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IFRS 9 replaces the multiple classification and measurements bases in IAS 39 with a single model that has two classification categories: amortized cost and fair value. Classification under IFRS 9 is driven by the entity’s business model for managing the financial assets and the contractual cash flow characteristics of the financial assets. A financial asset is measured at amortized cost if the objective of the business model is to hold the financial asset for the collection of the contractual cash flows and such contractual cash flows solely represent payments of principal and interest, interest being the consideration for the time value of money and the credit risk of the principal amount outstanding; otherwise the financial asset is measured at fair value.

The new standard further indicates that all equity investments should be measured at fair value. IFRS 9 removes the cost exemption for unquoted equities and derivatives on unquoted equities but provides guidance on when cost may be an appro- priate estimate of fair value. Fair value changes of equity investments are recognized in profit and loss unless management has elected the option to present unrealized and realized fair value gains and losses on equity investments that are not held for trading in OCI. Such designation is available on initial recognition on an instrument-by-instrument basis and is irrevocable. There is no subsequent recycling of fair value gains and losses to profit or loss; however, dividends from such investments will continue to be recognized in profit or loss.

Under the new model, management may still designate a financial asset as at fair value through profit or loss on initial recog- nition but only if this significantly reduces an accounting mismatch. The designation at fair value through profit or loss will continue to be irrevocable. The new standard removes the requirement to separate embedded derivatives from financial asset hosts. It requires a hybrid contract to be classified in its entirety at either amortized cost or fair value. As many embedded derivatives introduce variability to cash flows, which is not consistent with the notion that the instrument’s contractual cash flows solely represent the payment of principal and interest, most hybrid contracts with financial asset hosts will be measured at fair value in their entirety. The reclassification between categories is prohibited except in circumstances where the entity’s busi- ness model changes.

IFRS 9 is effective for annual periods beginning on or after January 1, 2013, with early application permitted. The European Commission has decided to defer the endorsement of this standard until it has carried out an in-depth analysis. As a result, European companies were unable to adopt the new standard for their 2009 financial statements while companies in more than 80 countries outside the European Union were able to early adopt the new standard.

Refer to the following table for a comparison of IFRS 9 and the FASB’s proposed model on classification and measurement.

IASB Exposure Draft, Financial Instruments: Amortized cost and impairment

In November 2009, the IASB issued ED 2009/12, which proposes fundamental changes to the current impairment guidance for financial assets accounted for at amortized cost. The proposed model is built upon the premise that interest charged on financial instruments includes a premium for expected losses, which should not be included as part of interest revenue/income. This results in an allocation of the initial estimate of expected credit losses over the expected life of the financial asset. At the inception of an instrument, the lender will be required to identify the effective interest rate (EIR) component, which repre- sents compensation for the expected losses. Interest income is recognized over the life of the instrument at the EIR net of the

expected loss component identified at inception. The premium associated with the expected losses is reflected each period as a reduction in the basis of the receivable (effectively an allowance for bad debts).

Unlike the incurred loss model currently required under IAS 39, the expected cash flow model does not wait for evidence that impairment has occurred but instead requires a continuous assessment of the expected cash flows over the life of the instru- ment. No impairment losses will be recognized if the original expected loss projection proves accurate. However, if more losses are expected than originally estimated, an impairment charge will be recognized for the decrease in the expected cash flows in the period in which the estimate changes. If favorable changes to loss expectations occur, a credit to income will be recognized for the increase in expected cash flows in the period in which the estimate changes. The model requires the use of an allowance account for credit losses. Direct write-offs are prohibited.

Recognizing the operational challenges in implementing and applying the expected cash flow model, the IASB created an Expert Advisory Panel to advise the board on the operational issues surrounding application of the proposed model and possible practical expedients.

Comments on the exposure draft were due on June 30, 2010. Refer to the following table for a comparison of the proposed FASB and IASB impairment models.

