Module 11
Module 11
Module 11
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Contents
INTRODUCTION __________________________________________________________ 1
Which version of the IFRS for SMEs Standard? __________________________________ 1
This module ______________________________________________________________ 1
IFRS for SMEs Standard ____________________________________________________ 2
Introduction to the requirements_______________________________________________ 3
What has changed since the 2009 IFRS for SMEs Standard ________________________ 5
REQUIREMENTS AND EXAMPLES ___________________________________________ 6
Scope of Sections 11 and 12 _________________________________________________ 6
Accounting policy choice ____________________________________________________ 7
Introduction to Section 11____________________________________________________ 8
Scope of Section 11 _______________________________________________________ 15
Basic financial instruments __________________________________________________ 17
Initial recognition of financial assets and liabilities ________________________________ 30
Initial measurement _______________________________________________________ 31
Subsequent measurement __________________________________________________ 42
Derecognition of a financial asset ____________________________________________ 79
Derecognition of a financial liability ___________________________________________ 87
Disclosures ______________________________________________________________ 91
SIGNIFICANT ESTIMATES AND OTHER JUDGEMENTS _________________________ 99
Initial measurement _______________________________________________________ 99
Subsequent measurement _________________________________________________ 100
Derecognition ___________________________________________________________ 100
COMPARISON WITH FULL IFRS STANDARDS _______________________________ 101
TEST YOUR KNOWLEDGE _______________________________________________ 103
APPLY YOUR KNOWLEDGE ______________________________________________ 107
Case study 1 ___________________________________________________________ 107
Answer to case study 1 ___________________________________________________ 109
Case study 2 ___________________________________________________________ 112
Answer to case study 2 ___________________________________________________ 114
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Module 11—Basic Financial Instruments
INTRODUCTION
When the IFRS for SMEs Standard was first issued in July 2009, the Board said it would
undertake an initial comprehensive review of the Standard to assess entities’ experience of the
first two years of its application and to consider the need for any amendments. To this end, in
June 2012, the Board issued a Request for Information: Comprehensive Review of the IFRS for SMEs.
An Exposure Draft proposing amendments to the IFRS for SMEs Standard was subsequently
published in 2013, and in May 2015 the Board issued 2015 Amendments to the IFRS for SMEs
Standard.
The document published in May 2015 only included amended text, but in October 2015, the
Board issued a fully revised edition of the Standard, which incorporated additional minor
editorial amendments as well as the substantive May 2015 revisions. This module is based on
that version.
The IFRS for SMEs Standard issued in October 2015 is effective for annual periods beginning on
or after 1 January 2017. Earlier application was permitted, but an entity that did so was
required to disclose the fact.
Any reference in this module to the IFRS for SMEs Standard refers to the version issued in
October 2015.
This module
An entity must choose to account for financial instruments either by applying the
requirements of both Section 11 Basic Financial Instruments and Section 12 Other Financial
Instruments Issues in full or by applying the recognition and measurement requirements of
IAS 39 Financial Instruments: Recognition and Measurement (of full IFRS Standards) and the
disclosure requirements of Sections 11 and 12. This training material covers only the first
option (that is, it does not cover the option to apply IAS 39). Whichever of the options an
entity applies, it must also apply Section 22 Equity and Liabilities.
This module focusses on the accounting and reporting of basic financial instruments in
accordance with Section 11 of the IFRS for SMEs Standard. Module 12 applies to all other
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Module 11—Basic Financial Instruments
financial instrument issues and hence covers more complex financial instruments and related
transactions including hedge accounting.
The module identifies the significant judgements required to account for and report basic
financial instruments and transactions. In addition, the module includes questions designed
to test your understanding of the requirements and case studies that provide a practical
opportunity to apply the requirements to account for and report basic financial instruments
applying the IFRS for SMEs Standard.
Upon successful completion of this module, you should, within the context of the IFRS for SMEs
Standard, be able to:
• define a financial instrument, a financial asset, a financial liability and an equity
instrument;
• identify financial assets and financial liabilities that are within the scope of Section 11;
• explain when to recognise a financial instrument and demonstrate how to account for
financial instruments on initial recognition;
• measure a financial instrument within the scope of Section 11 both on initial recognition
and subsequently;
• determine amortised cost of a financial instrument using the effective interest method;
• identify when to recognise an impairment loss (or reversal of an impairment loss) for
financial instruments held at cost or amortised cost, and demonstrate how to measure
that impairment loss (or the reversal of an impairment loss);
• identify appropriate methods of determining fair value for investments in ordinary or
preference shares;
• explain when to derecognise financial assets and financial liabilities and demonstrate how
to account for such derecognition;
• prepare appropriate information about financial instruments that would satisfy the
disclosure requirements in Section 11; and
• demonstrate an understanding of the significant judgements that are required in
accounting for basic financial instruments.
The IFRS for SMEs Standard is intended to apply to the general purpose financial statements of
entities that do not have public accountability (see Section 1 Small and Medium-sized Entities).
The IFRS for SMEs Standard includes mandatory requirements and other non-mandatory
material that is published with it.
The material that is not mandatory includes:
• a preface, which provides a general introduction to the IFRS for SMEs Standard and explains
its purpose, structure and authority;
• implementation guidance, which includes illustrative financial statements and a table of
presentation and disclosure requirements;
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Module 11—Basic Financial Instruments
• the Basis for Conclusions, which summarises the Board’s main considerations in reaching
its conclusions in the IFRS for SMEs Standard issued in 2009 and, separately, in the 2015
Amendments; and
• the dissenting opinion of a Board member who did not agree with the issue of the
IFRS for SMEs Standard in 2009 and the dissenting opinion of a Board member who did not
agree with the 2015 Amendments.
In the IFRS for SMEs Standard, Appendix A: Effective date and transition, and Appendix B:
Glossary of terms, are part of the mandatory requirements.
In the IFRS for SMEs Standard, there are appendices to Section 21 Provisions and Contingencies,
Section 22 Liabilities and Equity and Section 23 Revenue. These appendices provide
non-mandatory guidance.
The IFRS for SMEs Standard has been issued in two parts: Part A contains the preface, all the
mandatory material and the appendices to Section 21, Section 22 and Section 23; and Part B
contains the remainder of the material mentioned above.
Further, the SME Implementation Group (SMEIG), which assists the Board on matters related
to the implementation of the IFRS for SMEs Standard, publishes implementation guidance as
“questions and answers” (Q&As). The Q&As provide non-mandatory, timely guidance on
specific accounting questions raised with the SMEIG by users implementing the IFRS for SMEs
Standard. At the time of issue of this module (July 2018) the SMEIG has issued one Q&A for
Section 12, which is also relevant to this module.
1 If this option is selected, an entity shall apply the version of IAS 39 that applied immediately prior to IFRS 9 superseding
IAS 39. A copy of that version is available on the IASB website (ifrs.org – Home < Supporting implementation < IFRS for SMEs
< IFRS for SMEs and IAS 39).
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Module 11—Basic Financial Instruments
Scope
This module covers only the requirements in Section 11. Section 11 applies to basic financial
instruments and is relevant to all entities that assert compliance with the IFRS for SMEs
Standard. Section 12 applies to other, more complex financial instruments and transactions.
For the purposes of Section 11, basic financial instruments consist of:
• cash;
• debt instruments (such as an account, note, or loan receivable or payable) that meet
certain conditions (in particular, returns to the holder are either fixed or are variable on
the basis of a single referenced quoted or observable interest rate);
• commitments to receive a loan that cannot be settled net in cash and the loan is expected
to meet the same conditions as other debt instruments in this section; and
• investments in non-convertible preference shares and non-puttable ordinary shares or
preference shares.
Deciding whether an asset or liability that arises from a contact is a basic financial instrument
accounted for in accordance with Section 11 involves a number of steps:
• Step 1: The contract must give rise to a financial asset of one entity and a financial liability
or equity instrument of another entity (see paragraph 11.3)
• Step 2: The entity must have elected to account for financial instruments in accordance
with Sections 11 and 12 (see paragraph 11.2)
• Step 3: The financial instrument must not be specifically excluded from the scope of
Section 11 (see paragraph 11.7)
• Step 4: The financial instrument must be (a) cash or (b) an investment in non-convertible
preference shares and non-puttable ordinary shares or preference shares or (c) a debt
instrument that satisfies the requirements in paragraph 11.9 or (d) a commitment to
receive a loan that cannot be settled net in cash and, when the commitment is executed, is
expected to meet the conditions in paragraph 11.9 (see paragraph 11.8).
Recognition
Section 11 requires a financial asset or financial liability to be recognised only when the entity
becomes a party to the contractual provisions of the instrument.
Measurement
When first recognised, financial instruments are measured at their transaction price, unless
the arrangement constitutes, in effect, a financing transaction. If the arrangement constitutes
a financing transaction, the item is initially measured at the present value of the future
receipts discounted at a market rate of interest for a similar debt instrument.
After initial recognition an amortised cost model (or in some cases a cost model) is applied to
measure all basic financial instruments, except for investments in non-convertible and
non-puttable preference shares and non-puttable ordinary shares that are publicly traded or
whose fair value can otherwise be measured reliably without undue cost or effort. For such
investments, this section requires measurement after initial recognition at fair value with
changes in fair value recognised in profit or loss.
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Module 11—Basic Financial Instruments
This section requires that at the end of each reporting period, an assessment be made of
whether there is objective evidence of impairment of any financial asset that is measured at
cost or amortised cost.
The following are the changes made to Section 11 by the 2015 Amendments:
• addition of an undue cost or effort exemption from the measurement of investments in
equity instruments at fair value (see paragraphs 11.4, 11.14(c), 11.32 and 11.44).
• clarification of the interaction of the scope of Section 11 with other sections of the IFRS for
SMEs Standard (see paragraph 11.7(b)–(c) and (e)–(f)).
• clarification of the application of the criteria for basic financial instruments to simple loan
arrangements (see paragraphs 11.9–11.9B).
• clarification of when an arrangement would constitute a financing transaction (see
paragraphs 11.13, 11.14(a) and 11.15).
• clarification in the guidance on fair value measurement in Section 11 of when the best
evidence of fair value may be a price in a binding sale agreement (see paragraph 11.27).
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Module 11—Basic Financial Instruments
The contents of Section 11 Basic Financial Instruments of the IFRS for SMEs Standard are set out
below and shaded grey. Terms defined in the Glossary are also part of the requirements. They
are in bold type the first time they appear in the text of Section 11. The notes and examples
inserted by the IFRS Foundation education staff are not shaded. The insertions made by the
staff do not form part of the IFRS for SMEs Standard and have not been approved by the
International Accounting Standards Board.
Notes
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Module 11—Basic Financial Instruments
Few small or medium-sized entities hold the complex financial instruments. The
requirements to account for complex financial instruments are not relevant to those
entities that hold only basic financial instruments. The requirements for accounting
for financial instruments are therefore split into two sections—Section 11 Basic Financial
Instruments and Section 12 Other Financial Instrument Issues. The requirements for
straightforward instruments are separated from the requirements for the complex
instruments, making it easier for entities to identify the requirements that apply to
them.
As its title suggests, Section 11 addresses basic financial instruments and basic
transactions involving financial instruments that small or medium-sized entities
commonly encounter. In contrast, Section 12 addresses the more complex financial
instruments and transactions that few private entities encounter. However, all entities
must review Section 12 to ensure that none of their financial instruments or
transactions fall within its scope. Even entities that normally engage in only simple
transactions may occasionally enter into more unusual transactions to which Section
12 applies. See paragraph 11.11 for examples of financial instruments that are within
the scope of Section 12.
Notes
An entity must select as an accounting policy choice either the option in paragraph
11.2(a) or the option in paragraph 11.2(b). It must apply this option to account for all
of its financial instruments.
Many preparers find IAS 39 more complex and difficult to apply than Sections 11
and 12. However, an entity may choose the option in paragraph 11.2(b), for example, if
it holds complex financial instruments or enters into hedging relationships. Before
choosing to apply IAS 39 an entity should consider carefully whether it has the
resources to do so.
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Module 11—Basic Financial Instruments
Once an entity has made its choice, changing to the other option (for example, from
(a) to (b)) constitutes a change in accounting policy, as described in Section 10
Accounting Policies, Estimates and Errors (paragraphs 10.8–10.14). Paragraph 10.8 specifies
that the entity can only make such a change if doing so would result in the financial
statements providing reliable and more relevant information about the effects of
transactions, other events or conditions on the entity’s financial position, financial
performance or cash flows. The change in accounting policy would be accounted for
retrospectively (that is, by restating the comparative financial information presented
as if the new accounting policy had always been applied) and the disclosures required
by paragraph 10.14 would be provided.
Introduction to Section 11
11.3 A financial instrument is a contract that gives rise to a financial asset of one entity and a
financial liability or equity instrument of another entity.
Notes
Equity is the residual interest in the assets of the entity after deducting all its
liabilities.
For the purposes of Section 11, a financial asset can be described as any asset that is:
(a) cash;
(b) an equity instrument of another entity;
(c) a contractual right:
(i) to receive cash or another financial asset from another entity; or
(ii) to exchange financial assets or financial liabilities with another entity
under conditions that are potentially favourable to the entity.
(d) a contract that will or may be settled in the entity’s own equity instruments
and under which the entity is or may be obliged to receive a variable number of
the entity’s own equity instruments.
For the purposes of Section 11, a financial liability can be described as any liability that
is:
(a) a contractual obligation:
(i) to deliver cash or another financial asset to another entity; or
(ii) to exchange financial assets or financial liabilities with another entity
under conditions that are potentially unfavourable to the entity.
(b) a contract that will or may be settled in the entity’s own equity instruments
and under which the entity is or may be obliged to deliver a variable number of
the entity’s own equity instruments.
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Module 11—Basic Financial Instruments
For simplicity, these descriptions of a financial asset and a financial liability differ
slightly from the definitions of a financial asset and a financial liability in the
IFRS for SMEs Standard (see the Glossary), but are suitable for the purposes of Module
11. A financial asset or financial liability that meets the definitions in the Glossary
but not the descriptions is probably outside the scope of Section 11, and would be
accounted for in accordance with Section 12. This is explained further in Section 12.
It is evident from the descriptions above that financial instruments arise from rights
and obligations under contracts. The terms ‘contract’ and ‘contractual’ refer to an
agreement between two or more parties that has clear economic consequences that
the parties have little, if any, discretion to avoid, usually because the agreement is
enforceable by law. Contracts, and thus financial instruments, may take a variety of
forms and need not be in writing. For a contract to be valid, both parties must give
their approval. Approval may be given indirectly, for example, by an entity acting in
such a way that the other parties involved believe the entity’s intention is to make a
contract. For example, an entity that purchases or sells goods or property, engages a
builder to carry out work, borrows money or orders goods or machinery from a
manufacturer is a party to a contract.
Common examples of financial assets representing a contractual right to receive cash
in the future and corresponding financial liabilities representing a contractual
obligation to deliver cash in the future are:
In each case, one party’s contractual right to receive cash is matched by the other
party’s corresponding obligation to pay cash.
Examples—financial instruments
Ex 1 A bank advances an entity a five-year loan. The bank also provides the entity with
an overdraft facility for a number of years.
The entity has two financial liabilities—the obligation to repay the five-year loan and
the obligation to repay the bank overdraft to the extent that it has borrowed using the
overdraft facility. Both the loan and the overdraft result in contractual obligations for
the entity to pay cash to the bank for the interest incurred and for the return of the
principal (see paragraph (a)(i) of the definition of a financial liability in the Glossary).
The amounts due from the entity under the loan and overdraft facility are financial
assets of the bank. Note: The bank cannot apply the IFRS for SMEs Standard (see
paragraphs 1.2 and 1.3).
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Module 11—Basic Financial Instruments
Ex 2 Entity A owns preference shares in Entity B. The preference shares entitle Entity A
to dividends, but not to any voting rights.
Entity B: The preference shares may be equity instruments or financial liabilities of
Entity B, depending on their terms and conditions (see Section 22 Liabilities and Equity).
Entity A: Irrespective of Entity B’s treatment, the preference shares are a financial asset
because the investment will either satisfy part (b) or (c)(i) of the definition of a financial
asset. The financial asset will usually be within the scope of Section 11 (see paragraph
11.8).
Ex 4 Entity A purchases a subsidiary from Entity B. Under the agreement, Entity A pays
the purchase price in two instalments—CU5 million (2) upfront and a further
payment (which is not a contingent payment) of CU5 million two years later.
The CU5 million payable two years later is a financial liability of Entity A—it is an
obligation to deliver cash in two years’ time (see part (a)(i) of the definition of a
financial liability in the Glossary). It is a financial asset of Entity B—a contractual right
to receive cash (see part (c)(i) of the definition of a financial asset in the Glossary).
Ex 5 An entity has a present obligation in respect of income tax due for the prior year.
An income tax liability is created as a result of statutory requirements imposed by
governments. The rights and obligations are not created by a contract and hence the
liability does not satisfy the requirements of 11.3 and is not a financial liability.
Accounting for income tax is dealt with in Section 29 Income Tax.
Ex 6 Every year for the past 20 years a catering entity has paid CU50,000 towards the
costs of the carnival in the village in which the entity operates. The entity is well
known as the main sponsor of the annual event and its advertisements include
reference to its status as main sponsor of the village carnival. The villagers now
expect the entity to pay CU50,000 to cover the costs of the carnival this year.
The obligation to pay CU50,000 does not arise from a contract and hence is not a
financial liability. The obligation may meet the conditions to be recognised as a
constructive obligation. A constructive obligation falls within the scope of Section 21
Provisions and Contingencies.
Note: If, however, the catering entity entered into a contract to pay CU50,000 towards
the village carnival, then the entity has a financial liability.
(2) In this example, and in all other examples in this module, monetary amounts are denominated in ‘currency units (CU)’.
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Module 11—Basic Financial Instruments
Ex 8 An entity is fined for three separate breaches of legislative requirements: (i) the
late payment of income tax; (ii) failing to submit its company accounts on time;
and (iii) false claims made in advertisements for its products.
Fines do not arise from contracts. They are levied because of breaches of statutory
requirements and therefore, are not financial liabilities of the entity. Since the entity
must pay the fines, the entity will need to consider recognising a liability in
accordance with Section 2 Concepts and Pervasive Principles. If the payment is of uncertain
timing or amount, it is accounted for in accordance with Section 21 Provisions and
Contingencies.
