Ch 8. / KAP.12 - Financial Instruments

Question 1

What are the definitions? of the following:

Financial Asset

Answer 1

Financial Asset: Any asset that is:

• Cash
• Equity Instrument of another company (Investment shares)
• A Contractual right to:
  
  • ​Receive cash
  • Another financial asset
  • Exchange of financial asset/liability that is potentially favourable.
• A Contract that will/may be settled in the entity own instruments.

Examples:

Shares as an investment
Options contract
Trade Receivables ^{(Technically financial instrument but is not treated by IFRS 9)}

Question 2

What are the definitions? of the following:

Financial Liability

Answer 2

Financial Liability: Any Liability that is:

• A Contractual obligation:
  
  • To deliver cash
  • Another Financial asset
  • Exchange of financial asset/liability that is potentially UNFAVOURABLE
• ​ A contract under which an entity is obliged to issue a variable number of its own equity instruments.

​Examples:

Trade Payables
Debenture loans payable
Redeemable preference shares
Forward contracts standing at a loss.

Question 3

What are the definitions? of the following:

Equity Instrument

Compound Instrument

Derivatives

Answer 3

Equity Instrument:

A contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.

Examples: Entity’s own shares or non-cumulative irredeemable preference shares

Compound Instrument:

Where a financial instrument contains some characteristics of equity and some of the financial liability. E.g Convertable Loan Notes

Derivatives:

Has 3 main characteristics:-

1. Value changes in response to an underlying asset (Share price, forex rates, Interest rates).
2. Requires no initial net investment, or an initial net investment that is smaller than required for other contracts with a similar expected market response.
3. Settled in the future

​Example. Contract for differences, forward contracts or options

Question 4

8.1 Standards

Which standards affect financial instruments? and what is the reasoning for them?

Answer 4

3 key standards:-

- IAS 32: Financial Instruments: Presentation (& classification)

- IFRS 7: Financial Instruments: Disclosures

- IFRS 9: Financial Instruments (Measurements)

Reasoning:-

Many financial instruments were recorded inconsistently or even “Off-balance sheet” which meant they were not being recognised or disclosed.

The lack of comparability and omission of the information, Exposed the shareholders to significant risk.

Question 5

What are the main classifications of a financial instrument?

Answer 5

• Financial Asset
• Financial Liability
• Equity Instrument
• Compound Instrument

Question 6

How to classify a liability vs equity?

Answer 6

The problem many financial instrument contracts are in substance different from the legal form. So to help identify the difference between equity and financial liability is the golden rule:

• Fixed consideration + Fixed Number of shares deliverable = EQUITY
• Fixed consideration + Variable Number of shares or Redeemable = LIABILITY

Financial Liability instrument is it gives rise to a contractual obligation:

1) To deliver cash
2) Another financial asset that may be variable in an F.V amount.

Equity Instrument only gives evidence to the right to receive (not specifically contractually obliged to do so) an asset (Cash or PPE or dividends) from the residual value of an entity after deducting all of its liabilities. i.e retained earnings.

There is no legal requirement to deliver further cash or assets except in the case of liquidation.

Interest, dividends and loss and gains

All Payments in regards to financial liabilities are treated as a finance expense via P/L

All Dividends payments are paid/charged via the statement of changes in equity

Question 7

Why is it important to understand the difference between a financial liability to equity from a Stakeholder perspective?

Answer 7

• Classification as a financial liability will result in increased gearing and reduced reported profit lower EPS (as distributions are classified as finance cost a P/L expense.
• Classification as equity will decrease gearing and have no effect on reported profit (as
  distributions are charged to equity). Reduced share of dividends and dilution of ownership.

Question 8

When can a financial asset and financial liability be offset?

Answer 8

The net amount (offset amount) may only be reported when the entity:

• - Has a legally enforceable right to set off the amounts
• - Intends either to settle on a net basis or to realise the asset and settle the liability simultaneously’ (IAS 32, para 42).

Question 9

What is a Compound instrument?

How to account for Compound Instruments?

On recognition

Answer 9

Where a financial instrument contains some characteristics of equity and some of the financial liability then its separate components need to be classified separately

On Recognition

Dr - Cash/Asset - F.V of the consideration received on the agreement date.

