4. Case Study
4.2. Cash Flow Characteristics Test
4.2.1. The Details of the Financial Assets as of 2013/12/31 and the Classification
instruments. IFRS 9 describes interests are consideration for the time value of money and credit risk associated with the principal outstanding during a specific period.
The company’s business model objectives are both to collect contractual cash flows and too sale; as a result, the debts that pass the cash flow characteristics test should be measured at FVTOCI.
4.2.1. The Details of the Financial Assets as of 2013/12/31 and the Classification Assessment
Table 3 is the summary of the cash flow characteristics analysis and the classification under IFRS9
Table 3: Asset Classification under IAS39 and and IFRS9
Asset Type Holding
Cash Flow Characteristics
Analysis
Classification under IFRS 9 Financial assets measured at fair value
through profit or loss
Derivatives:
Cross currency swaps 75,801 4.2.1.A FVTPL4
Forward exchange contracts 210,201 4.2.1.A FVTPL
Foreign exchange swaps 122,952 4.2.1.A FVTPL
Government Bonds 887,481 4.2.1.B. AC/5FVTOCI’6
Total 1,296,436 Available-for-sale financial assets
4 FVTPL: fair value through profit or loss
5 AC: amortized cost
6 FVTOCI’: fair value through other comprehensive income (cumulative fair value gains and losses recognized in OCI would be recycled to profit or loss upon derecognition)
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Stocks 200,375,331 4.2.1.C FVTOCI
Government Bonds 341,814,562 4.2.1B AC/FVTOCI’
Corporate Bonds 208,877,077 4.2.1.D AC/FVTOCI’
Financial bonds 8,696,974 4.2.1.D AC/FVTOCI’
Beneficiary certificate 153,461,970 4.2.1.E FVTPL
Asset securitization beneficiary 836,965 4.2.1.F FVTPL
Total 914,062,879 Financial assets carried at cost
Stock of non-listed companies 692,373 4.2.1.C FVTOCI7
Debt instruments without active market
Preferred stock 688,000 4.2.1.I FVTPL
Structured notes 1,030,280 4.2.1.N FVTPL
Asset securitization beneficiary 2,861,066 4.2.1.F FVTPL
Assets-backed securities(CDO) 1,305,255 4.2.1.L FVTPL
Corporate bonds 2,825,164 4.2.1.B A/CFVTOCI’
Financial bonds 8,378,562 4.2.1.D AC/FVTOCI’
Zero-coupon bonds 188,677,006 4.2.1.J AC/FVTOCI’
Negotiable certificates of deposit 1,136,100 4.2.1.M AC/FVTOCI’
Mortgage-backed securities(MBS) 30,498,163 4.2.1.K AC/FVTOCI’
Total 247,399,596
A. Derivatives
All derivatives are measured at fair value through profit or loss (FVTPL), unless they are qualified and are designated for hedge accounting. Since the accounting treatment of derivative is not different, all the derivatives of F Company should be measured at FVTPL
B. Government Bonds
In addition, the contractual cash flows of government bonds are solely the principal and interest, the interests are the time value of money and credit risk associated with the principal outstanding during a specific period. Thus, it pass the cash flow characteristics test
7 FVTOC: fair value through other comprehensive income (only dividend are recorded in profit or loss)
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C. Stocks
The equity investments are not held for trading, thus, the stocks should classified as be FVTOCI, and only recognize profit or loss when the Company has the right to receive dividends from invested companies.
D. Corporate and financial Bonds
i. The corporate and finance bonds would have no derivative embedded, otherwise the entire instrument would be measured at fair value through profit or loss, or the derivative shall be separated from the host contract (bond) and booked at fair value, according to IAS39.
ii. In market practice, the bond holders have prepayment option that protect the bond holders against credit deterioration of the issuer, or a change in control of the issuer; or the holder or issuer against changes in relevant taxation or law; and the prepayment amount substantially represent unpaid amounts of principal and interest, sometimes that include reasonable compensation for early termination. Under this circumstance, the debt instrument could still pass the cash flow characteristics test.