Ex 10 At the end of the reporting period an entity has an asset—the prepayment of three
months of rent on its office building.
Assets (such as prepaid expenses) for which the future economic benefit is the receipt
of goods or services rather than the right to receive cash or another financial asset, are
not financial assets.
Similarly, accruals for which the future outflow of benefits is the delivery of goods or
services, rather than the payment of cash or financial assets, are not financial
liabilities.
Ex 11 An entity sells goods to customers. The law in the entity’s jurisdiction requires
that the entity provides a one-year guarantee to repair or replace any defective
products.
The warranty obligation is not a financial liability because there is no contract between
the entity and its customers. The customers have a statutory right to demand repair or
replacement of defective products. The warranty provision is accounted for in
accordance with Section 21 Provisions and Contingencies.
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Module 11—Basic Financial Instruments
Ex 14 An entity is both the policyholder and the beneficiary in a life insurance (also
known as life assurance) contract. The contract requires the insurer to pay the
entity a sum of money upon the death or terminal illness of the owner-manager of
the entity. Under the contract, the entity is required to pay a stipulated amount
annually until the insured event (death or illness) occurs.
A policyholder’s contractual right to receive cash under the contract meets the
definition of a financial asset. However, such financial assets do not typically meet the
requirements in paragraph 11.9, and are therefore not typically accounted for in
accordance with Section 11 (see Example 16 and 17).
11.4 Section 11 requires an amortised cost model for all basic financial instruments except for
investments in non-convertible preference shares and non-puttable ordinary or preference
shares that are publicly traded or whose fair value can otherwise be measured reliably
without undue cost or effort.
Notes
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Whether determining the fair value would involve undue cost or effort depends on the
entity’s specific circumstances and on management’s judgement in assessing the costs
and benefits. Management must consider how the absence of such information could
affect the economic decisions of those expected to use the financial statements.
Applying the requirement would involve undue cost or effort by an SME if the
incremental cost (for example, valuers’ fees) or additional effort (for example,
endeavours by employees) substantially exceeded the benefits that having the
information would provide to those expected to use the SME’s financial statements (see
paragraph 2.14B). If an SME already has, or could easily and inexpensively acquire, the
information necessary to comply with a requirement, any related exemption on the
grounds of undue cost or effort would no longer apply. This is because, in such cases,
the benefits to users of the financial statements of having the information, would be
expected to exceed any further cost or effort by the SME. Assessing whether a
requirement would involve undue cost or effort on initial recognition in the financial
statements, for example at the date of the transaction, should be based on information
about the costs and benefits at that date. If the undue cost or effort exemption also
applies after initial recognition, for example to a subsequent measurement of an item,
a new assessment of undue cost or effort should be made at that subsequent date,
based on information available at that date (see paragraph 2.14C). Where an entity
uses the undue cost or effort exemption for financial instruments, the entity shall
disclose that fact and the reasons why applying the requirement would involve undue
cost or effort (see paragraph 2.14D).
11.5 Basic financial instruments within the scope of Section 11 are those that satisfy the
conditions in paragraph 11.8. Examples of financial instruments that normally satisfy
those conditions include:
(a) cash;
(b) demand and fixed-term deposits when the entity is the depositor, for example bank
accounts;
(c) commercial paper and commercial bills held;
(d) accounts, notes and loans receivable and payable;
(e) bonds and similar debt instruments;
(f) investments in non-convertible preference shares and non-puttable ordinary and
preference shares; and
(g) commitments to receive a loan if the commitment cannot be net settled in cash.
Example—commercial paper
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Module 11—Basic Financial Instruments
Example—bonds
11.6 Examples of financial instruments that do not normally satisfy the conditions in paragraph
11.8, and are therefore within the scope of Section 12, include:
(a) asset-backed securities, such as collateralised mortgage obligations, repurchase
agreements and securitised packages of receivables;
(b) options, rights, warrants, futures contracts, forward contracts and interest rate
swaps that can be settled in cash or by exchanging another financial instrument;
(c) financial instruments that qualify and are designated as hedging instruments in
accordance with the requirements in Section 12;
(d) commitments to make a loan to another entity; and
(e) commitments to receive a loan if the commitment can be net settled in cash.
Notes
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Module 11—Basic Financial Instruments
Scope of Section 11
11.7 Section 11 applies to all financial instruments meeting the conditions of paragraph 11.8
except for the following:
(a) investments in subsidiaries, associates and joint ventures that are accounted
for in accordance with Section 9 Consolidated and Separate Financial Statements,
Section 14 Investments in Associates or Section 15 Investments in Joint Ventures.
(b) financial instruments that meet the definition of an entity’s own equity, including
the equity component of compound financial instruments issued by the entity
(see Section 22 Liabilities and Equity).
(c) leases, to which Section 20 Leases or paragraph 12.3(f) apply. However, the
derecognition requirements in paragraphs 11.33–11.38 apply to the
derecognition of lease receivables recognised by a lessor and lease payables
recognised by a lessee, and the impairment requirements in paragraphs 11.21–
11.26 apply to lease receivables recognised by a lessor.
(d) employers’ rights and obligations under employee benefit plans, to which Section
28 Employee Benefits applies.
(e) financial instruments, contracts and obligations under share-based payment
transactions to which Section 26 Share-based Payment applies.
(f) reimbursement assets that are accounted for in accordance with Section 21
Provisions and Contingencies (see paragraph 21.9).
Notes
All interests in subsidiaries, associates and joint ventures that are accounted for in
accordance with Section 9, 14 or 15 respectively are outside the scope of Section 11
even though the equity shares or other instruments representing those interests are
financial instruments. However, the fair value model under those three sections refers
to some paragraphs of Section 11 that are applicable. For entities using the fair value
model for investments under Section 9, 14 or 15, the only paragraphs from Section 11
that should be applied are those listed in these sections. No other part of Section 11
should be applied.
Section 22 Liabilities and Equity establishes principles to guide issuers with classifying
financial instruments as either financial liabilities or equity. Therefore Section 22 is
applied first to determine whether a financial instrument is a financial asset, a
financial liability, equity or a compound financial instrument (an instrument that
contains both equity and liability components—see Glossary).
Section 11 applies to those instruments that are financial assets or financial liabilities,
and to the liability component of a compound financial instrument. Section 11 does
not apply to financial instruments, or components of financial instruments, that meet
the definition of that entity’s own equity instruments, for example an issuer’s ordinary
shares and preference shares that do not satisfy the definition of a financial liability.
The exemption applies only to the issuer of the equity instrument. The holder of the
instrument should apply Section 11 unless the investment is excluded by paragraph
11.7(a) or does not meet the criteria in paragraph 11.8(d).
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All financial assets and equity instruments in this example are excluded from Section
11 (see paragraph 11.7(a)). If the instruments are financial liabilities of the investees
and satisfy paragraph 11.8, the investee will need to account for the financial liabilities
in its own individual financial statements, in accordance with Section 11.
Ex 18 Entity A, as part of its ordinary activities, contracted for advice regarding a new
marketing campaign from a local PR consultancy. The consultancy agreed to
accept ordinary shares of Entity A as payment for its services.
Entity A is paying for services in shares rather than in cash. It accounts for this
equity-settled share-based payment transaction applying Section 26.
Example—reimbursement asset
Ex 19 The facts are the same as in Example 14. Prior to the year end, the owner-manager
of the entity becomes ill, and a claim of CU20,000 is lodged with the insurance
company. The claim has not been settled by the year-end. The entity is obliged
under a co-operation contract with Entity B to pay an amount of CU10,000 to
Entity A in the event of the death or illness of the owner manager.
A policyholder’s contractual right to receive cash under the contract meets the
definition of a financial asset. This is a reimbursement asset as per paragraph 21.9
because some or all of the amount required to settle a provision (the payment to Entity
B) is reimbursed by another party (the insurer). Paragraph 21.9 (Section 21) contains
specific requirements for reimbursement assets. Such rights are recognised as separate
assets only when it is virtually certain that the entity will receive the reimbursement
on settlement of the obligation in accordance with paragraph 21.9.
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Notes
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Other derivatives are part of another financial instrument or a contract to buy or sell a
non-financial item, for example a loan with interest payments that are linked to the
price of a commodity. If a derivative is embedded in or combined with another
financial instrument, the conditions in paragraph 11.9 should be assessed against the
instrument as a whole. If the conditions are satisfied for the instrument as a whole,
that instrument is accounted for in accordance with Section 11.
A derivative embedded in a contract will cause the whole financial instrument to fall
outside the scope of Section 11 and within the scope of Section 12. However,
exceptions apply—for example, instruments specifically excluded from Section 12 in
accordance with paragraph 12.3(b)–(f).
The following are examples of financial instruments that are likely to be complex and
therefore in Section 12:
• foreign currency forward exchange contracts;
• commodity forward exchange contracts;
• equity forward exchange contracts;
• treasury forwards (interest rate forwards linked to government debt);
• foreign currency futures;
• commodity futures;
• treasury futures (interest rate futures linked to government debt);
• interest rate swaps;
• foreign currency swaps (also called foreign exchange swaps or cross currency
swaps);
• commodity swaps;
• equity swaps;
• credit swaps;
• total return swaps;
• commitment to receive a loan;
• purchased or written treasury bond options (call or put);
• purchased or written currency options (call or put);
• purchased or written commodity options (call or put); and
• purchased or written stock options (call or put).
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Ex 21 Entity A owns 0.5% of the non-puttable ordinary shares that carry voting rights at
a general meeting of shareholders of Entity B.
The holding of ordinary shares in Entity B is a financial asset of Entity A—it is an equity
instrument of another entity (see part (b) of the definition of a financial asset in the
Glossary). Entity A must account for its investment in the non-puttable ordinary shares
of Entity B in accordance with Section 11 (see paragraph 11.8(d)).
Note: Paragraph 11.9 does not apply to items specified in paragraph 11.8(a) and (d).
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11.9 A debt instrument that satisfies all of the conditions in (a)–(d) shall be accounted for in
accordance with Section 11:
(a) returns to the holder (the lender/creditor) assessed in the currency in which the
debt instrument is denominated are either:
(i) a fixed amount;
(ii) a fixed rate of return over the life of the instrument;
(iii) a variable return that, throughout the life of the instrument, is equal to a
single referenced quoted or observable interest rate (such as LIBOR); or
(iv) some combination of such fixed rate and variable rates, provided that both
the fixed and variable rates are positive (for example, an interest rate swap
with a positive fixed rate and negative variable rate would not meet this
criterion).
For fixed and variable rate interest returns, interest is calculated by multiplying the
rate for the applicable period by the principal amount outstanding during the
period.
(b) there is no contractual provision that could, by its terms, result in the holder (the
lender/creditor) losing the principal amount or any interest attributable to the
current period or prior periods. The fact that a debt instrument is subordinated to
other debt instruments is not an example of such a contractual provision.
(c) contractual provisions that permit or require the issuer (the borrower) to prepay a
debt instrument or permit or require the holder (the lender/creditor) to put it back
to the issuer (ie to demand repayment) before maturity are not contingent on future
events other than to protect:
(i) the holder against a change in the credit risk of the issuer or the instrument
(for example, defaults, credit downgrades or loan covenant violations) or a
change in control of the issuer; or
(ii) the holder or issuer against changes in relevant taxation or law.
(d) there are no conditional returns or repayment provisions except for the variable
rate return described in (a) and prepayment provisions described in (c).
Notes
In accordance with Section 11, all debt instruments that satisfy the criteria in
paragraph 11.9 are, after initial recognition, measured using an amortised cost model
(see paragraph 11.14(a)). If a debt instrument does not satisfy the criteria in paragraph
11.9 it is accounted for in accordance with Section 12 and measured at fair value.
If the contractual cash flows of a debt instrument consist only of principal (that is, the
capital amount borrowed, which some call the ‘face value’ of the loan) and interest on
that principal, then the debt instrument will usually be measured at cost or amortised
cost in accordance with Section 11.
The effective interest method is not an appropriate method for allocating cash flows
that are not principal or interest on the principal outstanding. Therefore, if a financial
instrument contains contractual cash flows that are not principal or interest on the
principal outstanding, amortised cost under Section 11 is unlikely to be an appropriate
measurement basis.
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Interest cash flows relate closely to the amount advanced to the debtor (that is, the
principal amount) because interest is compensation for the time value of money and
the credit risk associated with the instrument and its issuer.
Credit risk is the risk that one party to a financial instrument will cause a financial loss
for the other party by failing to discharge an obligation (that is, failing to repay
principal and interest in a timely manner).
To ensure that returns to the holder are intended only to provide interest on that
principal, the criteria in paragraph 11.9 require that the returns to the holder must
either be fixed or be variable on the basis of a single referenced quoted or observable
interest rate. If there is significant uncertainty about the realisation of the cash flows
receivable or payable, for reasons other than credit risk or fluctuations in a quoted or
observable rate, for example, LIBOR (London Interbank Offered Rate) or EURIBOR (Euro
Interbank Offered Rate), the debt instrument will not meet the criteria in paragraph
11.9 and will be accounted for at fair value in accordance with Section 12.
For debt instruments to satisfy paragraph 11.9(a) they must either have fixed returns,
returns equal to a single referenced quoted or observable interest rate, or some
combination of these fixed and variable rates. For such debt instruments the
contractual arrangement will define the amounts and dates of payments, such as
interest and principal payments. Debt instruments often have a fixed maturity date.
Returns based on an index or rate other than a quoted or observable interest rate (for
example a price index, a commodity index, or a government-published inflation rate)
will not satisfy paragraph 11.9(a) and therefore, the related instrument is not
accounted for at amortised cost.
If the contractual terms of a financial instrument could result in the holder losing the
principal amount or any interest due (paragraph 11.9(b)), the returns to the holder are
not certain to be fixed or variable based on a single referenced quoted or observable
interest rate so. The instrument, therefore, would not be measured at amortised cost.
An example would be a financial instrument with cash flows linked to the profits of
the issuer.
A significant risk of non-payment does not preclude a financial asset meeting the
requirements in paragraph 11.9 as long as its contractual payments are fixed or
variable on the basis of a single quoted or observable interest rate as set out in
paragraph 11.9(a) and all the other criteria in paragraph 11.9 are met. Although the
holder may lose the principal amount or any interest attributable to the current
period or prior periods if the debtor is unable to make payment due to financial
difficulties, this is not a contractual provision and would not violate paragraph
11.9(b).
An option for a debtor to choose to prepay a debt instrument (for example, a loan) will
not necessarily prevent an instrument from satisfying the requirements in paragraph
11.9 (see paragraph 11.9(c)). To satisfy the requirement in paragraph 11.9(c),
the prepayment amount must be substantially equal to the unpaid amounts of
principal and interest. Such prepayment provisions may include terms that require
the issuer to compensate the holder for the early termination of the instrument.
However, if the option to prepay is triggered by a contingent (that is, possible, but
uncertain) future event, the debt instrument will not satisfy the requirement in
paragraph 11.9(c) and is accounted for in accordance with Section 12. Such
contingent future events must be considered uncertain when the contract is signed
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and therefore, cannot be planned. They include, for example, a 50% decrease in the
price of gold, an initial public offering of the issuer’s shares, a business combination
between the issuer and another party, the unexpected retirement of a major
shareholder of the issuer or a change in tax or other legislation.
Any conditional returns or repayment provisions except for the variable rate return
described in paragraph 11.9(a) and prepayment provisions described in paragraph
11.9(c) would mean that returns to the holder are not certain to be fixed or variable on
the basis of a single referenced quoted or observable interest rate. Therefore, if such
provisions exist, the debt instrument will not meet the requirements in paragraph 11.9
and will not qualify for amortised cost accounting (see paragraph 11.9(d)).
Sometimes an instrument has a feature that combines a fixed interest return and a
variable interest return (for example, a variable rate debt instrument with an interest
rate cap, collar or floor). Basic caps, collars and floors, by themselves, will not cause an
instrument to violate the conditions in paragraph 11.9(a).
Example—insurance contract
Ex 23 The facts are the same as in Example 14. A policyholder’s contractual right to
receive cash under the contract meets the definition of a financial asset. However,
the contractual rights in an insurance contract are conditional upon an uncertain
future event (the death or illness of the owner manager while cover continues to
be provided).
The rights do not meet the requirements in paragraph 11.9, and are consequently
outside Section 11. Normally these rights are also outside the scope of Section 12
because of the exemption in paragraph 12.3(d). If the rights are outside the scope of
Sections 11 and 12 the following apply:
• any contingent assets should be accounted for in accordance with Section 21
Provisions and Contingencies;
• any reimbursement rights (that is, when some or all of the amount required to
settle a provision may be reimbursed by the insurer) shall also be accounted for in
accordance with Section 21; and
• any further assets resulting from those rights must be recognised and measured in
accordance with Section 2 Concepts and Pervasive Principles.
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11.9A Examples of debt instruments that would normally satisfy the conditions in
paragraph 11.9(a)(iv) include:
(a) a bank loan that has a fixed interest rate for an initial period that then reverts
to a quoted or observable variable interest rate after that period; and
(b) a bank loan with interest payable at a quoted or observable variable interest
rate plus a fixed rate throughout the life of the loan, for example LIBOR plus
200 basis points.
11.9B An example of a debt instrument that would normally satisfy the conditions set out in
paragraph 11.9(c) would be a bank loan that permits the borrower to terminate the
arrangement early, even though the borrower may be required to pay a penalty to
compensate the bank for its costs of the borrower terminating the arrangement early.
11.10 Other examples of financial instruments that would normally satisfy the conditions in
paragraph 11.9 are:
(a) trade accounts and notes receivable and payable, and loans from banks or
other third parties.
(b) accounts payable in a foreign currency. However, any change in the account
payable because of a change in the exchange rate is recognised in profit or
loss as required by paragraph 30.10.
(c) loans to or from subsidiaries or associates that are due on demand.
(d) a debt instrument that would become immediately receivable if the issuer
defaults on an interest or principal payment (such a provision does not violate
the conditions in paragraph 11.9).
Ex 24 Entity A owes (that is, has a contractual obligation to pay) Entity B CU10,000 for
goods it purchased on 30 days’ credit from Entity B on 30 December 20X0.
