In general, initial recognition is the recognition of an item (e.g., asset, expense, etc.) that would occur if an entity issued financial statements on the date when the item first or initially qualifies for recognition. For example, if an entity produces financial statements for the year to 31 December and that an item qualifies for recognition on 1 November. Initial recognition is effected at 1 November, although the entity will not reflect the financial effect of the item in its statement of financial position until 31 December.

For a financial asset or a financial liability, an entity recognizes it in its statement of financial position (balance sheet) when it becomes party to the contractual provisions of the instrument in which the asset or liability is an underlying. At initial recognition, an entity measures a financial asset or a financial liability at its fair value plus or minus, in the case of a financial asset or a financial liability not carried at fair value through profit or loss (FVTPL), transaction costs that are directly attributable to the purchase of the financial asset or issue of the financial liability.

At initial recognition of a financial asset, an entity classifies it based on two main criteria: its business model for managing the asset and the asset’s contractual cash flow characteristics, measurement bases are amortized cost, fair value through other comprehensive income (FVTOCI), fair value  through profit or loss (FVTPL):

Amortized cost—a financial asset is measured at amortised cost if 1) it is held within a business model whose objective is to hold assets for the purpose of collecting contractual cash flows and 2) the contractual terms of the financial asset produce, on specified dates, cash flows that are solely payments of principal and interest on the principal amount outstanding.

Fair value through profit or loss—a measurement base for any financial assets that are neither measured at amortized cost (not held for their contractual cash flows) nor at fair value through other comprehensive income.

Fair value through other comprehensive income—financial assets that are held in a business model whose objective is to collect contractual cash flows and sell financial assets.

Reclassification (from one method to another) is necessitated by a change of business model for managing financial assets.