2. FINANCIAL INSTRUMENTS
Financial assets include cash resources, securities, securities purchased under resale agreements, loans, derivatives and certain other assets. Financial liabilities include deposits, cheques and other items in transit, securities sold under repurchase agreements, derivatives, debt and certain other liabilities.
The use of financial instruments exposes CWB to credit, liquidity and market risk. A discussion of how these are managed can be found in the Risk Management section of the MD&A.
CLASSIFICATION AND MEASURMENT OF FINANCIAL ASSETS Initial Recognition and Measurement Financial assets consist of both debt and equity instruments. Financial assets are initially recognized at fair value and subsequently measured at fair value through profit or loss (FVTPL), fair value through other comprehensive income (FVOCI) or amortized cost.
Derivatives are measured at FVTPL, except to the extent that they are designated in a hedging relationship, in which case the IAS 39 hedge accounting requirements are applied as described in Note 10.
Debt Instruments Debt instruments, including loans and debt securities, are initially measured at fair value and are subsequently classified and measured at FVTPL, FVOCI or amortized cost based on the contractual cash flow characteristics of the instrument and the business model under which the asset is held. The intent of the assessment of the contractual cash flow characteristics of an instrument is to determine if contractual payments to be received represent solely principal and interest (SPPI), consistent with a basic lending arrangement. Principal, for the purposes of the test, is defined as the fair value of the instrument at initial recognition and is subject to change over its life due to transactions such as repayments and amortization of related premiums or discounts. Interest represents consideration for the time value of money, credit risk, other basic lending risks and costs, such as liquidity risk and administrative costs, as well as a profit margin. Contractual terms that introduce risks or volatility that are unrelated to a basic lending arrangement do not represent cash flows that are SPPI and as a result, the related financial asset is classified and measured at FVTPL. For debt instruments that meet the requirements of the SPPI test, classification at initial recognition is determined based on the business model under which the assets are managed. Considerations include how performance of the debt instruments is evaluated, the risks that affect the performance of the business model, and how those risks are managed, and the manner in which management is compensated. Potential business models are as follows:
• Held to collect: Objective is to collect contractual cash flows. • Held to collect and sell: Objective is to both collect contractual cash flows and sell the financial assets. • Held for sale or other business models: Encompasses all other business models. CWB does not currently hold assets within this category.
The use of judgment is required in assessing both the contractual cash flow characteristics and the business model of debt instruments.
Measured at Amortized Cost Debt instruments measured at amortized cost are managed under a ‘held to collect’ business model and have contractual cash fl ows that satisfy the requirements of the SPPI test. These financial assets are initially measured at fair value, net of transaction costs, and are subsequently measured at amortized cost using the effective interest rate method, net of allowance for credit losses estimated based on the expected credit loss (ECL) approach. Measured at Fair Value through Other Comprehensive Income Debt instruments measured at FVOCI, which are managed under a ‘held to collect and sell’ business model and have contractual cash flows that represent SPPI, are initially recorded at fair value, net of transaction costs. Subsequent to initial recognition, unrealized gains and losses related to the debt instruments are recorded in other comprehensive income (OCI), net of tax. Impairment losses and recoveries, estimated using an ECL approach, are recognized in the consolidated statements of income and correspondingly reduce the accumulated changes in fair value recorded in OCI. Gains and losses realized on disposal of debt instruments classified at FVOCI are included in the consolidated statements of income. Equity Instruments Equity instruments are classified and measured at FVTPL unless an irrevocable election is made to designate non-trading instruments at FVOCI at the time of initial recognition. If the election is applied, unrealized gains and losses are recorded in OCI, net of tax, and are not subsequently reclassified to the consolidated statements of income. When realized, gains and losses that arise upon derecognition are reclassified from accumulated other comprehensive income (AOCI) to retained earnings. Equity securities are not subject to an impairment assessment. IMPAIRMENT Expected Credit Loss Approach The ECL approach categorizes financial assets into three stages based on changes in credit risk since initial recognition of the asset. A financial asset can move between stages depending on improvement or deterioration of credit risk. Performing Assets • Stage 1: From initial recognition until the date on which the financial asset experiences a significant increase in credit risk (SICR), the allowance for credit losses is measured based on ECL from defaults occurring in the 12 months following the reporting date. • Stage 2: A financial asset migrates to Stage 2 when it experiences a SICR subsequent to initial recognition and the allowance for credit losses is measured based on ECL from defaults occurring over the remaining life of the asset.
74 | CWB Financial Group 2022 Annual Report
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