FINANCIAL ASSETS

AND LIABILITIES

FINANCIAL ASSETS AND LIABILITIES

IAS 32: Financial Instruments: Presentation IAS 39: Financial Instruments: Recognition and Measurement IFRS 7: Financial Instruments: Disclosure IFRS 9: Financial Instruments

FINANCIAL ASSETS AND LIABILITIES

DEFINITION (IAS 32 and IAS 39) Financial Instrument: Any contract that gives rise to both: i. a financial asset of one entity, and ii. a financial liability or equity instrument of another entity Financial Asset: Any asset that is: Cash An equity instrument of another entity (investment in shares) Contractual right to receive cash or another financial asset from another entity, or to exchange financial instruments with another entity (receivables)

FINANCIAL ASSETS AND LIABILITIES

DEFINITION (IAS 32 and IAS 39) Financial Liability: Any liability that is: A contractual obligation To deliver cash or another financial asset to another entity, or To exchange financial instruments with another entity under conditions that are potentially unfavourable Payables, loans, derivatives etc.

Equity Instrument: Any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities Ordinary shares, preference shares, warrants

FINANCIAL ASSETS AND LIABILITIES

Points to note: Financial assets / liabilities are: Contractual rights/ obligations, Rights/ obligations that will lead to receipt (asset) or payment (liability) of cash or the acquisition (asset) or issue (liability) of equity instrument

FINANCIAL ASSETS AND LIABILITIES

Assets and liabilities that are NOT financial instruments: Physical assets (PPE, inventory) Create an opportunity to generate cash but does not give rise to a present right to receive cash or another financial asset Leased assets Intangibles assets Prepaid expenses Deferred revenue No contractual obligation to pay cash or another financial asset, but associated with future delivery of goods or services Warranty obligations Income tax liability not contractual but statutory requirements

FINANCIAL ASSETS AND LIABILITIES

IAS 32: FINANCIAL INSTRUMENTS: PRESENTATION
SCOPE: Applied in the presentation and disclosure of ALL types of financial instruments (assets/ liabilities)

EXCLUDE subsidiaries, associates and joint ventures, pensions and insurance contracts

FINANCIAL ASSETS AND LIABILITIES

IAS 32: FINANCIAL INSTRUMENTS: PRESENTATION
Liabilities and Equity: Financial instruments should be presented according to their substance not merely their legal form

Liability or Equity? Substance of the contractual arrangement on initial recognition Definitions of financial liability and equity instrument Critical feature of liability obligation to transfer economic benefit If critical feature NOT met equity instrument E.g. preference shares financial liability or equity instrument?

FINANCIAL ASSETS AND LIABILITIES

IAS 32: FINANCIAL INSTRUMENTS: PRESENTATION
Compound Financial Instruments: Financial instruments contain BOTH a liability and an equity element

IAS 32 to be classified separately (according to the substance of contractual agreement and definition) IAS 32 requires: Calculate the value of liability component Deduct liability component from the instrument as a whole and residual value as equity component E.g. Convertible debt

FINANCIAL ASSETS AND LIABILITIES

IAS 32: FINANCIAL INSTRUMENTS: PRESENTATION

2 elements MUST be separately recognised in SOFP Liability element (Current liability/ Non-current liability) Equity element (as equity option) Interest, dividends, losses and gains (relating to financial liability) recognised as income or expense in profit or loss Distribution to holders of financial assets (equity instrument) debit directly to equity (Statement of changes in Equity)

Transaction costs (equity instrument) accounted for as a DEDUCTION from equity (normally debited to share premium)

FINANCIAL ASSETS AND LIABILITIES

IAS 32: FINANCIAL INSTRUMENTS: PRESENTATION
Example (Kaplan p.297): Convert issues a convertible loan of $5million that attracts interest of 2%. Market rate = 8%, being interest rate for an equivalent debt without conversion option. Repayment of convertible loan in full after 3 years or convertible to equity:

Year 1 2 3

Discount factor at 8% 0.923 0.857 0.794

Required: Split the loan between debt and equity at inception and calculate the finance charge for each year until conversion/ redemption

FINANCIAL ASSETS AND LIABILITIES

IFRS 7: FINANCIAL INSTRUMENTS: DISCLOSURE

adds certain new disclosures about financial instruments to those currently required by IAS 32; replaces the disclosures previously required by IAS 30; and puts all of those financial instruments disclosures together in a new standard on Financial Instruments: Disclosures. The remaining parts of IAS 32 deal only with financial instruments presentation matters.