The debt instrument is a trade payable (financial liability) of Entity A and a trade
receivable (financial asset) of Entity B. The debt instrument satisfies the
requirement in paragraph 11.9(a)(i) and therefore, provided all the conditions in
paragraph 11.9(b)–(d) are met, the debt instrument is accounted for in accordance
with Section 11 by both Entity A and Entity B.
Ex 25 Entity A owes Entity B CU950 for 95 items purchased at CU10 per item on credit
from Entity B. Entity B has a special offer—10% discount on all products
purchased during the year of the offer, provided that more than 99 items are
purchased in that year. Entity A buys five more items and the total amount
payable is therefore CU900.
The debt instrument satisfies paragraph 11.9(a)(i) because the amount is fixed
initially at CU950 and then later fixed at CU900. The discount does not affect the
fact that amounts are fixed under the contract (that is, CU10 per item if less than
100 items are purchased and CU9 per item if 100 or more items are purchased).
Therefore, provided all the conditions in 11.9(b)–(d) are met, the debt instrument is
accounted for in accordance with Section 11 by both Entity A and Entity B.
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Ex 26 An entity holds a ten-year treasury bond (that is, government bond) with a fixed
coupon (ie the annual interest rate paid on a bond or similar instrument).
The investment in treasury bonds is a financial asset of the entity. Treasury bonds
are usually quoted in an active market. However, being quoted in an active market
does not automatically lead to fair value measurement. A treasury bond with a
fixed coupon will usually satisfy the requirements in paragraph 11.9 and would
therefore be measured at amortised cost in accordance with Section 11.
Ex 27 An entity holds a six-year debt instrument that pays a variable rate of interest
specified as LIBOR plus 150 basis points, with interest payments receivable
quarterly in arrears.
The debt instrument is a financial asset of the entity. It satisfies paragraph
11.9(a)(iv). Therefore, provided all the conditions in paragraph 11.9(b)–(d) are met,
the debt instrument is accounted for in accordance with Section 11.
Ex 28 An entity has an overdraft facility. The bank charges interest on any amount
overdrawn of EURIBOR plus 300 basis points.
The debt instrument is a financial liability of the entity. It satisfies paragraph
11.9(a)(iv). Therefore, provided all the conditions in paragraph 11.9(b)–(d) are met,
the debt instrument is accounted for in accordance with Section 11.
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Ex 31 An entity has a fixed-rate mortgage loan from a bank that it used to finance the
purchase of its office building. The entity has the contractual right to pay off
the mortgage early and would probably do so if market interest rates fell
significantly, because the entity would then be able to refinance at a lower rate.
The mortgage loan satisfies paragraph 11.9(a)—the entity pays a fixed rate of interest
on the loan. There is a contractual provision that permits the entity to prepay the
mortgage but, as it is not contingent on future events, paragraph 11.9(c) is satisfied.
Prepayment would not cause the bank to lose its principal or any accrued interest,
so the requirement in paragraph 11.9(b) will be satisfied. Assuming there are no
additional conditional returns or repayment provisions (paragraph 11.9(d)), the
mortgage loan satisfies paragraph 11.9.
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11.11 Examples of financial instruments that do not satisfy the conditions in paragraph 11.9
(and are therefore within the scope of Section 12) include:
(a) an investment in another entity’s equity instruments other than non-convertible
preference shares and non-puttable ordinary and preference shares (see
paragraph 11.8(d));
(b) an interest rate swap that returns a cash flow that is positive or negative, or a
forward commitment to purchase a commodity or financial instrument that is
capable of being cash-settled and that, on settlement, could have positive or
negative cash flow, because such swaps and forwards do not meet the condition
in paragraph 11.9(a);
(c) options and forward contracts, because returns to the holder are not fixed and
the condition in paragraph 11.9(a) is not met; and
(d) investments in convertible debt, because the return to the holder can vary with
the price of the issuer’s equity shares instead of just with market interest rates.
3 A mutual fund is an investment vehicle that is made up of a pool of funds collected from many investors for the purpose
of investing in securities such as shares, bonds and similar assets. A mutual fund is operated by investment managers, who
invest the fund’s capital and attempt to produce capital gains and income for the fund’s investors.
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Ex 35 An entity holds a note receivable that does not charge interest. The note gives
the entity (the holder) the contractual right to receive and the issuer the
contractual obligation to deliver 1,000 government bonds, rather than cash, on
maturity of the note receivable.
The note receivable is a financial asset of the entity because the entity has the
contractual right to receive financial assets (in this case government bonds).
Government bonds are financial assets, because their holder has the contractual
right to receive cash from the government. The note is a financial liability of the
note issuer.
Because the market value of the government bonds fluctuates over time, returns to
the holder of the note are not fixed or variable based on a single quoted or
observable interest rate. The debt instrument, therefore, does not satisfy the
condition in paragraph 11.9(a). The amount repaid will equal the market value of
the 1,000 government bonds at maturity. As the debt instrument (note receivable)
does not satisfy all the conditions in paragraph 11.9, it cannot be accounted for in
accordance with Section 11. It must be accounted for in accordance with Section 12.
Ex 36 An entity holds a debt instrument with interest payments indexed to the price
of oil. The debt instrument has a fixed payment at maturity and a fixed
maturity.
Returns to the entity vary with the price of oil rather than with only market interest
rates, so the debt instrument does not satisfy the condition in paragraph 11.9(a) and
cannot be accounted for in accordance with Section 11. It is accounted for in
accordance with Section 12.
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Ex 38 A customer takes legal action against an entity for damage the customer states
was caused by one of the entity’s products. The entity takes out a three-year
bank loan to finance the legal fees. There is a contractual provision in the loan
contract that if the entity wins the case, the entity may repay the loan early. If
the entity is unsuccessful, it cannot repay the loan early.
The loan does not satisfy the conditions in paragraph 11.9(c) because the contractual
provision that permits the entity to repay the loan before maturity is contingent on
the outcome of the case (a future event). Therefore, the debt instrument (the loan)
does not satisfy all the conditions in paragraph 11.9 and consequently cannot be
accounted for in accordance with Section 11. It must be accounted for in
accordance with Section 12.
Ex 39 An entity buys a fixed rate interest-only strip on a bond (that is, the entity buys
the stream of future interest payments on a fixed rate bond). The strip was
created in a securitisation and is subject to prepayment risk (that is, the risk
that all or part of the principal of a loan will be paid before the scheduled
maturity). The entity therefore obtains the right to receive the interest cash
flows, but not the principal cash flows from the debt instrument.
For a debt instrument to satisfy the condition in paragraph 11.9(b) there must be no
contractual provision that could, by its terms, result in the holder losing the
principal amount. In this case the principal amount is the original investment by
the entity. If the issuer of the bond (creditor) chooses to settle the bond early, the
entity may not recover its investment since no interest payments will be incurred
after settlement of the principal. Since the entity may lose some or all of its original
investment (as it will not receive the interest payments it paid for) the fixed rate
interest-only strip does not satisfy the conditions in paragraph 11.9, so the debt
instrument cannot be accounted for in accordance with Section 11. It must be
accounted for in accordance with Section 12.
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Entity B’s perspective: Entity B applies Section 22 Liabilities and Equity to determine
whether its own shares should be classified as equity, a compound instrument or a
financial liability within the scope of Section 11 or Section 12.
Notes
Unconditional receivables and payables are recognised as assets or liabilities when the
entity becomes a party to the contract and, as a consequence, has a legal right to
receive or a legal obligation to pay cash.
The following arrangements are not recognised as financial assets and liabilities:
• Planned future transactions, no matter how likely, are not assets and liabilities
because the entity has not become a party to a contract.
• Assets to be acquired and liabilities to be incurred as a result of a firm
commitment to purchase or sell goods or services are generally not recognised
until at least one of the parties has performed under the agreement. For example,
an entity that receives a firm order does not generally recognise an asset (and the
entity that places the order does not recognise a liability) at the time of the
commitment but, rather, delays recognition until the ordered goods or services
have been shipped, delivered or rendered.
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Initial measurement
11.13 When a financial asset or financial liability is recognised initially, an entity shall measure
it at the transaction price (including transaction costs except in the initial
measurement of financial assets and liabilities that are subsequently measured at fair
value through profit or loss) unless the arrangement constitutes, in effect, a financing
transaction for either the entity (for a financial liability) or the counterparty (for a financial
asset) to the arrangement. An arrangement constitutes a financing transaction if
payment is deferred beyond normal business terms, for example, providing interest-
free credit to a buyer for the sale of goods, or is financed at a rate of interest that is not
a market rate, for example, an interest-free or below market interest rate loan made to
an employee. If the arrangement constitutes a financing transaction, the entity shall
measure the financial asset or financial liability at the present value of the future
payments discounted at a market rate of interest for a similar debt instrument as
determined at initial recognition.
Examples—financial assets
1 For a long-term loan made to another entity, a receivable is recognised at the
present value of cash receivable (including interest payments and repayment of
principal) from that entity.
Examples—financial liabilities
1 For a loan received from a bank, a payable is recognised initially at the present
value of cash payable to the bank (for example, including interest payments and
repayment of principal).
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Notes
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the full amount payable on demand (see example 53)). On subsequent measurement it
will continue to be recognised at the full amount outstanding with no discounting.
Transaction costs
What are transaction costs?
Transaction costs are incremental costs that are directly attributable to the acquisition,
issue or disposal of a financial asset or financial liability. An incremental cost is one
that would not have been incurred if the entity had not acquired, issued or disposed of
the financial instrument (see Glossary). Transaction costs include fees and
commissions paid to agents (including employees acting as selling agents, if such costs
are incremental), advisers, brokers and dealers; levies by regulatory agencies and
securities exchanges; and transfer taxes and duties. Fees included in transaction costs
include those that are an integral part of generating an involvement with the resulting
financial instrument (for example, negotiating the terms of the instrument, and
preparing and processing documents).
Transaction costs do not include debt premiums or discounts, financing costs or
internal administrative costs.
How to account for transaction costs
Transaction costs attributable to the acquisition of a financial instrument which will
be measured, after initial recognition, at amortised cost or cost (see paragraph 11.14
(a), (b) and (c)(ii)) are included in the amount recognised on initial recognition of the
financial instrument. For financial assets, incremental costs that are directly
attributable to the acquisition of the asset are added in arriving at the amount
recognised on initial recognition. For financial liabilities, directly related costs of
issuing debt are deducted in arriving at the amount of debt recognised on initial
recognition. Transaction costs will therefore be included in the calculation of
amortised cost using the effective interest method and consequently are recognised in
profit or loss over the life of the instrument.
The journal entry for transaction costs that are paid in cash and relate to financial
instruments to be measured at amortised cost is:
Dr Financial asset/financial liability
Cr Cash
For financial instruments that are measured at fair value through profit or loss after
initial recognition (see paragraph 11.14(c)(i)), transaction costs are recognised as
expenses when they are incurred. In other words, transaction costs are not taken into
account when determining the amount to recognised initially. The journal entry for
transaction costs that are paid in cash and relate to financial instruments to be
subsequently measured at fair value is:
Dr Profit or loss
Cr Cash
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Examples—financial assets
Ex 43 An entity provides services to a customer and charges the customer CU200 with
payment due within 60 days. Payment terms of 30–90 days are normal in the
industry.
The entity initially recognises a trade receivable at CU200 (that is, the undiscounted
amount of cash receivable)—the transaction took place under normal business terms
with no implicit financing transaction therefore discounting is not required. The
journal entries on initial recognition are:
Dr Trade receivable (financial asset) CU200
Cr Profit or loss–revenue CU200
To recognise the revenue from the rendering of services on credit.
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Ex 44 An entity deposits CU20,000 into a 120-day notice deposit account with a bank.
The entity will receive fixed interest at 1.644% for the 120-day period (that is,
equivalent to 5% per year ignoring compounding), payable at the end of the
deposit period. The market rate for this type of deposit with the bank is 1.644%
per 120-day period.
As the deposit with the bank is at a market interest rate for a similar loan it must be
recognised at the transaction price of CU20,000 (see calculation below). The journal
entries on initial recognition are:
Dr Bank deposit (financial asset) CU20,000
Cr Cash (financial asset) CU20,000
To recognise the bank deposit.
Ex 45 The facts are the same as in example 44. However, in this example, the entity had
to pay the bank an upfront administration fee of CU50 to cover paperwork etc.
The deposit is recognised at CU20,050, which is equal to the CU20,000 plus the
transaction cost. The journal entries on initial recognition are:
The difference between the current sale price (CU1,650) and the consideration
receivable (CU2,000) will be recognised as interest revenue using the effective interest
method—it represents a financing transaction (see example 70).
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Ex 47 The facts are the same as in example 46. However, in this example, the current
cash sale price for the machine is unknown. The market rate of interest for a
two-year loan to the customer would be 10% per year.
A receivable is recognised at the present value of the amount receivable which is
CU2,000 ÷ (1.1)2 = CU1,652.89.
If the current cash sale price is not known, it may be estimated as the present value of
the cash receivable discounted using the market rate of interest for a similar debt
instrument (see the third example of financial assets in paragraph 11.13).
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Ex 49 The facts are the same as in example 48. However, in this example, the entity
grants the interest-free loan of CU500 to a major customer instead of an employee
for a period of three years. Assume the market rate of interest for a similar loan
to this customer is also 5% per year. Entity A expects to receive implicit benefits
from making the loan, such as customer loyalty and preferential placement of
products in the customer’s shops, but the terms of the loan do not require the
customer to take any specific actions.
The present value of the loan receivable (financial asset) discounted at 5% is CU500 ÷
(1.05)3 = CU431.92. Therefore, CU431.92 is recorded on initial measurement of the loan
receivable. This amount will accrete to CU500 over the three-year term using the
effective interest method (see example 66).
The difference between the CU500 and the CU431.92 of CU68.08 will probably need to
be recognised as an expense immediately unless it meets the definition of an
intangible asset under Section 18 Intangible Assets other than Goodwill. Since the amount
relates only to uncertain benefits, it is unlikely that it will meet the criteria for
recognition as an asset under any other sections. It does not meet the definition of a
financial asset as there is no contractual right to receive cash or other financial assets.
Even if the customer intends to return additional money to the entity (for example, by
sharing a portion of its profits, there is no contractual requirement to do this).
The journal entries on initial recognition are:
Dr Loan receivable (financial asset) CU431.92
Dr Profit or loss—discount to customer (expense) or CU68.08
Intangible asset (asset)
Cr Cash (financial asset) CU500
To recognise the loan granted to a customer.
Ex 50 On 1 January 20X0 an entity acquires a zero-coupon bond in the market for CU98
in an arm’s length transaction. The entity incurs transaction fees of CU2. The
bond will be redeemed at CU126 on 31 December 20X4.
Since it is clear the purchase of the zero-coupon bond took place in an arm’s length
transaction in the market, interest will be payable by the issuer of the bond at a market
rate (note, although the bond is zero coupon, interest is payable via the accretion of the
bond from CU98 to CU126). Therefore, the bond should be recorded at the transaction
price. As the bond will be measured at amortised cost, the transaction costs are
included in the initial measurement of the bond.
The CU100 will accrete to CU126 over the four-year period (see example 71).
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Examples—financial liabilities
Ex 51 An entity buys goods from a manufacturer for CU400 with 120 days’ interest-free
credit, the normal business terms in the industry.
The entity initially recognises a trade payable at CU400 (that is, the undiscounted
amount of cash payable). The transaction takes place on normal business terms with
no implicit financing transaction, so discounting is not required. The journal entries
on initial recognition are:
Dr Inventories (asset) CU400
Cr Trade payable (financial liability) CU400
To recognise the acquisition of inventory on credit.
The amount would be discounted if payment was deferred beyond normal business
terms and, therefore, in effect, contained an implicit financing transaction.
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Note: Since interest on the loan is charged at the market rate, the present value of cash
payable to the bank will be equal to the transaction price of CU5,000 (see calculation
below).
Ex 55 The facts are the same as in example 54. However, in this example, the entity
obtains the loan after taking advice from a specialist loans broker. The broker
charges the entity CU100.
The loan is initially recorded at the transaction price less the broker fees (that is,
CU4,900). The journal entries are:
Loan
Dr Cash (financial asset) CU5,000
Cr Loan (financial liability) CU5,000
To recognise the loan.
Transaction fee
Dr Loan (financial liability) CU100
Cr Cash (financial asset) CU100
To recognise the borrowing costs.
Note: The amount recognised on initial recognition (CU4,900) will accrete to CU5,000
over the term using the effective interest method with additional interest expense
recognised totalling CU100 over the term of the loan (see example 73).
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Ex 56 A bank provides an entity with a four-year loan for CU5,000 under normal market
terms for that type of loan, including charging interest at a variable rate of
interest specified as LIBOR plus 250 basis points, with interest payments
receivable annually in arrears.
Since interest is payable at a market rate for that type of loan, the loan is recorded by
the entity at the transaction price (that is, CU5,000). The journal entries are:
Dr Cash (financial asset) CU5,000
Cr Loan (financial liability) CU5,000
To recognise the bank loan.
Note: If transaction fees of CU50 were incurred on getting the loan, it would be recorded
at CU4,950. The journal entry for the transaction fees would be:
Transaction fee
Dr Loan (financial liability) CU50
Cr Cash (financial asset) CU50
To recognise the borrowing costs.
Note: The CU50 transaction fees would be amortised over the period of the loan through
the effective interest method.
Ex 57 A bank provides an entity with a five-year loan of CU5,000. The bank charges the
entity interest at 10% per year with interest paid at the end of each year. The
market rate for similar five-year fixed-interest loans with interest paid yearly in
arrears is 8%. The bank transferred to the entity an additional amount (an
upfront fee) of CU400, which is considered to compensate the entity for paying a
higher rate of interest.
Since the CU400 is considered to compensate the entity for paying interest above the
market rate, the entity is effectively paying a normal market rate to borrow CU5,400.
Therefore, the loan is recorded at the transaction amount, which is the face value of
the loan plus the upfront cash payment (that is, CU5,400). The journal entries on
initial recognition are as follows:
Loan
Dr Cash (financial asset) CU5,000
Cr Loan (financial liability) CU5,000
To recognise the bank loan.
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CU5,400 is equal to the present value of the loan (see calculation below):
Time Cash payable Discount factor (8%) Present value
(a) (b) (a)x(b)
Year 1 500 0.9259 462.96
Year 2 500 0.8573 428.67
Year 3 500 0.7938 396.92
Year 4 500 0.7350 367.51
Year 5 500 0.6806 340.29
Year 5 5,000 0.6806 3402.92
5,399.27
The difference between CU5,399.27 (in the table) and CU5,400 is due to rounding.
