Reclassification of Financial Asset

Requirement and Timing of Reclassification

• PFRS 9, paragraph 4.4.1, provides the primary requirement: An entity shall reclassify financial assets only when it changes the business model for managing the financial assets.

• Prospective Application: According to paragraph 5.6.1, reclassification occurs prospectively from the reclassification date. There is no restatement of previously recognized gains, losses, or interest.

• Definition of Reclassification Date (Appendix A of PFRS 9): The reclassification date is defined as the first day of the reporting period following the change in the business model that results in the reclassification.

• Timeline Example: If an entity changes its business model during the calendar year $2024$, the reclassification date is $January\,1,\,2025$, which is the first day of the next reporting period.

• Disclosure Requirement: Although the reclassification is not recorded until the siguiente period, the entity must disclose the change in the business model in its $2024$ financial statements because such a change is considered a significant and demonstrable event.

Exemptions from Financial Asset Reclassification

• Equity Investments - Proprietary Trading: Equity investments held for trading or measured at Fair Value Through Profit or Loss (FVPL) cannot be reclassified due to the consequential requirements of PFRS 9. In effect, no equity investments can be reclassified.

• Equity Investments - Irrevocable Election: Equity investments measured at Fair Value Through Other Comprehensive Income (FVOCI) by irrevocable election cannot be reclassified specifically because the initial election is irrevocable.

• Debt Investment Restriction: Only debt investments are eligible for reclassification because the concept of a "change in business model" applies only to debt instruments.

• Debt Investment - Irrevocable Election: Even for debt investments, if the asset was measured at FVPL by irrevocable election (the fair value option), it cannot be reclassified.

Reclassification from Fair Value Through Profit or Loss (FVPL) to Amortized Cost

• Guiding Principle (PFRS 9, paragraph 5.6.3):

  • The fair value at the reclassification date becomes the new carrying amount at amortized cost.
  • The difference between this new amortized cost carrying amount and the face amount of the asset shall be amortized over the remaining life of the financial asset.
  • A new effective interest rate (EIR) must be determined based on the fair value at the reclassification date.

• Illustration:

  • On $January\,1,\,2024$, an entity purchased bonds with a face amount of $P\,5,000,000$ for $P\,6,000,000$ (held for trading).
  • Initial Entry: Financial asset-FVPL $P\,6,000,000$ / Cash $P\,6,000,000$.
  • On $December\,31,\,2024$, fair value is $P\,5,200,000$. Change in business model occurs to "collection of contractual cash flows."
  • Step 1: Record unrealized loss on $December\,31,\,2024$: Unrealized loss-FVPL $P\,800,000$ / Financial asset-FVPL $P\,800,000$.
  • Step 2: Record reclassification on $January\,1,\,2025$: Investment in bonds $P\,5,200,000$ / Financial asset-FVPL $P\,5,200,000$.
  • Note: The new carrying amount of $P\,5,200,000$ is higher than the face amount of $P\,5,000,000$, representing a premium of $P\,200,000$. The new EIR will be lower than the nominal rate.

Reclassification from Amortized Cost to Fair Value Through Profit or Loss (FVPL)

• Guiding Principle (PFRS 9, paragraph 5.6.2):

  • The fair value is determined at the reclassification date.
  • The difference between the previous carrying amount (amortized cost) and the fair value at reclassification date is recognized as a gain or loss in the income statement.

• Illustration:

  • On $January\,1,\,2024$, an entity purchased face value bonds of $P\,5,000,000$ for $P\,4,500,000$ to collect contractual cash flows.
  • By $December\,31,\,2024$, carrying amount is $P\,4,700,000$ after $P\,200,000$ discount amortization. Business model changes to realizing gains.
  • On $January\,1,\,2025$ (reclassification date), fair value is $P\,5,500,000$.
  • Step 1: Recognize gain on reclassification: Investment in bonds $P\,800,000$ / Gain on reclassification of financial asset $P\,800,000$.
  • Step 2: Record reclassification: Financial asset-FVPL $P\,5,500,000$ / Investment in bonds $P\,5,500,000$.
  • Following this, all subsequent changes in fair value are reported in profit or loss.

