What are the three levels of disclosure under IFRS 7?

IFRS 7, titled Financial Instruments: Disclosures, is an International Financial Reporting Standard (IFRS) published by the International Accounting Standards Board (IASB). It requires entities to provide certain disclosures regarding financial instruments in their financial statements. The standard was originally issued in August 2005 and became applicable on 1 January 2007, superseding the earlier standard IAS 30, Disclosures in the Financial Statements of Banks and Similar Financial Institutions, and replacing the disclosure requirements of IAS 32, previously titled Financial Instruments: Disclosure and Presentation.

Disclosure requirements[edit]

IFRS 7 requires entities to provide disclosures about:

Fair value measurement[edit]

The three-level "fair value hierarchy" is used to measure the fair values of each class of financial instruments with as little involvement of judgement as possible.

Level 1The preferred inputs to valuation methods are unadjusted quoted prices of identical instruments in active markets. However, such quoted prices are often unavailable and assumptions have to be made in determining the fair values.Level 2If the inputs to valuation techniques include directly observable data from less active markets or of instruments that are similar but not the same as the entity's instruments, such a fair value estimate is classified as level 2.Level 3These inputs are not based on observable market data from independent sources, and include the entity's own data.

Disclosure of fair value is not required if the carrying amount of a financial instrument is a reasonable approximation of fair value or if the fair value cannot be reliably ascertained.

IFRS 7 forms part of a set of IFRSs pertaining to financial instruments – IAS 32, IAS 39 and IFRS 7. IAS 39 is being re-written in phases – a part of the rewritten IAS 39 appears at IFRS 9. IFRS 7 pertains largely to the qualitative and quantitative disclosures to be made pertaining to financial instruments. IFRS 7 overrides IAS 30. Notably, while IAS 30 was applicable to banks and financial intermediaries only, IFRS 7 is applicable to all entities, even if financial instruments form a small part of the total business of the entity.

IFRS 7 is primarily intended at disclosures about risks inherent in financial instruments that an entity holds or issues. As to what is a financial instrument, see notes under IAS 32/ IAS 39.

The various disclosures required under IFRS 7 regarding financial instruments are classified and discussed below:

1.     Disclosures pertaining to significance and statement of financial position:

As regards impact of financial instruments on the financial position, and the statement of financial position (balance sheet) of the entity, the entity shall make the following disclosures:

Significance of financial instruments to the entity

Para 7 requires disclosure about the significance of financial instruments to the financial position and performance of the entity.

Categories of financial instruments:

The carrying amounts of each of the following categories of financial instruments shall be disclosed either in the body of the balance sheet or by way of notes:

1. Financial assets at fair value through profit or loss (FVTPL), distinguishing between those FVTPL-ed on initial recognition, or classified as trading assets under IAS 39. Note that trading assets are required to be fair valued through profit and loss account as per IAS 39. In addition, in certain circumstances, entities have the option of treating to FVTPL other financial assets. See notes under IAS 39.

2. Held-to-maturity (HTM) investments: for meaning of HTM, see notes under IAS 39.

3. Loans and receivables

4. Available-for-sale (AFS) financial assets: for meaning of AFS assets, see notes under IAS 39

5. Financial liabilities at FVTPL, distinguished the same way as in case of financial assets.

6. Financial liabilities measured at amortised cost.

7. Additional disclosures about credit risk etc. in case of loans treated through FVTPL, as per para 9 and 10

8. Information about any financial asset/liabilities that have been reclassified as per Para 12 and 12A

De-recognition:

De-recognition typically arises when financial assets are transferred, that is, sold or securitized. For all such assets that are de-recognized, the following information shall be provided:

(a)    the nature of the assets;

(b)   the nature of the risks and rewards of ownership to which the entity remains exposed;

(c)    when the entity continues to recognise all of the assets, the carrying amounts of the assets and of the associated liabilities (note that if substantial risks/rewards are retained, the transaction of sale/securitisation does not qualify for de-recognition); and

(d)   when the entity continues to recognise the assets to the extent of its continuing involvement, the total carrying amount of the original assets, the amount of the assets that the entity continues to recognise, and the carrying amount of the associated liabilities (note that subsequent amendments in IAS 39 make continuing involvement. One of the disqualifying conditions for de-recognition).