The entries to make on subsequent measurement are set out in example 76.
See calculation of the present value at the market rate of 10% below:
Present value
Cash payable Discount factor (10%)
Time (a)x(b)
(a) (b)
The immaterial difference between CU1,250.62 (in the table above) and CU1,250 is due to
rounding.
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Subsequent measurement
11.14 At the end of each reporting period, an entity shall measure financial instruments as
follows, without any deduction for transaction costs the entity may incur on sale or other
disposal:
(a) debt instruments that meet the conditions in paragraph 11.8(b) shall be measured
at amortised cost using the effective interest method. Paragraphs 11.15–11.20
provide guidance on determining amortised cost using the effective interest
method. Debt instruments that are classified as current assets or current liabilities
shall be measured at the undiscounted amount of the cash or other consideration
expected to be paid or received (ie net of impairment—see paragraphs 11.21–
11.26) unless the arrangement constitutes, in effect, a financing transaction (see
paragraph 11.13).
(b) commitments to receive a loan that meet the conditions in paragraph 11.8(c) shall
be measured at cost (which sometimes is nil) less impairment.
(c) investments in non-convertible preference shares and non-puttable ordinary or
preference shares shall be measured as follows (paragraphs 11.27–11.32 provide
guidance on fair value):
(i) if the shares are publicly traded or their fair value can otherwise be
measured reliably without undue cost or effort, the investment shall be
measured at fair value with changes in fair value recognised in profit or
loss; and
(ii) all other such investments shall be measured at cost less impairment.
Impairment or uncollectability must be assessed for financial assets in (a), (b) and (c)(ii)
above. Paragraphs 11.21–11.26 provide guidance.
Examples—financial assets
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Examples—financial liabilities
Ex 62 An entity buys goods from a manufacturer for CU400 on 1 November 20X2 with
120 days’ interest-free credit, which are normal business terms in the industry.
At the entity’s financial year-end (31 December 20X2) it has not yet paid the
manufacturer.
On 1 November 20X2 the entity initially recognised the trade payable at CU400 (see
example 51).
The trade payable is a current liability and the transaction took place under normal
business terms with no hidden financing transaction. Therefore, on subsequent
measurement at 31 December 20X2 the trade payable continues to be measured at the
undiscounted amount of the cash expected to be paid (that is, CU400).
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Notes
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11.17 When calculating the effective interest rate, an entity shall estimate cash flows considering
all contractual terms of the financial instrument (for example, prepayment, call and similar
options) and known credit losses that have been incurred, but it shall not consider possible
future credit losses not yet incurred.
Example—amortisation period
11.18 When calculating the effective interest rate, an entity shall amortise any related fees,
finance charges paid or received (such as ‘points’), transaction costs and other premiums
or discounts over the expected life of the instrument, except as follows. The entity shall
use a shorter period if that is the period to which the fees, finance charges paid or
received, transaction costs, premiums or discounts relate. This will be the case when the
variable to which the fees, finance charges paid or received, transaction costs, premiums
or discounts relate is repriced to market rates before the expected maturity of the
instrument. In such a case, the appropriate amortisation period is the period to the next
such repricing date.
Notes
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Example—amortisation period
Ex 65 A bank provides an entity with a five-year loan for CU1,000. The first two years of
the loan are interest-free. After that, interest is payable monthly in arrears at the
variable quoted market interest rate in the jurisdiction as quoted at the start of
each month. The entity is charged an upfront fee of CU70.
The fee of CU70 will be amortised over the first two years (not the entire five years).
This is because the interest will be repriced to the market rate after two years.
The loan may be considered to be at a fixed rate for two years, hence the interest of
CU70 is allocated using the effective interest method. One way of doing this is as
follows:
(a) The effective interest rate of 3.695% is the rate that accretes CU930 to CU1,000 over the two-
year period. The effective interest rate can be determined using the ‘Goal Seek’ function in an
Excel spreadsheet (see note below paragraph 11.20).
Note: The carrying amount of the loan is CU930 on initial recognition (CU1,000 less
upfront interest paid of CU70). Interest expense is recognised to accrete the loan from
CU930 to CU1,000 over the two-year period.
11.19 For variable rate financial assets and variable rate financial liabilities, periodic
re-estimation of cash flows to reflect changes in market rates of interest alters the effective
interest rate. If a variable rate financial asset or variable rate financial liability is
recognised initially at an amount equal to the principal receivable or payable at maturity,
re-estimating the future interest payments normally has no significant effect on the
carrying amount of the asset or liability.
11.20 If an entity revises its estimates of payments or receipts, the entity shall adjust the carrying
amount of the financial asset or financial liability (or group of financial instruments) to
reflect actual and revised estimated cash flows. The entity shall recalculate the carrying
amount by computing the present value of estimated future cash flows at the financial
instrument’s original effective interest rate. The entity shall recognise the adjustment as
income or expense in profit or loss at the date of the revision.
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Notes
The cash flows that are discounted to arrive at the effective interest rate are the
contractual cash flows that management expects to occur over the instrument’s
expected life. If actual cash flows differ from expectation, the entity will need to revise
its amortised cost calculations. If an entity did not revise its amortised cost
calculations a balance may remain on the receivable/payable after the last cash flow
has taken place or the receivable/payable may have a carrying amount of nil even
though there are still cash flows remaining that should continue to be recognised.
For fixed interest instruments (for example, those instruments satisfying the
conditions in paragraph 11.9(a)(i) or (ii)) when cash flows are re-estimated the effective
interest rate generally stays constant over the instrument’s term and so is not updated.
In contrast, for variable rate financial assets and variable rate financial liabilities (for
example, those instruments satisfying the conditions in paragraph 11.9(a)(iii) or (iv)),
when cash flows are re-estimated to reflect movements in market rates of interest, the
effective interest rate is updated. This is because for variable rate instruments it would
be inappropriate to determine at inception a single fixed rate to discount estimated
future cash flows as varying interest receipts/payments are a contractual term of a
variable rate instrument.
If a variable rate financial asset or variable rate financial liability is recognised initially
at an amount equal to the principal receivable or payable on maturity, re-estimating
the future interest payments normally has no significant effect on the carrying
amount of the asset or liability. This is because the effective interest rate at any date
will normally approximate the market rate at that date (see examples 77 and 78).
The re-estimation of future cash flows for reasons other than changes in market rates
or financial instruments not being variable rate instruments will normally result in a
change in the carrying amount, since the revised estimated cash flows are discounted
at the instrument’s original effective interest rate. The adjustment is recognised in
profit or loss as income or expense (see example 79).
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Example of determining amortised cost for a five-year loan using the effective interest method
On 1 January 20X0, an entity acquires a bond for CU900, incurring transaction costs of CU50. Interest of CU40
is receivable annually, in arrears, over the next five years (31 December 20X0–31 December 20X4). The bond
has a mandatory redemption of CU1,100 on 31 December 20X4.
CU CU CU CU
(1,100.00) 0
* The effective interest rate of 6.9584% is the rate that discounts the expected cash flows on the bond to the
initial carrying amount:
Notes
The effective interest rate is the rate that exactly discounts estimated future cash
payments or receipts through the expected life of the financial instrument or,
when appropriate, a shorter period, to the carrying amount of the financial asset or
financial liability at initial recognition (see paragraph 11.16). In other words, the
carrying amount on initial recognition less the estimated future cash payments or
receipts through the expected life of the financial instrument discounted at the
effective interest rate = 0.
The effective interest rate can be determined using the ‘Goal Seek’ function in an
Excel spreadsheet. This has been illustrated below using the example of a five-year
bond. Additional help can be found on using the Goal Seek function in the help
section of Excel.
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Set out the table as shown below in the Excel spreadsheet. The items in shaded
boxes are formulas. The other numbers are taken from the example above which is
taken from the IFRS for SMEs Standard.
A B C D E
1 Effective rate Z%
2
Year (α) (β) (γ) (δ)
Carrying Interest income Cash inflow Carrying amount at
3 amount at at Z% end of period
beginning of (β = α x Z%) ( δ = α+β+γ)
period
4 CU CU CU CU
5 20X0 950 =B5*C1 -40 =B5+C5+D5
The objective is to set the carrying amount at 31 December 20X4 (cell E9) to be equal to
zero by changing cell C1. This can be done using the Goal Seek function. Cell E9 will
be equal to zero if the effective interest rate is in cell C1. This uses the fact that:
Carrying amount on initial recognition less estimated future cash receipts through the
expected life of the financial instrument discounted at the effective interest rate = 0.
Note: Before using the Goal Seek function, make sure cell C1 is empty or the Goal Seek
function will not work. The ‘Z%’ is currently input in cell C1 for illustration purposes
only.
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Alternatively, the effective interest rate can be calculated using the ‘Internal Rate of
Return’ (IRR) formula using Excel spreadsheet. The formula is presented in a shaded
box.
A B
1 Cash flows
2 950
3 -40
4 -40
5 -40
6 -40
7 -1140
8
9 Effective rate =IRR (B2:B7,)
In cell B9 ‘B2:B7’ identifies the cash flow values presented in cells B2 to B7. The comma
indicates that we have not estimated the IRR.
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Examples—financial assets
(a) The effective interest rate of 5% per year is the rate that discounts the expected cash flows on the loan
receivable to the initial carrying amount of CU431.92. The effective interest rate can be determined using the
‘Goal Seek’ function in an Excel spreadsheet (see note above). However, in this example, as there is only
one payment, the effective interest rate can be determined by solving the equation CU431.92 = CU500 ÷ (1 +
X)3 where ‘X’ is the effective interest rate.
Ex 67 The facts are the same as in example 66. However, in this example, the 3-year
loan was provided to the employee on 1 May 20X1. As a simplifying assumption,
recognise interest on a proportionate basis and assume 365 days in each year.
Accrued interest on 31 December 20X1 is CU14.49 (that is, CU21.59 × 245 ÷ 365 days)
Therefore, the journal entry in 20X1, excluding those on initial recognition are:
Dr Loan receivable (financial asset) CU14.49
Cr Profit or loss—interest income CU14.49
To recognise interest income for the period.
Therefore, on 31 December 20X1 the loan has a carrying amount of CU446.41 (that is,
CU431.92 + CU14.49).
Note: On 31 December 20X2 the loan has a carrying amount of CU468.73 (that is,
CU446.41 + (CU21.59 – CU14.49) + (CU22.68 × 245 ÷ 365 days)).
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Ex 68 The facts are the same as in Example 45: On 1 December 20X1 an entity deposits
CU20,000 into a 120-day notice deposit account with a bank. The entity will
receive fixed interest at 1.644% for the 120-day period (equivalent to 5% per year,
ignoring compounding), payable at the end of the deposit period. The market
rate for this type of deposit with the bank is 1.644% per 120-day period.
On initial recognition, the deposit is measured at CU20,000 by the entity (see
example 44).
In 120 days the CU20,000 will have increased by CU329 (that is, CU20,000 × 1.644%) to
CU20,329.
(a) The effective interest rate of 1.644% is the rate that discounts the expected cash flows on the deposit to the
initial carrying amount: CU20,329 ÷ 1.01644 = CU20,000
The effective interest rate can be determined by solving the equation CU20,000 = CU20,329 ÷ (1+X) where
‘X’ is the effective interest rate.
Therefore X = CU20,329 ÷ CU20,000 less 1 = 0.01644.
On 31 December 20X1 the entity’s financial year-end, 31 of the 120 days have passed.
Because interest is payable in full at the end (that is, no compounding during the 120-
day period), the interest of CU329 can be allocated on a straight-line basis during the
120 days.
At 31 December 20X1, the deposit will be recognised at CU20,085 (that is, CU329 × 31
÷ 120 days).
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Ex 69 The facts are the same as in example 68. However, in this example, the entity
paid the bank an upfront administration fee of CU50 to cover paperwork etc.
The deposit is recognised at CU20,050 by the entity on initial recognition (see
example 45).
In 120 days the CU20,050 must increase to CU20,329 (repayment of CU20,000
principal and CU329 interest). The balancing figure is CU279 (that is, CU20,329 less
CU20,050).
(a) The effective interest rate of 1.392% is the rate that discounts the expected cash flows on the deposit to the
initial carrying amount of CU20,050.
The effective interest rate can be determined by solving the equation CU20,050 = CU20,329 ÷ (1 + X) where
‘X’ is the effective interest rate.
Therefore X = CU20,329 ÷ CU20,050 less 1 = 0.0139.
On 31 December 20X1 the deposit will be measured at CU20,122 (that is, CU20,050 +
(CU279 × 31 ÷ 120 days)).
(a) The effective interest rate of 10.096% is the rate that discounts the expected cash flows on the
receivable to the initial carrying amount of CU1,650.
The effective interest rate can be determined using the ‘Goal Seek’ function in an Excel spreadsheet
(see note above). However, in this example as there is only one payment the effective interest rate can
be determined by solving the equation CU1,650 = CU2,000 ÷ (1 + X)2 where ‘X’ is the effective interest
rate.
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(a) The effective interest rate of 4.73% is the rate that discounts the expected cash flows on the loan receivable
to the initial carrying amount of CU100. The effective interest rate can be determined using the ‘Goal Seek’
function in an Excel spreadsheet (see note above). However, in this example as there is only one payment
the effective interest rate can be determined by solving the equation CU100 = CU126 ÷ (1+X)5 where ‘X’ is
the effective interest rate.
Therefore (1 + X)5 = CU126 ÷ CU100, so X = (CU126 ÷ CU100)0.2 less 1 = 0.0473.
Examples—financial liabilities
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As there are no transaction costs, the effective interest rate is 8% (see calculation
below):
(a) The effective interest rate of 8% is the rate that discounts the expected cash flows on the loan to the initial
carrying amount: CU400 ÷ 1.08 + CU5,400 ÷ (1.08)2 = CU5,000. The effective interest rate can be
determined using the ‘Goal Seek’ function in an Excel spreadsheet (see note above).
Cash payment
Dr Loan (financial liability) CU400
Cr Cash (financial asset) CU400
To recognise the settlement of financial liability.
Ex 73 The facts are the same as in example 72. However, in this example, the entity
obtains the loan after taking advice from a specialist loans broker. The broker
charges the entity CU100 for these services.
On initial recognition, the entity measures the loan at the transaction price less the
broker’s fees (that is, CU4,900).
The CU4,900 will accrete to CU5,000 over the two-year term using the effective
interest method.
(a) The effective interest rate of 9.139% is the rate that discounts the expected cash flows on the loan to the
initial carrying amount: CU400 ÷ 1.09139 + CU5,400 ÷ (1.09139)2 = CU4,900. The effective interest rate can
be determined using the ‘Goal Seek’ function in an Excel spreadsheet (see note above).
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Ex 74 The facts are the same as in example 72. However, in this example, the
entity’s functional currency is FCU. Assume the following exchange rates are
experienced over the loan:
• 1 January 20X1: FCU1 to CU5
• Average exchange rate in 20X1: FCU1 to CU5.5
• 31 December 20X1: FCU1 to CU5.1
• Average exchange rate in 20X2: FCU1 to CU4.5
• 31 December 20X2: FCU1 to CU4
The loan balances (which are monetary items) at year-end should be translated
at the exchange rate at the year-end date. Interest should be translated at an
average rate for the year.
The journal entries are:
Initial recognition
Dr Cash (financial asset) FCU1,000(a)
Cr Loan (financial liability) FCU1,000
To recognise the receipt of cash and the obligation to repay the loan.
20X1
Interest
Dr Profit or loss—interest expense FCU72.73(b)
Cr Loan (financial liability) FCU72.73
To recognise interest expense for the period.
Cash
Dr Loan (financial liability) FCU78.43(c)
Cr Cash (financial asset) FCU78.43
To recognise the settlement of a financial liability.
(a)
CU5,000 ÷ 5 = FCU1,000.
(b)
CU400 ÷ 5.5 = FCU72.73.
(c)
CU400 ÷ 5.1 = FCU78.43.
At 31 December 20X1 the loan is recorded at FCU980.39 (that is, CU5,000 ÷ 5.1)
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An exchange gain of FCU13.91 arises from the difference between the FCU980.39
recorded at the 31 December 20X1 and the opening loan balance being adjusted
for the interest and cash payments, that is, FCU994.30 (calculation: FCU1,000 +
FCU72.73 less FCU78.43).
Therefore, further journal entries are:
20X1
Exchange gain
Dr Loan (financial liability) FCU13.91(d)
Cr Profit or loss—exchange gain FCU13.91
To recognise the foreign exchange gain on a financial liability.
20X2
Interest
Dr Profit or loss—interest expense FCU88.89(e)
Cr Loan (financial liability) FCU88.89
To recognise interest expense for the period.
Cash
Dr Loan (financial liability) FCU1,350(f)
Cr Cash (financial asset) FCU1,350
To recognise the settlement of a financial liability.
(d)
FCU994.30 less FCU980.39 = FCU13.91.
(e)
CU400 ÷ 4.5 = FCU88.89.
(f)
FCU5,400 ÷ 4 = FCU1,350.
At 31 December 20X2 the loan is fully repaid (last interest payment plus
principal).
An exchange loss of FCU280.72 arises due to the difference between the FCU1,350
paid on 31 December 20X2 and the opening loan balance adjusted for the interest
(that is, FCU1,069.28 (FCU980.39 + FCU88.89)).
Therefore, the further journal entries in 20X2 are:
Exchange loss
Dr Profit or loss—exchange loss FCU280.72(g)
Cr Loan (financial liability) FCU280.72
To recognise the foreign exchange loss on a financial liability.
(g)
FCU1,350 less FCU1,069.28 = FCU280.72
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Ex 75 On 1 January 20X0 a bank provides an entity with a five-year loan for CU5,000.
The bank charges the entity an interest rate of 10% with interest paid at the
end of each year. The market rate for similar five-year fixed-interest loans
with interest paid yearly in arrears is 8%. The bank transferred to the entity
an additional amount (an upfront fee) of CU400 which is considered to
compensate the entity for paying the higher rate of interest. The entity has a
31 December financial year-end.
The transaction amount, which is the face value of the loan plus the upfront cash
payment is CU5,400 (see example 57).
