Week 5 Everything

Question 1

Financial instruments

Answer 1

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

Question 2

Fundamental characteristics of financial instruments:

Answer 2

Contract that establishes a right or an obligation.

“two sided”: one party of the contract must have a
financial asset, whilst the other party to the contract has responsibilities (obligations), so he/she will record either a financial liability or an equity instrument.

Question 3

Financial Assets Definition [AASB132.11]

Answer 3

cash

equity instrument of another entity (shares of another company) (i.e. Investment in Company X)

contractual right

a contract that will or may be settled in the entity’s own equity instruments, both derivative and non-derivative

Question 4

contractual right

Answer 4

To receive cash or another financial asset from another entity (e.g. trade receivable; debentures held).

To exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity (e.g. forward foreign currency contract – where the entity is a winning position)

Question 5

Examples of financial assets

Answer 5

cash; trade accounts receivable; convertible notes receivable; loans receivable; bonds receivable; various derivatives, including forward foreign currency contracts

Question 6

Financial assets ARE NOT

Answer 6

physical assets; leased assets or intangible assets

Question 7

Financial Liabilities Definition [AASB132.11]

Answer 7

contractual obligation

a contract that will or may be settled in the entity’s own equity, both derivatives and non-derivatives (e.g. convertible note payable)

Question 8

contractual obligation

Answer 8

to deliver cash or another financial asset to another entity (i.e. loan payable; trade payable)

to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity (e.g. forward foreign currency contract – where the entity is in a losing position)

Question 9

Examples of financial liabilities:

Answer 9

trade accounts payable; convertible note payable; loans payable; bonds payable; various derivatives, including forward foreign currency contracts

Question 10

Equity instruments

Answer 10

Any contract that evidences a RESIDUAL* interest in the asset of an entity after deducting all of its liabilities (i.e. ordinary shares in a company). BUT the contract DOES NOT INCLUDE an obligation:

Question 11

Any contract that evidences a RESIDUAL* interest in the asset of an entity after deducting all of its liabilities (i.e. ordinary shares in a company). BUT the contract DOES NOT INCLUDE an obligation:

Answer 11

To deliver cash or another financial asset to another entity;

To exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the issuer

Question 12

Examples of equity instruments

Answer 12

ordinary shares

Question 13

Residual

Answer 13

Residual means that the holder of that equity instrument is NOT entitled to a fixed-rate of return (i.e. interest revenue)

Question 14

When a company issues a financial instrument (i.e. bond; shares, etc.) the company is required to determine whether the financial instrument is to be reported as a

Answer 14

financial liability or an equity instrument.

Question 15

Financial Liability:

Answer 15

If any interest, dividends, losses or gains arise, shall be recorded in Profit or Loss or Other Comprehensive Income

Question 16

Equity instrument:

Answer 16

If any interest, dividends, losses or gains arise, shall be recorded in Changes in Equity

Question 17

To decide, look at the SUBSTANCE of the contractual arrangement
(AASB132):

Answer 17

is there a contractual obligation to deliver cash or other financial assets?

 YES  Financial Liability
 NO  Equity instrument

Question 18

Primary financial instruments:

Answer 18

Value of a primary financial instrument is determined in its own right, directly from the market. include trade receivables and payables; loans receivable and payable; and equity securities such as ordinary shares

Question 19

Derivative financial instruments

Answer 19

Value of a derivative financial instrument is dependent upon the value of the underlying primary financial instrument (e.g. the value of BHP share options depends the value of BHP shares). Create rights and obligations with the effect of transferring one or more of the financial risks inherent in an underlying primary financial instrument (e.g. BHP share options transfer the risk of falls in fair value of BHP Shares from the option holder to the option issuer);

Question 20

Examples of derivative financial instruments

Answer 20

options, futures, forward contracts and interest rate and currency swaps

Question 21

Recognition of financial instruments

Answer 21

An entity may recognise a financial instrument in its statement of financial position ‘when the entity becomes party to the contractual provisions of the instruments’

Question 22

Initial measurement of financial instruments

Answer 22

An entity shall measure a financial asset or liability at its fair value plus or minus the transaction costs that are directly attributable to the acquisition of the financial asset or the issue of the financial liability

Question 23

Initial measurement of financial instruments equation

Answer 23

Fair value (+/- transaction costs)

Question 24

Fair value

Answer 24

The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date

Question 25

Subsequent measurement of financial instruments

Answer 25

After the initial recognition, two possible subsequent

measurements: amortised cost or fair value

Question 26

Subsequent measurement of financial assets

Answer 26

After the initial recognition, the choice between amortised cost and fair value depends on how the financial assets are classified. Two elements to determine the classification, the entity’s business model and the contractual cash flow characteristics

Question 27

The financial asset is measured at amortised cost if the financial asset has the two elements below

Answer 27

1) business model: The business usually holds financial assets in order to collect their contractual cash flows

cash flow characteristics: The financial asset gives rise
to cash flows on specified dates that represent only
payments of principal and interest on the principal
amount outstanding.

Question 28

Where the business model or/and the cash flow characteristics
are different the financial asset is measured at

Answer 28

fair value

e.g. equity instruments are measured at fair value

Question 29

Principal

Answer 29

Amount of money to be paid or received to enter the

contract (financial instrument) and the amount of money to be received or paid to extinguish that contract.

Question 30

Principal example

Answer 30

Loan agreement between Bank and Company:

Company borrows an amount (principal) from Bank.
At the end of the loan: Company pays back the amount (principal).

Question 31

Interest

Answer 31

A contractual amount to be paid (financial liability)

or to be received (financial asset) on specific dates during the duration of the contract (financial instrument).

Question 32

Interest example

Answer 32

Interest on a loan issued by Bank to Company. Bank

receives interest revenues and Company pays interest expenses

Question 33

Disclosure of risk requirements

Answer 33

Financial instruments are subject to extensive disclosure requirements (AASB 7), especially after significant losses in relation to financial instruments during GFC.

Question 34

As a general principle, the company shall disclose:

Answer 34

information that enables users to evaluate the
significance of financial instruments for its financial
position and performance

Information that enables users to evaluate the nature and extent of risks arising from financial instruments
which the entity has at reporting date, and how the
entity manages those risks.

Question 35

Disclosure of risk requirements

What are the risks to be disclosed?

Answer 35

Credit risk

Liquidity risk

Market risk

Question 36

Credit risk

Answer 36

risk that a counterparty will default on its contractual obligations resulting in financial loss to the company

Question 37

Liquidity risk

Answer 37

Risk that the company will not be able to meet its payment obligations associated with financial liabilities

Question 38

Market risk

Answer 38

Risk that the fair value of a financial instrument will fluctuate due to changes in market prices. There are three types of market risk:

Currency risk
• Interest rate risk
• Other price risk

Question 39

How are these risks disclosed?

Answer 39

• Qualitative disclosure

* Quantitative disclosure