Chapter 29 - Financial Instruments Flashcards
There are a number of accounting standards that deal with the treatment of financial instruments.
What are they?
- IAS 32 Financial Instruments: Presentation
- IFRS 7 Financial Instruments: Disclosures
- IFRS 9 Financial Instruments.
How does IAS 32 define financial instruments?
IAS 32 defines a financial instrument as “any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.”
What is an equity instrument?
An equity instrument is a contract that evidences a residual interest. A residual interest means that the holder of the equity instruments, or ordinary shares (that is, the person who purchased the shares), is entitled to a share of any excess of assets over all of its liabilities if, and when, the company winds up.
An item is classified as equity if what conditions are met?
An item is classified as equity if the following conditions are met:
- there is no contractual obligation; and
- it will be settled by the issue of a fixed number of shares in exchange for a fixed amount of cash or another financial asset.
IFRS 9 Financial Instruments allows financial assets to be classified and measured using what 3 options?
1 - fair value through profit or loss (FVTPL)
2 - fair value through other comprehensive income (FVTOCI)
3 - financial assets at amortized cost
What financial assets are measured at fair value through profit or loss (FVTPL)?
Financial assets classified and measured at FVTPL are:
- equity instruments held for trading and purchased with the intention of making short-term gains;
- derivatives other than hedging instruments; and
- debt instruments not classified and measured at fair value through other comprehensive income or amortised cost.
A financial asset is classified as FVTPL unless another classification has been chosen. Transaction costs associated with the acquisition of a financial asset measured in this category are expensed to the statement of profit or loss when incurred.
Explain the rules regarding financial assets measured at fair value through other comprehensive income?
The classification of financial assets measured at FVTOCI is designated at initial recognition and cannot be changed.
As a result, changes in fair value are presented in the other comprehensive income section of the SPLOCI.
Transaction costs incurred in relation to the acquisition of a financial asset are included in the cost of the asset at initial recognition.
Explain the rules for financial assets measured at amortised cost
A financial asset may have costs or income other than just interest income associated with it. In these circumstances an ‘effective interest’ is used to recognise the income in the statement of profit or loss in a constant manner over the term of the asset’s life. The effective interest rate is the interest rate that discounts future cash flows to zero.
Unless an entity has chosen to measure a financial asset at FVTPL, a debt instrument that meets the following two tests must be designated at amortised cost:
- Business Model Test – where the financial asset is held for the purpose of collecting contractual cash flows relating to the asset rather than for short-term trading.
- Contractual Cash Flow Characteristic Test – where the cash flows only relate to the collection of principal and interest.
What are the 2 categories of financial liability?
1 - Financial liability at fair value through profit and loss (FVTPL).
2 - Financial liabilities measured at amortised cost.
Classification is made at the initial recognition date.
When are financial liabilities measured at fair value through profit and loss (FVPTL)?
A financial liability is measured at FVTPL if:
- it reduces or eliminates the accounting mismatch that would arise from measuring assets and liabilities on different bases; or
- the liability is part of a group of financial liabilities (or a group of financial assets and liabilities) whose performance is measured and managed on a fair value basis. The management of such a group should be documented in terms of management’s risk management and investment strategy and the information provided to key management personnel.
Changes in fair value are recognised in the SPLOCI in the period that the change in fair value occurred.
When are financial liabilities measured at amortised cost?
Loans can have several costs, such as interest, issue costs and premiums on redemption. A bank charges issue costs in relation to the arrangement of a loan facility. Loans can be structured so that minimum interest is paid over the term of the loan and a large payment made at the end of the loan term (i.e. premium on redemption).
When there are costs other than just the interest cost, an effective interest rate is used to charge the total cost associated with the loan facility over the term of the loan. The use of an effective interest rate means that the total cost is charged over the term of the loan rather than when the costs are incurred – for example, at the start of the loan period when the issue costs are incurred, or at the end of the loan when the premium on redemption is paid.
What happens when you issue a loan that has issuance costs?
The loan is recognised on the date it was made net of the issuance costs.
How does IFRS 7 compare with FRS 102?
Under FRS 102, financial instruments are either measured at amortised cost or fair value through profit or loss depending on their characteristics. The disclosure requirements are greater under IFRS than under FRS 102.