The journal entries at the end of 20X0 are as follows (for calculations see the table below):
Interest
Dr Profit or loss—interest expense CU431.81
Cr Loan (financial liability) CU431.81
To recognise interest expense for the period.
Cash payment
Dr Loan (financial liability) CU500
Cr Cash (financial asset) CU500
To recognise the settlement of a financial liability.
(a) The effective interest rate of 8% (rounded) is the rate that discounts the expected cash flows on the loan
to the initial carrying amount of CU5,400. The effective interest rate can be determined using the ‘Goal
Seek’ function in an Excel spreadsheet (see note above).
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Cash payment
Dr Loan (financial liability) CU75
Cr Cash (financial asset) CU75
To recognise the settlement of a financial liability.
(a) The effective interest rate of 10.013% per year is the rate that discounts the expected cash flows on the debt
instrument to the initial carrying amount of CU1,250. The effective interest rate can be determined using the
‘Goal Seek’ function in an Excel spreadsheet (see note above).
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Ex 77 On 1 April 20X1 a bank provides an entity with a four-year loan for CU5,000
under normal market terms for that type of loan, including charging interest
at a variable rate of interest specified as LIBOR plus 2.5%, with interest payable
annually in arrears. On 1 April 20X1 LIBOR is 2% and on 31 December 20X1
LIBOR is 2.5%.
Since interest is payable at the market rate for that type of loan, the loan is recorded
by the entity at the transaction price of CU5,000, because the transaction price will
approximate the present value of the future payments discounted at the market
rate.
Since there are no transaction costs on the loan and the loan is recognised at
transaction price, the effective interest rate on 1 April 20X1 is 4.5% (2% plus 2.5%).
The transaction price at which the loan is recognised is equal to the principal
payable on maturity. Therefore, re-estimating the future interest payments will
have no significant effect on the carrying amount of the loan (see paragraph 11.19).
Cash flows over the life of the loan will constantly vary as LIBOR varies. However,
because interest is charged at the market rate for this type of loan, if the effective
interest rate is set to LIBOR plus 2.5% it will at any time always exactly discount
estimated future cash payments over the remaining loan term to CU5,000. Hence,
the carrying amount of the loan throughout the four years will be CU5,000.
Ex 78 The facts are the same as in example 77. However, in this example, the entity
incurred transaction costs of CU50 on setting up the loan.
For simplicity, for variable rate loans it is better to consider transaction costs
separately from the loan when determining the effective interest rate. This avoids
having a different effective interest rate to the market rate (as the effective rate will
need to take into account that the CU4,950 (net of CU50 transaction costs) needs to
accrete to CU5,000). For fixed rate loans it is easier to include the transaction costs
in the calculation as cash flows over the period of the loan are known.
The CU50 should be amortised over the four-year period using the effective interest
method as follows:
50.00
(a) The effective interest rate of 0.252% per year is the rate that accretes CU4,950 to CU5,000 over the
four-year period. The effective interest rate can be determined using the ‘Goal Seek’ function in an
Excel spreadsheet (see note above).
Note: Any amount of the CU50 not yet amortised at any point in time will be netted
off the loan in the statement of financial position. In effect, the calculation of the
effective interest rate was computed in two separate parts.
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(a) The effective interest rate of 8.612% per year is the rate that discounts the original expected cash
flows on the loan to the initial carrying amount of CU4,900. The effective interest rate can be
determined using the ‘Goal Seek’ function in an Excel spreadsheet.
The original effective interest is 8.612% per year. Therefore, under the revised
calculation at 31 December 20X1 the present value of revised estimated future cash
flows discounted using the original effective interest rate (8.612%) is CU4,958.85 (for
the calculation see the table below).
Under the original calculation on 31 December 20X1 the amortised cost was
CU4,921.99. The difference of CU36.86 (CU4,958.85 less CU4,921.99) is recognised in
profit or loss during 20X1.
Therefore, further journal entries to recognise this difference on 31 December 20X1
are as follows:
Dr Profit or loss—expense CU36.86
Cr Loan (financial liability) CU36.86
To recognise the adjustment to the carrying amount of a financial liability due to changes in estimated cash
flows.
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Note: The interest expense and cash payment will be recognised in 20X1 as well as
they are unaffected by the revised payments. The journal entries are as follows:
Interest incurred
Dr Profit or loss—interest CU421.99
Cr Financial (financial liability) CU421.99
To recognise interest expense for the period.
Cash payment
Dr Financial (financial liability) CU400
Cr Cash CU400
To recognise the settlement of a financial liability.
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Notes
11.22 Objective evidence that a financial asset or group of assets is impaired includes
observable data that come to the attention of the holder of the asset about the following
loss events:
(a) significant financial difficulty of the issuer or obligor;
(b) a breach of contract, such as a default or delinquency in interest or principal
payments;
(c) the creditor, for economic or legal reasons relating to the debtor’s financial
difficulty, granting to the debtor a concession that the creditor would not otherwise
consider;
(d) it has become probable that the debtor will enter bankruptcy or other financial
reorganisation; or
(e) observable data indicating that there has been a measurable decrease in the
estimated future cash flows from a group of financial assets since the initial
recognition of those assets, even though the decrease cannot yet be identified
with the individual financial assets in the group, such as adverse national or local
economic conditions or adverse changes in industry conditions.
Notes
A financial asset or a group of financial assets is impaired and impairment losses are
incurred if, and only if, there is objective evidence of impairment as a result of one or
more events that occurred after the initial recognition of the asset (a ‘loss event’) and
that loss event (or events) affects the estimated future cash flows of the financial asset
or group of financial assets that can be reliably estimated. It may not be possible to
identify a single, discrete event that caused the impairment. Rather, the combined
effect of several events may have caused the impairment.
Losses expected as a result of future events (for example, an expectation of a downturn
in the market), no matter how likely, are not recognised.
Examples of adverse national or local economic conditions referred to in paragraph
11.22(e) may include an increase in the unemployment rate in the geographical area of
the creditors, a decrease in property prices for mortgages in the relevant area or a
decrease in oil prices for loan assets to oil producers.
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Example—impairment recognition
Ex 80 Entity A lends CU100 to an employee for one year with interest payable at 8%.
The entity rarely makes loans to employees and therefore this is considered a
one-off transaction. There is no reason to believe that the employee will not pay
the interest and principal on the loan when it falls due. The market rate of
interest for similar loans is 8% per year (that is, the market rate of interest for a
similar loan to this individual). Similar to the approach in Example 81, Entity A
wishes to recognise an impairment loss of CU10 on the loan because in the past,
Entity A has found that, on average, 10% of its trade receivable balances (that is,
amounts due from customers) are not repaid.
Entity A cannot recognise an impairment loss of CU10 based on its bad debt rate for its
customers because there is no objective evidence of impairment of the loan to the
employee as a result of a past event that occurred after initial recognition.
The employee loan does not have similar credit risk characteristics to the trade
receivables and therefore cannot be grouped with trade receivables when considering
impairment (see paragraph 11.24).
Only if there is objective evidence of impairment of the employee loan would an
impairment loss be recognised. For example, if there was evidence that the employee
was experiencing financial difficulties (for example, a declaration of such difficulties
by the employee), meaning the employee might not be able to repay the loan on time,
this would constitute objective evidence of a possible impairment.
11.23 Other factors may also be evidence of impairment, including significant changes with an
adverse effect that have taken place in the technological, market, economic or legal
environment in which the issuer operates.
Notes
Changes that have an adverse effect on the issuer may affect the issuer’s ability to
repay the holder and may be evidence of impairment of the related financial assets of
the holder. Examples of the type of changes referred to in paragraph 11.23 include a
reduction in the level of demand for the issuer’s goods, legislation that affects the
issuer’s business, an increase in interest rates if the issuer has a high level of variable
rate debt etc.
Other factors that an entity considers include information about the debtors’ or
issuers’ liquidity, solvency and business and financial risk exposures, levels of and
trends in delinquencies for similar financial assets, national and local economic trends
and conditions and the fair value of collateral and guarantees.
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11.24 An entity shall assess the following financial assets individually for impairment:
(a) all equity instruments regardless of significance; and
(b) other financial assets that are individually significant.
An entity shall assess other financial assets for impairment either individually or grouped
on the basis of similar credit risk characteristics.
Notes
The only instruments in the scope of Section 11 that are included in paragraph 11.24(a)
are investments in non-convertible preference shares and non-puttable ordinary or
preference shares whose fair value cannot be measured reliably without undue cost or
effort. Under the requirements of paragraph 11.24, all such instruments must be
individually assessed for impairment.
For the purposes of a collective evaluation of impairment, financial assets are grouped
on the basis of similar credit risk characteristics. Credit risk characteristics are
indicative of debtors’ ability to pay all amounts due according to the contractual terms
and include characteristics such as asset type, industry, geographical location,
collateral type, past-due status and other relevant factors. However, if information is
available that specifically identifies losses on individual assets in a group even if not
individually significant, those assets should be assessed individually (not as part of a
group) unless those assets are collectively immaterial.
After initial recognition financial assets that are neither individually significant nor
equity instruments can be tested for impairment in a group of similar assets (see
paragraph 11.24). When there is an indication of impairment in a group of similar
assets and impairment cannot be identified with an individual asset in that group,
future cash flows in a group of financial assets are collectively evaluated for
impairment. When historical loss experience is used it is adjusted on the basis of
current observable data to reflect the effect of current conditions that did not affect
the period on which the historical loss experience is based and to remove the effects of
conditions in the historical period that do not exist currently.
Section 11 does not permit an entity to recognise impairment or bad debt losses in
addition to those that can be attributed to individually identified financial assets or
attributed to identified groups of financial assets with similar credit risk
characteristics on the basis of objective evidence about the existence of impairment in
those assets. Reserves and other amounts that an entity might put aside for other
reasons, such as regulatory requirements or tax purposes, but that cannot be
supported by objective evidence about impairment, are not recognised as impairment
losses.
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Ex 81 An entity sells goods on credit to its customers. At its year-end the entity has
CU10,000 of trade receivable assets. In the previous year 2% of the trade
receivable balances outstanding at year-end were never paid. Therefore, the entity
wishes to recognise a general bad debt provision (an impairment loss) against
trade receivables of 2% of CU10,000 (the carrying amount of trade receivables in
the entity’s statement of financial position would be CU9,800).
The entity knows that one customer with an outstanding balance of CU500 has
gone into liquidation.
The method of loss provisions used by Entity A is not appropriate unless the customers
have similar risk characteristics and the rates under the formula reflect actual
experience of delinquencies, and those delinquency rates are projected to continue in
the future. Moreover, if information is available that specifically identifies losses on
any individual balances that do not follow the historical delinquency rates and those
customer balances are not collectively immaterial, those specific balances must be
assessed individually rather than applying the formula to them.
The CU500 balance is significant to the total trade receivable balance of CU10,000.
Paragraph 11.24 requires financial assets that are individually significant to be assessed
individually for impairment. This balance and any other significant trade receivable
balances should be assessed individually for impairment.
Even if the CU500 balance were judged not individually significant it should be tested
for impairment individually. Measurement of impairment on a group basis may be
applied to groups of small balance items with similar credit risk characteristics only if
there is indication of impairment in that group of similar assets but the impairment
cannot be identified with an individual asset in that group.
In this example the entity should recognise a bad debt provision (that is, an
impairment loss) against the CU500 owed by the customer who has gone into
liquidation. A provision should be made based on how much of the CU500 the entity
expects will not be recovered. The entity may be able to recognise further bad debt
provisions for other trade receivable balances either individually or grouped on the
basis of similar credit risk characteristics, provided there is objective evidence that the
individual trade receivable balance or group of trade receivable balances are impaired.
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In the circumstances that the formula was appropriate, it must be reviewed for
reasonableness on a regular basis. In particular, if the entity’s customer base changes
significantly, the formula may need to be revised to consider the risk characteristics of
the new customer base. It is important that any method of determining impairment
loss for trade receivables does not give a materially different value to the amount that
would be determined by a strict application of paragraphs 11.24 and 11.25.
Ex 83 An entity has trade receivables in its statement of financial position. The entity
determines, on the basis of historical experience, that one of the main causes of
default on trade receivables is the death of the borrower. The entity observes that
the death rate does not change significantly from one year to the next. Some of
the borrowers in the entity’s group of trade receivables may have died in that
year, indicating that an impairment loss has occurred on those loans, even if, at
the year-end, the entity does not yet know which particular borrowers have died.
It would be appropriate for an impairment loss to be recognised for these ‘incurred but
not reported’ losses (that is, a loss may be recognised on the basis of an expectation of
deaths that have occurred during the period (before year-end)).
However, it would not be appropriate to recognise an impairment loss for deaths that
are expected to occur in future periods, because the necessary loss event (the death of
the borrower) has not yet occurred.
Measurement
11.25 An entity shall measure an impairment loss on the following financial assets measured at
cost or amortised cost as follows:
(a) for a financial asset measured at amortised cost in accordance with paragraph
11.14(a), the impairment loss is the difference between the asset’s carrying amount
and the present value of estimated cash flows discounted at the asset’s original
effective interest rate. If such a financial asset has a variable interest rate, the
discount rate for measuring any impairment loss is the current effective interest rate
determined under the contract.
(b) for a financial asset measured at cost less impairment in accordance with paragraph
11.14(b) and (c)(ii) the impairment loss is the difference between the asset’s carrying
amount and the best estimate (which will necessarily be an approximation) of the
amount (which might be zero) that the entity would receive for the asset if it were to
be sold at the reporting date.
Notes
The carrying amount of the asset is reduced, either directly or through use of an
allowance account (for example, a ‘bad debt provision’ is sometimes used for trade
receivables—see example 81). In the latter case the asset’s carrying amount in the
entity’s statement of financial position is stated net of any related allowance.
Whichever presentation is used, the amount of the impairment loss is recognised in
profit or loss.
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or reduced through use of an ‘allowance account’ (for example, a ‘bad debt provision’),
as follows:
Dr Profit or loss—impairment loss CU1,000
Cr Bad debt provision (set off against the financial CU1,000
asset)
To recognise the impairment loss.
In the latter case the carrying amount of the trade receivable is presented net of the
bad debt provision in the entity’s statement of financial position.
Ex 85 The facts are the same as in example 84. However, in this example, the entity has
given the customer extra time to pay off the debt. The entity expects the
customer will be able to pay about one year after the reporting date. The market
interest rate for a similar one-year loan to this customer is 5% per year.
The amount payable must now be discounted as the transaction is no longer on normal
business terms and effectively includes a financing transaction (a one-year interest-free
loan).
There is no original effective interest rate (as the instrument was not previously
discounted) so the entity should use the market rate of interest for a similar one-year
loan.
The receivable must be recognised at CU952.38 (that is, CU1,000 ÷ 1.05).
The carrying amount of the trade receivable may either be reduced directly, as follows:
Dr Profit or loss—impairment loss CU47.62
Cr Trade receivables (financial asset) CU47.62
To recognise the impairment loss.
or reduced through use of an ‘allowance account’ (for example, a ‘bad debt provision’),
as follows:
Dr Profit or loss—impairment loss CU47.62
Cr Bad debt provision (set off against the financial CU47.62
asset)
To recognise the impairment loss.
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Ex 86 An entity is concerned that one of its customers (Customer B) will not be able to
make all principal and interest payments due on a loan in a timely manner
because the customer is experiencing financial difficulties. The entity and the
customer negotiate a restructuring of the loan. The entity expects that the
customer will be able to meet its obligations under the restructured terms. In
which of the following cases (different restructuring scenarios) would the entity
need to recognise an impairment loss?
(a) Customer B will pay the full principal amount of the original loan five years
after the original due date, but none of the interest due under the original
terms.
(b) Customer B will pay the full principal amount of the original loan on the
original due date, but none of the interest due under the original terms.
(c) Customer B will pay the full principal amount of the original loan on the
original due date but with interest at a lower interest rate than the interest
rate inherent in the original loan.
(d) Customer B will pay the full principal amount of the original loan five years
after the original due date and all interest accrued during the original loan
term, but no interest for the extended term.
(e) Customer B will pay the full principal amount of the original loan five years
after the original due date and all interest, including interest for both the
original term of the loan and the extended term.
An impairment loss should be recognised in cases (a)–(d) as the present value of the
future principal and interest payments discounted at the loan’s original effective
interest rate will be lower than the carrying amount of the loan.
In case (e), even though the timing of payments has changed, the lender will receive
interest on interest, and the present value of the future principal and interest
payments discounted at the loan’s original effective interest rate will equal the
carrying amount of the loan. Therefore, there is no impairment loss. However, given
customer B’s financial difficulties, case (e) would need to be carefully considered to
ensure it is a realistic restructuring scenario.
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In this case, the loan receivable will be measured at CU205.68 at 31 December 20X2.
Alternatively, it can be reduced through use of an ‘allowance account’ (for example, a
‘bad debt provision’), as follows:
Dr Profit or loss—impairment loss CU270.51
Cr Bad debt provision (set off against the financial CU270.51
asset)
To recognise the impairment loss.
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20X3 –
205.68 10.28 215.96
20X4 –
215.96 10.80 226.76
20X5 –
226.76 11.34 238.10
20X6 238.10 11.90 (250.00) –
On 31 December 20X1 the carrying amount of the loan receivable is CU5,400 (CU5,000
in the table above plus the CU400 of interest not paid in 20X1 as expected).
As a result of the restructuring, on 31 December 20X1 the present value of estimated
cash flows discounted at the asset’s original effective interest rate of 8% is CU4,629.63
(see the calculation at the end of this example).
Therefore, an impairment loss of CU770.37 (CU5,400 less CU4,629.63) is recognised in
profit or loss for 20X2.
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The entity has elected that the carrying amount of the trade receivable will be reduced
directly, as follows:
Dr Profit or loss—impairment loss CU770.37
Cr Loan receivable CU770.37
To recognise the impairment loss.
Reversal
11.26 If, in a subsequent period, the amount of an impairment loss decreases and the decrease
can be related objectively to an event occurring after the impairment was recognised (such
as an improvement in the debtor’s credit rating), the entity shall reverse the previously
recognised impairment loss either directly or by adjusting an allowance account. The
reversal shall not result in a carrying amount of the financial asset (net of any allowance
account) that exceeds what the carrying amount would have been had the impairment not
previously been recognised. The entity shall recognise the amount of the reversal in profit
or loss immediately.
