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39. Unless paragraph 44 applies, an entity shall classify financial assets as subsequently measured at amortised cost, fair value through other comprehensive revenue and expense or fair value through surplus or deficit on the basis of both:
(a) The entity’s management model for financial assets and
(b) The contractual cash flow characteristics of the financial asset.
40. A financial asset shall be measured at amortised cost if both of the following conditions are met:
(a) The financial asset is held within a management model whose objective is to hold financial assets in order to collect contractual cash flows and
(b) 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.
41. A financial asset shall be measured at fair value through other comprehensive revenue and expense if both of the following conditions are met:
(a) The financial asset is held within a management model whose objective is achieved by both collecting contractual cash flows and selling financial assets and
(b) 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.
42. For the purpose of applying paragraphs 40(b) and 41(b):
(a) Principal is the fair value of the financial asset at initial recognition. Paragraph AG64 provides additional guidance on the meaning of principal.
(b) Interest consists of consideration for the time value of money, for the credit risk associated with the principal amount outstanding during a particular period of time and for other basic lending risks and costs, as well as a profit margin. Paragraphs AG63 and AG67–AG71 provide
43. A financial asset shall be measured at fair value through surplus or deficit unless it is measured at amortised cost in accordance with paragraph 40 or at fair value through other comprehensive revenue and expense in accordance with paragraph 41. However, an entity may make an irrevocable election at initial recognition for particular investments in equity instruments that would otherwise be measured at fair value through surplus or deficit to present subsequent changes in fair value in other comprehensive revenue and expense (see paragraphs 106–107).
Option to Designate a Financial Asset at Fair Value Through Surplus or Deficit
44. Despite paragraphs 39–43, an entity may, at initial recognition, irrevocably designate a financial asset as measured at fair value through surplus or deficit if doing so eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an ‘accounting mismatch’) that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases (see paragraphs AG91–AG94).
45. An entity shall classify all financial liabilities as subsequently measured at amortised cost, except for:
(a) Financial liabilities at fair value through surplus or deficit. Such liabilities, including derivatives that are liabilities, shall be subsequently measured at fair value.
(b) Financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or when the continuing involvement approach applies. Paragraphs 26 and 28 apply to the measurement of such financial liabilities.
(c) Financial guarantee contracts. After initial recognition, an issuer of such a contract shall (unless paragraph 45(a) or (b) applies) subsequently measure it at the higher of:
(i) The amount of the loss allowance determined in accordance with paragraphs 73–93; and
(ii) The amount initially recognised (see paragraph 57) less, when appropriate, the cumulative amount of amortisation recognised in accordance with the principles of PBE IPSAS 9.
(d) Commitments to provide a loan at a below-market interest rate. An issuer of such a commitment shall (unless paragraph 45(a) applies) subsequently measure it at the higher of:
(i) The amount of the loss allowance determined in accordance with paragraphs 73–93; and
(ii) The amount initially recognised (see paragraph 57) less, when appropriate, the cumulative amount of amortisation recognised in accordance with the principles of PBE IPSAS 9.
(e) Contingent consideration recognised by an acquirer in a PBE combination to which PBE IPSAS 40 applies. Such contingent consideration shall subsequently be measured at fair value with changes recognised in surplus or deficit.
Option to Designate a Financial Liability at Fair Value Through Surplus or Deficit
46. An entity may, at initial recognition, irrevocably designate a financial liability as measured at fair value through surplus or deficit when permitted by paragraph 51, or when doing so results in more relevant information, because either:
(a) It eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as ‘an accounting mismatch’) that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases (see paragraphs AG91–AG94); or
47. An embedded derivative is a component of a hybrid contract that also includes a non-derivative host— with the effect that some of the cash flows of the combined instrument vary in a way similar to a stand- alone derivative. An embedded derivative causes some or all of the cash flows that otherwise would be required by the contract to be modified according to a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract. A derivative that is attached to a financial instrument but is contractually transferable independently of that instrument, or has a different counterparty, is not an embedded derivative, but a separate financial instrument.
Hybrid Contracts with Financial Asset Hosts
48. If a hybrid contract contains a host that is an asset within the scope of this Standard, an entity shall apply the requirements in paragraphs 39–44 to the entire hybrid contract.
Other Hybrid Contracts
49. If a hybrid contract contains a host that is not an asset within the scope of this Standard, an embedded derivative shall be separated from the host and accounted for as a derivative under this Standard if, and only if:
(a) The economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host (see paragraphs AG103 and AG106);
(b) A separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and
(c) The hybrid contract is not measured at fair value with changes in fair value recognised in surplus or deficit (i.e., a derivative that is embedded in a financial liability at fair value through surplus or deficit is not separated).
50. If an embedded derivative is separated, the host contract shall be accounted for in accordance with the appropriate Standards. This Standard does not address whether an embedded derivative shall be presented separately in the statement of financial position.
51. Despite paragraphs 49 and 50, if a contract contains one or more embedded derivatives and the host is not an asset within the scope of this Standard, an entity may designate the entire hybrid contract as at fair value through surplus or deficit unless:
(a) The embedded derivative(s) do(es) not significantly modify the cash flows that otherwise would be required by the contract; or
(b) It is clear with little or no analysis when a similar hybrid instrument is first considered that separation of the embedded derivative(s) is prohibited, such as a prepayment option embedded in a loan that permits the holder to prepay the loan for approximately its amortised cost.
52. If an entity is required by this Standard to separate an embedded derivative from its host, but is unable to measure the embedded derivative separately either at acquisition or at the end of a subsequent financial reporting period, it shall designate the entire hybrid contract as at fair value through surplus or deficit.
53. If an entity is unable to measure reliably the fair value of an embedded derivative on the basis of its terms and conditions, the fair value of the embedded derivative is the difference between the fair value of the hybrid contract and the fair value of the host. If the entity is unable to measure the fair value of the
embedded derivative using this method, paragraph 52 applies and the hybrid contract is designated as at fair value through surplus or deficit.
54. When, and only when, an entity changes its management model financial assets it shall reclassify all affected financial assets in accordance with paragraphs 39–43. See paragraphs 94–100, AG111– AG113 and AG220–AG221 for additional guidance on reclassifying financial assets.
55. An entity shall not reclassify any financial liability.
56. The following changes in circumstances are not reclassifications for the purposes of paragraphs 54–55:
(a) An item that was previously a designated and effective hedging instrument in a cash flow hedge or net investment hedge no longer qualifies as such;
(b) An item becomes a designated and effective hedging instrument in a cash flow hedge or net investment hedge; and
(c) Changes in measurement in accordance with paragraphs 152–155.