Chapter 12 - Financial Instruments

Question 1

Financial assets - FVPL vs FVOCI = how do you account for costs

Answer 1

IR

FVPL = Expensed in PI

FVOCI = Include costs in IR (FV plus transaction costs)

Amortised cost= include costs

Question 2

What is a compound instrument

Answer 2

One that has the characteristics of both financial liability and equity.

Question 3

Example of a compound instrument

Answer 3

issue of a bond that allows the holders to request redemption in the form of cash or a fixed no. of equity shares

Question 4

Issued vs purchased

Answer 4

Purchased is asset

issued is liability

Question 5

Impairment IFRS 9

Answer 5

Uses an expected loss approach to impairment accounting. what we think we wont get.

apply to debt instruments = fvoci or amortised costs

help to not over/under state assets

changes in value - incr or decr = goes to PL

Question 6

Credit loss

Answer 6

PV of the diff between the contractual cf due to an entity and cf that it is expected to receive

due = what you should receive
expects = actually receive

Question 7

How to work out the liability and equity component

Answer 7

The initial carrying amount of the liability component is calculated as the present
value of the cash repayments, discounted using the market rate on non-convertible
bonds. The equity component is the difference between the cash received and the
liability component at the issue date.

Question 8

Liability and equity component

Answer 8

• a liability component (the obligation to repay cash)

* an equity component (the obligation to issue a fixed number of shares).

Question 9

Impairment loss

Answer 9

entities must calculate a loss allowance

applies to debt instruments measured at amortised costs or at FVOCI

Question 10

Credit loss

Answer 10

the pv of the diff between contractual cash flow due to an entity and the cash flow that it expects to recievce

Question 11

expected credit loss

Answer 11

weighted average credit loss

Question 12

lifetime expected credit loss

Answer 12

expected credit losses that result from all possible default events

Question 13

12 month expected credit loss

Answer 13

proportion of lifetime expected credit losses that arise from default events within 12 months of reporting date

Question 14

events that suggest an asset is credit impaired

Answer 14

sign financial diff of the issuer or borrower

breach of contract such as default

the borrower being granted concessions

becoming probable that the borrower will enter bankruptcy

Question 15

How to work out interest income if an asset is credit impaired

Answer 15

assets net carrying amount = gross amount - loss allowance

Question 16

Accounting for loss allowance - measured at amortised cost

Answer 16

Dr P/L
Cr Allowance (SFP)

Allowance account reduced the net carrying amount of the financial asset

Question 17

Accounting for loss allowance - measured at FVOCI

Answer 17

Dr P/L
Cr OCI

We do not touch the financial asset in the SFP as it is already at its FV

Question 18

Derecognition - financial liability

Answer 18

when the obligation is EXTINGUISHED

• is discharged
• Is cancelled
• expires

diff between consideration and CA is recognised in PL

Question 19

Derecognition - financial asset

Answer 19

• Contractual rights to CF expire
• entity transfers substantially all of the risk and rewards of FA to another party

diff between consideration and CA is recognised in PL

Question 20

Derivatives

Answer 20

Value of a contract which is derived from a value of an underlying asset.

A derivative is a financial instrument whose value changes in relation to changes in a variable, such as an interest rate, commodity price, credit rating, or foreign exchange rate. There are two key concepts in the accounting for derivatives. The first is that ongoing changes in the fair value of derivatives not used in hedging arrangements are generally recognized in earnings at once. The second is that ongoing changes in the fair value of derivatives and the hedged items with which they are paired may be parked in other comprehensive income for a period of time, thereby removing them from the basic earnings reported by a business.

Question 21

Characteristic of a derivate

Answer 21

• its value changes in response to the value changes of an underlying item (eg commodity prices)
• requires little or no investment

it is settled at a future date

Question 22

eg of a derivate

Answer 22

future, interest rate swaps and options

such as an interest rate, commodity price, credit rating, or foreign exchange rate.

Question 23

derivatives are measured through..

Answer 23

FVPL

Initially at FV - costs expensed to pl

subs - remeasured to FV at each reporting date with gain/loss in SPL

Question 24

EMBEDDED derivatives

Answer 24

component of a contract that includes a non-derivate host and which affects CF in a similar way to a standard derivative

Question 25

hedge accounting

Answer 25

used to manage the problems with derivates.

derivates provide huge volatility in SPL

EG payment of 5m in EUR. so it will cost you 5m EUR go in a contract to manage spend and interest rate. would be worried about interest rate changes so prob is we have changes in the FV which is all going through PL. Derivate is the forward contract.

Hedge accounting is a method of accounting where entries to adjust the fair value of a security and its opposing hedge are treated as one. Hedge accounting attempts to reduce the volatility created by the repeated adjustment to a financial instrument’s value, known as fair value accounting or mark to market. This reduced volatility is done by combining the instrument and the hedge as one entry, which offsets the opposing’s movements.

Question 26

hedge acc is a

Answer 26

optional set of rules which if applied could have or reduce the volatility of the derivate.

Question 27

hedge acc is optional but

Answer 27

if go ahead if the criteria is met

Question 28

an entity that choses to hedge acc must document the following:

Answer 28

• the hedge item: asset to buy in diners for eg. - it is the reason
• the hedge instrument: the derivate itself
• the risk

Question 29

2 types of hedge acc that are examable for IFRS9

Answer 29

Fair value hedge: movement in FV. Eg forward contract in 6 months time

cash flow hedge: movement in cash flow. protect yourself from future cash flow.

look in the detail. if you are protecting yourself from asset or liab = FV hedge. if your protecting from CF = it is cash flow hedge

Question 30

Any gain on hedged item and loss

Answer 30

on hedging instrument (or vice versa) will largely be offset in either PL or OCI meaning that the volatility is reduced.

Question 31

CF hedge

Answer 31

no entries are posted for the hedged item - the trans hasnt happened