Cr - Financial Liability - Carrying Amount of the Liability component:

• Present Value of liability discounted at the market rate for a similar liability without the equity component)

Cr - Equity - Residual amount (Balancing figure)

Question 10

What are Treasury shares?

and How is it recognised in the accounts?

Answer 10

A treasury share is when a company buys back its own shares. which they may cancel or reissue at a later date.

Recognised as:

The amount paid is presented as deducted from equity (as a component of OCE. Any premiums or discount is recognised in reserves. (there is no asset)

No gain or loss is shown in the P.L

• Undecided if shares are to be cancelled or reissued, treasury shares held, so the amounts just sit in the equity section.

Dr- B.S/OCE - Treasury shares (deduction in equity)
Cr. Cash

• If they decide to cancel
  
  • Dr - Ordinary Shares
  • Dr - Share Premium
  • Dr - Excess paid above share premium to be Expensed (to the retained earnings in equity)
  • Cr - Treasury shares
• If they decide to issue
  
  • Dr - Cash
  • Cr - Treasury Shares
  • Cr/Dr - Share premium

Question 11

How is a Financial Liability Recognised

and

How to choose measurement between FVTPL or Amoritised Cost?

Answer 11

A Financial Liability is recognised when an element/transaction meets the definition and should be initially recognised at the F.V.

The choice of the subsequent measurement and presentation of the Fin.L will dictate the financial liability initial measurement.

There are 2 main types, Financial Liabilities held at:

1. Amortised cost
2. Fair Value through Profit and loss (FVTPL)

How to choose?

• Amortised Costs

Most Fin. L will be held at A.C
Example: Loans and Borrowings held for the whole term and the company intends to repay capital and interest due on the loan.

• Fair Value through Profit and loss (FVTPL)

Except for Financial Liabilities​ which are:

• Held for Trading
• Out of money Derivatives (e.g.stock call options held at a loss, forward contracts held at a loss)
• Fin. L that would normally be held as amortised, but the entity can make an irreversible election to hold at FVTPL, but any movement in F.V is split:
  
  • change is due to own credit risk is via OCI
  • remaining FV change via P/L

​

Question 12

How to Initially Measure/Recognise and the Subsequent Measurement of Financial Liability via Amoritised Cost?

Answer 12

Initial Recognition

F.V + Transactions Costs

Face Value*
Less % Discount on issue
Less: Issue costs (e.g Legal fees)

= Initial Recognition of Liability

*Note: if the Loan was issued at 0% it should be discounted to P.V, using the market effective interest rate.

Note: Loan premiums are accounted for by using the effective rate of interest rather than the interest rate in the Loan Agreement. (example of substance over form)

Subsquent Measeurment

O/B: of Fin.Liability
Plus: Finance cost (Effective interest rate)
Less: Cash Payments/Coupon amounts)
C/B: of Fin.Liability

Question 13

How to Initially Measure/Recognise and the Subsequent Measurement of Financial Liability via FVTPL?

Answer 13

Initial Recognition

F.V with transaction costs going to the P/L

• *Face Value –)** = The net cash proceeds.
• *= Initial Recognition of Liability**

*Note: Cash flows discounted to P.V if interest fee loan

Note: Loan premiums are accounted for by using the discounted cash flows.

Subsquent Measeurment

- The liability is remeasured to F.V ^{<strong>(this is done by using the interest rate on the reporting date) </strong>}

O/B: of Fin.Liability
Plus: Finance cost (Effective interest rate)
Less: Cash Payments/Coupon amounts)
Balance: of Fin.Liability

*Bal Fig. Gain or loss in F.V charged to the P/L**

C/B of Fin Liability = P.V of remaining Cash flows (discounted using market interest rates on the reporting date)

*Note- If the Fin.Liability is FVTPL because of an accounting mismatch the % change in the interest rate due to own credit risk is split:

Gain or loss on remeasurement due to own credit risk is split:

• - Own Credit Risk —) OCI
• - Remainder to P/L

Question 14

How are Financial Guarantee contracts given by the company are accounted for?

Answer 14

Financial Guarantee - Guarantee given by the entity to cover a debt is a liability.

Initial recognition is at F.V

Cr - Liability

Dr- P/L

Subsequently, remeasure it at the higher of:

• • the amount determined in accordance with IAS 37 (provisions).
• • amount initially recognised less the cumulative amortisation (when appropriate).

