AASB 9 Financial Instruments became effective for annual reporting periods beginning or after 1 January 2018 and replaced AASB 139 Financial Instruments: Recognition and Measurement.
Under AASB 9, equity investments are normally measured at fair value through profit or loss (FVPL). This is because equity investments do not generally meet the ‘solely payments of principal and interest’ test required for amortised cost classification. There is, however, one exception to this rule. Entities can, on initial recognition, make an irrevocable election to present subsequent changes in the fair value of an investment in an equity instrument in other comprehensive income. This option applies to equity instruments that are not held for trading and are not contingent consideration of an acquirer in a business combination. The election is available on an instrument-by-instrument basis.
Entities may find the fair value through other comprehensive income (FVOCI) designation appealing as subsequent gains and losses (including any related foreign exchange gains and losses) on these instruments are recognised in other comprehensive income and not profit or loss. Dividends that represent a return on investment (as opposed to a return of investment) continue to be recognised in profit or loss. Cumulative gains and losses recognised in other comprehensive income are never subsequently reclassified from equity to profit or loss – even on disposal of the investment – meaning there is no need to review such investments for possible impairment.
Importantly, not all investments in ‘equity’ instruments qualify for FVOCI designation under AASB 9. To be eligible for FVOCI classification, the term ‘equity instrument’ uses the strict definition in AASB 132 Financial Instruments: Presentation which states that an equity instrument is “any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities”.
Under AASB 132, certain narrowly-defined categories of puttable instruments, and instruments repayable on a pre-determined liquidation, are required to be classified by the issuer as equity instruments because of an exception to the general definitions of financial liabilities and equity instruments. These instruments, however, do not actually meet the definition of an equity instrument and therefore the related asset cannot be designated at FVOCI by the holder.
This mainly relates to limited-life entities which may be required to be wound up after a certain period of time. Such an entity’s limited life imposes an obligation, outside of the entity’s control, to distribute all its assets. Similarly, professional partnerships may be required to be dissolved on the death or retirement of a partner imposing a similar obligation on the partnership. Other entities that rely on the exceptions to the general definitions of financial liabilities and equity instruments to classify their issued instruments as equity are open-ended mutual funds, unit trusts and some co-operative entities. Such entities often provide their unit holders or members with a right to redeem their interests in the issuer at any time for cash, a feature that would otherwise require classification as financial liabilities.
On the first-time application of AASB 9, entities have the opportunity to make designations in accordance with AASB 9. This includes, at the date of initial application, any investment in a non-derivative equity instrument that is not held for trading and is not contingent consideration of an acquirer in a business combination that may be designated as at FVOCI. The date of initial application is the date when an entity first applies the requirements of the new standard, which is the beginning of the period in which it first reports under AASB 9, not the earliest period presented as comparatives. Such a designation should be made on the basis of the facts and circumstances that exist at the date of initial application, including whether equity-type investments meet the definition of equity instrument at that date and whether equity instruments meet the definition of held for trading as if they had been acquired at that date.