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CFA Level I Exam · Analyzing Balance Sheets

Financial Instruments Classification and Measurement Bases (IFRS 9)

Updated 7 October 2026 · Fact-checked

Under IFRS 9, a financial asset is measured at amortized cost, fair value through OCI (FVOCI) or fair value through profit or loss (FVTPL). Classification depends on the business model and the contractual cash flows. Fair value inputs are ranked Level 1 (quoted prices), Level 2 (observable inputs) and Level 3 (unobservable inputs).

Understand Financial Instruments and Measurement Bases

A financial instrument is a contract that creates a financial asset for one party and a financial liability or equity for another. Examples are bonds, loans, receivables, shares and derivatives. The accounting question is how to measure each one on the balance sheet and where changes in value go.

There are three measurement bases. Amortized cost starts with the initial amount and adjusts it using the effective interest rate. Market price changes are ignored. Fair value is the price you would receive to sell an asset or pay to transfer a liability in an orderly transaction between market participants. Fair value changes go either to profit or loss (P&L) or to other comprehensive income (OCI).

For debt assets under IFRS 9, you ask two questions. First, what is the business model: collect contractual cash flows, collect and also sell, or something else (such as trading)? Second, do the cash flows consist solely of payments of principal and interest (the SPPI test)? If the business model is hold to collect and SPPI is met, use amortized cost. If the model is collect and sell and SPPI is met, use FVOCI. Anything else is FVTPL. An entity may also elect the fair value option (FVTPL) for a debt asset if it removes an accounting mismatch.

Equity investments fail SPPI, so they are FVTPL by default. For equity not held for trading, the entity may make an irrevocable election to use FVOCI. Gains and losses then stay in OCI and are not recycled to P&L on sale, though dividends still go to P&L. For debt at FVOCI, interest income (effective interest method), impairment and foreign exchange effects go to P&L, and the rest of the fair value change goes to OCI. On sale, the OCI amount is recycled to P&L.

Most financial liabilities are at amortized cost. Liabilities held for trading, including derivatives, are at FVTPL. Under the fair value option, the part of the change caused by the entity's own credit risk goes to OCI. Old US GAAP labels (held-to-maturity, available-for-sale, trading) map roughly to amortized cost, FVOCI and FVTPL.

The fair value hierarchy ranks inputs. Level 1 is a quoted price in an active market for an identical item. Level 2 uses observable inputs other than Level 1, such as quotes for similar items or yield curves. Level 3 uses unobservable inputs, such as management's own model assumptions. Level 3 gives the analyst the least confidence.

Key formulas to remember

Amortized cost, end of period
Opening carrying amount + interest income (opening amount × effective rate) − cash received (coupon) − principal repaid − impairment
Interest income is based on the effective rate, not the coupon rate. Discounts accrete up, premiums amortize down.
Debt asset classification rule
Hold to collect + SPPI → amortized cost; Collect and sell + SPPI → FVOCI; otherwise → FVTPL
Both tests must be passed for amortized cost or FVOCI. Failing SPPI forces FVTPL.
Equity investment rule
Default FVTPL; irrevocable election to FVOCI if not held for trading
With the FVOCI election, no recycling of gains to P&L; dividends go to P&L.
Fair value hierarchy
Level 1 = quoted identical in active market; Level 2 = observable inputs; Level 3 = unobservable inputs
The level of the item is set by the lowest-level input that is significant to the measurement.
Unrealized gain or loss
Fair value − carrying amount
Goes to P&L for FVTPL and to OCI for FVOCI.

How to solve Financial Instruments and Measurement Bases questions

Use this order for any classification or measurement question. It stops you from jumping to the wrong basis.

  1. 1Decide whether the item is an asset or a liability, and whether it is debt, equity or a derivative.
  2. 2For a debt asset, find the business model: hold to collect, collect and sell, or trading and other.
  3. 3Check SPPI. If cash flows are not solely principal and interest, the asset is FVTPL.
  4. 4Assign the basis: amortized cost, FVOCI or FVTPL. Check for an election (equity FVOCI, or the fair value option).
  5. 5Place the gain or loss: P&L for FVTPL; OCI for FVOCI price changes; effective interest income to P&L for amortized cost and debt FVOCI.
  6. 6For a hierarchy question, find the input type: quoted identical (Level 1), observable (Level 2), or unobservable (Level 3).
  7. 7Check the answer against the balance sheet and net income effect the question asks about.

Quickest way: Three-word shortcut: model, SPPI, equity

When to use it: Use it for 90-second MCQs that ask which basis applies or where a gain is reported.