Numbers similar to amortised cost when there’s no change in risk

If there is a change in risk. resulting in increased liability.

1st Calculate the normal level of amortisation

But the increased liability is then calculated by taking the

C/B Liability after amortisation
Bal Fig- the cost of an increase in financial guarantee risk Cr- Liability/ Dr- P/L
C/B Remeasurement of Liability

Question 15

When are financial assets Recognised?

How should they be classified?

and

How does the classification affect the measurement basis?

Answer 15

IFRS 9 says that an entity should recognise a financial asset:

• ‘when, and only when, the entity becomes a party to the contractual provisions of the instrument’

Classification of Financial asset?

The Cash Flow Test ^{<em>is used to identify the type of financial asset:-</em>}

Do contractual terms of the financial asset give rise to, specified dates to cash flows that are Solely Payments of Principal and Interest S.P.P.I on the principal outstanding.?

Simply - Are the ONLY cashflows coming in capital and interest?

• Yes - Debt Instrument
• No - Equity Instrument

The Business Model Test:- ^{Is used to identify the measurement basis}

• Hold to collect
• Hold to collect and sell
• Other or unsure

Question 16

How to Measure a Financial asset that is an Equity Instrument?

Answer 16

Business Model test

FVTOCI -

• • The equity instrument must not be held for trading, and
    
    • • Irrevocable choice for this designation upon initial recognition of the asset.

FVTPL -

• The default expectation is that equity instruments will have the designation of fair value through profit or loss.

FVTPL Measurement

Initial Measurement:

• at F.V (Most likely the purchase price)
• Transactions costs are expensed to P/L

Subsequent Measurement:

• Asset is revalued to fair value
• with the gain or loss recorded P/L

FVTOCI Measurement

Initial Measurement:

• at F.V (Most likely the purchase price)
• + Plus Transaction Costs (capitalised)

Subsequent Measurement:

At each year-end or before disposal of an asset:

• The asset is remeasured to F.V
• Gains or losses recognised in the OCI

Question 17

How are Investments into debt Instruments (Financial assets) accounted for?

Answer 17

The Business Model Test is carried out to see how they should be measured.

Hold to collect - To collect contractual cashflow SPPI —) Amortised Cost

E.g Investment into a Debenture or trade receivables.

Hold to collect and sell - To collect contractual cashflow and Sell —) OCI

E.g Government treasury bonds

Other/All other business models - unsure if planning to trade, or anything else —) FVTPL

Question 18

How to measure a Debt Instrument?

Held to collect - To collect contractual cashflow SPPI —) Amortised Cost

Answer 18

Investments in debt that are measured at amortised cost:

• *- Initially recognised @ at F.V plus Transaction costs.
• Interest income is calculated using the effective rate of interest.**

Question 19

How to measure a Debt Instrument?

Hold to collect and sell - To collect contractual cashflow and Sell —) OCI

Answer 19

Initial Recognition

F.V - The amount of money invested
+ Transactions costs
= Financial Asset

Subsequent Measurement:

O/B - Dr Financial Asset
Dr - Interest charge at Effective rate = Cr P/L Finance Income (But Charged on the balance as if it was treated as amortised cost)
Cr- Cash Flow/coupons Received = Dr Cash
C/B - Financial Asset
Bal Fig. - Revaluation gain or loss charged to OCi
C/B - Remeasuremed Financial Asset

Question 20

How to measure a Debt Instrument? Other

Other/All other business models - unsure if planning to trade, or anything else —) FVTPL

Answer 20

For investments in debt that are measured at fair value through profit or loss:

Initial Measurement

• The asset is initially recognised at fair value, with any transaction costs expensed to the statement of profit or loss.
  
  • F.V = likely to be at cost Dr- Financial Asset - Cr Bank
  • Transactions costs - P/L Dr- P/L Expense - Cr Bank

Subsequent Measurement At the reporting date,

• the asset will be revalued to fair value
• gain or loss recognised in the statement of profit or loss.

O/B Dr - Financial Asset
Dr - Interest Income charged on the principal
Cr - Cash Receipts/Coupon Interest Income
C/B Dr- Financial Asset before Remeasurement
Bal Fig. revaluation gain or loss via P/L
C/B Dr- Financial asset remeasured to F.V

Question 21

How is the reclassification of financial assets treated?

