This free, guided checker walks your finance team through the key decision points for IFRS 9 Embedded Derivatives Separation. Answer a few questions to see the likely treatment and the evidence to document.
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This tool is a high-level IFRS screening aid for general information only and is not accounting, audit or legal advice. Conclusions require entity-specific evidence and judgement - confirm the treatment with your advisor.
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Read the full contract for indexation clauses, caps and floors, conversion rights, extension or prepayment options, and payments denominated in a currency other than the parties' functional currencies. IFRS 9.4.3.1 describes an embedded derivative as a component of a hybrid contract that causes some of the combined instrument's cash flows to vary the way a stand-alone derivative would. The common miss is scanning only the pricing clause - termination penalties, renewal formulas, and currency clauses in supply and service agreements also embed derivatives.
No embedded derivative exists; account for the contract under the standard governing the host arrangement with no IFRS 9.4.3 separation analysis (IFRS 9.4.3.1).
Official guidance: IFRS issued standards
Confirm the whole hybrid contract sits within IFRS 9 before running the IFRS 9.4.3 tests: financial assets and liabilities generally do, while insurance contracts follow IFRS 17 and own-use commodity contracts may be excluded unless they can be settled net (IFRS 9.2.1; IFRS 9.2.4-2.6). The scope-outs are not absolute - IFRS 17.11(a) points insurers back to IFRS 9 for embedded derivative identification, and derivatives embedded in leases are expressly subject to the IFRS 9 embedded derivative requirements (IFRS 9.2.1(b)). Document the scope route before any separation work.
Assess the embedded feature under the standard governing the host; for insurance contracts, IFRS 17.11(a) directs the embedded derivative assessment back to IFRS 9 (IFRS 9.2.1).
Official guidance: IFRS issued standards
Test the feature as if it were a free-standing contract against the three-part derivative definition in IFRS 9 Appendix A: value changes in response to an underlying, little or no initial net investment, and settlement at a future date. An underlying that is a non-financial variable specific to a party to the contract - such as the entity's own revenue or EBITDA - takes the feature outside the definition. Do not skip this leg: features that merely reset pricing to current market terms often fail the definition and never reach the closely-related test.
The feature would not be a derivative on a stand-alone basis, so IFRS 9.4.3.3(b) precludes separation; account for the hybrid contract as a whole under the host guidance.
Official guidance: IFRS issued standards
IFRS 9.4.3.2 eliminates bifurcation for financial-asset hosts: a structured note held, a convertible bond held, or a loan receivable with indexed returns is classified in its entirety under the business model and contractual cash flow tests. Make the assessment from the reporting entity's side of the contract - the same convertible bond is a whole instrument for the investor but contains a potentially separable feature for the issuer. Misreading which side of the instrument the entity holds is the most common error in this analysis.
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Official guidance: IFRS issued standards
Classify the entire hybrid asset at amortised cost, FVOCI, or FVTPL based on the business model within which it is held and whether its contractual cash flows are solely payments of principal and interest (IFRS 9.4.1.1-4.1.4). The embedded feature is not ignored - it forms part of the contractual cash flows tested against the SPPI criterion in IFRS 9.4.1.3, and leverage, equity linkage, or commodity indexation will generally fail that test. The typical outcome for structured notes held is FVTPL for the whole instrument, not bifurcation.
Hybrid financial asset classified as a whole instrument under IFRS 9.4.1; embedded derivative separation is not permitted (IFRS 9.4.3.2). Complete the business model and SPPI assessment of the entire hybrid financial asset before initial classification (IFRS 9.4.1.1).
Official guidance: IFRS issued standards
Compare the risk driver of the feature to the risk profile of the host: interest rate and credit-of-the-issuer features are natural to a debt host, while equity, commodity, and most third-party credit exposures are not. IFRS 9.B4.3.5 lists features that are not closely related - equity- or commodity-indexed payments, embedded credit derivatives, and certain call, put, and prepayment options - while IFRS 9.B4.3.8 lists closely related features such as unleveraged caps and floors at or out of the money at issuance, currency clauses in a currency commonly used for the goods traded, and inflation-linked payments in the entity's own economic environment. Anchor the memo to the closest listed example rather than arguing by analogy from scratch.
