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Accounting 4 > Financial Instruments > Flashcards

Financial Instruments Flashcards

1
Q

What is a financial instrument?

A

I don’t know, look it up Karen

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2
Q

What legislation deals with financial instruments accounting treatment?

A
  • IFRS 9 mainly
  • IFRS 7
  • IAS 32
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3
Q

When working with financial instruments, what are all the things that need to be considered?

A
  • should it be recognized?
  • is it classified as an asset, financial liability, equity or a compound?
  • How should it further be classified?
  • was there a change in classification?
  • How should it be accounted for?
  • is the instrument impaired or should it be?
  • have there been any modifications to the instrument?
  • What disclosure is required?
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4
Q

When should a financial instrument be recognized?

A

When the company becomes party to the contractual provisions of the agreement

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5
Q

How are financial asset instruments classified?

A

We need to observe these two things to determine this
1. business model, which can be
- holding to collect cash flows
- holding to sell for profit
- both
2. contractual Cash flows characteristics which can be
- random dividends
- contractual payments

Scenario 1 (amortized cost)
- business model = hold to collect contractual cash flows
- cash flows = contractual payments
- OR irrevocably elect FV-P/L only if significantly reduces measurement or recognition inconsistency

Scenario 2 (FV-OCI)
- business model = held to collect cash flows and to sell for profit
- cash flows = contractual payments
- OR irrevocably elect FV-P/L only if significantly reduces measurement or recognition inconsistency

Scenario 3 (FV-P/L)
- business model = held for trading
- cash flows = contractual payments

Scenario 4 (FV-P/L)
- business model = held for trading
- cash flows = random dividends

Scenario 5 (FV-P/L OR irrevocably elect FV-OCI)
- business model = not held for trading
- cash flows = random dividends

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6
Q

How are financial liability, equity and compound instruments classified?

A

> A financial liability instrument is classified as FV-P/L if either of the following is met, and in any OTHER case, it will be at amortized cost
- held for trading
- irrevocably designated that way (this can only be done if it 1. reduces measurement or recognition inconsistency and 2. group stuff)

> equity instruments are gay

> compound instruments
- the part that is a financial liability is as above
- the part that is equity is as described in equity as above

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7
Q

When can a financial instrument be reclassfied?

A
  • Financial assets can be reclassified when the business model changes
  • financial liabilities can never be reclassified
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8
Q

How should the different types of reclassifications be accounted for?

A
  • it needs to be applied prospectively
  • it must be applied from first day of the reporting period after the decision was made (reclassification date)

Scenarios
1. Amortized cost -> FV-P/L
* remeasure to FV
* gain or loss goes into P/L

  1. FV-P/L -> amortized cost
    * CA at reclassification date = FV at that date
    * calculate the effective interest rate that remeasurement date
  2. amortized cost -> FV-OCI
    * remeasure to FV
    * gain/loss goes to OCI
    * effective interest rate and expected credit losses are not adjusted
    * amortized cost element does not change
  3. FV-OCI -> amortized cost
    * remeasured to new FV at reclassification date
    * reduce CA of asset to the amortized cost
    * above adjustment included in OCI
    * allowance for credit losses still in OCI
  4. FV-P/L -> FV-OCI
    * continue to measure at FV
    * effective interest rate calculated at reclassification date
    * apply impairment requirements
  5. FV-OCI -> FV-P/L
    * continue to measure at FV
    * reclassify cumulative gains or losses to P/L
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9
Q

How should a Financial instrument be accounted for initially?

A
  • initially
  • if not FV-P/L then capitalize transaction costs
  • if FV-P/L then expense the transaction costs
  • there will be Fair Value Gain or loss and it’ll be in profit and loss if observable inputs were used for the FV, and it’ll be deferred if non-observable inputs were used
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10
Q

How could Financial Asset instruments be accounted for subsequently?

A

> amortized cost
- measured using the effective interest rate
- less any loss allowance

> FV-OCI
- measured at FV
- gains and loss go into OCI
- interest added yearly according to the effective rate
- loss allowance does not affect the CA, goes into OCI

> FV-P/L
- measured at FV
- gains and losses go into P/L

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11
Q

How could Financial liability instruments be accounted for subsequently?

A

> amortized cost
- measured at amortized cost using the effective interest rate

> FV - P/L
- measured at FV
. Gains and losses go through P/L

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12
Q

Which financial instruments can be impaired?

A

Financial assets that have an amortized cost element. therefore those carried at amortized cost or FV-OCI

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13
Q

What does it mean for a financial asset instrument to be impaired?

A

It means that we will need to account for a loss allowance to reflect the fact that some or all of the contractual cash flows might not be collected

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14
Q

What types of impairments to financial assets are there?