Collateral:

This provision puts disclosure requirement for collateral provided, as well as collateral held.

The entity shall disclose carrying value of financial assets provided by it as collateral for liabilities or contingent liabilities.

The entity shall disclose the fair value and other particulars about financial and non-financial collateral held by it that it is permitted to sell in absence of default by the owner of the collateral. Note that in case of secured lending business, most security interests held by a lender may not come for this clause as the right to sell the collateral arises usually only in case of default by the obligor.

Allowance for credit losses:

This provision requires disclosures about credit losses where the entity does not make impairment provisions against specific assets but debits impairment losses to a credit losses allowance.

Defaults and breaches:

The standard requires the entity to provide details of defaults. Note that these are details of defaults committed by the entity, not defaults against it. The following are the defaults:

a) details of any defaults during the period of principal, interest, sinking fund, or redemption terms of those loans payable;

b) the carrying amount of the loans payable in default at the end of the reporting period; and

c) whether the default was remedied, or the terms of the loans payable were renegotiated, before the financial statements were authorised for issue;

d) defaults of other loan covenants.

2. Disclosures pertaining to comprehensive income:

As regards income, expenses, gain or losses pertaining to financial instruments, the following are the disclosures required either in the statement of comprehensive income (profit and loss a/c) or notes:

        Incomes/exps and gains/losses:

1. The net gains or net losses on:

a.       Financial assets and financial liabilities measured at fair value through profit or loss (FVTPL), distinguishing between those FVTPL-ed on initial recognition, or classified as trading assets under IAS 39.

b.      Held-to-maturity (HTM) investments: for meaning of HTM, see notes under IAS 39.

c.       Loans and receivables

d.      Available-for-sale (AFS) financial assets: for meaning of AFS assets, see notes under IAS 39

e.      Financial liabilities measured at amortised cost.

2. total interest income and total interest expense (calculated using the effective interest method – see notes under IAS 39) for financial assets or financial liabilities that are not at fair value through profit or loss;

3. Fee income and expense (other than amounts included in determining the effective interest rate);

4. interest income on impaired financial assets accrued in accordance with IAS 39 (for meaning of impairment, and indications, see notes under IAS 39)

5. the amount of any impairment loss for each class of financial asset.

3. Other disclosures:

Accounting policies:

Disclosure of significant accounting policies concerning financial instruments shall be made.

Hedge accounting disclosures:

Hedge accounting for hedging derivatives is done as per IAS 39. Hedges are of 3 types – cash flow hedges, fair value hedges, and hedges of net investment in non-integral foreign operations. See notes under IAS 39 for details. The financial statements will reflect each type of hedge, the risk hedged, and the hedging instruments. In addition, details are required for each type of hedges as follows: 

Cash flow hedges:

• The expected timing of the cash flows and when are they expected to affect revenue (note cash flow hedges pertain to volatility of future cash flows)
• A description of any forecast transaction for which hedge accounting had previously been used, but which is no longer expected to occur;
• The amount that was recognised in other comprehensive income during the period (note that any gain/loss on valuation of cash flow hedges is parked in the “other comprehensive income” and is released from there as the cash flow volatility hits the entity);
• The amount that was reclassified from equity to profit or loss for the period, showing the amount included in each line item in the statement of comprehensive income (the reclassification or release from “other comprehensive income” happens when the variability of the cash flows starts affecting the entity)
• The amount that was removed from equity during the period and included in the initial cost or other carrying amount of a non-financial asset or non-financial liability whose acquisition or incurrence was a hedged highly probable forecast transaction (if the cash flow hedge pertains to a non-financial asset/liability, the gain/loss may be an adjustment to the cost of such asset/liability).

