IFRS 9 - Financial Instruments (Initial Measurement) Flashcards
You should be able to identify, measure and account for financial instruments
Define Credit Risk
The risk that one party to a financial instrument
will cause financial loss for the other party
by failing to discharge an obligation
Define Market Risk
the risk that the FAIR VALUE or FUTURE CASH FLOWS of a FIN. INSTRUMENT will FLUCTUATE because of changes in MARKET PRICES
Define Interest rate risk
The risk that the the risk that the FAIR VALUE or FUTURE CASH FLOWS of a FIN. INSTRUMENT will FLUCTUATE because of changes in market interest rates
What are the three types of Market Risks
Currency risk
Interest Rate risk
Other Price Risk
Define Liquidity risk
risk that an entity will encounter DIFFICULTY in meeting OBLIGATIONS associated with financial liabilities that are settled by DELIVERING CASH or ANOTHER FINANCIAL ASSET
Define Other Price Risk
The risk that the the risk that the
FAIR VALUE or
FUTURE CASH FLOWS
of a
FIN. INSTRUMENT
will FLUCTUATE because of changes in market prices
OTHER than interest rate risk or currency risk
Define Fair Value
the amount received for the selling of an asset (or paid to settle / transfer a liability)
in an orderly transaction between market participants at the measurement date
Besides being competitive i.r.o. primary operating activities, what else should an entity be competitive in?
- Capital financing activities
- Investment activities
- Risk Management activities
Define Financial Instrument.
Any contract –> BOTH:
- FINANCIAL ASSET of one entity
&
- FINANCIAL LIABILITY / EQUITY INSTRUMENT of another entity
Define Financial Asset
Any asset that represents:
(a) CASH
(e. g. deposit at bank)
(b) CONTRACTUAL right to RECEIVE cash or another financial asset from another entity
(e. g. debtors and loans receivable)
(c) contractual right to EXCHANGE financial assets/liabilities with another entity under conditions that are POTENTIALLY FAVOURABLE to the entity
(e. g. Swaps)
(d) any EQUITY instrument of ANOTHER entity
(e. g. share investment)
Are physical assets such as PPE / INVENTORIES financial assets?
NO –> do not represent a contractual right to receive cash from another entity
Are prepayments financial assets?
NO –> prepayment represents right to receive GOODS / SERVICES
What is a FINANCIAL Liability?
Any liability that is a CONTRACTUAL OBLIGATION to DELIVER CASH to another entity;
E.g. Creditors and loans payable
A contractual obligation to EXCHANGE FINANCIAL ASSET / LIABILITIES with another
entity under conditions that are POTENTIALLY UNFAVOURABLE to the entity.
Are liabilities arising from statutory requirements (e.g. obligation to pay tax) financial liabilities?
NO –> not CONTRACTUAL in nature
What is an Equity instrument?
- Any contract that evidences a RESIDENTIAL INTEREST
- in the ASSETS of an entity
- after DEDUCTING all its liabilities
(E = A - L)
What are the characteristics defining a Derivative instrument?
- Its value changes in response to changes in a specified UNDERLYING item e.g. interest
rate, security price etc. - It requires NO / LITTLE INITIAL NET INVESTMENT,
- It is settled at a FUTURE date.
What is an investment in the shares of another entity (acquired for speculative purposes) classified as?
Financial asset –> investment in the equity instrument of another entity
What are redeemable preference shares issued an entity classified as in the books of this entity?
Financial liability –> contractual obligation to deliver cash
What are ordinary shares issued at incorporation classified as in the books of this entity?
Equity instrument –> contract that gives holders of ordinary shares a residual interest in the net assets
What are options that issue to the holders ordinary shares at Rxx per share classified as in the books of the entity that issued them?
Equity Instrument –> contractual obligation to issue ordinary shares (equity instruments)
NOTE: NO obligation to transfer CASH hence EQUITY not FINANCIAL
What is a prepayment i.r.o. an insurance policy classified as?
Current asset –> Contractual right to receive SERVICES
What is motor vehicle leased under a finance lease classified as in the books of the lessee?
Financial liability –> Contractual obligation to deliver cash
What is large computer installation leased under a finance lease classified as in the books of the lessor?
Financial asset –> Entity has contractual right to receive cash
What are the classes of Financial Assets?
- Financial asset AT AMORTISED COST
- Investment in DEBT INSTRUMENT at FV through OCI
- Investment in EQUITY INSTRUMENT at FV through OCI
- Financial asset at FV through P/L
How is the ‘financial assets at amortised cost’ class measured?
At Amortised cost using the effective interest method
How is the ‘Investment in DEBT INSTRUMENT at FV through OCI’ class measured? What is the account called?
Mark-to-Market reserve - debt instrument
How is the ‘Investment in EQUITY INSTRUMENT at FV through OCI’ class measured? What is the account called?
