Chapter 4 - financial instruments

Question 1

What is a financial instrument?

Answer 1

a financial instrument is any contract which gives rise to a financial asset in one entity and a financial liability or equity instrument in another entity

Question 2

Financial asset

Answer 2

• cash
• a contractual right to receive cash (e.g. receivables)
• a contractual right to exchange financial assets or liabilities on favourable terms (a derivative)
• an equity instrument in another entity (an investment).

Question 3

Financial liability

Answer 3

• deliver cash (e.g. payables)
• exchange financial assets or liabilities on unfavourable terms (a derivative)

Question 4

Equity instrument

Answer 4

an equity instrument is a residual interest in the net assets of an entity without any contractual obligations (e.g. shares issued by the entity).

Question 5

Redeemable preference shares and treatment

Answer 5

• Redeemable at the option of the shareholder
• Classifies as a financial liability

Question 6

Recognition of redeemable preference shares

Answer 6

Recognised as a finance cost in the SPL

Question 7

Recognition of irredeemable preference shares

Answer 7

Deducted from retaining earnings in the SOCIE

unless mandatory obligation to pay then a finance cost in the SPL

Question 8

Effective rate

Answer 8

Effective rate of interest spreads all of the costs of the liability to the SPL over the term of the instrument

Question 9

Coupon rate

Answer 9

amount of interest paid - always given as a percentage of the nominal value

Question 10

what is a compound instrument

Answer 10

Financial instrument that has characteristics of both equity and a liability

Question 11

2 main categories when disclosing financial instruments:

Answer 11

1. information about their significance, or quantitative disclosure
2. information about the nature and extent of associated risks, and how the entity manages those risks, or qualitative disclosure.

Question 12

Quantitative disclosure

Answer 12

• an entity must disclose the carrying vale of each class of financial instrument
• the fair value of each class of financial instrument should also be disclosed

Question 13

Qualitative disclosure

Answer 13

• The entity must disclose information to enable users to understand management’s attitude to risk
• Disclosures may focus on the entity’s credit risk, liquidity risk and market risk