Financial Instruments Flashcards
broadly, what is a financial instrument?
means of raising finance e.g. loans, shares etc.
Why is IAS 39 Financial Instruments: Recognition and Measurement obselete
had a role to play in the global financial crisis
what is the definition of a financial instrument
any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity
what is a financial assets
cash, equity of another entity, or contractual right to receive cash
what is a financial liability
any liability that is a contractual obligation to deliver cash
what is an equity instrument
any contract that evidences a residual interest of an entity after deducting all of its liabilities
examples of financial assets
cash
accounts receivable
loans receivable
examples of financial liabilities
bank overdraft
accounts payable
loans payable
certain preference shares (those with a mandatory repayment date)
examples of equity instruments
ordinary shares
certain preference shares (those with no mandatory repayment date)
which financial standard deals with the classification of financial instruments
IAS 32 Financial Instruments: Presentation
for the buyer, is a financial instrument an asset or liability
asset
for the issuer of a financial instrument, why is it important to classify as an asset or liability correctly
can affect gearing
different accounting treatments apply to financial liabilities and financial assets
how to determine whether to classify financial instruments issued as debt or equity
if it includes a contractual obligation to deliver cash or another financial asset then it is a liability
otherwise it in equity
what are redeemable preference shares
preference shares that require a future repayment of the share capital
should preference shares be issued as debt or equity
issuer has an obligation to deliver cash
should be treated as liability
where should dividends on preference shares be expensed
finance costs
what is a compound financial instrument
a financial instrument that contains both a liability and an equity component
what is an example of a compound financial instrument
convertible bond
liability component = issuer has obligation to repay bond coupon
equity component = the bond holder has the option to convert to ordinary shares
how should compound financial assets be recognised
liability and equity components should be recognised separately
how to calculate liability component of a convertible bond
fair value of net proceeds
how to calculate equity component of a convertible bond
fair value of whole bond - fair value of liability component
what accounting standard deals with the recognition of financial instruments
IFRS 9 Financial Instruments
under IFRS 9, when should financial instruments be recognised
when there is a contract between the entity buying the assets and the entity issuing the instrument
when should financial instruments be derecognised, according to IFRS 9
when the right or obligation to receive or pay cash expired
at what value should financial instruments be recognised at initially
at their fair value, on the day the asset was bought/liability issued
i.e. amount of money that passed hands
if a financial instrument is intended to be held until maturity, how should it be measured
Amortised cost method
what does the effective interest method take into account
the premiums and discounts as well as the interest receivable
what are the two ways in which assets can be measured over their lifetime
fair value
or
amortised cost
why is amortised cost less volatile than fair value
spreads income over the lifetime of the asset
what is the calculation for amortised cost
initial recognition + interest earned - interest received/payments made
what are the two tests that need to be passed before an asset can be measured at amortised cost
business model test
cash flow characteristics test
what is the business model test
must be holding the financial asset to collect its contractual cash flows
i.e. must be holding until maturity and not planning to trade before
what is the cash flow characteristics test
the contractual cash flows must consist only of principal and interest
i.e. cash flows connected to inflation would fail this test
examples of some financial assets that can be measured at amortised cost
holding of loan stocks until maturity
examples of financial assets that pass the cash flow characteristics but not the business model test
financial asset we plan to trade before maturity
how should financial assets planned to be sold before maturity be measured
fair value through OCI
what is an example of a financial asset that doesnt pass the cash flow characteristics test or the business model test
holding of ordinary shares
how should the holding of ordinary shares be measured
at fair value through profit or loss
under what heading in the SOFP are assets measured at amortised costs
Financial assets at amortised costs
which financial standard deals with disclosures of financial instruments
IFRS 7 Financial Instruments: Disclosures
why are disclosures important for financial instruments
enables users to evaluate significance of financial instruments on the entity’s financial position and performance
enables users to evaluate the risk related to financial instruments
what does the equity component of a convertible bond represent
the premium paid to have the option to convert
