Classification of Equity Instruments under IFRS 9: Determinants and Consequences

Abstract

One of the main differences between International Financial Reporting Standard (IFRS) 9 Financial Instruments and International Accounting Standard (IAS) 39 Financial Instruments: Recognition and Measurement is the classification and measurement of equity instruments that are financial assets. Under IFRS 9, a firm must measure acquired equity instruments at fair value through profit or loss (FVPL) unless the firm irrevocably chooses at initial recognition to measure those assets at fair value through other comprehensive income (FVOCI). In this case, a firm must recognise all changes in FVOCI without the possibility of reclassifying these amounts into profit or loss. In this context, this study has two main objectives. First, it examines the frequency of firms that elect to classify equity instruments as FVOCI in the first year of IFRS 9 adoption and identifies the determinants of the decision to classify equity instruments as available for sale (AFS) (under IAS 39) or as financial assets at FVOCI (under IFRS 9). Second, it considers whether this choice has any influence on the value relevance of financial information. The results of a sample based on firms in the FTSE 100 and EURO STOXX 50 show that risk is the main determinant of the reclassification from AFS to FVOCI in the first year of IFRS 9 adoption, while the level of variable compensation for CEOs (for AFS) and the level of fair value hierarchy (for AFS and FVOCI) are the main determinants for the classification of equity instruments. Regarding the consequences of this change, the findings indicate that the prohibition of recycling for the FVOCI option under IFRS 9 leads investors to pay more attention to the changes in fair value as recognised in OCI.

Empirical Evidence of the Impact of Senior Executive Ownership on Firm Performance: Classification of Investments in Equity Instruments under IFRS 9 as a Mediator Variable

“…The first orientation focuses on the remuneration of senior executives, particularly the CEO, being determined by the capital and labor markets. The second direction focuses on senior executives using remuneration as a tool to maximize their own interests to the detriment of the those of other stakeholders (Pinto and Morais, 2022). Executive remuneration is normally determined by reference to information in the income statement.…”

“…Shi et al (2021) conclude that there is a positive relationship between FP and CEO compensation based on the suitability of the strategic selection of CEOs. Changes in the fair value of assets and liabilities affect the statement of income over threefold more than the statement of comprehensive income (Pinto and Morais, 2022). Therefore, the application of fair value accounting increases income volatility.…”

“…The second subset includes studies that examined the impact of CIEI according to IFRS 9 on FP. For example, Pinto and Morais (2022) demonstrated a negative association between leverage and EICR, whereas Zang et al (2022) show that most companies selected EICR and that there is no relationship between earnings volatility and the choice of EICR.…”

“…For example, the senior executives may choose the first alternative if they want to decrease the variance in earnings, which is normally employed in remuneration arrangement. Under IFRS 9, the prevention of the recoverability of equity instruments in other comprehensive income creates new areas of discussion on the relevance of the profit and loss statement (Pinto and Morais, 2022).…”

IFRS-9, expected loan loss provisioning and bank liquidity creation: early evidence

“…Using data on Italian and German firms, Henkel and Bürger (2020) observe that such disclosures have typically not been adequate thus far, especially for Italian firms. Pinto and Morais (2022) find that, in the initial period, the majority of firms listed on FTSE-100 and EURO Stoxx 50 classified their equity (available for sale) instruments as fair value through other comprehensive income (FVOCI) to negate its potential adverse impact on profitability metrics.…”