9. Financial assets and financial liabilities Flashcards
What is a financial instrument?
Any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity
What were some of the issues that lead to the need for an accounting standard for financial instruments?
There are 5
- 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
What are the three accounting standards to deal with financial instruments?
IAS 32 Financial instruments: Presentation
IFRS 7 Financial Instruments: Disclosures
IFRS 9 Financial instruments
What does IAS 32 Financial Instruments: Presentation deal with?
The classification of financial instruments and their presentation in the financial statements.
What does IFRS 7 Financial Instruments: Disclosures deal with?
How they are measured and when they should be recognised
What does IFRS 9 Financial Instruments deal with?
Disclosure of financial instruments in financial statements
What is a financial asset? 4 things
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
Give 3 examples of a financial asset.
- Trade receivables
- Options
- Investment in equity shares
What is a financial liability?
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
Give 3 examples of a financial liability.
- Trade payables
- Debenture loans
- Redeemable preference shares
Why is a prepayment for goods or services not a financial instrument?
Because the future economic benefit is from the receipt of goods or services rather than a financial asset
Why is tax liability not a financial instrument?
Because the obligation to pay is statutory, not contractual.
What is a financial liability initially recognised at?
Fair value
This is usually…
Net proceeds of cash received
Less: costs of issuing
How are financial liabilities subsequently measured?
At amortised cost
How do you calculate amortised cost?
Initial value + effective interest - interest paid
Why is effective interest different to interest paid?
There may be additional costs of borrowing such as
- Redemption premiums
- Issue costs
- Discounts on issue
If irredeemable preference shares contain no obligation to make any payment, either of capital or dividend, then what are they classified as?
Equity
If preference shares are redeemable, or have a fixed cumulative dividend, then what are they classified as?
A financial liability
Where are equity dividends declared reported?
In equity
How are dividends on instruments classified as a liability treated?
As a finance cost in the P+L
What is a compound instrument?
An instrument that has characteristics of both equity and liabilities.
Give an example of a compound instrument
Convertible loan
What is a convertible loan?
A loan repayable in the issuing company’s shares instead of cash
What kind of accounting is used for convertible instruments?
Split accounting
Why is there a debt element in a convertible instrument?
The issuer has the potential obligation to deliver cash
Why is their an equity element to convertible instruments?
The investors may choose to convert the loan into shares instead
How is a convertible loan initially recognised?
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
How is a convertible loan subsequently measured?
Liability: Amortised cost (Initial market value + market interest - interest paid)
Equity:
Remains the same until debt redeemed
When should an entity recognise a financial asset on its statement of financial position?
When and only when the entity becomes party to the contractual provision of the instrument
How do we initially measure financial assets?
Fair value
Transaction costs can be included unless the asset is fair value through P+L
How are equity investments measured? 3 things
Fair value through P+L
Transaction costs are expensed
Any gains or losses shown in statement of P+L
When can an entity classify equity investments in fair value through other comprehensive income and what do they have to do for this?
- When the investment is seen as a long term investment
- The designation must be done on acquisition
When we classify equity under FVOCI, how do we treat transaction costs?
Capitalise them
When we classify equity under FVOCI, how do we treat gains or losses?
Revalued each year
Gain or loss shown in other comprehensive income
Gain taken to investment reserve in equity
Can an investment reserve be negative?
Yes!
What do we do with investment reserve when the investment is sold?
Transferred to retained earnings or left in equity
What are three three ways debt instruments are categorised?
- Fair value through profit or loss
- Amortised cost
- Fair value through other comprehensive income
What is the default category for debt instruments?
Fair value through profit or loss
What are the two tests for determining the remaining two categories for categorising debt instruments?
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
To carry an investment at amortised cost, what are the criteria?
- 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.
How do you calculate amortised cost of a debt instrument?
Balance cfwd
Interest income
Less: Payment received
Interest goes to P+L under finance cost
To carry an investment at FVOCI, what are the criteria?
- 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.
How do you recognise FVOCI of a debt instrument?
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
What are the two requirements to offset financial assets/financial liabilities?
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.
When should you derecognise a financial asset?
When, and only when, the contractual rights to the cash flows from the financial asset expire
When should you derecognise a financial liability?
When, and only when, the obligation specified in the contract is discharged or cancelled or expires
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.
Factoring of receivables
What is the main factor to consider when assessing how to account for receivables?
Who bears the risk
What does a sale of a receivable with recourse mean and how is it treated?
The factor can return any unpaid debts to the business
Treated as a secure loan against receivables
What does a sale of a receivable without recourse mean and how is it treated?
The factor bears the risk of the recoverable debts
Treated as a sale and receivables removed from company’s financial statements
