Financial assets and financial liabilities

Question 1

A financial instrument is

Answer 1

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

Question 2

A financial asset is:

Answer 2

Cash
An equity instrument of another entity
A contractual right to receive cash or another financial asset
A contractual right to exchange financial assets or liabilities on favourable terms

Question 3

A financial liability is:

Answer 3

A contractual obligation to deliver cash or another financial
asset

A contractual obligation to exchange financial assets or liabilities on unfavourable terms

Question 4

Examples of financial assets include:

Answer 4

 trade receivables
 options
 investments in equity shares.

Question 5

Financial liabilities will be carried at

Answer 5

amortised cost

Question 6

Amortised cost is calculated as:

Answer 6

Initial value + effective interest – interest paid

Question 7

The effective rate of interest is

Answer 7

The interest charge

Question 8

The loan note % is the

Answer 8

Amount actually paid per year

Question 9

If irredeemable preference shares contain no obligation to make any payment, either of capital or dividend, they are classified as

Answer 9

equity.

Question 10

If preference shares are redeemable, or have a fixed cumulative dividend they are classified as

Answer 10

a financial liability.

Question 11

Coupon rate =

Answer 11

How much is actually paid for shares

Question 12

A compound instrument is a

Answer 12

financial instrument that has characteristics of
both equity and liabilities, such as a convertible loan.

Question 12

The accounting for a convertible loan falls into two stages,

Answer 12

initial and subsequent measurement.

Question 12

A convertible loan has the following characteristics:

Answer 12

 repayable, at the lender’s option, in shares of the issuing company instead of cash
 number of shares to be issued fixed at the inception of the loan
 lender will accept a rate of interest below the market rate for non-
convertible instruments

Question 13

Initial recognition

Answer 13

The liability is measured at its fair value. The fair value is the present value of the future cash flows (interest and capital) discounted using the market rate of interest for non-convertible debt instruments.
The equity element is equal to the loan proceeds less the calculated liability element.

Question 14

Subsequent measurement

Answer 14

The liability is measured at amortised cost:
Initial value + market-rate interest – interest paid
The equity is not re-measured and remains at the same value on the statement of financial position until the debt is redeemed.

Question 15

An entity shall recognise a financial asset on its statement of financial position when, and only when,

Answer 15

the entity becomes party to the contractual provisions of the instrument

Question 16

Equity instruments (purchases of shares in other entities) are measured at either:

Answer 16

 fair value through profit or loss, or
 fair value through other comprehensive income

Question 17

Fair value through profit or loss

Answer 17

This is the default category for equity investments.
Any transaction costs associated with the purchase of these investments are expensed to profit or loss, and are not included within the initial value of the asset.
The investments are then revalued to fair value at each year-end, with any gain or loss being shown in the statement of profit or loss.

Question 18

Fair value through other comprehensive income

Answer 18

Instead of classifying equity investments as fair value through profit or loss (FVPL), an entity may designate the investment as ‘fair value through other comprehensive income’ (FVOCI). This designation must be made on acquisition and can only be done if the investment is intended as a long- term investment. Once designated this category cannot later be changed to FVPL.

Question 19

Under FVOCI:

Answer 19

 transaction costs are capitalised
 investments revalued to fair value each year-end, with any gain or loss being shown in other comprehensive income and taken to an investment reserve in equity.

Question 20

the investment reserve can/cannot be negative.

Answer 20

can

Question 21

Debt instruments (such as bonds or redeemable preference shares) are categorised in one of three ways:

Answer 21

 fair value through profit or loss
 amortised cost
 fair value through other comprehensive income

Question 22

Factoring of receivables is where

Answer 22

a company transfers its receivables balances to another organisation (a factor) for management and collection, and receives an advance on the value of those receivables in return.