Reclassification from Amortized Cost to Fair Value Through Other Comprehensive Income (FVOCI)

• Guiding Principle (PFRS 9, paragraph 5.6.2):

  • The asset is measured at fair value at the reclassification date.
  • The difference between the amortized cost and fair value is recognized in other comprehensive income (OCI).
  • The original effective interest rate is NOT adjusted.

• Illustration:

  • On $January\,1,\,2024$, bonds with face amount $P\,6,000,000$ were purchased for $P\,5,500,000$ (Amortized Cost model).
  • On $December\,31,\,2024$, amortized cost is $P\,5,800,000$ ($P\,300,000$ discount amortization). Business model changes to collecting cash flows AND selling in the market (FVOCI).
  • On $January\,1,\,2025$, fair value is $P\,6,200,000$.
  • Step 1: Record reclassification: Financial asset-FVOCI $P\,5,800,000$ / Investment in bonds $P\,5,800,000$.
  • Step 2: Recognize fair value change: Financial asset-FVOCI $P\,400,000$ / Unrealized gain-OCI $P\,400,000$. (Calculation: $6,200,000 - 5,800,000 = 400,000$).

Reclassification from Fair Value Through Other Comprehensive Income (FVOCI) to Amortized Cost

• Guiding Principle (PFRS 9, paragraph 5.6.5):

  • The fair value at reclassification date becomes the new amortized cost carrying amount.
  • The cumulative gain or loss previously recognized in OCI is eliminated and adjusted against the fair value at reclassification date.
  • This reverts the investment back to amortized cost measurement as if it had always been measured that way.
  • The original effective interest rate is NOT adjusted.

• Illustration:

  • On $January\,1,\,2024$, bonds with face amount $P\,5,000,000$ were purchased for $P\,4,600,000$ (FVOCI model).
  • On $December\,31,\,2024$, carrying amount at amortized cost is $P\,4,800,000$ ($P\,200,000$ discount amortization). Fair value is $P\,5,300,000$.
  • Step 1: Recognize unrealized gain on $December\,31,\,2024$: Financial asset-FVOCI $P\,500,000$ / Unrealized gain-OCI $P\,500,000$.
  • Step 2: Record reclassification on $January\,1,\,2025$: Investment in bonds $P\,5,300,000$ / Financial asset-FVOCI $P\,5,300,000$.
  • Step 3: Eliminate OCI: Unrealized gain-OCI $P\,500,000$ / Investment in bonds $P\,500,000$.
  • Result: the amortized cost ($P\,4,800,000$) is restored.

Reclassification from Fair Value Through Profit or Loss (FVPL) to Fair Value Through Other Comprehensive Income (FVOCI)

• Guiding Principle (PFRS 9, paragraph 5.6.6):

  • The asset continues to be measured at fair value.
  • Fair value at reclassification date becomes the new carrying amount.
  • A new effective interest rate must be determined based on the fair value at the reclassification date.

• Illustration:

  • On $January\,1,\,2024$, purchased bonds (face $P\,3,000,000$) for $P\,3,300,000$ (FVPL model).
  • On $December\,31,\,2024$, business model changes to "collecting contractual cash flows and selling."
  • On $December\,31,\,2024$, fair value is $P\,3,600,000$.
  • Step 1: Unrealized gain on $December\,31,\,2024$: Financial asset-FVPL $P\,300,000$ / Unrealized gain-FVPL $P\,300,000$.
  • Step 2: Record reclassification on $January\,1,\,2025$: Financial asset-FVOCI $P\,3,600,000$ / Financial asset-FVPL $P\,3,600,000$.

Reclassification from Fair Value Through Other Comprehensive Income (FVOCI) to Fair Value Through Profit or Loss (FVPL)

• Guiding Principle (PFRS 9, paragraph 5.6.7):

  • The asset continues to be measured at fair value.
  • Fair value at reclassification date becomes the new carrying amount.
  • The cumulative gain or loss in OCI is reclassified to profit or loss (recycled) at the reclassification date.