Answer 21

Reclassification of financial assets is Very rare.

Only applicable if there is a change in the business model.

Reclassification is done on a prospective basis. Since previous years was accounted for correctly based on the business model in place at that time. Therefore previously recognised gains/losses are not restated.

If an entity changes its business model for managing financial assets, all affected financial assets are reclassified

Reclassification is not permitted for equity instruments classified as FVTOCI due to the irrevocable election made.

Question 22

Define the following Loss Allowance terms:

Credit loss:

Expected credit losses:

Lifetime expected credit losses:

12-month expected credit losses:

Answer 22

Expected credit losses: The weighted-average credit losses.

Lifetime expected credit losses: The expected credit losses that result from all possible default events.

12-month expected credit losses: The portion of lifetime expected credit losses that result from default events that might occur 12 months after the reporting date.

Credit loss: The present value of the difference between the cash flows that they legally entitled to vs the cash flows they expect to receive.

Cashflows Legally receivable
Less Cash Flows Expected to be received
= Loss
X Discounted to the reporting date
= P.V Credit Losses

Question 23

What is loss allowance and how are financial assets impaired?

and

What type of financial assets is it applied to?

Answer 23

IFRS 9 uses a forward-looking impairment model.

Under this model, future expected credit losses are recognised. (A loss Allowance)(similar to a provision based on assumptions)

His is different to the impairment mode IAS 36. as impairment is only recognised when objective evidence of impairment exists.

Usually applied to financial assets that are:

1. Held to collect sppi —> Amortised Cost

2. Held to collect sppi and possibly sell —>FVOCI

Question 24

What is a loss allowance and how should they be treated?

Answer 24

How to Recognise and calculate Loss Allowances

There are three stages:-

Stage 1 - Initial Recognition of Fin.Asset-

a loss allowance equal to 12-month expected credit losses must be recognised.

Calculation Amount

P.V of Credit Loss Expected
x The probability of default in 12 months
= Credit Loss Amount

At Year-end

Effective Interest is charged on the gross amount and increasing the credit losses Provision

Stage 2 - Credit risk has significantly increased

E.g Borrower is in default by >30 days/or industry has seen a downturn.

Recognise a Provision for the P.V of full lifetime of credit losses = Gross Carrying Amount

Calculation -

P.V Lifetime Credit loss on the date of recognition
X Charge Interest rate for each year to Reporting Date
Less - Credit losses already accounted (12 months + any interest on this)
= Loss allowance to be Recognised in the current period.

Stage 3 - Objective Impairment

Recognise the P.V of full lifetime of credit losses on the Net Carrying Amount

Question 25

How is loss allowance on Investments in debt instruments measured at amortised cost Presented in the accounts?

Answer 25

• Recognised in profit or loss Dr- P/L - loss allowance
• Credit losses held in a separate allowance account offset against the carrying amount of the asset:

Financial asset X
Cr - Allowance for credit losses (X)
Carrying amount (net of allowance for credit losses) X

Question 26

How are loss allowances on Investments in debt instruments measured at fair value through other comprehensive income presented?

Answer 26

• *• Portion of the fall in fair value relating to credit losses recognised in profit or loss**
• *• Remainder recognised in other comprehensive income**
• *• No allowance account necessary because already carried at fair value (which is automatically reduced for any fall in value, including credit losses)**

Question 27

How loss allowance reversals treated?

Answer 27

Impairment reversals

• At each reporting date, the loss allowance is recalculated.
• It may be that the allowance was previously equal to lifetime credit losses but now, due to reductions in credit risk,
  
  • only needs to be equal to 12-month expected credit losses.
  • As such, there may be a substantial reduction in the allowance required.
• Gains or losses on remeasurement of the loss allowance are recorded in profit or loss.

Question 28

What simplifications are allowed in ifr9 Loss allowances?

Answer 28

Simplifications
IFRS 9 permits some simplifications:

• Trade Receivables and Contract Assets that do not have a significant financing component.
  
