Test 1 Flashcards
Financial Instrument
A monetary contract that can be traded such as stock, bond, derivative
Why can’t prepaid expenses be considered a financial instrument?
Prepaid expenses for which the future economic benefit is the receipt of goods or
services instead of the right to receive cash or another financial asset is not a
financial asset.
What is a primary financial instrument?
A primary instrument is a financial investment whose price is based directly on its market value.
Examples; stocks, bonds and spot comodities.
What is a derivative financial instrument?
Is a complex type of financial security that is set by two or more parties.
What is a call option?
A call option gives the holder of the option a right to buy a specific item (for example,
shares in a particular company) at a future time for a prespecified price. This price is
usually described as either the exercise price, or the strike price. Once the exercise
price is determined it will remain fixed regardless of variations in the market price of
the underlying item. To the extent that the option can be traded, the sale price of the
option would fluctuate as the value of the underlying item changes, with an increase in
the price of the underlying item leading to an increase in the price of the option (and
vice versa).
What is a put option?
A put option on shares entitles the holder of the option to require another party to buy
a given quantity of a specific item (for example, shares) at a future date for a prespecified price. The value of the put option will also be dependent upon the market
price of the underlying asset.
Can equity shares be considered a financial instrument?
Equity shares in another entity could be considered to be a financial instrument.
They are primary financial instruments
What is a primary financial instrument? with examples
Examples of primary financial instruments would include receivables, payables and
equity securities. Primary financial instruments generate rights and obligations between
the parties directly involved in the underlying transaction. For example, acquiring
shares in a company gives the investor a financial asset in the company and the shares
are considered an equity instrument of the company. Acquiring inventory on credit
from a company gives the selling company a financial asset (a right to cash), and the
purchaser a financial liability (an obligation to deliver cash to the company).
What is a derivative financial instrument? with examples
Derivative financial instruments have been defined as instruments ‘which create rights
and obligations that have the effect of transferring one or more of the financial risks
inherent in an underlying primary financial instrument, and the value of the contract
normally reflects changes in the value of the underlying financial instrument’
Derivative financial instruments would include financial options, futures, forward
contracts and interest rate or currency swaps.
Would physical assets (inventories, property, plant and equipment) be considered to be financial instruments?
Physical assets (such as inventories, property, plant and equipment), leased
assets, and intangible assets (such as patents and trademarks) are not financial
assets. Control of such physical and intangible assets creates an opportunity to
generate an inflow of cash or another financial asset, but it does not give rise to a
present right to receive cash or another financial asset.
Would prepayments be considered financial instruments?
Similarly, prepayments are not financial instruments because they typically provide a
right to future goods or services and not to cash or another financial instrument.
What is a compound financial instrument?
A compound financial instrument is a financial instrument that contains both a financial
liability and an equity element.When the initial carrying amount of a compound financial instrument is allocated to its
equity and liability components, the equity component is assigned the residual amount
after deducting from the fair value of the instrument as a whole the amount separately
determined as the fair value of the liability component.
Is there a consequence for reported profit or loss if a financial instrumnent is desginated as debt rather than equity?
If a financial instrument is designated as debt then the related payment would be
considered to be interest expense, and this would reduce profits. By contrast, if the
financial instrument is considered to be equity, then the related payment would be of
the form of dividends, and this is an appropriation of profits, or retained earnings, and
is not considered an expense. Therefore, profit or loss would not be impacted by a
dividend payment.
What doe Mark to Market mean?
Mark-to-market means that particular assets will be valued on the basis of their net
market value, that is, their current selling prices less the costs that will arise in making
such a sale. When assets are ‘marked to market’ it is normal for any gain or loss in the
value of the assets to be treated as part of the period’s profit or loss (that is, as a
revenue or expense item).
A set off of assets and liabilities is
A set-off is the reduction of an asset by a liability or a liability by an asset in the
presentation of a statement of financial position so that only the net amount is
presented.
When does a right of set off exist?
A financial asset and a financial liability shall be offset and the net amount
presented in the statement of financial position when, and only when, an
entity:
(a) currently has a legally enforceable right to set off the recognised
amounts; and
(b) intends either to settle on a net basis, or to realise the asset and settle the
liability simultaneously
Why would companies perform a set off of assets and liabilities?
By performing a set-off of assets and liabilities a company’s reported gearing ratios
would show improvement. This may be particularly beneficial for companies that are
subject to debt constraints, or where debt levels look unfavourable relative to
competitors/industry norms
Material Accounting misstatement (MAM)
information in the financial statements that is sufficiently incorrect that it may impact the economic decisions of someone relying on those statements
Complex group structures
exist where subsidiary of an entity holds or owns shares in another entity which makes that other entity the subsidiary of the parent company as well.
dominant senior managers
Enron Facts
- Was an american energy company that declared bankruptcy in late 2001.
- was the child of two merger companies in 1985
-Famous for bringing down Arthur Anderson resulting in todays big 4
Enron facts
- The only Enron focused on infrastructure the new enron focused on Gas banks
Gas Banks Enron
- commodity trading market but only in gas.
- a trading platform that allowed everyone to buy and trade gas via tokens on gas bank trading.
- enron made money via commissions.
Mark to market Enron
-Early 1990s
- Mark to market; valuing assets according to their market price, instead of historical cost + depreciation.
- when no market - mark to model.
