Part 5 - Fair value measurement / Financial instruments / Foreign currency

Question 1

what is fair value?

Answer 1

fair value would be the price it received to sell the asset or paid to transfer a liability in a orderly transaction between market participants at the measurement date

Question 2

What’s the objective of FV measurement?

Answer 2

to estimate the price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants at the measurement date under current market condition

Question 3

what’s a transaction price?

Answer 3

price paid to acquire the asset or receive to assume the liability.

usually transaction price = fair value but may not if following conditions exits
- related party transaction, under duress

Question 4

Valuation approach to calculate Fair value

Answer 4

• market approach - use prices and other relevant info generated by market transaction by identical asset
• cost approach - amount required currently to replace the service capacity of an asset (current replacement cost)
• income approach - discounted future cash flow or revenue/expense

Question 5

What’s a Financial instrument>

Answer 5

any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity

Question 6

Whats a equity instrument?

Answer 6

contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities (evidences of ownership of an entity like shares certificate)

Question 7

Issuer of financial instruments should classify it as either liability or equity, but how should derivative financial instruments which gives a party a choice over how it settles should do?

Answer 7

treat as financial asset/liability unless all of settlement alternatives would result in being an equity instruments

Question 8

How to account for treasury shares?

Answer 8

deduct from equity and no gain/loss recognize

Question 9

how to classify a financial asset?

Answer 9

Amortized cost

• Business model test: objective is to collect contractual clash flow
• Contractual cash flow test - give rise to dates that CF are solely payments of principal and interest on amount outstanding

FVOCI

• collect CF AND sell financial assets
• CF solely payments of principal and interest

FVTPL
- assets that are not classify as amortized cost and FVOCI. can make an irrevocable election initially to designate as FVTPL.

Question 10

How to classify a financial liability?

Answer 10

All should be classify as amortize cost except if it’s held for trading or made an election(FVTPL)

Question 11

What are some characteristics of a derivatives?

Answer 11

• its value changes in response to the change in specific interest rate, commodity prices, exchange rate etc
• it requires no initial net investment
• it is settled at a future

Question 12

What is the initial recognition for financial instruments?

Answer 12

recognize when entity becomes party to the contractual provision of the instrument and measure at fair value + transaction cost (not FVTPL)

Question 13

What are transaction cost for financial instruments?

Answer 13

incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset/liability

Question 14

After initial recognition how to account for transaction cost?

Answer 14

adjusted to the carrying value of all financial instruments except for FVTPL which will be expensed

Question 15

How to account for subsequent measurements of financial instruments?

Answer 15

Amortized cost: use effective interest method (amortized to expense)

FVOCI: fair value with other side going to OCI

FVTPL: fair value with other side going to profit and loss

both equity investment measure at FV (classified as FVOCI and FVTPL)

Question 16

What if a change in fair value related to changes in the entity’s own credit status?

Answer 16

the portion related to changes in credit status will go to OCI, with remainder going to profit/loss

Question 17

What kind of financial instruments are subject to impairment?

Answer 17

debt instruments measured at amortized cost or FVOCI
trade receivable
lease receivable
contract asset
loan commitment except classified as FVTPL
Financial guarantee contracts except FVTPL

Question 18

How to recognize using the impairment model

Answer 18

at each reporting date, recognize a loss allowance (with offset to an impairment gain and loss recognized in P/L)

Question 19

What are the three stages of impairment?

Answer 19

stage 1: no significant increase in credit risk since initial recognition. recognize 12 months of expected credit loss and recognize interest in gross basis

stage 2: significant increase in credit risk
- recognize lifetime ECL but interest on a gross basis (don’t deduct loss allowance)

stage 3: financial asset is credit impaired
- lifetime ECL and interest recognized on a net basis

Question 20

How to determine if there is a significant increase in credit risk

Answer 20

if contractual payment are more than 30 days past due presume credit risk had increase

Question 21

What is credit loss?

