Financial Instruments Flashcards
What is a financial instrument?
I don’t know, look it up Karen
What legislation deals with financial instruments accounting treatment?
- IFRS 9 mainly
- IFRS 7
- IAS 32
When working with financial instruments, what are all the things that need to be considered?
- 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?
When should a financial instrument be recognized?
When the company becomes party to the contractual provisions of the agreement
How are financial asset instruments classified?
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
How are financial liability, equity and compound instruments classified?
> 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
When can a financial instrument be reclassfied?
- Financial assets can be reclassified when the business model changes
- financial liabilities can never be reclassified
How should the different types of reclassifications be accounted for?
- 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
- FV-P/L -> amortized cost
* CA at reclassification date = FV at that date
* calculate the effective interest rate that remeasurement date - 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 - 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 - FV-P/L -> FV-OCI
* continue to measure at FV
* effective interest rate calculated at reclassification date
* apply impairment requirements - FV-OCI -> FV-P/L
* continue to measure at FV
* reclassify cumulative gains or losses to P/L
How should a Financial instrument be accounted for initially?
- 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
How could Financial Asset instruments be accounted for subsequently?
> 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
How could Financial liability instruments be accounted for subsequently?
> amortized cost
- measured at amortized cost using the effective interest rate
> FV - P/L
- measured at FV
. Gains and losses go through P/L
Which financial instruments can be impaired?
Financial assets that have an amortized cost element. therefore those carried at amortized cost or FV-OCI
What does it mean for a financial asset instrument to be impaired?
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
What types of impairments to financial assets are there?
- 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)
What are all the things one should consider when accounting for a credit-impaired financial asset?
- whether it became credit impaired while you had it or it was credit impaired when you purchased it
How does the table that we use to workout the values of a financial asset with impairment work?
- 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
How does someone account for the impairment of a finanical asset?
~ 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
How does the financial asset being measured at FV-OCI in comparsion to being measured at Amortized cost affect the impairment process?
the credit entry of the impairment doesnt go into a SOFP account but rather a OCI account now
How does someone account for a fair value adjustment on a financial asset that has been impaired?
What is a modification to a financial asset?
This is when the terms of your financial asset has changed, payment terms or anything like that
How do we account for a modification to a Financial asset?
- 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
What does the standard say specifically about gains and losses on financial instruments?
Should dividends from mandatorily redeemable preference shares go through profit and loss statement?
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
Does a fair value gain in a derivative need to go into profit and loss?
Yes, they don’t meet the criteria to be measured at amortised cost, so they need to be measured at fair value
Should the fair value adjustment on a liability designated at FVPL always through profit and loss?
No, If the FV adjustments are due to credit risk, then it should be taken to OCI instead of Profit and Loss
When can something be classified into OCI and not Profit and Loss?
When it isn’t part of the main operations of business of the entity, otherwise it wouldn’t be a faithful representation
