Financial assets and financial liabilities Flashcards
What is the financial instrument?
- is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity
What are the three reporting standards that deal with financial instruments:
- IAS 32 Financial Instruments: Presentation
- IFRS 7 Financial Instruments: Disclosures
- IFRS 9 Financial Instruments
What IAS 32 deals with?
- the classification of financial instruments and their presentation in financial statements
What IFRS 9 deals with?
- how financial instruments are measured and when they should be recognised in financial statements
What IFRS 7 deals with?
- the disclosure of financial instruments in financial instruments in financial statements
What is the financial asset?
- cash
- a contractual right to receive cash or another financial asset from another entity
- a contractual right to exchange financial assets or liabilities with another entity under conditions that are potentially favourable
- an equity instrument of another entity
Examples of financial assets
- trade receivables
- options
- investments in equity shares
What is financial liability?
- any liability that is a contractual obligation to:
- to deliver cash or another financial asset to another entity
- to exchange financial assets or liabilities with another entity under conditions that are potentially unfavourable
- that will or may be settled in the entity’s own equity instruments
Examples of financial liabilities
- trade payables
- debenture loans
- redeemable preference shares
Initial recognition of financial liabilities
- recognised at its fair value
- usually the net proceeds of the cash received less any costs of issuing the liability
Subsequent measurement of financial liabilities
- will be carried at amortised cost
- initial value + effective interest - interest paid
Features of a Deep discount bonds
- issued at a significant discount to its nominal value
- typically it has a coupon rate of interest much lower than the market rate
- full cost include:
- issue costs
- discount on issue
- annual interest payments
- premium on redemption
What is the other name of effective interest?
periodic rate of interest
Preference share if irredeemable
- contains no obligation to make nay payment, either of capital or dividend, they are classified as equity
Preference share if redeemable
- have a fixed cumulative dividend they are classified as a financial liability
Treatment of interest and dividend
- equity dividends declared are reported directly in equity
- dividends on instruments classified as a liability are treated as a finance cost in the statement of profit or loss
What is a compound instrument?
- is a financial instrument that has characteristics of both equity and liabilities, such as a convertible loan
Characteristic of a convertible loan
- it is repayable, at the lender’s option, in shares of the issuing company instead of cash
- the number of shares to be issued is fixed at the inception of the loan
- the lender will accept a rate of interest below the market rate for non-convertible instruments
What is split accounting?
- there is a liability or debt element, as the issuer has the potential obligation to deliver cash
- there is also an equity element, as the investors may choose to convert the loan into shares instead
IFRS 9 Financial assets
An entity shall recognise a financial asset on its statement of financial position when, and only when, the entity becomes party to the contractual provisions of the instrument
Equity instruments- Fair value through profit or loss
- default category for equity investments
-any transaction costs with the purchase are expensed to profit or loss - investments are revalued to fair value at each year-end, with any gain or loss being shown in the statement of profit or loss
Equity instruments - Fair value through other comprehensive income
- fair value through other comprehensive income
- intended as a long - term investment
- transaction costs are capitalised
- each year end, with any gain or loss being shown in other comprehensive income and taken to an investment reserve in equity
Categories of debt instruments
- fair value through profit or loss
- amortised cost
- fair value through other comprehensive income
Fair value through profit or loss FVPL
Business model test: purpose in holding the investment
Contractual cash flow characteristics test: cash received as a result of holding the investment
Amortised cost
Business model test: must intend to hold the investment to maturity
Contractual cash flow test: solely of principal and interest
Fair value though other comprehensive income FVOCI
Business model test: hold till maturity, but may sell the asset if the possibility of buying another asset with a higher return arises
Contractual cash flow characteristics test: cash flow solely of principal and interest, as for amortised cost
What if a debt instrument is held at FVOCI
- the asset is initially recognised at fair value plus transaction costs
- interest income is calculated using the effective rate of interest
- at the reporting date, the asset will be revalued to fair value with the gain or loss recognised in other comprehensive income
When the financial instruments should be derecognised /financial asset
- when, and only when, the contractual rights to the cash flows from the financial asset expire
When the financial instruments should be derecognised/ financial liability
- when, and only when, the obligation specified in the contract is discharged or cancelled or expires
What is the factoring of receivables?
- is where a company transfers its receivables balances to another organisation ( factor) for management and collection, and receives an advance on the value of those receivables in return
Who bears risk in factoring of receivables?
- a sale of receivables with recourse: factor can return any unpaid debts to the business, business retain risk of irrecoverable debts
- a sale of receivables without recourse means the factor bears the risk of irrecoverable debts
What is IFRS7?
- provides the disclosure requirements for financial instruments