Answer 21

difference between all contractual cash flow that are due to an entity in accordance with the contract and CF entity expects to receive, discounted at the original effective interest rate

Question 22

What is expected credit loss?

Answer 22

weighted average of credit losses with the respective risk of a default occurring as the weights. with lifetime ECL are losses that result from all possible default events over the expected life of a financial instrument. calculate as PV of all cash shortfalls over remaining expected life

Question 23

What`s the qualifying criteria for hedge accounting?

Answer 23

• the economic relationship between the hedge item and hedging instrument (moving opposite direction)
• effect of credit risk - doesn’t dominate the value change result from that economic relationship
• hedge ratio - should be the same as required for risk management purpose (ration between $ amount of hedge item and instrument)

Question 24

What are the three types of hedging relationship?

Answer 24

fair value hedge - a hedge of the exposure to change in fair value of a recognized asset/liabilitiy.
- recognize gain and loss in profit/loss

cash flow hedge - hedge of the exposure to variability in cash flow

• portion of gain/loss that’s an effective hedge - recognize in OCI.
• portion that’s not effective - recognize in profit/loss
• hedge of a net investment in a foreign operation

Question 25

What is extinguishing financial liabilities with equity instruments (IFRIC 19)

Answer 25

applies when debtor and creditor might renegotiate terms of financial liability with debtor extinguishes the liability fully or partially by issuing equity instruments to the creditor

• remove financial liability only if meet requirement for extinguishment. equity instrument measure at FV, gain /loss goes to Ni

Question 26

What are monetary balance sheet items?

Answer 26

Units of currency held and asset/liabilities to be received or paid in a fixed or determinable number of units of currency

Question 27

What are some examples of non-monetary balance sheet items?

Answer 27

Inventory, capital asset

Question 28

How to record initial transaction date?

Answer 28

Translate foreign currency using current rate in effect. If it’s advance consideration, should use the date when entity recognize the non-monetary assets the payment is for

Question 29

How should monetary items be valued afterwards?

Answer 29

Need to re-value based on the current exchange rate at balance sheet date

Question 30

How should non-monetary items be valued?

Answer 30

Translate non-monetary items at historic rate (unless carried at market – then at date FV was determined)

Question 31

How should accrual interest expense should be translated?

Answer 31

Should use the average rate of the yr as interest expense has been incurred throughout the yr

Question 32

How to account for forward contracts with foreign currency hedge when preparing for financial statements?

Answer 32

Transaction date: Use current rate

BS Date:

• Translate monetary items at BS date (current rate) with exceed to foreign exchange gain/loss
• Record net value of forward contract on books as asset/liabilities (differences between transaction date FW contract rate and BS date’s FW rate contract)
• The exchange gain/loss will be included in profit/loss

Settlement date:

• remove AR/AP amount
• Remove net forward contract amount
• Credit/debit cash paid amount based on forward contract rate
• the differences will go to foreign exchange gain/loss

Question 33

What is the functional currency?

Answer 33

It is the currency of the primary economic environment in which the entity operates.

Primary factor to determine functional currency:

• mainly influence sales prices
• country that competitive forces and regulations mainly determine sale price
• currency that mainly influence labour, materials, cost of providing G/S

Question 34

What is the presentation currency?

Answer 34

currency in which the FS are presented

Question 35

How to foreign shareholder equity be accounted for in the BS if the functional currency is the presentation currency

Answer 35

capital stock uses historical rate
Retained earnings = accumulated translate net income - accumulated translated dividend (use rate of declaration)
Revenue/expense - historical rate (average rate of exchange for the yr usually)
- Depreciation - historical rate of related asset

Question 36

If the functional currency is the local currency how should exchange gain/losses be included

Answer 36

should be deferred and included in OCI (ASPE in shareholder equity)

• Recognize % of cumulative exchange gain/loss in other comprehensive income in NI when reduction in net investment

Question 37

What is the difference in ASPE and IFRS in terms of converged in foreign currency?

Answer 37

IAS 21 requires non-monetary items measured at FV be translated at the date when FV was determined while ASPE 1651 translate them at the BS date