Learning unit 7 - Financial instruments (assets)

Question 1

Define what is a financial instrument in terms of IAS 32

Answer 1

A financial instrument is defined as any contract that gives rise to a:

• financial asset of one entity; and
• financial liability or equity instrument of another entity

IAS 32.11

Question 2

Define in terms of IAS 32 what is a financial asset.

Answer 2

A financial asset is defined as:

• cash
• an equity instrument of another entity
• a contractual right to:
  > receive cash or another financial asset from another entity; or
  > exchange financial asset or financial liabilities with another entity under conditions that are potentially favorable to the entity; or
• certain contracts to be settled in the entity’s own equity instruments

IAS 32.11

Question 3

When are financial assets recognized in terms of IFRS 9?

Answer 3

Financial assets are recognized when the entity becomes party to the contractual provisions of the financial instrument (IFRS 9.3.1.1)

Question 4

List the four formal classifications of financial instruments

Answer 4

• amortized cost
• fair value through profit or loss
• fair value through other comprehensive income for debt instruments
• fair value through other comprehensive income for equity instruments

IFRS 9.4.1.1

Question 5

List the two criteria used in classifying financial assets.

Answer 5

1. Its contractual cash flow characteristics; and
2. The business model within which that financial asset is managed

Question 6

Describe what is the contractual cash flows test (Step 1: CCF)

Answer 6

The contractual cash flow test involves assessing whether the asset’s contractual terms will lead to the entity receiving:
- cash flows on specified dates
- that are solely payments of:
> principal, and
> interest on the principal

Question 7

Describe what is the business model test (Step 2: BM)

Answer 7

The business model test involves assessing the business model relevant to the asset to determine the objectives applied in managing that asset:

• to hold the asset with the principal aim to sell the asset (hold to sell)
• to collect the contractual cash flows (hold to collect); or
• to collect the contractual cash flows and to sell the asset (hold to collect and sell)

Question 8

When shall a financial asset be classified at amortized cost (IFRS 9.4.1.2)?

Answer 8

• If the contractual cash flows give rise to cash flows on specified dates and these cash flows must be solely payments of principal and interest on the principal amount outstanding
• The business model relevant to the asset must be to collect contractual cash flows

(example: loan granted to third party for which they repay principal debt plus interest).

Question 9

When shall a financial asset be classified at fair value through other comprehensive income - debt investments (IFRS 9.4.1.2A)?

Answer 9

CCF = specified dates and payments are solely principal and interest on principal.

BM = the objective of the BM must be collect the contractual cash flows and sell the asset.

Question 10

When shall a financial asset be classified at fair value through profit or loss (IFRS 9.4.1.5)

Answer 10

• This classification applies to any financial asset that does not meet the requirements to be classified as amortized cost or FV through other comprehensive income
• FA are designated as FVPL if there is a accounting mismatch

Question 11

When shall a financial asset be classified at fair value through other comprehensive income - equity investments (IFRS 9.4.1.2)

Answer 11

An entity may elect to classify a FA as FVOCI for equity instruments if:

• is an investment in an equity instrument that:
  > is not held for trading; and
  > is not ‘contingent consideration recognized by an acquirer in a business combination to which IFRS 3 applies

Question 12

Differentiate between the following business models used in determining the classification of financial assets:

1. Hold to collect
2. Hold to collect and sell
3. Hold to sell

Answer 12

Hold to collect
- assets are managed in a way that enables the collection of contractual cash flows over the life of the asset

Hold to collect and sell
- both collection of contractual cash flows and the sale of the asset are integral to the objective

Hold to sell
- decision regarding assets will be based on their fair values.

Question 13

Where the fair value of a financial asset differs from the transaction price and the financial asset fair value has been reliably measured, how is the financial asset initially measured?

Answer 13

If the fair value was of a FA has been reliably measured, the difference between the transaction price and FV is recognized immediately under profit or loss.

(IFRS 9.5.1.1A)

Question 14

Define loss allowance.

IFRS 9 appendix A (impairments of financial assets)

Answer 14

A loss allowance is defined as the:

• allowance for expected credit losses on financial assets measured at amortized cost, lease receivables & contract assets
• Accumulated impairment amount for financial assets measured at FV through OCI; and the
• provision for expected credit losses on loan commitments and guarantee contracts