F2 - 10. Financial Instruments

Question 1

What is a financial instrument?

Answer 1

Any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another

Question 2

What are the 3 main types of financial asset?

Answer 2

1. Equity instrument in another entity (shares)
2. Cash or receivables
3. Derivates standing at a gain

Question 3

What are the 3 main types of financial liability?

Answer 3

1. Payables
2. Redeemable preference shares
3. Derivates standing at a loss

Question 4

What is an equity instrument?

Answer 4

A contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities i.e. a company’s own shares

Question 5

Are financial instruments classified as their substance or their legal form?

Answer 5

Substance e.g. redeemable or cumulative preference are liabilities and not equity

Question 6

What are compound intstruments?

Answer 6

Financial instruments that show characteristics of both equity and liabilities

Question 7

How are compound instruments treated at inception?

Answer 7

Split into debt and equity components:

• The fair value of the liability is measured as the PV of the future expected cash flows, discounted at the market rate
• The fair value of the equity component is the remainder of the issue proceeds

Question 8

How are compound instruments subsequently treated?

Answer 8

• Liability is held at amortised cost

- Equity remains the same

Question 9

What is a derivate?

Answer 9

A financial instrument that requires little or not initial investment and derives its value from underlying items, to be settled at some future date

Question 10

How are derivates accounted for?

Answer 10

At fair value, with gains/losses going through the P&L

Question 11

How are financial instruments initially measured?

Answer 11

At fair value including any transaction costs (unless held at FVTPL)

Asset = + Transaction Costs
Liability = - Transaction Costs

Question 12

What types of financial assets are subsequently measured at amortised cost?

Answer 12

Assets held in order to collect contractual cash flows rather than selling the asset, where the cash flows are solely payments of principle and interest

> DEBT NOT SHARES

Question 13

What types of financial assets are subsequently measured at fair value through profit or loss?

Answer 13

Equity investments (shares) and derivatives

Question 14

What types of financial assets are subsequently measured at fair value through other comprehensive income?

Answer 14

Assets held when the business intends to collect contractual cash flows AND to sell them, where the cash flows are solely payments of principle and interest

Question 15

What happens to gains and losses through OCI when financial assets held at FVTOCI are derecognised?

Answer 15

They are reclassified to the P&L

Question 16

What is an irrevocable election?

Answer 16

When shares are not held for trading, the entity can make an irrevocable election to present changes through OCI instead of the P&L - gains are not reclassified when shares are sold

Question 17

How are financial liabilities subsequently held?

Answer 17

At amortised cost (some held for short term profit making are held at FVTPL)

Question 18

What are the conditions for reclassification of financial assets?

Answer 18

1. The entity changes its business model for managing financial assets
2. All financial assets affected must be reclassified

Question 19

Can financial liabilities be reclassifed?

Answer 19

NEVER