Investment funds: Changes in the reporting of financial instruments in accordance with IFRS

At the end of this year, not only investment funds, but also several other types of entities (investment companies, securities dealers, pension companies and their funds) in the Czech Republic will have a transitional period that may be used to become acquainted with the new accounting standards.

The amendment to Decree No. 501/2002 Coll. changes the method of reporting, valuating and presenting information on financial instruments (for definitions, see IFRS). The procedures to be followed by investment companies and their funds from 2021 onwards are based in particular on IFRS 9 Financial Instruments, then IAS 32 Financial Instruments: Presentation and IFRS 7 Financial Instruments: Disclosures. Below are the most important changes introduced by the amendment to the decree.

IFRS 9 Financial Instruments

Financial assets

According to IFRS 9, financial assets are divided according to the purpose of holding and the type of future cash flows from this asset into three basic categories, which differ in the approach to their valuation. The decisive factor for the correct classification of a financial instrument is not its legal form.

It follows from the above that entities will need to reassess the classification of their portfolios or parts of them and subsequently their valuation.

Capital financial assets are classified and measured in the FVPL category unless the entity selects the FVOCI category. However, accounting for revaluation to equity is not permitted for financial assets held for trading. Therefore, there will be no change in accounting for capital assets held for trading with the transition to IFRS 9. Revaluation differences after the introduction of IFRS 9 may arise, for example, for interests with significant or decisive influence, for which the revaluation is recognised in equity by the end of 2020 and it will be possible to decide next year whether the revaluation will be recognised in equity or in the economic results of the respective period.

Financial commitments

Financial liabilities, such as trade payables, borrowings and loans, are measured at amortised cost (AC) in accordance with IFRS 9. For example, fair value measurement has so far been applied to loans used in investing activities, and in the case of non-investment loans (e.g. for an investment company) the residual value.

Other liabilities are remeasured to fair value with an impact on profit or loss (changes in fair value resulting from changes in market variables, e.g. derivatives) or with an impact on other comprehensive income (changes in fair value resulting from changes in the entity's credit risk). In the case of revaluation to fair value, it will be necessary in practice to distinguish the effect of credit risk and market risks due to their different accounting for the relevant financial liabilities.

IAS 32 Financial Instruments: Presentation

A key factor in distinguishing between a financial liability and an equity instrument is whether the entity has a contractual obligation to deliver cash (or to deliver another financial instrument). In practice, this may mean that issued investment instruments will be included in financial liabilities if the above condition is met. Investment shares that are associated with the owner's right of redemption by the fund and do not involve the voting right at the general meeting of the fund will be newly reported as part of the entity's external resources.

The classification of issued securities will also affect the reporting of accounting cases related to the issued security (interest, dividends, profits and losses). For financial liabilities, the related accounting cases are accounted for in the income statement. The situation is different for equity instruments, where they are accounted for in equity. The dividend paid out from the issued investment instrument, which meets the conditions for classification as financial liabilities, will no longer reduce the net assets, but the profit or loss of the company.

Expected loss model

The essence of the model is to reflect in the accounting losses that are expected in the future, not the creation of provisions only based on objective evidence. Provisions are created when the financial asset is created, i.e. annual expected loss, subsequently the financial asset may fall in the event of a significant increase in credit risk or subsequently by credit impairment to other stages, where provisions corresponding to losses are reported for the entire life of the asset. For financial assets carried at amortised cost and for debt assets measured at fair value through profit or loss, it will be necessary to calculate and disclose in the notes to the financial statements expected losses in accordance with IFRS 9.

The entity should perform an analysis of historical losses and evaluate the development of financial assets in the future. For funds with a short investment history, it may be more difficult to document an analysis of historical losses.

A simplified procedure can be used for certain types of financial assets. Adjustments for low-risk financial assets can only be made in the amount of the annual expected loss (e.g. non-investment receivables or receivables from banks). In contrast, trade receivables and contractual assets arising from transactions governed by IFRS 15 that do not include a significant financial component, adjustments may be recognised in the amount of the lifetime loss immediately on initial recognition and no longer follow the development of the risk of these receivables for the purpose of shifting between different stages of the expected loss model. Even with simplified procedures, however, it is necessary to create adjustments for financial assets that are not yet past due.

IFRS 16 Leasing

If the fund or investment company is in the position of a lessee, they are obliged to account for leasing (operational and financial) for long-term and more significant lease agreements. The assets of the entity will need to recognise the usage rights that are the subject of the lease arrangements, and it will also be necessary to account for the liability arising from the obligation to make lease payments.

We expect the impact of IFRS 16 especially for investment companies or securities dealers, where the rent paid will meet the conditions for its accounting set out in IFRS 16.

IFRS 7 Financial Instruments: Disclosures

The structure of the fund statements remains unchanged. However, the requirements for the annexes to the financial statements of investment funds will be extended. The annexes to the financial statements will be supplemented with new information in accordance with IFRS 7, which is much more extensive than the requirements published so far in accordance with the Decree.

Disclosure of fair value in the notes to the financial statements

Newly, it will be necessary to publish the methods of calculating fair values, including their level. A three-level hierarchy is established to determine the fair value of the relevant financial instrument.

In accordance with IFRS 13, it will be necessary to disclose in the notes to the financial statements, among other things:

• Fair value measurement techniques and inputs used to perform these valuations; if there has been a change in the measurement technique, the entity must disclose that change and the reasons for it.
• For revaluations of fair value within the third level, it will be necessary to state the effect on the economic result or other comprehensive income of the given period.

Risk management

The notes to the financial statements will need to be supplemented to provide all the following information: (i) what risks are associated with the financial instruments used; (ii) what financial instruments are affected by those risks; and (iii) how those risks are measured and managed. It will be necessary to publish tables of liquidity, sensitivity to changes in interest rates and foreign currencies.

Reporting a comparable period

According to the transitional provisions of IFRS 9, it will be possible to use the so-called modified retrospective adjustment, in which the book values ​​are recalculated at the beginning of 2021 and any differences are accounted for against the results of previous years. It will not be necessary to correct the values ​​of the comparable period.

Effectiveness and recommendations

The implementation of IFRS 9 affects not only the company's financial statements, but also the operational and organisational measures of financial institutions and is essential for the regular publication of NAV. Investment funds should have accounting systems and model documentation ready at the beginning of the coming year.

We wish you a successful implementation of IFRS. In case of need or ambiguity we are available for consultation.

lukas.hendrych@bdo.cz, magdalena.rehorova@bdo.cz