The two main categories of disclosures required by IFRS 7 are: information about the significance of financial instruments. information about the nature and extent of risks arising from financial instruments

FINANCIAL ASSETS AND LIABILITIES IAS 39: FINANCIAL INSTRUMENTS: RECOGNITION AND
MEASUREMENT

IAS 39 deals with: Recognition of financial instruments Derecognition of financial instruments Initial measurement of financial instruments Subsequent measurement of financial instruments Gains and losses Impairment of financial instruments

FINANCIAL ASSETS AND LIABILITIES IAS 39: FINANCIAL INSTRUMENTS: RECOGNITION AND
MEASUREMENT

SCOPE: all entities and ALL types of financial instruments except those specifically excluded (e.g. investments in subsidiaries, associates and joint ventures) RECOGNITION: Remember: SUBSTANCE OVER FROM

FINANCIAL ASSETS AND LIABILITIES IAS 39: FINANCIAL INSTRUMENTS: RECOGNITION AND
MEASUREMENT

RECOGNITION: ALL financial instruments should be recognised in SOFP: i. when the reporting entity becomes a party to the contractual provisions of the instrument

DIFFERENT from recognition criteria in the Framework: i. Recognised when there is a probable inflow/ outflow of resources ii. Cost or value can be measured reliably

FINANCIAL ASSETS AND LIABILITIES IAS 39: FINANCIAL INSTRUMENTS: RECOGNITION AND
MEASUREMENT

MEASUREMENT: INITIAL Measurement: Financial asset/ financial liability recognised in SOFP: When the reporting entity becomes a party to the contractual provisions of the instrument

At COST (fair value of the consideration given or receipt + transaction costs) EXCEPTION to financial instrument is designated as at fair value through profit or loss (transaction costs not added to fair value at initial recognition)

Fair value may be estimated using valuation technique

FINANCIAL ASSETS AND LIABILITIES IAS 39: FINANCIAL INSTRUMENTS: RECOGNITION AND
MEASUREMENT

SUBSEQUENT Measurement: Subsequent Measurement Financial Asset Financial Liability

Fair value, without deduction for transactions costs that may be incurred on sale or other disposal (change in FV recognised in income statement)
Amortised costs using effective interest method (effective interest amount to income statement)

Financial liability at fair value through profit or loss

Amortised costs

FINANCIAL ASSETS AND LIABILITIES IAS 39: FINANCIAL INSTRUMENTS: RECOGNITION AND
MEASUREMENT

Financial Asset I. Fair value through profit or loss Meets either of the following condition: Financial assets is classified as held for trading Principally for the purpose of selling or repurchasing Part of portfolio of identified financial instruments for short term profit-taking
II. III.

IV.

Held to maturity investments (intention to hold to maturity) Loans and receivables (non-derivative financial assets with fixed or determinable payments not quoted in active market) Available for sale financial assets (those not classified as above)

FINANCIAL ASSETS AND LIABILITIES IAS 39: FINANCIAL INSTRUMENTS: RECOGNITION AND
MEASUREMENT

Amortised cost = initial recognition - principal repayments +/- cumulative amortisation any write-down for impairment or uncollectability

Once a financial instrument has been classified as at FAIR VALUE THROUGH PROFIT OR LOSS cannot be reclassified

FINANCIAL ASSETS AND LIABILITIES IAS 39: FINANCIAL INSTRUMENTS: RECOGNITION AND
MEASUREMENT

Gains and Losses: Instruments at FV through profit or loss: Gains/ losses in profit or loss

Available for sale: Gains/ losses recognised directly in equity through statement of comprehensive income Amortised cost: Gains/ losses in profit or loss

FINANCIAL ASSETS AND LIABILITIES IAS 39: FINANCIAL INSTRUMENTS: RECOGNITION AND
MEASUREMENT

Impairment: Financial Assets at amortised costs Impairment loss in profit or loss

Financial Assets at costs (if FV cannot be reliably measured) Impairment loss cannot be reversed Available for sale financial assets Removed from equity and recognised in net profit or loss (even though financial asset has not been derecognised)

FINANCIAL ASSETS AND LIABILITIES IAS 39: FINANCIAL INSTRUMENTS: RECOGNITION AND
MEASUREMENT

DERECOGNITION: Removal of a previously recognised financial instrument from statement of financial position

Financial assets derecognised when: Contractual rights to cash flows expire, or Substantially all the risks and rewards of ownership of the financial asset to another party Financial liability derecognised when: it is extinguished (when obligation in the contract is discharged or cancelled or expires)

FINANCIAL ASSETS AND LIABILITIES IAS 39: FINANCIAL INSTRUMENTS: RECOGNITION AND
MEASUREMENT

DERECOGNITION: Only part of a financial asset or liability to be derecognised, if Specific cash flows can be identified, or A fully proportionate (pro rata) share of the total cash flows

On derecognition, GAINS/ LOSSES recognised in profit or loss (income statement):

Carrying amount Less: Proceeds received/ paid Less: Any cumulative gain or loss reported in equity Difference to net profit/ loss X (X) (X) X