Balance Sheet Netting of Derivatives and Other Financial Instruments

In response to stakeholders’ concerns, the boards decided to jointly issue a separate exposure draft proposing changes to address differences in their standards on balance sheet netting of derivative contracts and other financial instruments that can result in material differences in financial reporting by financial institutions. The boards plan to publish exposure drafts of converged requirements relating to the balance sheet netting of derivative contracts and other financial instruments, and related disclosures in fourth-quarter 2010, to hold public roundtables in first-quarter 2011, and to finalize improved and converged requirements by June 2011, at the same time when they finalize other changes to their financial instruments standards discussed above.

FASB proposed ASU: Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities

On May 26, 2010, the FASB issued a proposal to amend the accounting for financial instruments. The FASB’s proposal addresses all aspects of financial instrument accounting, including classification and measurement, impairment, and hedge accounting. The proposal would significantly change the current accounting for many financial instruments by expanding the use of fair value and limiting amortized cost measurements to certain issuances of an entity’s own debt. For example, financial instruments currently measured at amortized cost (such as held-for-investment loans, held-to-maturity securities, and debt instruments) would be measured at fair value.

The FASB has proposed that all financial instruments be measured at fair value with changes in fair value recognized in net income. However, changes in fair value of certain financial instruments may be recognized in OCI if the instrument is held for the collection or payment of contractual cash flows, meets certain cash flow characteristics, and does not contain embedded derivatives that require bifurcation. Gains and losses in OCI are reclassified into the income statement upon sale or settlement of the instrument. For financial liabilities, an entity could irrevocably elect at inception to measure certain types of its own liabilities

at amortized cost provided: (a) such financial liabilities are eligible for fair value through OCI accounting and (b) measuring the liabilities at fair value would create or exacerbate a measurement mismatch. All equity securities will be measured at fair value with changes in fair value recognized in income. Core deposits (without a stated maturity and considered by management as a stable source of funds) would be recorded at remeasurement value through net income or OCI. Noncore/time deposits would be carried at fair value. Further, loan commitments and standby letters of credit would be measured at fair value and classified in a manner consistent with how the loan would be classified if and when it is funded.

The FASB has proposed a single model for recognizing and measuring impairment of financial assets recorded at fair value with changes in fair value recognized in OCI. For these financial assets, credit impairment would be recognized in net income when an entity does not expect to collect all of the contractually promised cash flows (which include both principal and interest). An entity no longer would wait for a probable event to recognize a loss; instead, it would need to consider the impact of past events and existing conditions on the collectability of contractual cash flows. Moreover, the interest income would be recognized based on the asset balance less allowance, which will reduce interest income as compared with the existing guidance.

The final standard is expected by the second quarter of 2011. However, these changes are unlikely to be effective before 2013. The board also has proposed, subject to certain conditions being met, to provide nonpublic entities with less than $1 billion in total assets, a four-year deferral from recognizing certain loans and core deposit liabilities at fair value on the balance sheet. Comments on the exposure draft are due on September 30, 2010. Refer to the following table for a comparison of the FASB’s proposed model on classification and measurement of financial assets and IFRS 9.

FASB Exposure Draft, Proposed ASU: Amendments for Common Fair Value Measurement and Disclosure Requirements in US GAAP and IFRSs-Fair Value Measurements and Disclosures (Topic 820) and IASB Exposure Draft, Measurement Uncertainty Analysis Disclosure for Fair Value Measurements

In May 2009, the IASB issued Exposure Draft 2009/5 containing provisions similar to those in ASC 820, Fair Value Measure- ments and Disclosures. This joint project forms part of the MoU between the FASB and IASB. The objective of the project is to bring together, as closely as possible, the fair value measurement guidance. The proposals in the exposure draft eliminate some but not all of the current US GAAP and IFRS differences in this area.

