Chapter 11 (Financial instruments)

Question 1

Define a financial asset

Answer 1

A financial asset is “any asset that is:

1. Cash;
2. An equity instrument of another entity;
3. A contractual right to receive cash or another financial asset from another entity”

Question 2

Define a financial liability

Answer 2

“A contractual obligation to deliver cash”

A financial liability is “any liability that is a contractual obligation to deliver cash or another financial asset to another entity”

Question 3

Define an equity instrument

Answer 3

“A residual interest in assets minus liabilities”

An equity instrument is “any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities”. Ordinary shares are the most common instance of an equity instrument

Question 4

When is a financial instrument an equity instrument according to IAS32?

Answer 4

“An equity instrument includes no obligation to deliver cash or financial assets”

IAS32 states that a financial instrument should be classified as an equity instrument if and only if: “the instrument includes no contractual obligation … to deliver cash or another financial asset to another entity … “

Question 5

How must redeemable preference shares be presented and why?

Answer 5

“Liabilities, because the shareholders has the right to require repayment”

Redeemable preference shares classifies as liabilities rather than equity and must either:

1. Provide for mandatory repayment of the share capital at a future date, or
2. Give the shareholders the right to require repayment of the share capital on or after a particular date, for a fixed or determinable amount

Question 6

How is the liability part in a compound financial instrument calculated (for example
a loan that is convertible to ordinary shares)?

Answer 6

“It should be separated in a liability part and an equity part, based on a calculation”

In the case of convertible loan stock, IAS32 states the fair value of the liability component should be determined by calculating the present value of the scheduled payments of interest and principal, ignoring the conversion option

Question 7

How must the initial measurement of financial instruments be performed?

Answer 7

“At fair value”

IFRS9 requires that financial assets and liabilities should be measured initially at their fair value

Question 8

There are three classes of subsequent measures of financial assets - which?

Answer 8

1. Financial assets at amortised cost
2. Financial assets at fair value through other comprehensive income
3. Financial assets at fair value through profit or loss

Question 9

What is the effective interest method?

Answer 9

“The interest rate that equals the discounted future cash receipts to the initial carrying amount of the asset”

The “effective interest method” is a way of calculating the amount of interest earned to date. This method uses an interest rate that exactly discounts estimated future cash receipts to the initial carrying amount of the asset. The calculation takes into account not only interest receivable, but also items such as premiums and discounts.

Question 10

Which are the two subsequent measures of financial liabilities?

Answer 10

1. Financial liabilities at fair value through profit or loss
2. Trade payables

Question 11

Which are the three classes of risk in IFRS7 that should be considered in the
footnotes?

Answer 11

1. Credit risk
2. Liquidity risk
3. Market risk