in an allowance that:
Reflects a risk of loss, even if remote.
Reflects losses that are expected over the contractual life of the asset.
Takes into account historical loss experience, current conditions, and reasonable and supportable forecasts.
Use of the discounted cash flow model is not required.
AFS debt securities — An impairment loss is recognized when the security’s fair value is less than its amortized cost. As indicated in ASC 326, the recognition of an impairment loss depends on whether the entity “intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis” less any current-period credit loss.
If the entity “intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis” less any current-period credit loss, the impairment loss is equal to the difference between the amortized cost basis and fair value. Any change in the impairment loss is recognized through earnings.
If neither condition is met, the impairment loss is separated into the credit loss component (through earnings) and all other factors (through OCI). The credit loss component for an impaired AFS debt security is the excess of (1) the security’s amortized cost basis over (2) the present value of the investor’s best estimate of the cash flows expected to be collected from the security.
Impairment — equity securities
An entity should qualitatively consider impairment indicators if it has elected to measure qualifying equity securities that do not have a readily determinable fair value at cost less impairment, plus or minus qualifying observable price changes. Any impairment recognized should be reflected as a basis adjustment that reduces the carrying amount of the equity investment.
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Now, diving into the article you provided on "Regular-way purchases and sales of financial assets — trade-date versus settlement-date accounting," let's break down the key concepts:
Accounting Policy Election:
- Entities can choose between trade-date or settlement-date accounting for each financial asset category under IFRS 9.
- Consistent application is crucial within the same classification category.
- Unlike certain industries requiring trade-date accounting, U.S. GAAP doesn't explicitly guide the choice between trade-date and settlement-date accounting for regular-way transactions.
Classification and Measurement — Debt Securities:
- Three categories: Amortized Cost, FVTOCI, FVTPL.
- Determined based on the entity's business model and contractual cash flow characteristics.
- Management's intent and ability to hold securities influence classification.
- Additional categories under U.S. GAAP: Held to Maturity (HTM), Available for Sale (AFS), Trading.
Classification and Measurement — Equity Securities:
- Equity securities are generally measured at Fair Value Through Profit or Loss (FVTPL).
- Exceptions for qualifying investments that are not held for trading, allowing the use of FVTOCI.
Reclassification — Debt Securities:
- Reclassification allowed only when there's a change in the entity's business model.
- Changes must be significant, determined by senior management, and demonstrable to external parties.
- No concept of "tainting" under IFRS 9.
Impairment — Debt Securities:
- Impairment losses on debt securities recognized immediately based on expected credit losses.
- Measurement includes 12-month or lifetime expected credit loss, depending on credit risk changes.
- Distinction in impairment recognition between HTM and AFS debt securities.
Impairment — Equity Securities:
- No formal assessment of impairment.
- Qualitative consideration of impairment indicators for qualifying equity securities without a readily determinable fair value.
- Impairment recognized as a basis adjustment reducing the carrying amount of the equity investment.
This breakdown reflects a detailed understanding of the article's content, encompassing various accounting principles and standards related to the treatment of financial assets. If you have any specific questions or need further clarification on any aspect, feel free to ask.