The feature is closely related, so the IFRS 9.4.3.3(a) condition fails and the hybrid contract is accounted for without separation (IFRS 9.B4.3.8).
Official guidance: IFRS issued standards
For financial liability and non-financial hosts, separation applies if and only if the three conditions in IFRS 9.4.3.3 are all met: (a) the feature is not closely related to the host, (b) a separate instrument with the same terms would be a derivative, and (c) the hybrid contract is not measured at fair value through profit or loss. Check condition (c) first - trading liabilities and hybrids designated at FVTPL never require bifurcation. As an alternative to separating, IFRS 9.4.3.5 permits designating the entire hybrid contract at FVTPL at initial recognition, subject to the restrictions in that paragraph.
Account for the hybrid contract without separation; a failed IFRS 9.4.3.3 condition, typically close relation or existing FVTPL measurement, precludes bifurcation.
Official guidance: IFRS issued standards
Once separated, the embedded derivative is accounted for like any other derivative: fair value at initial recognition and at each reporting date, with changes recognised in profit or loss unless it is designated in a qualifying hedging relationship (IFRS 9.4.3.3; IFRS 9.5.7.1). Value option-based features on the stated terms of the option and calibrate non-option features such as embedded forwards or swaps so they have a fair value of zero at inception (IFRS 9.B4.3.3). Determine fair value under IFRS 13 and expect Level 2 or Level 3 inputs for bespoke contract features.
Measure the separated embedded derivative at fair value with changes recognised in profit or loss before finalizing the entries (IFRS 9.4.3.3; IFRS 9.5.7.1).
Official guidance: IFRS issued standards
Separate the derivative first: an option-based feature is measured on the stated terms of the option, while a non-option feature is separated on terms that give it a fair value of zero at initial recognition, and the host takes the residual amount (IFRS 9.B4.3.3). The host is then accounted for under the appropriate standard - amortised cost for a plain debt liability host, or the relevant non-financial guidance (IFRS 9.4.3.4). A common error is measuring the host at its stand-alone fair value and treating the derivative as the plug, which misstates day-one value and subsequent effective interest.
Allocate the initial carrying amount - embedded derivative at fair value, host at the residual - then account for the host under its governing standard (IFRS 9.4.3.4; IFRS 9.B4.3.3).
Official guidance: IFRS issued standards
IFRS 9.4.3.7 provides the measurement ladder: measure the embedded derivative on its terms and conditions; if that is not possible, measure it as the difference between the fair value of the hybrid contract and the fair value of the host; only if that also fails is the entire hybrid contract designated at FVTPL under IFRS 9.4.3.6. Inability to measure is expected to be rare, so document the valuation attempts before invoking the fallback. When the fallback applies it is a required designation, not a free accounting policy choice.
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Official guidance: IFRS issued standards
Identify the host by stripping out the embedded feature and asking what remains: a debt instrument, an equity-like residual interest, or a non-financial executory contract. Financial-asset hosts take the whole-instrument route with no bifurcation (IFRS 9.4.3.2); financial-liability and non-financial hosts run the three-condition test (IFRS 9.4.3.3). A host with no stated maturity that represents a residual interest in an entity's net assets has equity characteristics, which changes what counts as closely related in the next step of the analysis.
Characterise the host contract as financial asset, financial liability, or non-financial before concluding on separation (IFRS 9.4.3.2-4.3.3).
Official guidance: IFRS issued standards
Disclose the accounting policy applied to hybrid contracts (IFRS 7.21), fair values by class with the valuation techniques and inputs used (IFRS 7.25; IFRS 13.91-93), and, for compound instruments with multiple interdependent embedded derivatives, the existence of those features (IFRS 7.17). Separated derivatives also enter the market, credit, and liquidity risk disclosures of IFRS 7.31-42. Auditors expect the memo's separation conclusion to trace directly to the policy note wording, so draft both together.
Embedded derivative separation analysis is complete with policy, fair value, and risk disclosures in place (IFRS 7.17; IFRS 7.21; IFRS 13.91). Draft the hybrid contract policy, fair value, and valuation-input disclosures before finalizing the financial statements (IFRS 7.21; IFRS 13.91-93).
Official guidance: IFRS issued standards
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