How financial instruments are classified and measured under IFRS 9 and ASC 320/825

Financial instruments include cash, investments, receivables, loans, and derivatives—essentially any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another. IFRS 9 (Financial Instruments) and US GAAP (ASC 320, 825, and related topics) govern how these instruments are recognized, classified, measured, and presented. Both frameworks require a mix of amortized cost and fair value measurement, depending on the entity’s business model and the characteristics of the instrument.

The objective is to ensure that financial statements reflect the economic substance and risk profile of financial assets and liabilities rather than their legal form alone.

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Classification categories under IFRS 9.

IFRS 9 classifies financial assets based on two criteria:

1. Business model for managing the asset (hold to collect, hold to sell, or both).

2. Contractual cash flow characteristics (whether cash flows are solely payments of principal and interest—SPPI test).

From these, three measurement categories arise:

Category	Business Model Objective	Measurement Basis	Income Recognition
Amortized Cost	Hold to collect contractual cash flows	Effective interest method	Interest income, expected credit loss (ECL)
Fair Value through OCI (FVOCI)	Hold to collect and sell	Fair value on balance sheet, unrealized gains in OCI	Interest and ECL in P&L
Fair Value through P&L (FVTPL)	Other (e.g., trading)	Fair value	All gains/losses in P&L

Example – bond held to collect and sell:FV = 1,050,000; amortized cost = 1,000,000 → unrealized gain 50,000 → OCI.Entry:

• Debit: Financial Asset – FVOCI 50,000

• Credit: OCI – Fair Value Gain 50,000

Equity investments may be irrevocably designated FVOCI, with fair value changes in OCI (no recycling to P&L).

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Classification categories under US GAAP.

US GAAP uses similar but not identical categories, primarily for debt securities:

Category	Definition	Measurement	Unrealized Gains/Losses
Held-to-Maturity (HTM)	Intent and ability to hold to maturity	Amortized cost	None recognized
Available-for-Sale (AFS)	Not held for trading or HTM	Fair value	OCI (until realized)
Trading	Held for short-term profit	Fair value	P&L

For equity securities, ASC 321 requires fair value through net income (FVTNI) unless the fair value option is elected or measurement alternative applies (cost less impairment + observable price changes).

Example – trading security (GAAP):

• Debit: Investment in Trading Security 1,000,000

• Credit: Cash 1,000,000

  
  

  End of period FV = 1,080,000 → gain 80,000 in P&L.

• Debit: Investment in Trading Security 80,000

• Credit: Unrealized Gain (P&L) 80,000

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Impairment under IFRS 9 (expected credit loss model).

IFRS 9 replaced the “incurred loss” model with a forward-looking expected credit loss (ECL) approach.

Stages of impairment:

1. Stage 1: Performing assets – recognize 12-month ECL.

2. Stage 2: Significant credit deterioration – recognize lifetime ECL.

3. Stage 3: Credit-impaired – recognize lifetime ECL, interest on net carrying amount.

Example:Loan 500,000; 12-month ECL = 1% = 5,000.Entry:

• Debit: Impairment Loss 5,000

• Credit: Allowance for ECL 5,000

If credit risk worsens and lifetime ECL = 25,000:

• Debit: Impairment Loss 20,000

• Credit: Allowance for ECL 20,000

Measurement inputs: probability of default (PD), loss given default (LGD), and exposure at default (EAD).

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Impairment under US GAAP (CECL model – ASC 326).

ASC 326 introduced the Current Expected Credit Loss (CECL) model for financial assets measured at amortized cost.Unlike IFRS 9’s staged model, CECL recognizes lifetime expected losses from initial recognition.

Example:Loan receivable 500,000; expected lifetime loss = 15,000.Entry:

• Debit: Provision for Credit Loss 15,000

• Credit: Allowance for Credit Losses 15,000

Subsequent changes in expectation are recognized immediately in P&L.