• Illustration:

  • On $January\,1,\,2024$, purchased bonds (face $P\,4,000,000$) for $P\,4,200,000$ (FVOCI model).
  • On $December\,31,\,2024$, fair value is $P\,3,900,000$; premium amortization is $P\,100,000$.
  • Entry 1 (Amortization): Interest income $P\,100,000$ / Financial asset-FVOCI $P\,100,000$.
  • Entry 2 (FV Change): Unrealized loss-OCI $P\,200,000$ / Financial asset-FVOCI $P\,200,000$. (Calculation: $4,100,000 - 3,900,000 = 200,000$).
  • Entry 3 (Reclassification): Financial asset-FVPL $P\,3,900,000$ / Financial asset-FVOCI $P\,3,900,000$.
  • Entry 4 (Recycle OCI): Unrealized loss-FVPL $P\,200,000$ / Unrealized loss-OCI $P\,200,000$.

Questions and Discussion

Conceptual Questions

1. Explain the requirement for the reclassification of financial assets between categories.
       Reclassification is only permitted when an entity changes its business model for managing financial assets.
2. When is the reclassification of financial asset recognized?
       It is recognized prospectively on the reclassification date (the first day of the next reporting period).
3. What financial assets are permitted to be reclassified?
       Only debt investments are permitted for reclassification.
4. What are the exemptions from reclassification of financial assets?
       Equity investments (trading or FVPL) and any investments (debt or equity) designated by irrevocable election cannot be reclassified.
5. Explain reclassification from FVPL to Amortized Cost.
       Fair value at reclassification date is the new carrying amount; premium/discount is amortized over remaining life; new EIR is determined.
6. Explain reclassification from Amortized Cost to FVPL.
       Difference between carrying amount and fair value at reclassification date is recognized in profit or loss.
7. Explain reclassification from Amortized Cost to FVOCI.
       Asset is measured at fair value; difference between amortized cost and fair value goes to OCI; original EIR is kept.
8. Explain reclassification from FVOCI to Amortized Cost.
       Cumulative OCI gains/losses are adjusted against the fair value to revert the carrying amount to its original amortized cost basis.
9. Explain reclassification from FVPL to FVOCI.
       Measurement remains at fair value; new EIR is determined at reclassification date.
10. Explain reclassification from FVOCI to FVPL.
        Measurement remains at fair value; cumulative OCI balances are reclassified to profit or loss.

Practical Problems For Review

• Problem 21-1 (FVOCI to Amortized Cost): Complex Company purchased bonds ($P\,5,000,000$) for $P\,4,500,000$ plus $P\,168,600$ transaction costs ($8\%$ effective yield). Quoted at $105$ ($2024$), $110$ ($2025$), and $115$ ($2026$). 2026 market rate is $10\%$.
• Problem 21-2 (Amortized Cost to FVOCI): Myopie Company purchased bonds ($P\,2,000,000$) for $P\,1,900,500$ ($10\%$ effective yield). Quoted at $110$ on $January\,1,\,2025$ and $120$ on $December\,31,\,2025$.
• Problem 21-3 (Amortized Cost to FVPL): Soledad Company purchased $10\%$ bonds for $P\,3,405,000$ ($8\%$ yield). Changed model $December\,31,\,2025$. Fair value on $January\,1,\,2026$ was $P\,2,845,000$.
• Problem 21-4 (FVPL to Amortized Cost): Royalty Company purchased bonds for $P\,5,550,000$ ($11\%$ yield). FV $P\,5,450,000$ ($2024$) and $P\,6,150,000$ ($2025$). Model changed on $December\,31,\,2025$.
• Problem 21-5 (FVOCI to FVPL): Zeta Company purchased bonds for $P\,4,335,000$ ($6\%$ yield). FV $P\,3,870,000$ ($2024$) and $P\,3,615,000$ ($2025$). Model changed $December\,31,\,2024$.
• Problem 21-6 (FVPL to FVOCI): Delta Company purchased bonds for $P\,3,530,000$ ($9\%$ yield). FV $P\,3,490,000$ ($2024$) and $P\,3,425,000$ ($2025$). Model changed $December\,31,\,2024$.