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FR Textbook > 9. Financial assets and financial liabilities > Flashcards

9. Financial assets and financial liabilities Flashcards

1
Q

What is a financial instrument?

A

Any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity

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2
Q

What were some of the issues that lead to the need for an accounting standard for financial instruments?

There are 5

A
  • Significant growth in number and complexity of financial instruments
  • Accounting standards had not developed in line with growth in instruments
  • There were problems with derivatives
  • Unrealised gains/losses were not recognised
  • Entities could choose when to recognise gains to smooth profits
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3
Q

What are the three accounting standards to deal with financial instruments?

A

IAS 32 Financial instruments: Presentation
IFRS 7 Financial Instruments: Disclosures
IFRS 9 Financial instruments

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4
Q

What does IAS 32 Financial Instruments: Presentation deal with?

A

The classification of financial instruments and their presentation in the financial statements.

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5
Q

What does IFRS 7 Financial Instruments: Disclosures deal with?

A

How they are measured and when they should be recognised

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6
Q

What does IFRS 9 Financial Instruments deal with?

A

Disclosure of financial instruments in financial statements

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7
Q

What is a financial asset? 4 things

A

Any asset that is..

  • Cash
  • A contractual right to receive cash or another financial asset from another entity
  • A contractual right to exchange financial assets or liabilities with another entity under conditions that are potentially favourable
  • An equity instrument of another entity
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8
Q

Give 3 examples of a financial asset.

A
  • Trade receivables
  • Options
  • Investment in equity shares
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9
Q

What is a financial liability?

A

Any liability that is a contractual obligation:

  • To deliver cash or another financial asset to another entity, or
  • To exchange financial assets or liabilities with another entity under conditions that are potentially unfavourable
  • That will or may be settled in the entities own equity instruments
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10
Q

Give 3 examples of a financial liability.

A
  • Trade payables
  • Debenture loans
  • Redeemable preference shares
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11
Q

Why is a prepayment for goods or services not a financial instrument?

A

Because the future economic benefit is from the receipt of goods or services rather than a financial asset

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12
Q

Why is tax liability not a financial instrument?

A

Because the obligation to pay is statutory, not contractual.

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13
Q

What is a financial liability initially recognised at?

A

Fair value

This is usually…

Net proceeds of cash received
Less: costs of issuing

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14
Q

How are financial liabilities subsequently measured?

A

At amortised cost

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15
Q

How do you calculate amortised cost?

A

Initial value + effective interest - interest paid

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16
Q

Why is effective interest different to interest paid?

A

There may be additional costs of borrowing such as

  • Redemption premiums
  • Issue costs
  • Discounts on issue
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17
Q

If irredeemable preference shares contain no obligation to make any payment, either of capital or dividend, then what are they classified as?

A

Equity

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18
Q

If preference shares are redeemable, or have a fixed cumulative dividend, then what are they classified as?

A

A financial liability

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19
Q

Where are equity dividends declared reported?

A

In equity

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20
Q

How are dividends on instruments classified as a liability treated?

A

As a finance cost in the P+L

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21
Q

What is a compound instrument?

A

An instrument that has characteristics of both equity and liabilities.

22
Q

Give an example of a compound instrument

A

Convertible loan

23
Q

What is a convertible loan?

A

A loan repayable in the issuing company’s shares instead of cash

24
Q

What kind of accounting is used for convertible instruments?

A

Split accounting

25
Q

Why is there a debt element in a convertible instrument?

A

The issuer has the potential obligation to deliver cash

26
Q

Why is their an equity element to convertible instruments?

A

The investors may choose to convert the loan into shares instead

27
Q

How is a convertible loan initially recognised?

A

Liability:
Measured at fair value - PV of future cashflows discounted using the market rate of interest for non convertible debt instruments

Equity:
Loan proceeds
Less: Calculated liability element

28
Q

How is a convertible loan subsequently measured?

A 
Liability:
Amortised cost (Initial market value + market interest - interest paid)

Equity:
Remains the same until debt redeemed

29
Q

When should an entity recognise a financial asset on its statement of financial position?

A

When and only when the entity becomes party to the contractual provision of the instrument

30
Q

How do we initially measure financial assets?

A

Fair value

Transaction costs can be included unless the asset is fair value through P+L

31
Q

How are equity investments measured? 3 things

A

Fair value through P+L

Transaction costs are expensed

Any gains or losses shown in statement of P+L

32
Q

When can an entity classify equity investments in fair value through other comprehensive income and what do they have to do for this?

A
  • When the investment is seen as a long term investment

- The designation must be done on acquisition

33
Q

When we classify equity under FVOCI, how do we treat transaction costs?

A

Capitalise them

34
Q

When we classify equity under FVOCI, how do we treat gains or losses?

A

Revalued each year
Gain or loss shown in other comprehensive income
Gain taken to investment reserve in equity

35
Q

Can an investment reserve be negative?

A

Yes!

36
Q

What do we do with investment reserve when the investment is sold?

A

Transferred to retained earnings or left in equity

37
Q

What are three three ways debt instruments are categorised?

A
  • Fair value through profit or loss
  • Amortised cost
  • Fair value through other comprehensive income
38
Q

What is the default category for debt instruments?

A

Fair value through profit or loss

39
Q

What are the two tests for determining the remaining two categories for categorising debt instruments?

A

Business model test - The purpose of holding the investment

Contractual cash flow characteristics test - Looks at cash received as a result of holding the investment

40
Q

To carry an investment at amortised cost, what are the criteria?

A
  • Business model test. The entity must intend to hold the investment to maturity.
  • Contractual cash flow characteristics test. The contractual terms of the financial asset must give rise to cash flows that are solely of principal and interest.
41
Q

How do you calculate amortised cost of a debt instrument?

A

Balance cfwd
Interest income
Less: Payment received

Interest goes to P+L under finance cost

42
Q

To carry an investment at FVOCI, what are the criteria?

A
  • Business model test - Hold the investment to maturity but may sell the asset if the possibility of buying another asset with a higher return arises.
  • Contractual cash flow characteristics test - The contractual terms of the financial asset must give rise to cash flows that are solely of principal and interest, as for amortised cost.
43
Q

How do you recognise FVOCI of a debt instrument?

A

Initially recognised at fair value + transaction costs

Interest income calculated using effective rate

At reporting date the asset is revalued to fair value with gain or loss in other comprehensive income

44
Q

What are the two requirements to offset financial assets/financial liabilities?

A

The entity…

  • has a legally enforceable right to set off the amounts, and
  • intends either to settle on a net basis or to realise the asset and settle the liability simultaneously.
45
Q

When should you derecognise a financial asset?

A

When, and only when, the contractual rights to the cash flows from the financial asset expire

46
Q

When should you derecognise a financial liability?

A

When, and only when, the obligation specified in the contract is discharged or cancelled or expires

47
Q

What is described below?

This is where a company transfers its receivables balances to another organisation (a factor) for management and collection, and receives an advance on the value of those receivables in return.

A

Factoring of receivables

48
Q

What is the main factor to consider when assessing how to account for receivables?

A

Who bears the risk

49
Q

What does a sale of a receivable with recourse mean and how is it treated?

A

The factor can return any unpaid debts to the business

Treated as a secure loan against receivables

50
Q

What does a sale of a receivable without recourse mean and how is it treated?

A

The factor bears the risk of the recoverable debts

Treated as a sale and receivables removed from company’s financial statements

FR Textbook (23 decks)

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