FARE 10 Financial instrument

Question 1

Types of financial instruments

Answer 1

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.

Question 2

Fair value option

Answer 2

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.

Question 3

Fair value disclosures required for financial instruments

Answer 3

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.

Question 4

Disclosures about “concentration of credit risk” of all financial instruments

Answer 4

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.

Question 5

Disclosures about “concentration of credit risk” of all financial instruments.
Requirements to disclose

Answer 5

Entities must disclose all significant concentrations of credit risk arising from all financial instruments.

Question 6

Disclosure about “market risk” of all financial instruments

Answer 6

Market risk is the possibility of loss from changes in market value. Entities encouraged, but not required to disclose quantitative information

Question 7

IFRS Disclosures about “concentration of credit risk” and “market risk” of all financial instruments.

Answer 7

Required

Question 8

Derivative instrument

Answer 8

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

Question 9

Underlying

Answer 9

a specified price, rate or other variable

Question 10

Notional amount

Answer 10

a specified unit of measure

Question 11

value or settlement amount

Answer 11

the amount determined by the multiplication of the notional amount and the underlying

Question 12

Payment provision

Answer 12

a specified (fixed) or determinable settlement that is to be made if the underlying behaves in a specified way

Question 13

Hedging

Answer 13

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.

Question 14

Common derivatives

Answer 14

1. Option contract
2. Futures Contract
3. Forward Contract
4. Swap Contract

Question 15

Option contract

Answer 15

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.

Question 16

Futures contract

Answer 16

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.

Question 17

Forward contract

Answer 17

similar to futures contracts but they are privately negotiated between two parties with the assistance of an intermediary.

Question 18

Swap contract

Answer 18

a private agreement between two parties, assisted by an intermediary to exchange future cash payments.

Question 19

Derivative risk

Answer 19

1. Market risk - entity will occur risk

2. Credit risk - the other party will not perform according to the terms of contract

Question 20

Accounting for derivative instruments including hedging.

Balance sheet

Answer 20

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.

Question 21

Accounting for derivative instruments including hedging.

Reporting Gains or losses.

Answer 21

1. No hedging designation
2. Fair value hedge
3. Cash flow hedge
4. Foreign currency hedge

Question 22

Accounting for derivative instruments including hedging.
Reporting Gains or losses.
No hedging designation

Answer 22

Included in current earnings

Question 23

Accounting for derivative instruments including hedging.
Reporting Gains or losses.
Fair value hedge.

Answer 23

Included in current earnings as an offset to the gain/loss from the change in fair value of the hedge item

Question 24

Accounting for derivative instruments including hedging.
Reporting Gains or losses.
Cash Flow Hedge.

Answer 24

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

Question 25

Accounting for derivative instruments including hedging.
Reporting Gains or losses.
Foreign currency hedge

Answer 25

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