  1. Equity? Default FVTPL. Look for an irrevocable FVOCI election.
  2. Debt and hold to collect with SPPI? Amortized cost.
  3. Debt and collect and sell with SPPI? FVOCI. Anything else? FVTPL.
  4. Ask what hits net income: FVTPL changes do; FVOCI price changes do not.
  5. For hierarchy, spot the words: quoted price identical = L1, similar or yield curve = L2, model or management estimate = L3.

Common mistakes in Financial Instruments and Measurement Bases

  • Treating all debt securities as fair value on the balance sheet.

    Students recall that securities are marked to market.

    Fix: Debt held to collect with SPPI is at amortized cost, and market price changes are ignored.

  • Sending FVOCI equity gains to P&L on sale.

    Debt FVOCI gains are recycled, so students assume equity works the same way.

    Fix: For equity elected at FVOCI, gains are never recycled to P&L. Only dividends hit P&L.

  • Computing interest income using the coupon rate in amortized cost.

    The coupon is the cash figure given in the question.

    Fix: Interest income is carrying amount × effective rate. Coupon is the cash received. The difference changes the carrying amount.

  • Assigning a hierarchy level by how reliable the company feels about the number.

    Students read the levels as a confidence label.

    Fix: Classify by input type. Level 3 means significant unobservable inputs, regardless of management's confidence.

  • Thinking IFRS 9 still has held-to-maturity and available-for-sale categories.

    The old labels appear in searches and older notes.

    Fix: IFRS 9 uses amortized cost, FVOCI and FVTPL. Map old terms only as a rough guide.

Worked examples

Example 1

A company buys a bond with a business model of holding it to collect contractual cash flows. The cash flows are solely principal and interest. At year-end, the bond's market price is below its carrying amount. Under IFRS 9, how is it measured and what happens to the price fall? A) Amortized cost; no effect on P&L from the price fall, absent impairment. B) FVOCI; loss in OCI. C) FVTPL; loss in P&L.

Show the solution
  1. Business model is hold to collect, and SPPI is met.
  2. This points to amortized cost.
  3. Amortized cost ignores market price changes unless there is credit impairment.
  4. So there is no P&L or OCI entry for the price fall.

Answer: A. Amortized cost; the market price fall is ignored unless it signals impairment.

Example 2

On 1 January a company buys a 3-year bond with face value €100,000 for €95,000, held at amortized cost. Annual coupon is €4,000 and the effective interest rate, the rate that discounts the cash flows to the €95,000 price, is about 5.8%. Ignoring impairment, what is the carrying amount at the end of year 1, and what is year 1 interest income? A) €95,000 and €4,000. B) €96,510 and €5,510. C) €99,000 and €4,000.

Show the solution
  1. Interest income = 95,000 × 5.8% = €5,510.
  2. Cash coupon received = €4,000.
  3. Discount accretion = 5,510 − 4,000 = €1,510.
  4. Closing carrying amount = 95,000 + 1,510 = €96,510.
  5. Option B pairs €96,510 with €5,510, which matches. Options A and C use the coupon of €4,000 as interest income, which is the common trap.

Answer: B. Carrying amount €96,510 and interest income €5,510. The method is: closing = opening + (opening × effective rate − coupon received).

Exam tips

  • Most questions test the logic: business model plus SPPI. Learn the decision tree and you can answer most items quickly.
  • Watch where the gain goes. Many questions ask only whether net income changes, so the answer depends on P&L versus OCI.
  • For amortized cost, compute interest from the effective rate. Use the coupon only as the cash figure.
  • In hierarchy questions, key words such as 'quoted', 'similar', 'model' and 'management assumptions' identify the level.
  • If a question uses old US GAAP labels, convert them: held-to-maturity is close to amortized cost, trading to FVTPL, available-for-sale to FVOCI.

Practice questions from Analyzing Balance Sheets

Financial Instruments and Measurement Bases in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Financial Instruments and Measurement Bases: frequently asked questions

What are the three IFRS 9 measurement categories?

Amortized cost, fair value through other comprehensive income (FVOCI), and fair value through profit or loss (FVTPL). Debt assets are classified by business model and the SPPI test. Equity defaults to FVTPL, with a possible election to FVOCI.

How are held-to-maturity and available-for-sale securities treated?

These are older US GAAP-style categories. Held-to-maturity is roughly amortized cost and available-for-sale roughly FVOCI. IFRS 9 does not use those labels, so classify by business model and cash flow test.

What is the difference between FVOCI and FVTPL?

Both measure the asset at fair value on the balance sheet. FVTPL sends value changes to net income. FVOCI sends price changes to OCI, while interest, impairment and foreign exchange on debt still go to P&L.

How do I tell Level 2 from Level 3 fair value?

Level 2 uses inputs that can be observed, such as yield curves or prices of similar assets. Level 3 relies on significant unobservable inputs like management's own estimates. The lowest significant input sets the level.