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If the carrying amount of the trade receivable was reduced through use of an
‘allowance account’ (for example, a ‘bad debt provision’) the entity should record the
following journal entry to recognise the receipt of cash:
Dr Cash (financial asset) CU200
Cr Trade receivable (financial asset) CU200
To recognise receipts from trade receivables.
Dr Bad debt provision (set off against the financial asset) CU200
Cr Profit or loss–reversal of impairment loss CU200
To recognise the reversal of a prior period impairment loss.
Dr Bad debt provision (set off against the financial asset) CU800
Cr Trade receivable (financial asset) CU200
To recognise the write-off of the remaining trade receivable.
Ex 90 The facts are the same as in example 87. However, in this example, on 14
December 20X4 the employee won the lottery and told the entity he will repay the
loan in full in January 20X5 (two years ahead of the date agreed in the
restructuring).
Without the decision to repay, on 31 December 20X4 the carrying amount of the loan
receivable would have been CU453.51 (see the second table in example 87).
As the employee agreed before the year-end to repay the loan in full shortly after the
year-end, the carrying amount of the loan is CU500. Discounting is not required
because the payment will be received shortly after the year-end.
Therefore, a reversal of an impairment loss should be recognised in profit or loss for
the year ended 31 December 20X4 of CU46.49 (that is, CU500 less CU453.51).
The journal entry is as follows:
Dr Loan receivable (financial asset) CU46.49
Cr Profit or loss―reversal of impairment loss CU46.49
To recognise the reversal of a prior period impairment loss.
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The loan receivable (financial asset) will be measured at CU500 at 31 December 20X4.
Fair value
11.27 An entity shall use the following hierarchy to estimate the fair value of an asset:
(a) the best evidence of fair value is a quoted price for an identical asset (or similar
asset) in an active market. This is usually the current bid price.
(b) when quoted prices are unavailable, the price in a binding sale agreement or a
recent transaction for an identical asset (or similar asset) in an arm’s length
transaction between knowledgeable, willing parties provides evidence of fair
value. However, this price may not be a good estimate of fair value if there has
been a significant change in economic circumstances or a significant period of
time between the date of the binding sale agreement, or the transaction, and the
measurement date. If the entity can demonstrate that the last transaction price is
not a good estimate of fair value (for example, because it reflects the amount that
an entity would receive or pay in a forced transaction, involuntary liquidation or
distress sale), then that price is adjusted.
(c) if the market for the asset is not active and any binding sale agreements or recent
transactions of an identical asset (or similar asset) on their own are not a good
estimate of fair value, an entity estimates the fair value by using another valuation
technique. The objective of using a valuation technique is to estimate what the
transaction price would have been on the measurement date in an arm’s length
exchange motivated by normal business considerations.
Other sections of this Standard make reference to the fair value guidance in paragraphs
11.27–11.32, including Section 9, Section 12, Section 14, Section 15, Section 16
Investment Property, Section 17 Property, Plant and Equipment and Section 28.
Notes
The only instruments in the scope of Section 11 that are measured at fair value are
investments in non-convertible preference shares and non-puttable ordinary or
preference shares if the shares are publicly traded or their fair value can otherwise be
measured reliably without undue cost or effort. Therefore, the fair value guidance in
this section focuses on these instruments only. Section 12 provides further fair value
guidance for financial instruments in the scope of Section 12.
Identical assets (paragraph 11.27(a))
For an entity (entity X) holding an ordinary share or preference share of another entity
(entity Y), an ‘identical asset’ to that share (referred to in paragraph 11.27(a)) would be
a share in entity Y with identical terms and conditions. Ordinary shares in a company
may be divided into different classes of shares, with each class having slightly different
rights (for example, there may be ‘A’ ordinary and ‘B’ ordinary shares). An A ordinary
share would not usually be an identical asset to a B ordinary share. Therefore, if there
was a known fair value for the A ordinary shares (for example, due to a recent
transaction in the A ordinary shares) this fair value could not be inferred as the fair
value of the B ordinary shares. However, the price of A ordinary shares could be used
as a starting point, with adjustments being made to account for the differences in
terms and conditions between A ordinary shares and B ordinary shares.
Active market (paragraph 11.27(a))
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The existence of published price quotations in an active market for identical assets, for
example on a stock exchange, is the best evidence of fair value and when they exist
they are used to measure the financial asset or financial liability. A financial
instrument is regarded as quoted in an active market if quoted prices are readily and
regularly available from an exchange, dealer, broker, industry group, pricing service or
regulatory agency, and those prices represent actual and regularly occurring market
transactions on an arm’s length basis. Fair value is defined as the amount for which an
asset could be exchanged, a liability settled or an equity instrument granted could be
exchanged, between knowledgeable, willing parties in an arm’s length transaction (see
Glossary). The objective of determining fair value for a financial instrument that is
traded in an active market is to arrive at the price at which a transaction would occur
at the end of the reporting period in that instrument (that is, without modifying or
repackaging the instrument) in the most advantageous active market to which the
entity has immediate access.
If transactions are occurring frequently enough to generate reliable information on
prices on a continuous basis, the market would be considered active. However, if
transactions are no longer regularly occurring (even if prices are available) or the only
transactions taking place are forced transactions, the market is no longer active.
Judgement may need to be applied in assessing whether a market is active. An entity
should evaluate the significance and relevance of all relevant factors, to determine
whether, on the basis of the evidence available, a market is not active. If an entity
concludes that a market is not active, transactions or quoted prices in that market may
not be determinative of fair value.
Although an entity must have access to the market at the measurement date, it does
not need to be able to sell the particular asset or transfer the particular liability on that
date (for example, if there is a restriction on the sale of the asset). However, the entity
must be able to access the market when the restriction ceases to exist. If a market
participant would consider a restriction on the sale of an asset when determining the
price for the asset, an entity shall adjust the quoted price to reflect the effect of that
restriction.
In rare situations, a quoted price in an active market might not represent fair value at
the measurement date. That might be the case if, for example, significant events
(principal-to-principal transactions, brokered trades or announcements) take place
after the close of a market but before the measurement date. An entity establishes and
consistently applies a policy for identifying those events that might affect fair value
measurements.
Recent transactions (paragraph 11.27(b))
When quoted prices are unavailable, the price in a binding sale agreement or a recent
transaction provides evidence of the current fair value as long as there has not been a
significant change in economic circumstances or a significant period of time between
the date of the binding sale agreement, or the transaction, and the measurement date.
If conditions have changed since the time of the transaction (for example, a major fire
at an entity may seriously affect its share price), the fair value reflects the change in
conditions. Similarly, if the entity can demonstrate that the last transaction price is
not fair value (for example, because it reflected the amount that an entity would
receive or pay in a forced transaction, involuntary liquidation or distress sale), that
price is adjusted.
Unit of account
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The fair value of a portfolio of financial instruments is the product of the number of
units of the instrument and its quoted market price.
Valuation technique
11.28 Valuation techniques include using recent arm’s length market transactions for an identical
asset between knowledgeable, willing parties, if available, reference to the current fair
value of another asset that is substantially the same as the asset being measured,
discounted cash flow analysis and option pricing models. If there is a valuation technique
commonly used by market participants to price the asset and that technique has been
demonstrated to provide reliable estimates of prices obtained in actual market
transactions, the entity uses that technique.
11.29 The objective of using a valuation technique is to establish what the transaction price
would have been on the measurement date in an arm’s length exchange motivated by
normal business considerations. Fair value is estimated on the basis of the results of a
valuation technique that makes maximum use of market inputs and relies as little as
possible on entity-determined inputs. A valuation technique would be expected to arrive
at a reliable estimate of the fair value if
(a) it reasonably reflects how the market could be expected to price the asset; and
(b) the inputs to the valuation technique reasonably represent market expectations
and measures of the risk return factors inherent in the asset.
Notes
A valuation technique should incorporate all factors that market participants would
consider in setting a price and should be consistent with accepted economic
methodologies for pricing financial instruments. Choosing and applying valuation
techniques often involves a significant amount of judgement. A technique should be
selected that is appropriate for the instrument being valued and for which sufficient
data are available, in particular data that maximise the use of market inputs (that is,
inputs developed on the basis of available market data). Adjustments to market inputs
may need to be made, depending on factors specific to the shares, for example the
volume and level of sale and purchase activity of the shares. Once selected the
valuation techniques should be applied on a consistent basis, unless a change in
technique is appropriate because a different technique (for example, because a new
valuation technique has been developed or additional information becomes available)
would provide a more reliable estimate of fair value.
Entity-determined inputs are those that are not based on observable market data.
However, they reflect the assumptions that market participants would use when
pricing the shares, including assumptions about risk. In developing these inputs, an
entity may begin with its own data, which is adjusted if reasonably available
information indicates that (a) other market participants would use different data or (b)
there is something particular to the entity that is not available to other market
participants (for example, an entity-specific synergy). An entity need not undertake
exhaustive efforts to obtain information about market participant assumptions.
However, an entity cannot ignore information about market participant assumptions
that is reasonably available.
If an entity makes significant use of valuation techniques, it should periodically test
the techniques for validity using prices from any observable current market
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Examples—valuation techniques
Ex 92 The facts are the same as in example 91. However, in this example, Entity A
estimates the fair value of the shares it owns in company XYZ using a net asset
valuation technique. The fair value of company XYZ’s net assets including those
recognised in its statement of financial position and those that are not recognised
is CU850,000.
Share price = CU850,000 ÷ 5,000 shares = CU170 per share.
The fair value of Entity A’s investment in XYZ shares is estimated to be CU42,500 (250
shares × CU170 per share).
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No active market
11.30 The fair value of investments in assets that do not have a quoted market price in an active
market is reliably measurable if
(a) the variability in the range of reasonable fair value estimates is not significant for
that asset; or
(b) the probabilities of the various estimates within the range can be reasonably
assessed and used in estimating fair value.
11.31 There are many situations in which the variability in the range of reasonable fair value
estimates of assets that do not have a quoted market price is likely not to be significant.
Normally it is possible to estimate the fair value of an asset that an entity has acquired
from an outside party. However, if the range of reasonable fair value estimates is
significant and the probabilities of the various estimates cannot be reasonably assessed,
an entity is precluded from measuring the asset at fair value.
11.32 If a reliable measure of fair value is no longer available for an asset measured at fair value
(or is not available without undue cost or effort when such an exemption is provided (see
paragraphs 11.14(c) and 12.8(b)), its carrying amount at the last date the asset was
reliably measurable becomes its new cost. The entity shall measure the asset at this cost
amount less impairment until a reliable measure of fair value becomes available (or
becomes available without undue cost or effort when such an exemption is provided).
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Notes
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A transferee has the practical ability to sell the transferred asset if it is traded in an
active market because the transferee could repurchase the transferred asset in the
market if it needs to return the asset to the entity. For example, a transferee may have
the practical ability to sell a transferred asset if the transferred asset is subject to an
option that allows the transferor to repurchase it, but the transferee can immediately
obtain the transferred asset in the market if the option is exercised. A transferee does
not have the practical ability to sell the transferred asset if the entity retains such an
option and the transferee cannot immediately obtain the transferred asset in the
market if the entity exercises its option.
The critical question is what the transferee is able to do in practice, not what
contractual rights the transferee has concerning what it can do with the transferred
asset or what contractual prohibitions exist. In particular:
• a contractual right to dispose of the transferred asset has little practical effect
if there is no market for the transferred asset; and
• an ability to dispose of the transferred asset has little practical effect if it
cannot be exercised freely. For that reason:
o the transferee’s ability to dispose of the transferred asset must be
independent of the actions of others (that is, it must be a unilateral ability);
and
o the transferee must be able to dispose of the transferred asset without
needing to attach restrictive conditions or ‘strings’ to the transfer (for
example, conditions about how a loan asset is serviced or an option giving
the transferee the right to repurchase the asset).
That the transferee is unlikely to sell the transferred asset does not, of itself, mean that
the transferor has retained control of the transferred asset. However, if a put option or
guarantee constrains the transferee from selling the transferred asset, then the
transferor has retained control of the transferred asset.
Upon derecognising a financial asset in its entirety, the difference between the
carrying amount and the consideration received (including any new asset obtained less
any new liability assumed) is recognised in profit or loss.
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Ex 93 The following are four examples of when an entity must derecognise a financial
asset because it has transferred substantially all the risks and rewards of
ownership of a financial asset:
• An unconditional sale of a financial asset.
• A sale of a financial asset together with an option to repurchase the financial asset
at its fair value at the time of repurchase (from a risks and rewards perspective this
is the same as an unconditional sale of the asset and a subsequent reacquisition of
the asset in the market at a later date).
• A sale of a financial asset while retaining only a right of first refusal to repurchase
the transferred asset at fair value if the transferee subsequently sells it.
• A sale of 100 shares for CU30 per share together with an option for the purchaser to
require the entity (the seller) to repurchase the shares at CU30 each if the quoted
market price falls below CU10 within the next month. As market conditions are
good, it is highly unlikely that the share price will fall below CU10 (that is, it is
highly unlikely that the entity will need to repurchase the shares). Therefore, this
is effectively an unconditional sale.
Ex 94 The following are five examples of when an entity has retained substantially all
the risks and rewards of ownership of a financial asset and therefore should not
derecognise the asset:
• A sale and repurchase transaction where the repurchase price is a fixed price or the
sale price plus a lender’s return.
• A sale and repurchase transaction where the repurchase price is a fixed price or the
sale price plus a lender’s return and the transferee has a right to substitute assets
that are similar and of equal fair value to the transferred asset at the repurchase
date.
• A sale of a financial asset under an agreement to repurchase substantially the same
asset at a fixed price or at the sale price plus a lender’s return.
• A sale of short-term receivables in which the entity guarantees to compensate the
transferee for credit losses that are likely to occur.
• A sale of 100 shares for CU30 per share together with a contractual provision that
the entity has to repurchase the shares at CU31 if the quoted market price does not
rise to CU60 or above within the next month. As market conditions are ‘flat’, it is
highly unlikely that the share price will double within the next month (that is, it is
highly likely that the seller will be required to repurchase the shares). The seller
retains the price risk and pays a lender’s return. The repurchase of a financial asset
shortly after it has been sold is sometimes referred to as a wash sale.
Ex 95 An entity sells its investment in unquoted shares to a bank for CU1,000. One year
later the entity repurchases those shares from the bank for CU1,200.
The repurchase of the investment in itself does not preclude derecognition provided
that the original transaction met the derecognition requirements. However, if the
agreement to sell the investment in shares is entered into concurrently with the
agreement to repurchase the shares at a fixed price or the sale price plus a lender’s
return, then the asset is not derecognised. In the latter case, the CU200 in this example
would represent the lender’s return.
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11.34 If a transfer does not result in derecognition because the entity has retained significant
risks and rewards of ownership of the transferred asset, the entity shall continue to
recognise the transferred asset in its entirety and shall recognise a financial liability for the
consideration received. The asset and liability shall not be offset. In subsequent periods,
the entity shall recognise any income on the transferred asset and any expense incurred
on the financial liability.
11.35 If a transferor provides non-cash collateral (such as debt or equity instruments) to the
transferee, the accounting for the collateral by the transferor and the transferee depends
on whether the transferee has the right to sell or repledge the collateral and on whether
the transferor has defaulted. The transferor and transferee shall account for the collateral
as follows:
(a) if the transferee has the right by contract or custom to sell or repledge the
collateral, the transferor shall reclassify that asset in its statement of financial
position (for example, as a loaned asset, pledged equity instruments or
repurchase receivable) separately from other assets;
(b) if the transferee sells collateral pledged to it, it shall recognise the proceeds from
the sale and a liability measured at fair value for its obligation to return the
collateral;
(c) if the transferor defaults under the terms of the contract and is no longer entitled
to redeem the collateral, it shall derecognise the collateral and the transferee shall
recognise the collateral as its asset initially measured at fair value or, if it has
already sold the collateral, derecognise its obligation to return the collateral; and
(d) except as provided in (c), the transferor shall continue to carry the collateral as
its asset, and the transferee shall not recognise the collateral as an asset.
Notes
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An entity sells a group of its accounts receivable to a bank at less than their face amount.
The entity continues to handle collections from the debtors on behalf of the bank, including
sending monthly statements, and the bank pays the entity a market-rate fee for servicing the
receivables. The entity is obliged to remit promptly to the bank any and all amounts collected,
but it has no obligation to the bank for slow payment or non-payment by the debtors. In this
case, the entity has transferred to the bank substantially all of the risks and rewards of
ownership of the receivables. Accordingly, it removes the receivables from its statement of
financial position (ie derecognises them), and it shows no liability in respect of the proceeds
received from the bank. The entity recognises a loss calculated as the difference between
the carrying amount of the receivables at the time of sale and the proceeds received from the
bank. The entity recognises a liability to the extent that it has collected funds from the debtors
but has not yet remitted them to the bank.
The facts are the same as the preceding example except that the entity has agreed to buy
back from the bank any receivables for which the debtor is in arrears as to principal or interest
for more than 120 days. In this case, the entity has retained the risk of slow payment or
non-payment by the debtors―a significant risk with respect to receivables. Accordingly, the
entity does not treat the receivables as having been sold to the bank, and it does not
derecognise them. Instead, it treats the proceeds from the bank as a loan secured by the
receivables. The entity continues to recognise the receivables as an asset until they are
collected or written off as uncollectable.
Ex 96 An entity enters into an arrangement with a third party under which the entity
sells trade receivable assets with a carrying amount of CU19,000 (CU20,000 gross
amount less CU1,000 ‘bad debt allowance’) to the third party. The third party pays
the entity CU18,000 for the receivables. The entity and the third party estimate,
on the basis of the entity’s experience, that CU19,000 of the CU20,000 trade
receivables will be settled (bad debt losses are expected to be CU1,000). However,
the entity has not guaranteed to the third party that any particular amount will
be collected. The trade debtors will pay the entity and the entity will pass all
receipts to the third party.
Ultimately, because of one customer going into liquidation, only CU17,000 of the
trade receivables were actually settled. Therefore, the entity passed only CU17,000
to the third party.
In this case, the entity has transferred to the third party substantially all of the risks
and rewards of ownership of the receivables. In particular the third party has the
major risk, which is the credit risk. The third party would have benefited from any
upside (that is, if all CU20,000 of the debtors had paid, the third party would have
received CU20,000).