Key difference:IFRS 9 distinguishes between 12-month and lifetime ECL stages; US GAAP always uses lifetime expectations.

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Financial liabilities under both frameworks.

Aspect	IFRS 9	US GAAP (ASC 825, 815)
Default measurement	Amortized cost	Amortized cost
Fair value option	Allowed if reduces accounting mismatch	Allowed
Own credit risk	OCI (no recycling)	P&L (unless elected otherwise)
Derivatives & embedded features	Separated if not closely related	Same principle
Convertible debt	Split equity and liability (IAS 32)	Entirely liability unless BCF identified (ASC 470)

Example – amortized cost liability:Bond issued at discount 980,000, face 1,000,000, 5% coupon.Entry at issuance:

• Debit: Cash 980,000

• Debit: Bond Discount 20,000

• Credit: Bonds Payable 1,000,000

  
  

  Amortize discount over term via effective interest rate method.

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Hedge accounting under IFRS 9 and ASC 815.

Both frameworks align hedge accounting with risk management strategies but differ in eligibility and effectiveness testing.

IFRS 9:

• Expanded eligible hedged items (e.g., net positions, firm commitments).

• Relaxed 80–125% effectiveness threshold; qualitative assessment allowed.

• Allows rebalancing and partial discontinuation.

ASC 815:

• More prescriptive; 80–125% effectiveness test still applies.

• Requires formal designation and documentation at inception.

Example – fair value hedge of fixed-rate debt:

• Debit: Derivative Asset 40,000

• Credit: Gain on Hedge (P&L) 40,000

• Debit: Loss on Debt Revaluation 40,000

• Credit: Bonds Payable 40,000

Offsetting effects ensure net income neutrality.

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Comparative table: IFRS 9 vs US GAAP.

Area	IFRS 9	US GAAP (ASC 320/825/326)
Classification basis	Business model + cash flow test	Intent and ability (HTM, AFS, Trading)
Impairment model	Three-stage ECL (12-month / lifetime)	CECL (lifetime expected loss)
Equity investments	FVOCI option (no recycling)	FVTNI (through P&L)
Own credit risk	OCI	P&L
Embedded derivatives	Bifurcate if not closely related	Same
Reclassification	Only on business model change	Rarely permitted
Hedge effectiveness	Qualitative allowed	Quantitative required
Presentation of gain/loss	OCI and P&L split	OCI and P&L per classification

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Journal entries summary.

1) Purchase of bond (amortized cost):

• Debit: Investment in Debt Security xx

• Credit: Cash xx

2) Interest income (effective rate):

• Debit: Cash xx

• Credit: Interest Income xx

• Credit: Investment (amortization) xx

3) Fair value adjustment (FVOCI):

• Debit: Investment xx

• Credit: OCI – FV Adjustment xx

4) Expected credit loss:

• Debit: Impairment Loss xx

• Credit: Allowance for ECL xx

5) Sale of FVOCI asset:

• Debit: Cash xx

• Debit: OCI (recycling) xx

• Credit: Investment xx

• Credit: Gain on Sale xx

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Impact on financial performance and ratios.

Differences in classification and impairment directly affect:

• Earnings volatility: higher under fair value through P&L.

• Equity volatility: higher under FVOCI/AFS due to OCI movements.

• Leverage ratios: affected by fair value changes in liabilities.

• Credit quality metrics: sensitive to ECL/CECL provisioning models.

Analysts compare IFRS and US GAAP banks by adjusting for differing ECL vs CECL timings and OCI volatility.

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Operational considerations.

Entities must maintain:

• Robust classification documentation aligned with business models.

• Forward-looking credit loss modeling with macroeconomic overlays.

• Systems capable of tracking amortized cost, fair value, and OCI simultaneously.

• Governance for hedge designation and effectiveness testing.

IFRS 9 and US GAAP both aim to improve transparency and comparability in financial instruments, emphasizing credit risk awareness and alignment between accounting and risk management.

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