E. Mutual funds
The company mainly invested in equity funds. According to IFRS 9, equity instruments shall be measured at fair value, the value changes are recognized in profit or loss.
F. Asset securitization beneficiaries
The company only invested in REITs, it is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs
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meet the definition of equity instrument defined in IAS 32 paragraphs 16A and 16B or paragraphs 16C and16D (see Appendix 3); therefore, it shall be measured at fair value.
G. Derivative financial assets for hedging
The company has interest rate swaps as of December31, 2013. According to IFRS9, all derivatives shall be measured at fair value through profit and loss
H. Financial assets carried at cost
The company only has stock of non-listed companies, the equity investments are not held for trading, thus, the stock of non-listed investments should classified as be FVTOCI, and the company only recognized profit or loss when the Company has the right to receive dividends from non-listed companies.
I. Preferred stocks
Preferred stock can be exchanged for stock, also is host embedded derivatives. According to IFRS9, we should analyze the preferred stock in its entirely. The return of preferred stock is linked to the value of the equity of the issuer, thus, the contractual cash flows are not payment of principal and interest because the yield does not reflect only consideration for the time value of money and the credit risk.
J. Zero-coupon bonds
A zero-coupon bond is a bond that makes no periodic interest payments and is sold at a deep discount from face value. The buyer of the bond receives a return by the gradual appreciation of the security, which is redeemed at face value on a specified maturity date.
IFRS 9 describes interest as consideration for the time value of money and the credit risk
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associated with the principal outstanding during a particular period of time. The return of zero-coupon bonds represents the time value of money and the credit risk associated with the principal amount outstanding before redemption date.
Based on the above analysis, the contractual cash flows of zero coupon bonds shall pass cash flow characteristics test and are qualified for amortized cost accounting.
K. Mortgage-backed securities
The company mainly invested in agency pass-through securities with principal and interest guaranteed by a government sponsed agency. An agency reduces the risk of default to the pass-through holder by guaranteeing payment. According to the Q&A issue by Taiwan Account Research and Development Foundation, the government pass-through securities have no credit risk, in addition, based on the prospectus of MBS, the redemption price is 100% of the principal amount plus accrued interest, therefore, (see APPENDIX 1), the cash flow characteristic of the securities are payments of principal and interest on the principal amount outstanding only.
L. Assets-backed securities-- Collateralized debt obligation
A synthetic collateralized debt obligation (CDO) structure typically invest in highly rated bonds while also writing a credit default swap (CDS) over a portfolio of assets outside of the vehicle (SPE). The derivative neither reduces the cash flow variability of the portfolio of assets nor aligns the cash flows from the assets portfolio with those of the issued beneficial interest; the contractual flows are not solely the payment of principal and interest. (See APPENDIX 2)
M. Negotiable certificates of deposit
i. Negotiable certificates of deposit are fixed deposit receipts that can be sold in a secondary market. The terms related to this type of investment normally provide for
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interest payments to be applied every six months, up to the point that the security reaches maturity. Deposit interest, or the money paid as an incentive for saving or investing is calculated using a straightforward formula where the balance is multiplied by the percentage of the interest expressed as a decimal.
ii. Because a negotiable certificate of deposit can be sold repeatedly, an owner can choose to offer the asset on a secondary market as a means of generating quick cash in the event of an emergency.
iii. Based on the above analysis, the interest of NCD are the considerations for the time value of money and the credit risk associated with the principal amount outstanding during a particular period of time. Therefore, qualify for amortized cost accounting.
N. Structured Deposits
The deposit contracts are recorded at cost, and the interest revenue thereof is calculated at the normal market rate plus finance index (secondary market rate of commercial paper, London Inter-Bank offered Rate (Libor)), and Constant Maturity Swap (CMS).
Interest is defined in IFRS 9 as consideration for credit risk and the time value of money. The interest rate is the normal market interest rate plus financial index. It is clear that the contracture cash flow of the structured deposit could be more than insignificantly different than bench market cash flows (time deposit). It would not be qualified for amortized cost treatment.