The FASB and IASB have been jointly redeliberating the proposals in the IASB ED and, as a result, in June 2010, have issued the exposure drafts noted in the title above to further converge US GAAP and IFRS. Both boards plan to issue their new and updated standards by the first quarter of 2011.

Many of the proposed changes would result in conformed terminology and will drive consistent application of the principles of fair value measurements and disclosures between US GAAP and IFRS. Although many of these changes are not expected to have any significant effect on practice, some of the principles and disclosures stand to have a noteworthy impact under US GAAP as described below:

• The FASB is proposing that the “in use” premise can only be applied to measurement of nonfinancial assets. As a result, financial assets will be valued only based on the unit of account being measured. For example, financial assets (such as an equity security) no longer would be able to be aggregated to arrive at a valuation based on the “in use” premise but rather

securities that are not actively traded and recorded premiums or discounts on the block position. Those premiums and discounts may no longer be acceptable.

• The proposal includes a practical expedient for fair value measurement in situations in which an entity manages a group of financial assets and financial liabilities that have offsetting market risks or counterparty credit risks based on the net open risk position. Four criteria must be present to be able to use the practical expedient: (1) the entity must manage the portfolio based on the net open risk position as part of its documented risk management or investment strategy; (2) such informa- tion must be presented in that manner to management of the entity; (3) the management of the portfolio on a net open risk position basis must be consistently applied from period to period; and (4) the financial assets and financial liabilities must be measured at fair value on a recurring basis.

• The proposed ASU would extend the prohibition of the recognition of a blockage factor to all fair value measurements. Despite the change, certain premiums or discounts may apply but may be limited to instances such as control premiums when the unit of account is a reporting unit (e.g., for goodwill impairment testing and minority interest discounts).

• Additional disclosures will be required under the ASU. The most significant additional requirement will be a measurement uncertainty analysis (otherwise known as a sensitivity analysis) for Level 3 fair value measurements.

• The IASB’s exposure draft includes a similar disclosure requirement for measurement of uncertainties taking into account the impact of correlation between inputs.

IASB Exposure Draft, Derecognition: Proposed Amendments to IAS 39 and IFRS 7

In March 2009, the IASB issued ED 2009/3, Derecognition, which would amend the existing derecognition provisions of IAS 39. The main purpose of the exposure draft was to address the perceived complexities within IAS 39 and the resulting difficulty of application in practice. The draft included two approaches to derecognition of financial assets: the “proposed model” and the “alternative view.”

Comments were due July 31, 2009. The IASB also held a series of roundtable discussions with constituents in North America and Asia focusing on the ED proposals. There was consistent strong support for the alternative approach subject to a few modifica- tions, which the participants believed provided a better reflection of the economic reality. The alternative approach required that if the entity has given up control over any of the cash flows of the asset, the entity no longer controls that asset and hence the asset is derecognized in its entirety and a new asset/liability is recognized for any continuing involvement in the asset retained.

Based on the feedback received from respondents on the ED and from the outreach program undertaken by the staff, the board pursued the alternative derecognition approach for financial assets. However, the boards agreed in June 2010 that the near-term priority should be on increasing transparency and comparability around disclosures. As a result, the IASB now intends to finalize only the improved disclosure requirements published in 2009 by the third quarter 2010 and will reassess the nature and scope of any further improvement and convergence efforts by 2012. The tentative effective date of the new derecognition disclosure requirements is January 1, 2011.

FASB Limited Scope Amendments to Topic 860, Transfer and and Servicing

The FASB also recently added a limited scope project to its agenda designed to improve the accounting for repos or other agreements that both entitle and obligate the transferor to repurchase or redeem financial assets before their maturity. Although this is not a joint project with the IASB, the FASB intends to consider the proposed improvements with existing IFRS standards.

Derivative Instruments and Hedging Activities and IFRS 9

Impact US GAAP

(FASB proposed ASU )

IFRS

(IFRS 9—Classification and Measurement of Financial Assets—and impairment proposal)