Chapter 9 - Financial Assets and Financial Liabilities Flashcards
What is a financial instrument?
a contract between two parties that creates a financial asset for one, and liabilities or equity for another.
give some examples of financial instruments.
investments in shares, bonds, and receivables, trade payables, long term loans and equity share capital
What is a financial asset?
a non-physical asset such as:
- cash
- an equity instrument of another entity
- a contractual right to receive cash or another financial asset (e.g., receivables or purchased bonds)
- a contractual right to exchange financial assets or liability on favourable terms
What is a financial liability?
a contractual obligation to deliver cash or another financial asset.
contractual obligation to exchange financial assets or liabilities on unfavourable terms
What are unfavourable terms?
issuing an option to buy shares at a value below market price
On inception how are financial liabilities recognised?
- at its fair value. Usually the net proceeds of the cash received less any costs of issuing the liability
What is amortised cost for financial liabilities?
- any cash repaid, reducing the liability
- any interest accrued, using the effective interest rate
Fair value through profit and loss is used when for liabilities?
for liabilities held for trading or derivatives
What is the effective rate of interest?
spreads all of the costs of the liability (trans fees, issue discounts, annual interest payments and redemption premiums) to profit and loss over the term of the instrument.
What is the calculation for amortised cost?
initial value + effective interest - interest paid
What is a compound instrument?
one that has characteristics of both a financial liability and equity
What is a common example of a compound instrument?
a bond or loan allowing the lender the choice of redemption in the form of cash or a fixed number of equity shares
How are compound instruments accounted for?
using split accounting
what will the compound instrument be split into?
- a liability component (the obligation to repay cash)
- an equity component (the obligation to issue a fixed number of shares)
How is the debt split calculated?
Present value of cash flows discounted at the rate for non-convertible bonds
How is the equity split calculated?
balancing figure:
Cash received less liability
All financial assets are intially measured at what?
fair value
What are the 2 different treatments for financial assets?
- fair value through profit or loss (FVPL)
- fair value through other comprehensive income (FVOCI)
What is FVPL?
Initial recognition: Fair value (acquisition costs written off to SPL)
Subsequent treatment: Revalue each reporting date with gain or loss taken to SPL
What is FVOCI?
Initial recognition: Fair value plus acquisition costs
Subsequent treatment: Revalue each reporting date with gain or loss taken to OCI
what conditions must be met for an entity designate the equity investment through FVOCI?
- the equity instrument cannot be held for trading
- on acquisition there must be an irrevocable designation by the entity to treat the investment as FVOCI, and this cannot be changed later
How are debt instruments valued?
- amortised cost
- FVOCI
- FVPL
What is the default classification for debt instruments?
- fair value through profit and loss
What 2 tests must be passed for debt instruments to be value at amortised cost?
Business model test
Contractual cash flow characteristics test
What is the business model test for amoritised cost?
considers the entity’s intention. The entity must intend to hold the investment to redemption (i.e. the investment cannot be sold before maturity).
What is the contractual cash flow characteristics test for amortised cost?
This test considers the cash to be received as a result of holding the investment. The contractual terms of the financial asset must give rise to cash flows that are solely of principal and interest.
If designated as amortised cost what happens?
- the asset is initially recognised at fair value (price paid) plus transaction costs
- the interest income is calculated using the effective rate of interest on an amortised cost table
What is the business model for FVOCI for debt instruments?
- requires the entity to intend to hold the investment to maturity but allows for the possibility of selling the asset in order to acquire another higher-return asset
What is the Contractual cash flow characteristics test for FVOCI for debt instruments?
the contractual terms of the financial asset must give rise to cash flows that are solely of principal and interest
If designated as FVOCI for debt instruments what happens?
- the asset is initially recognised at fair value plus transaction costs
- interest income is calculated using the effective rate of interest on an amortised cost table
- at the reporting date the asset is revalued to fair value, with any gain or loss recognised in other comprehensive income. This gain is reclassified to P&L on disposal of asset
What happens if investment fails the test to be classified otherwise?
the default classification for debt investment is fair value through profit or loss (FVPL
What is the justification for debt instruments to be classified as FVPL?
the entity acquires these investments for trading purposes, so gains or losses should be shown in the SPL.
What happens when debt instruments are classified as FVPL?
initially are measured at fair value but transaction costs are written off to P&L.
investments revalued to fair value at each year end, with gain or loss shown in P&L
When should a financial liability be derecognised?
when the obligation is extinguished
when would an obligation be extinguished?
- when the contract is discharged, cancelled or expired
the difference between any consideration transferred and the carrying amount of the financial liability or asset is recognised where?
the P&L
When would a financial asset be derecognised?
- the contractual rights to the cash flows expires or,
- the entity transfers substantially all of the risks and rewards of the financial asset to another party
what is factoring of receivables?
- where an entity arranges for another organisation (a factor) to manage and collect the entity’s receivables and receives an advance on the value of those receivables in return
What is factoring with recourse?
Risk and reward therefore control, not transferred to the fatcor. Receivables not derecognised, treat proceeds as a loan
What is factoring without recourse?
Risk and reward therefore control, transferred to factor. Receivables derecognised, a treat proceeds as a reduction in receivables