  • The loss allowance should always be at an amount equal to lifetime credit losses
• Lease Receivables, Trade Receivables and Contract Assets with a significant financing component,
  
  • the entity can Choose the accounting policy to measure the loss allowance at an amount equal to lifetime credit losses.

Question 29

When is a Financial Asset and Financial Liability Derecognised?

Answer 29

A financial asset should be derecognised if one of the following has occurred:

• The contractual rights have expired
• The financial asset has been sold and substantially all the risks and rewards of ownership have been transferred from the seller to the buyer.

Substance over Form?

• The analysis of where the risks and rewards of ownership lie after a transaction is critical.
• If an entity has retained substantially all of the risks and rewards of a financial asset then it should not be derecognised, even if it has been legally ‘sold’ to another entity.

A Financial Liability should be derecognised when the obligation is:

• - discharged
• - cancelled
• - expires.

Question 30

What is the Accounting Treatment for a derecognition of Financial asset and Financial Liability?

Answer 30

The accounting treatment of derecognition is as follows:

• The difference between the carrying amount of the asset or liability and the amount received or paid for it should be recognised in profit or loss for the period.
• For investments in EQUITY instruments held at FVTOCI, the cumulative gains and losses recognised in OCI are NOT reclassified to profit or loss on disposal.
• For investments in DEBT instruments held at FVTOCI, the cumulative gains and losses recognised in OCI are reclassified to profit or loss on disposal.

Question 31

What is the Definition of a Derivative?

When is a contract to sell or buy a Non-financial item a derivative?

Answer 31

• Definitions*
• *Derivative is a financial instrument with the following characteristics:**
• (a) Its value changes in response to the change in a specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index or similar variable (called the ‘underlying’).
• (b) It requires little or no initial net investment relative to other types of contract that have a similar response to changes in market conditions.
• (c) It is settled at a future date.

Non-financial Items

A contract to buy or Sell a non-financial item (such as inventory or PPE is only a derivative if:

• A contract was not entered into for the purpose to actually receiver deliver the item. (Basically just trying to benefit from the F.V gain of the non-financial item, like a bet)
• It can be settled net in cash (or using another financial asset)

IFRS 9 contract considered to be settled net in cash when:

• terms of the contract permit either party to settle the contract net
• entity has a practice of settling similar contracts at net
• entity, for similar contracts, has a practice of taking delivery of the item and then quickly selling it in order to benefit from fair value changes
• non-financial item is readily convertible to cash.

Note:- If the contract is not a derivative then it is a simple executory contract. Such contracts are normally accounted for until the sale or purchase date.

Question 32

Name some common types of Derivative contracts?

Also, What is the difference between a forward and future Contract?

Answer 32

Forward contracts: The holder of a forward contract is obliged:

• to buy or sell a specific underlying asset,
• at a specified price
• at a specified future date.
  
  • e.g - large food manufacturers may purchase a farmer’s fruit in the future to lock in the price and control their manufacturing cost.

Futures contracts: oblige the holder to

• Buy or sell a standard quantity of a Specific underlying item
• at a specified future date.

Future vs Forward

Futures contracts are very similar to forward contracts. difference is that

• Futures contracts have standard terms and are traded on a financial exchange,
• Forward contracts are tailor-made and are not traded on a financial exchange.
• Swaps*
• *Two parties agree to exchange periodic payments at specified intervals over a specified time period.**

For example,

• in an interest rate swap, the parties may agree to exchange fixed and floating rate interest payments calculated by reference to a notional principal amount.
• or Currency Swaps
• *Options**
• *These give the holder the right, but not the obligation, to buy or sell a specific underlying asset on or before a specified future date.**

e.g

• Call options allow the holder to buy the asset at a stated price within a specific timeframe.
• Put options allow the holder to sell the asset at a stated price within a specific timeframe.

Question 33

How are derivatives accounted for?

Answer 33

• *Measurement of derivatives - FVTPL**
• On initial recognition,*
• - Measured at fair value. (Likely to be at cost)
  
  • - Transaction costs are expensed to P/L.

At the reporting date,

• Remeasured to fair value.
  
  • Movements in fair value are recognised in P/L

Question 34

What is an Embedded Derivative?

Answer 34

Definition - An embedded derivative is a:

‘component of a hybrid contract that also includes a non-derivative host, with the effect that some of the cash flows of the combined instrument vary in a way similar to a standalone derivative’ (IFRS 9, para 4.3.3).