FINANCIAL ASSETS AND LIABILITIES IAS 39: FINANCIAL INSTRUMENTS: RECOGNITION AND
MEASUREMENT

DERECOGNITION: Available for sale: Cumulative gain or loss previously recognised in equity should be recognised in profit or loss

FINANCIAL ASSETS AND LIABILITIES IFRS 9: FINANCIAL INSTRUMENTS: RECOGNITION AND

MEASUREMENT

IFRS 9 Financial Instruments by Tony Sweetman 10 Aug 2011 (Student Accountant) IFRS 9, Financial Instruments is part of the project to replace IAS 39, Financial Instruments Recognition and Measurement

Deals with classification and measurement of financial assets (November 2009) and financial liabilities (October 2010) IFRS 9 is effective for accounting periods commencing on or after 1 January 2013 further developments are in progress dealing with impairment, derivatives and hedging

FINANCIAL ASSETS AND LIABILITIES IFRS 9: FINANCIAL INSTRUMENTS: RECOGNITION AND

MEASUREMENT

To the extent that IFRS 9 does not yet deal with a particular issue, the requirements of IAS 39 continue to apply. For 2011 exams, IFRS 9 is examinable in relation to accounting for financial assets only Accounting for financial liabilities continue to be accounted for in accordance with IAS 39

For 2012 exams, IFRS 9 will be examinable in relation to accounting for both financial assets and financial liabilities

FINANCIAL ASSETS AND LIABILITIES IFRS 9: FINANCIAL INSTRUMENTS: RECOGNITION AND

MEASUREMENT

IFRS 9 vs IAS 9 (Financial Assets): number of classifications has been reduced from four to three

the available-for-sale classification has NOT BEEN retained within IFRS 9 elimination of the requirement to recycle gains and losses previously taken to equity upon derecognition of the financial asset

FINANCIAL ASSETS AND LIABILITIES IFRS 9: FINANCIAL INSTRUMENTS: RECOGNITION AND

MEASUREMENT

Classification of FINANCIAL ASSETS: I. Financial assets at fair value through profit or loss (FVTPL) Initial recognition at fair value is normally cost incurred and this will exclude transactions costs, which are charged to profit or loss as incurred

Remeasurement to fair value, any movement in fair value taken to profit or loss for the year

FINANCIAL ASSETS AND LIABILITIES IFRS 9: FINANCIAL INSTRUMENTS: RECOGNITION AND

MEASUREMENT
II.

Financial assets at fair value through other comprehensive income (FVTOCI) applies to equity instruments only

must be designated upon initial recognition Initial recognition at fair value (include the associated transaction costs of purchase) accounting treatment automatically incorporates an impairment review, with any change in fair value taken to OTHER COMPREHENSIVE INCOME in the year.

FINANCIAL ASSETS AND LIABILITIES IFRS 9: FINANCIAL INSTRUMENTS: RECOGNITION AND

MEASUREMENT
III.

Financial assets measured at amortised cost apply only to debt instruments must be designated upon initial recognition MUST pass two tests: The business model test: the entity must be holding the financial asset to collect in the contractual cash flows associated with that financial asset

The cash flow characteristics test: the contractual cash flows collected must consist solely of payment of interest and capital If fail measured at FVTPL

FINANCIAL ASSETS AND LIABILITIES IFRS 9: FINANCIAL INSTRUMENTS: RECOGNITION AND

MEASUREMENT
Impairment of FINANCIAL ASSETS: I. Financial assets that are measured at fair value fall in fair value is taken to profit or loss or other comprehensive income for the year
II.

Financial assets designated to be measured at amortised cost to profit or loss immediately

Derecognition (Gains and Losses): I. Financial assets that are measured at fair value to profit or loss an equity transfer from other components of equity to retained earnings (FVTOCI)
II.

Financial assets designated to be measured at amortised cost to profit or loss

FINANCIAL ASSETS AND LIABILITIES IFRS 9: FINANCIAL INSTRUMENTS: RECOGNITION AND

MEASUREMENT

Classification of FINANCIAL LIABILITIES: I. Financial liabilities at fair value through profit or loss (FVTPL)
I.

Financial liabilities measured at amortised cost

There have been no significant changes to accounting for financial liabilities.

FINANCIAL ASSETS AND LIABILITIES IFRS 9: FINANCIAL INSTRUMENTS: RECOGNITION AND

MEASUREMENT

Illustration 1 classification and measurement of financial assets An entity, Suarez, purchased a five-year bond on 1 January 2010 at a cost of $5m with annual interest of 5%, which is also the effective rate, payable on 31 December annually. At the reporting date of 31 December 2010 interest has been received as expected and the market rate of interest is now 6%. Required: Account for the financial asset at 31 December 2010 on the basis that: i. it is classified as FVTPL, and ii. it is classified to be measured at amortised cost, on the assumption it passes the necessary tests and has been properly designated at initial recognition.