Financial Instruments Part 1 (IAS 32, IFRS 9)

Question 1

Classification of financial instruments (IAS 32)

How does presentation define a financial instrument?

Answer 1

Defined as “any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.”

Question 2

When is the point of recognition for financial instruments?

Answer 2

Point of recognition is when the entity enters into a contract.

This means we may recognise financial assets/liabilities earlier than we would.

Question 3

Financial assets are any assets that is:

*Financial assets are viewed from the holder’s perspective.

Answer 3

Cash (e.g. bank)

An equity instrument of another entity (Investment in shares).

A contractual right - to receive cash or another financial asset from another entity

/to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity (e.g. in the money futures contract)

Question 4

A financial liability is any liability that is:

*financial liabilities are viewed from the issuers perspective

Answer 4

A contractual obligation - to deliver cash or another financial asset to another entity (e.g. bank loan payable)

or exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity. (e.g. out of the money futures contract).

Question 5

What is an equity instrument?

Answer 5

A contract that evidences a residual interest in the assets of another entity after deducting all of its liabilities. (e.g. ordinary shares ownership = residual interest).

Question 6

IAS 32 uses the definitions to classify financial instruments according to their…

Answer 6

substance rather than their legal form

(substance over form).

e.g. shares may be classified as debt if it has characteristics of debt.

Question 7

What is a compound financial instrument?

Answer 7

Financial instrument which contains both a liability and an equity component such as convertible bonds (loans).

This instrument allows the holder to either be repaid in cash (liability element) or shares (equity element).

Question 8

The distinction between liability (debt) and quity is not only important for classification in the SOFP, but also for….

Answer 8

SOCI

Question 9

IAS 32 classifications of financial instruments:

In SOCI, if a financial instrument is classified as a financial liability (debt)…

Answer 9

then distributions to the holders are classed as interest and recognized as an expense in the IS.

Question 10

IAS 32 classifications of financial instruments:

if a financial instrument is classified as an equity instrument

Answer 10

then distributions are treated as dividends and recorded in the SOCIE (normally as a reduction to retained earnings).

Question 11

Derivatives under IAS 32:

Derivatives are defined by IAS 32 as a financial instrument:

Answer 11

Whose value changes in response to an underlying variable. (such as changes in prices of shares or commodities, changes in foreign exchange rates or interest rates)

and requires little/no initial investment

and is settled at a future date.

Question 12

What are examples of derivatives?

Answer 12

Contracts such as forwards, swaps, options and futures.