• Hybrid Contract - generally combine both debt and equity characteristics
• Host Contract - The non-derivative element
• Eembedded Derivative - is the derivative component of a Hybrid Contract.

Question 35

How do you account for an embedded derivative?

Answer 35

• Host contract is within the scope of IFRS 9 (i.e a Fin.A or Fin.L)
  
  • Then the entire contract must be classified and measured in accordance with that standard.
• Host contract is NOT within the scope of IFRS 9 (i.e. it is not a i.e a Fin.A or Fin.L)
  
  • the embedded derivative can be SEPERATED out and measured at FVTPL if:
    
    • (i) ‘the economic risks and characteristics of the embedded derivative are NOT closely related to those of the host contract
• ​(ii) a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative.
• ​(iii) the entire instrument is not measured at fair value with changes in fair value recognised in profit or loss’ (IFRS 9, para 4.3.3).

Because of the complexity involved in splitting out and measuring an embedded derivative:-

• IFRS 9 permits a hybrid contract where the host element is outside the scope of IFRS 9 to be measured at FVTPL entirety.
• For the vast majority of embedded derivatives, the whole contract will simply be measured FVTPL

Question 36

When does IFRS 9 not require embedded derivatives to be separated from the host contract?

Answer 36

Question 37

What are the IFRS9 criteria that must be met for hedge accounting to be used?

Answer 37

Under IFRS 9, hedge accounting rules can only be applied if the hedging relationship meets the following criteria:

• 1 The hedging relationship consists only of eligible hedging instruments and hedged items.
• 2 At the inception of the hedge there must be formal documentation identifying the hedged item and the hedging instrument.
• 3 The hedging relationship meets all effectiveness requirements

Question 38

Define:

• Hedge Accounting
• Hedged Item
• Hedged Instrument

Answer 38

Hedge Accounting: – > is a method of managing/reducing risk by:

• - Designating a hedging instrument so that their change in fair value
• - Offset the change in fair value or cash flows of a hedged item.

Hedged item is an asset or liability that exposes the entity to risks of changes in fair value or future cash flows (and is designated as being hedged). There are 3 types of hedged item: (The element/item trying to protect)

• - A recognised asset or liability
• - An unrecognised firm commitment – a binding agreement for the exchange of a specified quantity of resources at a specified price on a specified future date
• - A highly probable forecast transaction – an uncommitted but anticipated future transaction.

A Hedging instrument is the designated derivative or a non-derivative financial asset or financial liability, whose fair value or cash flows are expected to offset changes in fair value or future cash flows of the hedged item.

Question 39

What are Fair Value Hedges?

and

How are they accounted for?

Answer 39

• *8.1.1 Fair value hedges**
• *These hedge the change in the value of a recognised asset or liability that could affect profit or loss**

eg hedging the fair value of fixed-rate loan note due to changes in interest rates.

All gains and losses on both the hedged item and hedging instrument are recognised as follows:

• (a) Immediately in profit or loss FVTPL
• (b) Immediately in FVTOCI if the hedged item is an investment in an equity instrument held at FVTOCI

Question 40

What is a Cash Flow Hedge?

How do you Account for Cash Flow Hedge?

Answer 40

• *8. 1.2 Cash flow hedges**
• *These hedges the risk of change in the value of future cash flows from a recognised asset or liability (or highly probable forecast transaction)** That could affect profit or loss.

e.g variable rote interest income stream.

Accounted for as follows:

• (a) The effective portion of the gain or loss on the hedging instrument, (ie the value of the hedged item the instrument is protecting) ​
  
  • - is recognised in OCI. (basically matched/offset)

(b) Any excess in hedged profits or losses is recognised immediately in P/L

The amount that has been accumulated in the cash flow hedge reserve is then accounted for as follows :

• - If a Hedged forecast transaction results in the recognition of a non-financial asset or non-financial liability,
  
  • the amount shall be removed from the cash flow reserve and be included directly in the initial cost or carrying amount of the asset or liability.
• - For all other cash flow hedges, the amount shall be reclassified from OCI to P/L in the same period(s) that the hedged expected future cash flows affect profit or loss.

Question 41

What type of Financial Assets are loss allowances recognised for?

