FARE 10 Financial instrument Flashcards
Types of financial instruments
a. cash, foreign currency, and demand deposits
b. evidence of an ownership interest in an entity
c. contracts which result in an exchange of cash or ownership interest in an entity.
d. Derivatives - financial instruments whose value or settlement amount is derived from the value of another unit of measure.
Fair value option
On specified election dates, entities may choose to measure eligible financial instruments at fair value. Under the fair value option, unrealized gains and losses are reported in earnings. The fair value option is irrevocable and is applied to individual financial instruments.
Fair value disclosures required for financial instruments
Fair values must be disclosed for all financial instruments for which it is practicable to estimate that value, together with the related carrying amounts showing clearly whether the amounts represent assets or liabilities.
Disclosures about “concentration of credit risk” of all financial instruments
Credit risk is the possibility of loss from the failure of another party to perform according to the terms of a contract. A concentration of credit risk occurs when an entity has contracts of material value with one or more parties in the same industry or region or having similar economic characteristics.
Disclosures about “concentration of credit risk” of all financial instruments.
Requirements to disclose
Entities must disclose all significant concentrations of credit risk arising from all financial instruments.
Disclosure about “market risk” of all financial instruments
Market risk is the possibility of loss from changes in market value. Entities encouraged, but not required to disclose quantitative information
IFRS Disclosures about “concentration of credit risk” and “market risk” of all financial instruments.
Required
Derivative instrument
financial instrument that “derives: its value from the value of some other instrument and has all three of the following characteristics:
a. one or more underlying and one or more notional amounts or payment provisions
b. it requires no initial net investment or one that is smaller that would be required for other types of similar contracts
c. its terms require or permit a net settlement
Underlying
a specified price, rate or other variable
Notional amount
a specified unit of measure
value or settlement amount
the amount determined by the multiplication of the notional amount and the underlying
Payment provision
a specified (fixed) or determinable settlement that is to be made if the underlying behaves in a specified way
Hedging
the use of a derivative to offset anticipated losses or to reduce earnings volatility. When a hedge is effective, the change in the value of the derivative offsets the change in value of a hedged item or the cash flows of the hedged item.
Common derivatives
- Option contract
- Futures Contract
- Forward Contract
- Swap Contract
Option contract
a contract between two parties that gives one party the right, but not the obligation, to buy or sell something to the other party at a specified price during a specified period of time.
The option buyer must pay a premium to the option seller to enter into the option contract.
A call option gives the holder the right to buy from the option writer at a specified price during a specified period of time.
A put option gives the holder the right to sell to the option seller at a specified price during a specified period of time.
Futures contract
an agreement between two parties to exchange a commodity or currency at a specified price on a specified future date. One party takes a long position and agrees to buy a particular item while the other party takes a short position and agrees to sell that item.
Forward contract
similar to futures contracts but they are privately negotiated between two parties with the assistance of an intermediary.
Swap contract
a private agreement between two parties, assisted by an intermediary to exchange future cash payments.
Derivative risk
- Market risk - entity will occur risk
2. Credit risk - the other party will not perform according to the terms of contract
Accounting for derivative instruments including hedging.
Balance sheet
Balance sheet - all derivative instruments are recognized in the balance sheet as either assets or liabilities, depending on the rights or obligations under the contracts.
All derivative instruments are measured at fair value.
Accounting for derivative instruments including hedging.
Reporting Gains or losses.
- No hedging designation
- Fair value hedge
- Cash flow hedge
- Foreign currency hedge
Accounting for derivative instruments including hedging.
Reporting Gains or losses.
No hedging designation
Included in current earnings
Accounting for derivative instruments including hedging.
Reporting Gains or losses.
Fair value hedge.
Included in current earnings as an offset to the gain/loss from the change in fair value of the hedge item
Accounting for derivative instruments including hedging.
Reporting Gains or losses.
Cash Flow Hedge.
Gains and losses on:
- ineffective portion of a cash flow hedge are reported in current income,
- effective portion of a cash flow hedge are deferred and are reported as a component of other comprehensive income until the hedge transaction impacts earnings
Accounting for derivative instruments including hedging.
Reporting Gains or losses.
Foreign currency hedge
a. Foreign currency fair value hedge - current earnings as an offset to the gain/loss from the cahnge in FV of the hedge item
b. Foreign currency cash flow hedge
- ineffective = current earnings (income statement)
- effective = OCI and later IS
c. Foreign currency net investment hedge - OCI as cumulative translation adjustment