Mark-to-Market reserve - Equity Instrument
How is the ‘Financial asset at FV through P/L’ class measured?
Designated or Mandatorily to P/L
What are the business models that IFRS 9 distinguishes between?
HOLDING financial assets TO COLLECT contractual cash flows;
COLLECTING contractual cash flows and SELLING financial assets;
OTHER BUSINESS MODELS (i.e. intention of selling the financial asset at a higher
value at a later stage)
Which class of financial asset is in accordance with the ‘Objective of collecting contractual cash flows’ business model?
At amortised cost
Which class of financial asset is in accordance with the 'Objective of collecting contractual cash flows & selling financial assets' business model?
Debt instrument @ FV through OCI
When may assets within the ‘Objective of collecting contractual cash flows’ business model be sold?
– sale due to increase in assets’ credit risk;
– sales are infrequent / insignificant;
– sales are close to maturity of asset and proceeds are close to the amount that would have been collected.
Why would an entity sell the ‘Objective of collecting contractual cash flows & sell
financial assets’ business model more frequently?
Company has cash lying around so needs to invest but doesn’t want to invest until maturity hence why they sell this class more frequently
What does collection of cash flows have to do with the ‘Other objectives’ business model? What kind of assets are primarily listed under this model?
Merely incidental
- assets could be managed with the purpose of CFs through sale
- Assets could be managed on FV basis
- Portfolio of financial assets held for trading
How are assets that fall under the ‘Other Objectives’ business model measured and why?
Measured at FV
Items held for trading
What are financial assets/liabilities that are held for trading?
– Acquired for the purpose of selling in the NEAR TERM;
– Are on initial recognition part of a portfolio of identified instruments that are
managed together and for which there is evidence of a recent actual pattern
of short term profit taking; or
– Derivative (except an effective hedging instrument or a financial guarantee
contract).
Are PPE financial assets? Why?
No they do not represent contractual right to future cashflows
Are Finance leases financial assets for lessors? Why?
Yes since the lessor accounts for an investment consisting of an amount receivable under the lease contract
Are prepaid expenses financial assets? Why?
No since they exist of a contractual right to receive SERVICES/GOODS (not cash flows)
Is interest receivable a financial asset? Why?
Yes since it represents a contractual right to receive cash
Is a purchased option that is in-the-money a financial asset?
Yes since it represents a contractual right to receive cash
Is a gold coin a financial asset? Why?
What about an investment in an ETF that tracks gold bullion?
No since it does not represent a contractual right to receive cash, even though it is highly liquid.
The investment is a financial asset since it represents a contractual right to receive cash
Are amounts payable arising from the acquisition of physical assets financial liabilities? Why?
Yes since they are contractual obligations to pay cash
Are installments in a finance lease financial liabilities from the perspective of the lessee? Why?
Yes since they are contractual obligations to pay cash
Are constructive obligations financial liabilities? Why?
No since they arise from the entity’s past practices and not contractual in nature
Are Income taxes use, VAT payable and PAYE financial liabilities? Why?
No since they arise from statutory requirements and not a contractual agreement
A financial asset is classified as a financial asset at amortised cost if?
- asset held within a BIZ model with the Objective of holding assets in order to COLLECT CONTRACTUAL CASH FLOWS
- Contractual terms of the fin.asset give rise to CONTRACTUAL CASH FLOWS that are solely payments of interest and principal
A financial asset is classified as “Debt instruments at FV through OCI” if?
Held within a BIZ model with the objective of holding assets in order to
COLLECT CONTRACTUAL CASH FLOWS and SELLING FINANCIAL ASSETS;
Contractual terms of the fin.asset give rise to CONTRACTUAL CASH FLOWS that are solely payments of interest and principal
If a financial asset is not measured at amortised cost then what should it be measured at?
Fair Value
A financial asset is classified as “Equity instruments at fair value through OCI” if?
– It is an equity instrument; and
– It is not held for trading
Only available to equity instruments,
Designation on a share–by–share basis.
NOTE: this is and IRREVOCABLE ELECTION
When is a financial instrument measured at Fair value through Profit or Loss (Designated)?
- Only if designation eliminates or significantly reduces a measurement or recognition inconsistency
NOTE: applied to financial instrument as a whole
When is a financial instrument measured at Fair value through Profit or Loss (Madatorily)?
What type of financial instrument is normally classified so?
- If the financial asset does not fall into either:
- amortised cost
- fair value through OCI
Held for trading securities
Whats the difference between trade date and settlement date accounting?
Trade date accounting
- recognise the asset and liability on the date that the entity commits to the purchase or sales of the asset
Settlement date accounting
- recognise the asset and liability on the date that the asset is delivered to or by the entity
What are financial instruments initially measured at? What is the exception to this rule?
FV + Transaction costs
Exception: At FV through P/L
Tx costs —> Expensed to P/L
