Narrow scope amendments proposed to AASB 9 to allow financial assets with prepayment options to be measured at amortised cost

Current position

Early prepayment of a financial asset before maturity can sometimes jeopardise the instrument being measured at amortised cost (if business model is ‘hold to collect’) or fair value through other comprehensive income (FVTOCI) (if business model is ‘hold to collect and sell’) because the settlement amount may include compensation other than solely payments of principal and interest (SPPI test).

AASB 9 Financial Instruments currently permits financial assets with early prepayment options to be measured at amortised cost or FCTOCI, if:

  • The business model is ‘hold to collect’, and
  • The contractual terms permit early repayment by either party before maturity, at an amount that represents substantially the unpaid amounts of principal and interest.

The early repayment may include a reasonable amount for additional compensation for the early termination of the contract.

What are the proposed changes?

Exposure Draft ED 279 Prepayment Features with Negative Compensation proposes a narrow scope amendment to AASB 9 to extend the exemption for early repayment to cases where compensation could be a variable amount (more or less than unpaid amounts of principal and interest), such as:

  • The instrument’s current fair value, or
  • An amount that reflects the remaining contractual cash flows discounted at the current market interest rate.

How did the proposed change come about?

The IFRS Interpretations Committee (the Interpretations Committee) was asked to clarify whether a debt instrument could meet the SPPI test if its contractual terms allowed early repayment on variable terms as described above.

In some cases, the lender could land up accepting substantially less than the unpaid amounts of principal and interest, which in effect means that the lender makes a payment to the borrower for early settlement (rather than the other way around) even though the borrower chose to terminate the contract early.

If current principles in AASB 9 were applied in this case, the SPPI test would fail, meaning that the instrument would be required to be measured at fair value through profit or loss rather than amortised cost or FVTOCI.

The Interpretations Committee recommended to the International Accounting Standards Board (IASB) that AASB 9 be changed so that such instruments could be measured either by amortised cost or FVTOCI, and the IASB have accordingly proposed these narrow scope amendments in this Exposure Draft.

When would these changes be effective?

The IASB is proposing that these changes will be effective at the same time as AASB 9, i.e. for annual periods beginning on or after 1 January 2019.

Comments due

There is only a 30 day comment period because the amendments are narrow in scope (they only impact entities holding prepayable financial assets), and urgent (there would be significant benefits to these entities if the amendments were finalised before the effective date for AASB 9).

Comments are therefore due to the Australian Accounting Standards Board by 17 May 2017 and the IASB by 24 May 2017.