Financial Instruments Flashcards
what is a financial instrument - financial asset, liability and equity instruments
This is a contract that creates a financial asset in one entity and a financial liability or equity instrument in another entity
Fin assets include cash, trade, receivables, investments in shares and loans
fin liabilities include trade payables and loans and equity instruments include ordinary share capital issued
Debt or Equity - initial recognition, F.V P&L, Equity
Equity
Initial recognition - FV less issue costs
when dividends are paid it is deducted from retained earnings
Debt
Debt is accounted for at amortised costs at default
initial recognition - fair value less issue costs
Finance costs increase and payments reduce.
Effective rate is finance cost. (P&L)
Coupon rate is payment - Cashflow
Liability can also be carried at FV through P&L
Only if carried for trading purposes
To avoid accounting mismatch e.g. where loan has been taken out to finance an asset at FV
Initial recognition is FV
Any difference between FV and amortised cost goes through P&L.
Effective rate and coupon rate stay on original amortised cost not FV
Gains and losses on remeasurement to FV are recognised in P&L unless they due to changes on entity’s own credit risk then OCI.
Consequences of classification - Debt or equity.
Is the transaction debt or equity?
Debt
1. Gearing goes up through finance cost
Equity
1. Gearing goes down
2. Dividends are not expenses
3. Equity dilutes existing shareholders.
Transaction must be recorded according to economic reality not legal form
Debt is an obligation and equity is evidence of ownership
1.is there obligation to pay dividends
2. does company have call option or shareholders have put option
3. PUT option creates an obligation
4. If equity is actually Dent, it should be classed as NCL and finance cost recognised for.
5. Fixed number of shares for fixed amount is equity
6. Debt is fixed term Equity is of a more permanent nature.