Accordingly, the entity removes the receivables of CU19,000 from its statement of
financial position (that is, derecognises them), and it shows no liability in respect of
the proceeds received from the third party.
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The entity should recognise a loss on sale of CU1,000 calculated as the difference
between the carrying amount of the receivables at the time of sale (CU19,000) and the
proceeds received from the third party of CU18,000.
The journal entries on transfer are as follows:
Dr Cash (financial asset) CU18,000
Dr profit or loss—loss on sale of trade receivables CU1,000
Cr Trade receivables (financial asset) CU19,000
To derecognise factorised trade receivables.
The entity recognises a financial liability for any cash receipts from the debtors that it
has not yet passed on to the third party.
The journal entries would be as follows on collection of cash:
The entity may pass the cash to the third party immediately, or it may wait and remit
all amounts collected at certain periods of time or in full on a certain date. If, for
example, the entity waited until all CU17,000 of receipts were received it would have a
financial liability for CU17,000. In this case, on payment to the third party, the
following journal entries should be recognised:
Dr Amount collected on behalf of third party CU17,000
(financial liability)
Cr Cash (financial asset) CU17,000
To recognise the transfer of cash collected on behalf of third party to the third party.
Ex 97 The facts are the same as in example 96. However, in this example, the entity will
pass all receipts to the third party up to a maximum of CU19,000. Also, if receipts
are less than CU19,000 the entity will make up the difference (that is, in all cases
the third party will receive CU19,000).
As only CU17,000 of the trade receivables are settled by the entity’s customers, the
entity pays a further CU2,000 on to the third party.
In this example, the entity has not transferred to the third party substantially all of the
risks and rewards of ownership of the receivables—the entity retains the major risk
which is the credit risk (the risk of debtors not paying). The entity also benefits from
any upside (that is, if all CU20,000 of the debtors had paid, the entity would still pay
only CU19,000 to the third party).
Accordingly, the entity does not treat the receivables as having been sold to the third
party (that is, it does not derecognise them). The entity continues to recognise the
trade receivables as an asset until they are collected or written off as uncollectible.
The substance of the transaction with the third party is a secured loan—the loan is
secured by the trade receivables. The entity receives a loan of CU18,000 and repays
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CU19,000, the difference of CU1,000 is a finance cost (interest) of the entity, that is, it is
the lender’s return (interest).
The journal entries are:
Initial recognition
Dr Cash (financial asset) CU18,000
Cr Loan (financial liability) CU18,000
To recognise the loan.
Ex 98 The facts are the same as in example 96. However, in this example, the entity will
pass all receipts to the third party up to a maximum of CU19,500. If receipts are
less than CU17,200 the entity will make up the difference. Under the contract, the
third party is prohibited from selling the receivables to another party.
As only CU17,000 of the trade receivables are actually settled, the entity pays a
further CU200 on to the third party.
In this case, the entity has retained some of the risks and rewards of ownership of the
receivables. The entity and the third party both share the credit risk (the risk of
debtors not paying). Also, the entity and the third party can both benefit from the
upside.
As the third party is prohibited from selling the receivables, the entity still has control
of the trade receivables. Therefore, the entity does not treat the receivables as having
been sold to the third party, and it does not derecognise them. The entity continues to
recognise the receivables as an asset until they are collected or written off as
uncollectible.
The entity shall recognise a financial liability for the consideration received of
CU18,000.
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Ex 99 The facts are the same as in example 96. However, in this example, the entity will
pass all receipts to the third party up to a maximum of CU19,500. If receipts are
less than CU17,200 the entity will make up the difference. Under the contract the
third party has the practical ability to sell the financial receivables in their
entirety to another party and can exercise that ability unilaterally and without
needing to impose additional restrictions on the transfer.
As only CU17,000 of the trade receivables are actually settled, the entity pays a
further CU200 on to the third party.
In this case, the entity has retained some of the risks and rewards of ownership of the
receivables. The entity and the third party both share credit risk (the risk of debtors
not paying). Both can also benefit from the upside.
As the third party can sell the receivables freely, the third party would be considered to
have control. Therefore, the entity should derecognise the trade receivables and
recognise separately the financial instrument created which results from the
requirement either to pay further contingent amounts to the supplier (if receipts are
less than CU17,200) or to receive an additional amount of up to CU500 (if receipts are
greater than CU19,500). This financial instrument does not satisfy the conditions in
paragraph 11.9 and therefore it is outside the scope of Section 11. This financial
instrument is accounted for in accordance with Section 12 and will not be addressed
further here. However, it is addressed in Module 12.
11.36 An entity shall derecognise a financial liability (or a part of a financial liability) only when it
is extinguished—ie when the obligation specified in the contract is discharged, is cancelled
or expires.
Notes
A financial liability is extinguished when the entity (the debtor) discharges the liability
by paying the creditor with cash or other financial assets or if the entity is released
from settling the liability by the creditor.
A financial liability will also be extinguished if the entity is released from settling the
liability by process of law. Some jurisdictions have a ‘statute of limitations’ which is a
statute that sets out the maximum period of time, after certain events have taken
place, that legal proceedings based on those events may be initiated. For example, if
such a period was five years, a supplier would no longer be able to legally enforce
payment by a customer if the supplier did not claim payment within five years from
the date the goods were provided. Until five years have passed, the customer would be
legally required to pay the supplier should the supplier make a claim and so it would
not be appropriate for the customer to derecognise any related financial liability.
Payment to a third party, including a trust, where the payment is to be used solely for
satisfying scheduled payments of both interest and principal of the outstanding debt
(sometimes called in-substance defeasance), does not, by itself, relieve the debtor of its
primary obligation to the creditor, in the absence of legal release.
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If an entity pays a third party to assume an obligation and notifies its creditor that the
third party has assumed its debt obligation, the entity does not derecognise the debt
obligation unless it is legally released from primary responsibility for the liability.
In some cases, a creditor releases a debtor from its present obligation to make
payments, but the debtor assumes a guarantee obligation to pay if the party assuming
primary responsibility defaults. In these circumstances the debtor:
• recognises a new financial liability for its obligation for the guarantee (note, the
guarantee is within the scope of Section 12); and
• recognises a gain or loss based on the difference between (a) any proceeds paid and
(b) the carrying amount of the original financial liability less the fair value of the
new financial liability.
11.37 If an existing borrower and lender exchange financial instruments with substantially
different terms, the entities shall account for the transaction as an extinguishment of the
original financial liability and the recognition of a new financial liability. Similarly, an entity
shall account for a substantial modification of the terms of an existing financial liability or
a part of it (whether or not attributable to the financial difficulty of the debtor) as an
extinguishment of the original financial liability and the recognition of a new financial
liability.
11.38 The entity shall recognise in profit or loss any difference between the carrying amount of
the financial liability (or part of a financial liability) extinguished or transferred to another
party and the consideration paid, including any non-cash assets transferred or liabilities
assumed.
Notes
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Ex 100 On 1 January 20X1 a bank provides an entity with a four-year loan of CU5,000 on
normal market terms, including charging interest at a fixed rate of 8% per year.
Interest is payable at the end of each year. The figure of 8% is the market rate for
similar four-year fixed-interest loans with interest paid annually in arrears.
Transaction costs of CU100 are incurred on originating the loan.
In 20X1 the entity experienced financial difficulties. On 31 December 20X1 the
bank agreed to modify the terms of the loan. Under the new terms the interest
payments in 20X2 to 20X4 will be reduced from 8% to 5%. The entity paid the
bank a fee of CU50 for paperwork relating to the modification.
Since the interest was initially set at the market rate, on 1 January 20X1 the entity
must on initial recognition measure the loan at the transaction price, less transaction
costs (that is, CU4,900).
The following was the original amortised cost calculation at 1 January 20X1.
At 31 December 20X1:
• the present value of the remaining cash flows of the original financial liability is
CU4,921.99 discounted at the original effective interest rate of 8.612%.
• the present value of the cash flows under the new terms discounted using the
original effective interest rate is CU4,539.67 (see table below). Including the CU50
fee, the present value of the total cash flows is CU4,589.67.
• the difference between CU4,921.99 and CU4,589.67 is CU332.32 which is only 6.8%
(CU332.32 ÷ CU4,921.99) of the present value of the remaining cash flows of the
original financial liability.
The entity applies its judgement to decide whether the terms of the instruments
exchanged are substantially different. If entity decides to look to full IFRS Standards
for guidance, then it would consider whether the discounted present value of the cash
flows under the new terms, including any fees paid net of any fees received and
discounted using the original effective interest rate, is at least 10% different from the
discounted present value of the remaining cash flows of the original financial liability.
As this difference is less than 10% of the present value of the remaining cash flows of
the original financial liability, the entity concluded that this modification should not
be considered a substantial modification of the terms of the existing loan. Therefore,
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Ex 101 The facts are the same as in example 100. However, in this example, the entity is
not required to pay any interest under the revised terms of the loan. The entity
needs to repay only the principal and this will be paid a year later than under the
original terms (that is, on 31 December 20X5).
At 31 December 20X1:
• the present value of the remaining cash flows of the original financial liability is
CU4,921.99 discounted at the original effective interest rate of 8.612%.
• the present value of the cash flows under the new terms discounted using the
original effective interest rate is CU3,593.01 (CU5,000 ÷ (1.08612)4). Including the
CU50 fee, the present value of the total cash flows is CU3,643.01.
• the difference between CU4,921.99 and CU3,643.01 is CU1,278.98 which is 26%
(CU1,278.98 ÷ CU4,921.99) of the present value of the remaining cash flows of the
original financial liability.
The entity applies its judgement to decide whether the terms of the instruments
exchanged are substantially different. If the entity decides to look to full IFRS
Standards for guidance, then it would consider whether the discounted present value
of the cash flows under the new terms, including any fees paid net of any fees received
and discounted using the original effective interest rate, is at least 10% different from
the discounted present value of the remaining cash flows of the original financial
liability. The difference is more than 10% of the present value of the remaining cash
flows of the original financial liability.
The entity concludes that the modification is a substantial modification of the terms of
the existing loan. Therefore, this debt restructuring would be accounted for as an
extinguishment of the original financial liability and the recognition of a new
financial liability.
The journal entries on extinguishment of the existing loan are as follows:
Dr Loan (financial liability) CU4,921.99
Cr Profit on derecognition of loan (CU4,921.99 less CU1,196.84
CU3,675.15 less CU50)
Cr New loan (financial liability) (see below) CU3,675.15
Cr Cash (financial asset) CU50.00
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The new financial liability is an interest-free loan of CU5,000 for four years. Assume 8%
is considered to be the market rate for similar four-year fixed-interest loans with interest
paid annually in arrears. The entity measures the new loan at the present value of the
future payments discounted at a market rate of interest for a similar loan (CU5,000 ÷
(1.08)4).
The amortised cost calculation at 1 January 20X2 is as follows:
Disclosures
11.39 The following disclosures make reference to disclosures for financial liabilities measured
at fair value through profit or loss. Entities that have only basic financial instruments (and
therefore do not apply Section 12) will not have any financial liabilities measured at fair
value through profit or loss and hence will not need to provide such disclosures.
Ex 102 Extract from notes to Entity A’s financial statements for the year ended
31 December 20X2
Loan receivables
Entity A occasionally provides its associates or employees with loans.
Loan receivables are measured at amortised cost using the effective interest
method less any impairment. Interest income is included in other income.
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Trade receivables
Most sales are made on normal short-term credit terms. Trade receivables in
respect of such sales are measured at the undiscounted amount of cash expected
to be received less any impairment. For sales made on terms that extend beyond
normal credit terms, receivables are initially measured at the present value of
future receipts discounted at a market rate of interest and are subsequently
measured at amortised cost using the effective interest method.
Trade payables
Trade payables are obligations that have arisen by purchasing goods and services
under normal short-term credit terms. Trade payables are measured at the
undiscounted amount of cash to be paid. Entity A buys some goods from overseas
suppliers. Trade payables denominated in a foreign currency are translated into
CU using the exchange rate at the reporting date. Foreign exchange gains or
losses are included in other income or other expenses.
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Notes
An entity may wish to present the disclosures required by paragraph 11.41 in a
separate table (see example 103), particularly if the entity has many different types of
financial instruments. However, if an entity has relatively few financial instruments
and the information required in paragraph 11.41 is already shown directly in the
financial statements, there is no need for the entity to present a separate disclosure
item for this information.
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11.42 An entity shall disclose information that enables users of its financial statements to
evaluate the significance of financial instruments for its financial position and
performance. For example, for long-term debt such information would normally
include the terms and conditions of the debt instrument (such as interest rate, maturity,
repayment schedule, and restrictions that the debt instrument imposes on the entity).
Ex 104 Extract from notes to Entity A’s financial statements for the year ended
31 December 20X2
20X2 20X1
CU CU
The bank overdraft is repayable on demand. Interest is payable on the bank overdraft at LIBOR
plus 2%.
Interest is payable on the seven-year bank loan at a fixed rate of 5% of the principal amount. The
bank loan is fully repayable in 20X6. Early payment is permitted without penalty.
The bank overdraft and fixed-rate bank loan are secured by a floating lien over the entity’s land
and buildings with a carrying amount of CU266,000 at 31 December 20X2 (CU312,000 at 31
December 20X1) (see note 12).
Interest is payable on the variable-rate loan at LIBOR plus 1%. The variable-rate bank loan is fully
repayable on 16 January 20X3. Early payment is prohibited. The variable-rate loan is secured by
CU300,000 of trade receivables (see note 16).
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11.43 For all financial assets and financial liabilities measured at fair value, the entity shall
disclose the basis for determining fair value, for example, quoted market price in an active
market or a valuation technique. When a valuation technique is used, the entity shall
disclose the assumptions applied in determining fair value for each class of financial
assets or financial liabilities. For example, if applicable, an entity discloses information
about the assumptions relating to prepayment rates, rates of estimated credit losses, and
interest rates or discount rates.
Notes
Ex 105 Extract from notes to Entity A’s financial statements for the year ended
31 December 20X2
20X2 20X1
CU CU
The fair value of the entity’s investments in listed equity securities is based on quoted market
prices at the reporting date on the [National Stock Market]. The quoted market price used is the
current bid price.
The fair value of the entity’s investments in unlisted equity securities is determined using a
discounted cash flow analysis based on assumptions that are supported by observable market
data, where available. For the discounted cash flow analysis, an earnings growth factor of 4%,
equal to the industry average, is used. A risk-free interest rate of 6% is used to discount the cash
flows as the estimated cash flows themselves are adjusted for risk.
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11.44 If a reliable measure of fair value is no longer available, or is not available without undue
cost or effort when such an exemption is provided, for any financial instruments that would
otherwise be required to be measured at fair value through profit or loss in accordance
with this Standard, the entity shall disclose that fact, the carrying amount of those financial
instruments and, if an undue cost or effort exemption has been used, the reasons why a
reliable fair value measurement would involve undue cost or effort.
Derecognition
11.45 If an entity has transferred financial assets to another party in a transaction that does not
qualify for derecognition (see paragraphs 11.33–11.35), the entity shall disclose the
following for each class of such financial assets:
(a) the nature of the assets;
(b) the nature of the risks and rewards of ownership to which the entity remains
exposed; and
(c) the carrying amounts of the assets and of any associated liabilities that the entity
continues to recognise.
Ex 106 Extract from notes to Entity A’s financial statements for the year ended
31 December 20X2
20X2 20X1
CU CU
During 20X2 the entity sold CU300,000 of its trade receivables to a bank for CU280,000.
The entity continues to handle collections from the debtors on behalf of the bank. The entity will
buy back any receivables for which the debtor is in arrears as to principal or interest for more than
120 days. The entity continues to recognise the full carrying amount of the receivables sold
(CU300,000) and has recognised the cash received on the transfer as a secured loan for
CU280,000. At 31 December 20X2 the carrying amount of the loan is CU285,000 including
accrued interest of CU5,000 under the effective interest method (see note 25). The bank is not
entitled to sell the trade receivables or use them as security for its own borrowings.
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Collateral
11.46 When an entity has pledged financial assets as collateral for liabilities or contingent
liabilities, it shall disclose the following:
(a) the carrying amount of the financial assets pledged as collateral; and
(b) the terms and conditions relating to its pledge.
Ex 107 Extract from notes to Entity A’s financial statements for the year ended
31 December 20X2
Ex 108 Extract from notes to Entity A’s financial statements for the year ended
31 December 20X2
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Ex 109 Extracts from notes to Entity A’s financial statements for the year ended
31 December 20X2:
20X2 20X1
CU CU
20X2 20X1
CU CU
20X2 20X1
CU CU
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Applying the requirements of the IFRS for SMEs Standard to transactions or other events often
requires the exercise of judgement. Information about significant judgements made by an
entity’s management and key sources of estimation uncertainty are useful when assessing an
entity’s financial position, performance and cash flows. Consequently, in accordance with
paragraph 8.6, an entity must disclose the judgements management has made when applying
the entity’s accounting policies that have the most significant effect on the amounts
recognised in the financial statements.
Furthermore, in accordance with paragraph 8.7, an entity must disclose information that
explains key assumptions about the future and other key sources of estimation uncertainty at
the reporting date, that have a significant risk of causing a material adjustment to the
carrying amounts of assets and liabilities within the next financial year.
Other sections of the IFRS for SMEs Standard require disclosure of information about particular
judgements and estimation uncertainties.
Initial measurement
1
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Subsequent measurement
1
Deciding whether the fair value of a particular investment can be measured reliably without
undue cost or effort using a valuation model also usually involves judgement.
Judgement is required in estimating the fair value of investments in ordinary shares and
preference shares when there is no active market. In particular, choosing and applying
valuation techniques involves a significant amount of judgement. Often the inputs into the
valuation model and other assumptions used when applying the model are subjective.
Judgement may also be required in assessing whether or not a market is active if transactions
are not occurring frequently and whether the transactions taking place are forced
transactions.
Estimating cash flows when determining the amortised cost of a financial instrument may
require judgement. For example, some instruments allow early prepayment by the issuer
(debtor). In this case the holder and the issuer need to estimate when the loan will be repaid
when determining the future cash flows to be used in the amortised cost calculation.
Judgement is usually required when assessing whether financial assets measured at cost or
amortised cost are impaired and hence when an impairment test must be performed.
In particular, Section 11 requires financial assets that are individually significant to be
assessed for impairment separately. Deciding which assets are ‘individually significant’
requires judgement.
