Under IFRS 9, a financial asset is classified into one of three subsequent measurement categories based on two joint criteria: the entity's business model for managing financial assets, and the contractual cash flow characteristics of the financial asset itself.
The Dual Basis for Classification
An entity classifies financial assets as subsequently measured at amortised cost, fair value through other comprehensive income, or fair value through profit or loss, on the basis of both the entity's business model for managing the financial assets and the contractual cash flow characteristics of the financial asset.
Measurement at Amortised Cost
A financial asset is measured at amortised cost if both of the following conditions are met:
- The financial asset is held within a business model whose objective is to hold financial assets in order to collect contractual cash flows.
- 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.
Measurement at Fair Value Through Other Comprehensive Income
A financial asset is measured at fair value through other comprehensive income if both of the following conditions are met: the asset is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets, and its contractual terms likewise give rise to cash flows that are solely payments of principal and interest.
Measurement at Fair Value Through Profit or Loss
A financial asset is measured at fair value through profit or loss unless it is measured at amortised cost or at fair value through other comprehensive income under the two categories above; this category is effectively the default for any financial asset that does not meet the conditions of the other two, although an entity may make an irrevocable election to present subsequent fair value changes on particular equity investments in other comprehensive income.
Why This Classification Matters
The classification determines how changes in the value of a financial asset are presented — in profit or loss or in other comprehensive income — as well as the scope of the expected credit loss requirements that apply to it, which makes assessing the business model and the cash flow characteristics an essential step whenever a new financial asset is recognised in an entity's books.
Why Both Criteria Must Be Met Together
Meeting the contractual cash flow characteristics test alone is not enough to classify a financial asset at amortised cost; the entity must also hold it within the appropriate business model. An entity could hold two debt instruments with identical contractual terms, yet classify one at amortised cost because it holds that instrument to collect its cash flows to maturity, while classifying the other at fair value through profit or loss because it manages it within a portfolio held for active trading and short-term fair value gains.
Legal References
- IFRS 9 — Financial Instruments, paragraph 4.1.1 (the dual basis for classifying financial assets).
- IFRS 9, paragraph 4.1.2 (conditions for measurement at amortised cost).
- IFRS 9, paragraph 4.1.2A (conditions for measurement at fair value through other comprehensive income).
- IFRS 9, paragraph 4.1.4 (fair value through profit or loss as the other category).
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