The International Financial Reporting Standards (IFRS) came into force in 2005 as a result of the decision from financial regulators to standardise the presentation of accounting data on an international scale through a single reference framework.
Revised in the wake of the 2008 global financial crisis, IFRS 7 requires an increased level of transparency from all companies using financial instruments to simplify international analysis of their financial and accounting information.
This article provides a full definition of IFRS 7, its accounting principles and details of the disclosures it requires to be met.
What is IFRS 7?
Finalised in August 2005 by the International Accounting Standards Board (IASB) and effective from 1 January 2007, IFRS 7 is an international accounting standard for financial instruments that replaces IAS 30 and IAS 32.
Proposing a new conceptual framework and limiting the scope for interpretation, IFRS 7 completes the rules on the recognition and presentation of financial instruments that were already contained in IAS 32 and IFRS 9. Following the global subprime crisis, this standard was significantly revised in 2009.
The objective of IFRS 7 is to require an entity that holds or issues financial instruments to disclose information that enables readers of its financial statements to evaluate the significance of financial instruments for its financial position and performance and the nature and extent of risks arising from those financial instruments.
Good to know: As defined in IAS 32, a financial instrument is any contract that gives rise to a financial asset for one entity and a financial liability or equity instrument for another entity.
How does IFRS 7 apply to all entities?
IFRS applies to all entities (listed and unlisted companies), irrespective of their industrial sector or the size and complexity of the financial instruments in their accounts. In fact, this standard does not only concern banks and insurance companies, but all companies with financial instruments, including corporates.
This IFRS 7 shall be applied by all entities to all types of financial instruments, except:
- those interests in subsidiaries, associates or joint ventures that are accounted for.
- financial instruments, contracts and obligations under share-based payment transactions (IFRS 2)
- employers’ rights and obligations arising from employee benefit plans (IAS 19)
- certain insurance contracts (IFRS 4)
- contracts for contingent consideration in a business combination (IFRS 3)
Disclosures about the significance of financial instruments
IFRS 7 requires an entity to disclose information that enables users of its financial statements to evaluate the significance of financial instruments for its financial position and performance. These disclosures apply as set out in paragraphs 8 to 30 of the standard, which are summarised below.
Balance sheet disclosures:
- Categories of financial assets and financial liabilities
- Defaults and breaches
- Financial assets and financial liabilities designated as at fair value through profit and loss
- Financial instruments with multiple embedded derivatives
- Credit loss expense account
- Guarantee instruments
Important: When applying the standard, it is important to distinguish between category and class. The classes of financial instruments as defined by IFRS 7 do not correspond to the categories in IAS 32 and IFRS 9.
Equity and Income Statement:
Other disclosures to be provided include:
- Accounting policies
- Fair value
- Hedge accounting
Disclosures about the risks associated with financial instruments
IFRS 7 requires an entity to provide both qualitative and quantitative information to users of its financial statements in order to enable them to evaluate not only the nature but also the extent of risks relating to those instruments to which it is exposed at the reporting date.
These disclosures therefore relate to the risks arising from financial instruments and how they are managed, including:
- Credit risk. In the event that one of the parties involved fails to meet its obligations, resulting in a financial loss for the other. Disclosures are required in relation to the maximum amount of exposure, the description and quality of the collateral and the quality of the assets involved.
- Liquidity risk. Liquidity risk is the risk that an entity will not be able to meet the obligations arising from its financial liabilities. Disclosures are required in relation to the maturity analysis of financial liabilities and the risk management approach.
- Market risk. Market risk is the potential for adverse changes in the fair value or future cash flows of a financial instrument arising from changes in market prices. Disclosures are required in relation to the entity's level of exposure to each of the market risks, namely foreign exchange risk, interest rate risk and price risk.
Although relatively complex to understand at first glance, IFRS standards represent a real challenge in terms of financial communication and in particular IFRS 7 which concerns the solidity and resilience of your cash management,
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