Week 4 - Financial Instruments Flashcards
What is a financial instrument?
A financial instrument is ‘any contract that gives rise to a financial asset of one entity and a financial liability or equity of another entity’ (IAS 32)
What is a financial asset?
A financial asset is any asset that is:
- cash
- a contractual right to receive cash or another financial asset from another entity
-a contractual right to exchange financial instruments with another entity under conditions that are potentially favorable
an equity instrument of another entity
What is a financial liability?
A financial liability is any liability that is a contractual obligation:
- to deliver cash or another financial asset to another entity
- to exchange financial instruments with another entity under conditions that are potentially unfavourable
Two criteria are used to determine how financial assets should be classified and measured; What are they?
The entity’s business model for managing financial assets and
The contractual cash flow characteristics of the financial asset.
Financial assets are classified and measured at either amortised cost or fair value.
2 conditions must be met, to measure debt asset (i.e. loans receivable) at amortised cost (through profit or loss P&L).
What are they?
Business model: Amortised cost is required where the asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows.
Contractual cashflows: And the contractual terms of the asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.
2 conditions must be met to measure at debt asset at fair value (through other comprehensive income) (FVTOCI).
What are they?
Contractual cashflows: when contractual cash flows are solely payments of principal and interest on principal amount outstanding
Business model: Asset held within a business model whose objective is achieved by collecting contractual cash flows and selling financial assets.
Fair value through profit or loss (FVTPL). i.e. 1. cash flows not solely principal and interest or 2. asset is held for sale only
What is amortised cost?
The amount at which the financial asset or liability was measured at initial recognition minus principal repayments, plus or minus the cumulative amortisation of any difference between the initial amount and the maturity amount, and minus any write-down for impairment or un-collectability.
What is the effective interest method?
A method of calculating amortization using the effective rate of a financial asset or liability. The effective interest rate is the rate that exactly discounts the expected stream of future cash payments through maturity or the next market-based repricing date to the current net carrying amount of the financial asset or liability. That computation should include all fees and points paid or received between parties to the contract. The effective interest rate is sometimes termed the level yield to maturity or to next repricing date and is the internal rate of return of the financial asset or liability for that period.
What is fair value?
Fair value:
(i.e. bonds or loans) estimated as the sum of all future cash payments or receipts discounted using the prevailing market rate of interest for a similar instrument of an issue with a similar credit rating.
If the fair value of the instrument cannot be reliably measured then the instrument is carried at amortised cost if it has a fixed maturity and at cost if it has no fixed maturity
What is the fair value hierarchy?
Fair value hierarchy’ determines order of sources of fair value as:
1 - Quoted price (if active market) – normally the current bid or asking price
2 - Valuation technique (if no active market) – eg via discounted cash flow analysis
3 - Equity instruments (if no active market) – must be measured at cost
What is derecognition?
IASB: ‘to remove from the statement of financial position’
When does derecognition occur?
Derecognise only when certain criteria are met:
1 - Derecognise when entity has transferred substantially all risks and rewards from the asset
2 - If it is unclear that 1 has happened, derecognise when the entity has lost control of the asset
What is the derecognition accounting treatment?
Difference between the carrying amount of the asset, or portion, transferred to another party and the sum of the proceeds received or receivable and any prior adjustment to reflect the fair value of that asset that had been reported in other comprehensive income
What is hedging and when does it arise?
Offsetting the loss or potential loss on one item against the gain or potential gain on another.
The loss or gain on the hedging arises from changes in fair values or cash flows
When does IFRS 9 permit the use of hedging?
IFRS 9 permits the use of hedging where derivatives are designated as the hedge instrument but only permits non-derivatives to hedge a foreign currency risk
