When are financial instruments measured at amortized cost vs fair value, and what's the impact?

Under IFRS 9 (and similar US GAAP guidance), financial assets are classified into three measurement categories based on two tests: the business model test and the cash flow characteristics test.

The Classification Framework

Category Details

Worked Example -- Crestmont Bank:

Crestmont purchases a $1,000,000 corporate bond at par, yielding 6%. At year-end, the bond's fair value is $1,020,000.

If classified as Amortized Cost:

• Balance sheet: $1,000,000 (no fair value adjustment)
• Income statement: $60,000 interest income
• No unrealized gain recognized

If classified as FVOCI:

• Balance sheet: $1,020,000 (fair value)
• Income statement: $60,000 interest income
• OCI: $20,000 unrealized gain (equity, not net income)

If classified as FVTPL:

• Balance sheet: $1,020,000 (fair value)
• Income statement: $60,000 interest + $20,000 unrealized gain = $80,000 total

Key Analytical Implications:

1. FVTPL creates the most volatile earnings because all fair value changes hit the income statement
2. Amortized cost provides the smoothest earnings but can hide economic losses
3. FVOCI is a middle ground -- fair value on the balance sheet but gains/losses bypass net income

Equity Instruments Exception: Under IFRS 9, equity investments that are not held for trading can be irrevocably designated as FVOCI. However, unlike debt instruments, the gains and losses in OCI are never recycled to the income statement.

Exam Tip: Expect questions asking you to identify the correct classification based on a scenario, or to calculate the income statement impact under different categories.

Test your understanding in our CFA Level I financial instruments practice questions.