Other hedging disclosures:

• In fair value hedges, gains or losses on the hedging instrument and on the hedged item attributable to the hedged risk.
• The ineffectiveness recognised in profit or loss that arises from cash flow hedges; and
• The ineffectiveness recognised in profit or loss that arises from hedges of net investments in foreign operations.

4. Fair value disclosures:

The fair value disclosure is one of the most significant disclosures required by the Standard. Para 25 requires disclosure of fair value of every class of financial assets held by the entity. Note that certain classes are carried in books at fair value – available-for-sale assets and trading assets. However, even in case of classes such as loans and receivables, and hold-to-maturity instruments, the Standard requires disclosure of fair values. The exceptions where fair valuation is not required are short term receivables, equity instruments where fair value cannot reliably be measured, and discretionary participation contracts (such as insurance contracts with profit participation features, or equity-linked instruments) where fair value cannot be reliably measured.

Fair values may either be based on market information such as quoted prices, or may be based on inputs derived from market data such as interest rates, or may be modeled entirely by the analyst. Accordingly, the fair value computation hierarchy is labeled as Level 1, Level 2 and Level 3 fair valuation. Level 1 is based on market data. Level 2 is valuation done by the analyst, but based on inputs derived from market data. Level 3 is subjective valuation done based on the analyst’s model.

Accordingly, fair value disclosures required

• The methods and, when a valuation technique is used, the assumptions applied in determining fair values of each class of financial assets or financial liabilities. Examples are default rates, credit spreads or interest rates used in valuation.
• Whether fair values are determined, in whole or in part, directly by reference to published price quotations in an active market or are estimated using a valuation technique.
• Whether the fair values are determined in whole or in part using a valuation technique based on assumptions that are not supported by prices from observable current market transactions in the same instrument and not based on available observable market data.
• If changing one or more of those assumptions to reasonably possible alternative assumptions would change fair value significantly, the entity shall state this fact and disclose the effect of those changes.
• The total amount of the change in fair value estimated using valuation techniques that was recognised in profit or loss during the period.

5. Risks arising from financial instruments:

There are copious disclosures about financial instruments risks required by the standard. The 3 main risk areas where disclosures are required are credit risk, liquidity risk and market risk. For each of these, qualitative as well as quantitative disclosures are mandated. The specific areas dealt with by the Standard are as follows:

Credit risk:

The disclosures below are required for each class of financial instruments:

• Maximum exposure to credit risk disregarding any collateral held or other credit enhancements;

• Description of collateral held as security and other credit enhancements in respect of the exposures as above;

• Information about the credit quality of financial assets that are neither past due nor impaired; and

• The carrying amount of financial assets that would otherwise be past due or impaired whose terms have been renegotiated.

As regards assets that are past due (that is, not paid when due) or impaired (see impairment of financial assets under IAS 39), the entity shall disclose by class of financial asset:

• Age analysis of the past due financial assets that are not impaired;

• Analysis of financial assets that are individually determined to be impaired as at the end of the reporting period, including the factors the entity considered in determining that they are impaired; and

• For each of the above, a description of collateral held by the entity as security and other credit enhancements and, unless impracticable, an estimate of their fair value.

Liquidity risk

The entity discloses the maturity analysis of assets/liabilities and discusses how does it manage the liquidity risk.

Market risk

A sensitivity analysis for each type of market risk to which the entity is exposed, showing how profit or loss and equity would have been affected by changes in the relevant risk variable, the methods and assumptions used in preparing the sensitivity analysis, and the changes from the previous period in the methods and assumptions used, will be disclosed.

As a part of the market risk disclosures, entities are required to show interest rate risk, currency risk and other price risk.

What are Level 1 Level 2 and Level 3 assets?

What are the disclosure requirements of IFRS 7?

What is the purpose of IFRS 7's disclosure requirements?

Which of the following are the main components of market risk in accordance with IFRS 7 financial instruments disclosures?