Financial Instruments Flashcards
What is a financial instrument?
A contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another
what are the 3 broad groups?
Equity instruments
Financial assets
Financial liabilities
What is an equity instrument?
An EQUITY INSTRUMENT is any contract that gives the holder a residual interest in the assets of an entity after deducting all of its liabilities
Examples:
The entity’s own shares
Warrants
Non-cumulative irredeemable preference shares
What is a financial asset?
Cash
A contractual right
to receive cash or another financial asset from another entity; or
to exchange financial assets or liabilities with another entity under conditions that are potentially favourable
An equity instrument of another entity
A contract that will or may be settled in the entity’s own equity instruments and is:
A non-derivative for which the entity is or may be obliged to receive a variable number of the entity’s own equity instruments
A derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments
Puttable instruments classified as equity or certain liabilities arising on liquidation classified by ias 32 as equity instruments
What are some examples of financial assets?
Examples
Trade receivables
Options
Shares (as an investment)
What is a financial liability?
A FINANCIAL LIABILITY is any liability that is:
A contractual obligation
to deliver cash or another financial asset to another entity (for example a trade payable, debenture loan and redeemable preference shares); or
to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity
A contract that will or may be settled in the entity’s own equity instruments and is:
A non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments; or
A derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments
What are some examples of financial liabilities?
Examples
Trade payables
Debenture loans payable
Mandatorily redeemable preference shares
Forward contracts standing at a loss
What is a derivative? (3 characteristics)
A DERIVATIVE has 3 characteristics:
Its value changes in response to an underlying variable (e.g. share price, commodity price, foreign exchange rate, interest rate)
It requires no initial net investment or an initial investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and
It is settles at a future date
Examples:
Foreign currency forward contracts
Interest rate swaps
Options
How should financial instruments be classified?
They should be classified by either debt or equity depending on their substance rather than their legal form
What are debt instruments?
Debt instruments are those which meet the definition of a financial asset or a financial liability.
How would redeemable preference shares be reported?
under non-current liabilities in the statement of financial position (assuming they are redeemable after more than one year).
What are compound financial instruments?
Some financial instruments contain both a liability and an equity element.
IAS 32 states that each component part of the instrument should be classified and valued separately according to the substance of the arrangement.
The most common type of compound instrument is convertible debt.
The compound instrument should be separated as follows.
Firstly determine the carrying amount of the debt component by reference to a similar liability that does not have conversion rights
Then value the equity component as the balancing figure
What does IFRS 9 say about financial instruments?
IFRS 9 states that a financial asset or financial liability should initially be recognised in the statement of financial position when the reporting entity becomes a party to the contractual provisions of the instrument.
A financial asset should be derecognised when:
The contractual right to the cash flows from the financial asset expire; or
The entity transfers substantially all the risks and rewards of ownership of the financial asset to another party.
A financial liability should be derecognised when it is extinguished, namely when the obligation specified in the contract is discharged, cancelled or expires.
What is the amortised cost for the classification of financial liabilities?
Initial Value + Effective Interest – interest paid
What do we do about transaction costs?
Transaction costs are included in the initial cost of the financial asset, unless the asset is Fair Value Through Profit or Loss.
If the asset is FVTPL, transaction costs are expensed through the P/L
What is factoring of receivables?
Factoring of receivables is where 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
What does a receivable factored with recourse mean?
Receivables factored with recourse are not derecognised. They continue to be an asset of the seller and a liability is recognised for amounts advanced by the factor.