A
  • Credit Impaired Financial Assets (this is when the event with a deferential impact on cash flows has ALREADY occurred)
  • Financial assets with expected credit losses (this is when the event has NOT YET occurred)
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15
Q

What are all the things one should consider when accounting for a credit-impaired financial asset?

A
  • whether it became credit impaired while you had it or it was credit impaired when you purchased it
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16
Q

How does the table that we use to workout the values of a financial asset with impairment work?

A
  • the coloumns for the table are as follows:
    Gross carrying amount / ALLOWANCE for losses (SOFP) / Amortozed Cost
  • the gross carrying amount is what we see on our statement of financial position in the account balance of the financial asset
  • the allowance for losses is also waht we see in the account balance of its own on the statement of financial position
  • the combination of these two is what we call the amortised cost amount
  • if it wasnt for the allowance for losses, the GCA and the amortized cost would be the same amount and normally are
17
Q

How does someone account for the impairment of a finanical asset?

A

~ Think about what type of impairments it needs
- if it is credit impaired (event already happened) then do the following
* if it was credit impaired when you bought it
> same as if it became credit impaired while you were holding it but now the interest rate must be calculated with the new payments and final payments
*if it became credit impaired when you were in ownership of it
> compute the interest rate if you don’t have it already BUT IT MUST BE THE ORIGINAL INTEREST RATE FROM THE DATE YOU BOUGHT IT
> compute the new Present value with the adjusted payments and final payments
> draw out the GCA / AL / AC table to see the value of the financial asset
/ the allowance does not decrease the gross carrying amount but increases the allowance for losses account which affects the amortised cost amount
/ note the other stuff that happens in the table, look at lecture videos
> Do the following journal entries:
/ DR allowance for Credit losses (P/L); CR Allowance for credit losses (SOFP)
/ DR Bank; DR Financial asset; CR Interest income; CR allowance for credit losses (SOFP)
/ when the financial asset matures… DR allowance for credit losses (SOFP); DR bank; CR Financial Asset
- if it there are EXPECTED credit losses (event hasn’t occurred yet) then do the following:
* think about if you need to account for lifetime expected credit losses or 12 month credit losses
> the following would mean it needs to be accounted for using the lifetime expected credit losses, all other financial assets can be measured at 12 months:
/ Credit impaired when it was purchased
/ Credit risk has increased significantly
/ its a trade receivable or contract asset that has no sinificant financing component
> however, the following financial assets can be elected to be measured using the lifetime expected losses
/ ALL trade receivables
/ ALL contract assets (IFRS 15)
/ ALL lease receiavbles (finance and operating)
> draw out the GCA / AL / AC table to see the value of the financial asset
/ the allowance does not decrease the gross carrying amount but increases the allowance for losses account which affects the amortised cost amount
> the journal entry that will be passed looks as follows: DR Allowance for credit losses expense/income(P/L); CR Allowance for credit losses (SOFP) OR if carried at FV-OCI; DR Allowance for credit losses expense/income(P/L); CR Allowance for credit losses (OCI)
> check if it needs to be adjusted if the account already exists

18
Q

How does the financial asset being measured at FV-OCI in comparsion to being measured at Amortized cost affect the impairment process?

A

the credit entry of the impairment doesnt go into a SOFP account but rather a OCI account now

19
Q

How does someone account for a fair value adjustment on a financial asset that has been impaired?

A
20
Q

What is a modification to a financial asset?

A

This is when the terms of your financial asset has changed, payment terms or anything like that

21
Q

How do we account for a modification to a Financial asset?

A
  • YOU NEED TO USE THE TABLE
    GCA / ALLOWANCE (SOFP) / Amort Cost
  • recognise your “modification gain/loss” using original rate; DR Modification loss, CR financial asset
  • the GCA will decrease in the table
  • the interest on the Gross carrying amount will be less as a result of of the modification effect on the gross carrying amount
22
Q

What does the standard say specifically about gains and losses on financial instruments?

A
23
Q

Should dividends from mandatorily redeemable preference shares go through profit and loss statement?

A

Yes, because they are a liability and no equity, it’s not a distribution of profits and will need to be paid whether we make profits or losses

24
Q

Does a fair value gain in a derivative need to go into profit and loss?

A

Yes, they don’t meet the criteria to be measured at amortised cost, so they need to be measured at fair value

25
Q

Should the fair value adjustment on a liability designated at FVPL always through profit and loss?

A

No, If the FV adjustments are due to credit risk, then it should be taken to OCI instead of Profit and Loss

26
Q

When can something be classified into OCI and not Profit and Loss?

A

When it isn’t part of the main operations of business of the entity, otherwise it wouldn’t be a faithful representation

Accounting 4 (32 decks)

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