Answer 41

Question 42

How Do you account for factoring on financial asset - debt instruments?

Answer 42

To Be Completed

Check to see if the risk and rewards of the financial asset have been transferred?

WITHOUT RECOURSE - The risk and rewards of the Fin.A has been transferred, you must account for the expense of the factoring and reduce the trader receivable.
(Basically sold the debt lower than the contractual right to receive cash from the customer)

Dr - Bank - xxx
Cr - Liability - xxx
Cr - Factoring expense - xxx

WITH RECOURSE - if the customer does not pay the debt to the factoring provider then the company must make payments to the factoring company, also if any monies paid more then the amount factored debt will be receivable to the original entity,

Risk and Rewards stay with the original entity, so the amount of trade debt that has been factored in In effect, a loan and must immediately be account for as a Fin.L

Question 43

What are the requirements for hedge effectiveness?

Answer 43

• There must be an economic relationship between the hedged item and the hedging instrument.
• Credit risk does not dominate the value changes in the economic relationship.
• The hedge ratio of the relationship is the same as that resulting from the quantity of the hedged item that the entity actually hedges and the quantity of the hedging instrument that the entity actually uses to hedge that quantity of the hedged item.
  
  • (Basically, the underlying quantity of the H.Item should be the same as the H.Intrsument)
  • e.g company wants to protect their 10m GBP investment in Euros from forex changes, it enters into a futures contract the H.Instrument should match the 10m GBP.
    
    • If it only matches 5m of the GBP then only that portion of the hedge can be hedged.

Question 44

When can an entity Discontinue (stop) hedge accounting?

Answer 44

An entity must cease hedge accounting if any of the following occur:

• Hedging instrument expires or is exercised, (terminated or sold)
• The hedge no longer meets the hedging criteria.
• A forecast future transaction that qualified as a hedged item is no longer highly probable.

Discontinuance should be accounted for prospectively (entries posted to date are not reversed).

Discontinuing a cash flow hedge,
The accounting treatment of theaccumulated gains or lossesof the H.Intsrumentwithin reserves depends on the reason for the discontinuation.

IFRS 9 says:

• If the forecast transaction is no longer expected to occur,
  
  • Gains and Losses recognised in OCI must be taken to P/L immediately.
• If the transaction is still expected to occur,
  
  • Gains and Losses will be retained in equity until the former hedged transaction occurs.

Question 45

What are the Disclosures of financial instruments? (ifrs7)

Answer 45

IFRS 7 Financial Instruments: Disclosures provides the disclosure requirements for financial instruments.

The main disclosures required are:

• 1. Information about the significance of financial instruments for an entity’s financial position and performance.
• 2. Information about the nature and extent of risks arising from financial instruments.

Further Elaboration:-

1 . Significance of financial instruments

• Must disclose the significance of financial instruments for their financial position and performance for each class of financial instruments.
• An entity must disclose items of income, expense, gains, and losses, with separate disclosure of gains and losses from each class of financial instrument.
• **2. Nature and extent of risks arising from financial instruments*
• Qualitative disclosures describe:***
• Risk exposures for each type of financial instrument.
• Management’s objectives, policies, and processes for managing those risks
• Changes from the prior period.

Quantitative disclosures provide information about the extent of the risk exposer, based on information provided internally to the entity’s key management personnel. These disclosures include:

• Summary quantitative data about exposure to each risk at the reporting date.
• Disclosures about credit risk, liquidity risk, and market risk.
• Concentrations of risk.

Question 46

Stakeholder Perspective

Answer 46

To be completed

Question 47

What is a Purchased or originated credit-impaired financial asset?

and

How is it accounted for?

Answer 47

A purchased or originated credit-impaired financial asset:

• Is one that is credit-impaired on initial recognition.
• Interest income is calculated on such assets using the credit-adjusted effective interest rate.
• The credit adjusted effective interest rate incorporates all the contractual terms of the financial asset as well as expected credit losses. In other words, the higher the expected credit losses, the lower the credit adjusted effective interest rate.

Accounting

• Since credit losses anticipated at inception will be recognised through the credit-adjusted effective interest rate, the loss allowance on purchased or originated credit-impaired financial assets should be measured only as the change in the lifetime expected credit losses since initial recognition.