Performing an impairment test for investments in preference shares and ordinary shares
whose fair value cannot be measured reliably without undue cost or effort requires significant
judgement. Since the fair value cannot be measured reliably without undue cost or effort, in
most cases the best estimate of the amount the entity would receive for the asset if it were to
be sold at the reporting date will need to be estimated. Therefore, the entity must use
judgement to estimate the impairment even though this might be only a rough
approximation in some cases.
Derecognition
1
Judgement is sometimes required in assessing whether substantially all the risks and rewards
are transferred to another party when determining whether to derecognise a financial asset.
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When the IFRS for SMEs Standard was issued in July 2009, Section 11 was based on IAS 39
Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures. At
that time IFRS 9 Financial Instruments had not been issued. Since then, IFRS 9 has been issued in
its final form and is effective for annual periods beginning on or after 1 January 2018. The IFRS
for SMEs Standard issued in 2015 continues to allow preparers to apply the recognition and
measurement requirements of IAS 39 instead of those of Sections 11 and 12 (paragraph
11.2(b)), and so the comparison will continue to be made for IAS 39. In addition, for reference,
a comparison with IFRS 9 is provided.
IAS 39 and the IFRS for SMEs Standard (see Section 11 Basic Financial Instruments and Section 12
Other Financial Instruments Issues) share some similar principles for the recognition,
measurement and disclosure of financial instruments. However, there are a number of
significant differences.
In the IFRS for SMEs Standard the accounting for basic financial instruments is addressed
separately from the accounting for more complex financial instrument transactions and the
requirements have been written in simplified language. In addition, there are a number of
changes in the details (outlined below).
Under the IFRS for SMEs Standard an entity shall choose to account for all of its financial
instruments either:
(a) by applying the provisions of both Section 11 and Section 12 in full; or
(b) by applying the recognition and measurement provisions of IAS 39 Financial Instruments:
Recognition and Measurement and the disclosure requirements of Section 11 and Section 12.
The difference between applying (b) and applying full IFRS Standards is the applicable
disclosure requirements. IFRS 7’s disclosures are divided into three main categories:
significance, risk and transfers. Section 11 includes many of the ‘significance’ disclosures in
IFRS 7. However, the IFRS for SMEs Standard includes none of the ‘risk’ disclosures in IFRS 7.
The only disclosure from IFRS 7 relating to ‘transfers’ that is included in the IFRS for SMEs
Standard relates to transfers of financial assets that do not qualify for derecognition.
The reasons that the IFRS for SMEs Standard omits so many of the IFRS 7 disclosures include:
(a) many of the IFRS 7 disclosures are designed for financial institutions (which are not
eligible to use the IFRS for SMEs Standard);
(b) many of the IFRS 7 disclosures are designed for entities whose securities trade in public
capital markets (which are also ineligible to use the IFRS for SMEs Standard); or
(c) in the case of disclosure of fair values for all financial instruments measured at
amortised cost, requiring such disclosures would be burdensome for small or medium-
sized entities and contrary to the objective of Section 11, which is an amortised cost
section for basic financial instruments.
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In July 2014 the Board issued the final version of IFRS 9, the new Standard on financial
instruments. The most significant changes compared to IAS 39 are a new model for
classification and measurement of financial assets and a new impairment model. IFRS 9 has
an effective date for annual periods that begin on or after 1 January 2018.
The recognition and derecognition requirements are largely unchanged between IAS 39 and
IFRS 9, so the section on ‘initial recognition’ and ‘derecognition’ also applies for IFRS 9.
Unlike Section 11, IFRS 9 has three categories for classification: fair value through profit or
loss (FVTPL), fair value through other comprehensive income (FVTOCI) and amortised cost (AC).
IFRS 9 does not permit any instruments to be measured at cost.
The classification of financial instruments under IFRS 9 is based on the contractual cash flows
of the instrument as well as the business model in which it is held. Those criteria are different
to the criteria used for classification of financial instruments in Section 11.
Generally, applying IFRS 9, the classification is mandatory based on the aforementioned
criteria. However, there are some exceptions. An entity can, for example, elect to designate a
financial instrument at FVTPL if certain criteria are met. This option is not available in the
IFRS for SMEs Standard.
The impairment model is based on expected losses and is therefore significantly different from
the impairment model in Section 11, which is based on incurred losses. Applying IFRS 9, if
credit risk has increased significantly since initial recognition, the entity has to provide for the
lifetime expected losses of the instrument. For all other instruments, an entity has to provide
for the losses expected within 12 months of the year end on a probability-weighted basis.
The requirements in IFRS 9 for financial liabilities are similar to those of Section 11.
There are also several differences between Section 12 and full IFRS Standards.
These differences are not covered in this module.
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Test your knowledge of the requirements for accounting and reporting basic financial
instruments in accordance with the IFRS for SMEs Standard by answering the questions below.
Once you have completed the test check your answers against those set out below this test.
Assume all amounts are material.
Question 1
Under the IFRS for SMEs Standard an entity can choose to apply the provisions of both Section
11 and Section 12 in full, or alternatively the entity may apply:
(a) full IFRS Standards for financial instruments (that is, the recognition and
measurement provisions of IAS 39 Financial Instruments: Recognition and Measurement, and
the presentation and disclosure requirements of IAS 32 Financial Instruments: Presentation
and IFRS 7 Financial Instruments: Disclosures).
(b) the recognition and measurement provisions of Section 11 and Section 12 and the
disclosure requirements of IFRS 7 Financial Instruments: Disclosures.
(c) the recognition and measurement provisions of IAS 39 Financial Instruments: Recognition
and Measurement and the disclosure requirements of Section 11 and Section 12.
(d) the recognition and measurement provisions of IAS 39 Financial Instruments: Recognition
and Measurement and the disclosure requirements of IFRS 7 Financial Instruments:
Disclosures.
Question 2
Which of the following items in an entity’s statement of financial position is a financial asset
or financial liability within the scope of Section 11?
(a) a liability for an amount due to a supplier for a past receipt of goods.
(b) an asset for a prepayment made to a supplier for the rent of a machine for two
months.
(c) a liability for a fine for the late payment of income tax by the entity.
(d) all of the above.
Question 3
Which of the following financial assets is not within the scope of Section 11?
(a) cash.
(b) trade receivables.
(c) a 5% holding in the non-puttable ordinary shares of another entity (investee).
(d) a 30% holding in the non-puttable ordinary shares of another entity (investee) where
the investee is classified as an associate of the entity.
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Question 4
Which of the following financial instruments is not within the scope of Section 11?
(a) investments in non-convertible, non-puttable preference shares.
(b) financial instruments that meet the definition of an entity’s own equity.
(c) a fixed-interest fixed-term loan from a bank.
(d) an interest-free three-year loan from a parent entity.
Question 5
An entity buys 100 non-puttable ordinary shares in a listed company on the market for cash of
CU20 per share. The entity also incurred broker’s fees of CU100.
At what amount should the entity measure the investment in shares on initial recognition?
(a) CU1,900.
(b) CU2,000.
(c) CU2,100.
Question 6
A bank provides an entity with a five-year loan for CU10,000 with fixed interest payable
annually in arrears at a rate of 6% of the principal amount. 6% is considered to be the market
rate for a similar five-year loan with interest payable annually in arrears. The bank charges
the entity a fee of CU50 for paperwork.
At what amount should the entity measure the loan on initial recognition?
(a) CU9,384.
(b) CU9,484.
(c) CU9,950.
(d) CU10,000.
(e) CU10,050.
Question 7
At the end of each reporting period investments in non-convertible preference shares and
non-puttable ordinary or preferences shares should be measured as follows:
(a) all such investments shall be measured at fair value with changes in fair value
recognised in profit or loss.
(b) all such investments shall be measured at amortised cost using the effective interest
method.
(c) all such investments shall be measured at cost less impairment.
(d) if the shares are publicly traded, the investment should be measured at fair value
with changes in fair value recognised in profit or loss. All other such investments
must be measured at cost less impairment.
(e) if the shares are publicly traded or their fair value can otherwise be measured reliably
without undue cost or effort, the investment should be measured at fair value with
changes in fair value recognised in profit or loss. All other such investments must be
measured at cost less impairment.
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Question 8
Question 9
When assessing financial assets held at amortised cost or cost for impairment an entity must
assess which of the following assets individually?
(a) only financial assets that are individually significant.
(b) only equity instruments that are individually significant.
(c) only equity instruments.
(d) all financial assets except equity instruments.
(e) all equity instruments and other financial assets that are individually significant.
Question 10
An entity sells a group of its accounts receivable to a bank at less than their ‘face amount’.
The entity continues to handle collections from the debtors on behalf of the bank, and the
bank pays the entity a market-rate fee for servicing the receivables. The entity is obliged to
remit promptly to the bank any and all amounts collected, but it has no obligation to the
bank for slow payment or non-payment by the debtors.
What is the correct accounting treatment for this transaction?
(a) The entity should remove the receivables from its statement of financial position
(that is, derecognise them), and show no liability in respect of the proceeds received
from the bank.
(b) The entity should continue to recognise the receivables in its statement of financial
position and show a liability in respect of the proceeds received from the bank.
(c) The entity should continue to recognise the receivables in its statement of financial
position and show no liability in respect of the proceeds received from the bank.
(d) The entity should remove the receivables from its statement of financial position
(that is, derecognise them), and show a liability in respect of the proceeds received
from the bank.
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Answers
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Apply your knowledge of the requirements for accounting and reporting basic financial
instruments in accordance with the IFRS for SMEs Standard by solving the case studies below.
Once you have completed the case studies check your answers against those set out at the
bottom of this test.
Case study 1
An entity has the following trial balance for the year ended 31 December 20X1.
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Revenue (6,888,545)
Cost of sales 5,178,530
Other income (63,850)
Distribution costs 175,550
Admin expenses 810,230
Other costs 106,763
Finance costs 26,366
Income tax 270,250
Dividends 150,000
(0)
Using the columns on the right, note which items are within the scope of Section 11 and,
for those that are, whether they should be measured after initial recognition at FVTPL,
amortised cost or cost less impairment.
Ignore the part of the trial balance that relates to the statement of comprehensive
income. As cash is a special case which does not fit into the three measurement
categories, the answer has been given.
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Case study 2
At 1 January 20X1 Entity A already has a five-year loan with another bank for CU5,000. Interest
is charged at EURIBOR plus 200 points. The market rate for similar loans is EURIBOR plus 200
points. Interest is payable annually in arrears and the entity pays this immediately when it is
due in cash. The loan was entered into on 1 January 20X0.
In 20X1 the associate unexpectedly experienced financial difficulties due to a health scare
regarding one of the associate’s leading products. Entity A and the associate agreed to a
restructuring of the terms of the loan on 31 December 20X1. Interest accrued for 20X1 was
not paid. No interest will be charged during 20X2 and 20X3 and the term of the loan should
be extended to 20X7. Hence the full principal is payable on 31 December 20X7. Interest at 5%
per year will be payable during 20X4–20X7.
In 20X1 the entity withdrew a further CU400 from the overdraft facility to buy raw materials,
and incurred interest of CU44 on the overdraft, bringing the outstanding balance to CU944 at
year-end.
In 20X2 the entity withdraws a further CU300 from the overdraft facility to buy raw materials.
In 20X2 interest of CU55 is incurred on the overdraft.
During 20X1 EURIBOR is a weighted average of 3% and during 20X2 it is a weighted average of
2.5%.
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Part A
Prepare the journal entries to record the two loans receivable and two loans payable on
1 January 20X1 (that is, initial recognition).
Part B
Prepare the journal entries to account for the all of the loans receivable and payable
mentioned above during 20X1 and 20X2 and determine their carrying amounts at
year-end 31 December 20X1 and year-end 31 December 20X2.
Part C
Prepare notes to satisfy the disclosure requirements in Section 11 for all the loans
receivable and payable as they may be presented in the financial statements for the year
ended 31 December 20X2 (with comparatives for 20X1 where required).
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(a) Calculation of the present value of the loan to the employee at the market rate of 7%:
Cash receivable Discount factor Present value
Time (a) (7%) (b) (a)x(b)
20X1 20 0.9346 18.69
20X2 520 0.8734 454.19
Total 472.88
Since interest on the loan is charged at the market rate, the present value of cash receivable from the associate will
be equal to the transaction price of CU5,000.
(b) Calculation of the present value of cash receivable from the associate at the market rate of 5%:
Cash receivable Discount factor Present value
Time (a) (5%) (b) (a)x(b)
20X1 250 0.9524 238.09
20X2 250 0.9070 226.76
20X3 250 0.8638 215.96
20X4 5,250 0.8227 4,319.19
Total 5,000.00
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Loan
Dr Cash (financial asset) CU10,000
Cr Loan (financial liability) CU10,000
To recognise the receipt of the proceeds of a loan and the obligation to repay the loan.
Transaction fees
Dr Loan (financial liability) CU100
Cr Cash (financial asset) CU100
To recognise borrowing costs.
Since interest on the loan is charged at the market rate, the present value of cash payable to the bank will be equal
to the transaction price of CU10,000.
(c) Calculation of the present value of cash payable to the bank at the market rate of 6%:
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Interest receivable
Dr Loan (financial asset) CU33.10(d)
Cr Profit or loss—interest income CU33.10
To recognise interest income for the period.
Cash received
Dr Cash (financial asset) CU20(d)
Cr Loan receivable (financial asset) CU20
To derecognise a financial asset.
At 31 December 20X1 the loan receivable from the employee has a carrying amount of CU485.98(d).
Assuming the employee repays the loan as expected on 31 December 20X2, the journal entries in 20X2 are:
Interest receivable
Dr Loan receivable (financial asset) CU34.02(d)
Cr Profit or loss―interest income CU34.02
To recognise interest income for the period.
Cash received
Dr Cash (financial asset) CU520(d)
Cr Loan receivable (financial asset) CU520
To derecognise a financial asset.
At 31 December 20X2 the loan receivable from the employee has a carrying amount of CU0(d) (that is, the loan
receivable is derecognised as the contractual rights to the cash flows from it are fully settled by the employee on
31 December 20X2).
(d)The amortised cost calculation is as follows:
Carrying
Carrying amount Cash amount at
at 1 January Interest at 7%* inflow 31 December
Time (A) (B) (C) (A)+(B)+(C)
20X1 472.88 33.10 (20) 485.98
20X2 485.98 34.02 (520) –
* The effective interest rate of 7% is the rate that discounts the expected cash flows on the loan
receivable to the initial carrying amount of CU472.88.
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No cash is paid in 20X2. At 31 December 20X2 the loan receivable from the associate has a carrying amount of
CU4,761.91(g):
(e)The original amortised cost calculation at 1 January 20X1 is as follows:
* The effective interest rate of 5% is the rate that discounts the expected cash flows on the loan receivable
to the initial carrying amount of CU5,000.
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(f)The
present value of estimated cash flows discounted at the asset’s original effective interest rate of 5% is
CU4,535.15 (see calculation below):
Original discount Present
Time Cash receivable
factor (5%) value
20X2 – 0.9524 –
20X3 – 0.9070 –
20X4 250.00 0.8638 215.96
20X5 250.00 0.8227 205.68
20X6 250.00 0.7835 195.88
20X7 5,250.00 0.7462 3,917.63
Total 4,535.15
(g) The revised amortised cost calculation at 1 January 20X2 is as follows:
Cash payable
Dr Loan (financial liability) CU600(h)
Cr Cash (financial asset) CU600
To recognise the settlement of a financial liability.
Cash payable
Dr Loan (financial liability) CU600(h)
Cr Cash (financial asset) CU600
To recognise the settlement of a financial liability.
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Interest expense
Dr Profit or loss—interest expense CU44
Cr Overdraft (financial liability) CU44
To recognise interest expense accrued in 20X1.
At 31 December 20X1 the overdraft has a carrying amount of CU944 (that is, CU500 + CU400 + CU44).
The overdraft is not discounted as it is repayable on demand.
The journal entries in 20X2 are:
Purchases
Dr Inventories (asset) CU300
Cr Overdraft (financial liability) CU300
To recognise the purchase of inventories.
Interest expense
Dr Profit or loss–interest expense CU55
Cr Overdraft (financial liability) CU55
To record interest expense accrued in 20X2.
At 31 December 20X2 the overdraft has a carrying amount of CU1,299 (that is, CU944 + CU300 + CU55).
The overdraft is not discounted as it is repayable on demand.
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At 31 December 20X1 the loan has a carrying amount of CU5,000. The loan is initially recognised at CU5,000,
which is equal to the principal payable on maturity. Therefore, re-estimating the future interest payments will
have no significant effect on the carrying amount of the loan (see paragraph 11.19). Cash flows over the life of
the loan will constantly vary as EURIBOR varies. However, because interest is charged at the market rate for
this type of loan, if the effective interest rate is set to EURIBOR plus 200 basis points it will at any time always
exactly discount estimated future cash payments over the remaining loan term to CU5,000. Hence the carrying
amount of the loan throughout the four years is CU5,000.
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[Extract from] Entity A group notes for the year ended 31 December 20X2
CU CU
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CU CU
CU CU
Note 14 Carrying amounts of financial assets and financial liabilities in Entity A’s statement of financial
position at 31 December 20X2
Note 20X2 Total 20X1
Total
CU CU
Financial assets
Trade receivables X X
Total X X
Financial liabilities
Total X X
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CU CU
The loan to the associate is repayable in full in 20X7. Interest is charged at 5% of the principal
amount from 20X4 to 20X7. The entity has provided the associate with an interest-free period
until 20X4. On 31 December 20X1, because the associate unexpectedly experienced financial
difficulties, the terms of the loan were restructured. Before the restructuring interest was
payable at 5% per year and the loan was repayable in full on 31 December 20X4.
CU CU
The bank overdraft is repayable on demand. Interest is payable on the bank overdraft at
EURIBOR plus 250 points. The overdraft limit is CU2,000 and any outstanding amount must be
fully repaid by 31 December 20X6.
The fixed-rate bank loan is repayable in full on 31 December 20X3. Interest is payable yearly
in arrears at 6% (20X1: 6%) of the principal amount.
The bank overdraft and fixed-rate loan are secured by a floating lien over land and buildings
owned by the entity with a carrying amount of CU56,000 at 31 December 20X2 (CU42,000 at
31 December 20X1).
The variable-rate loan is repayable in full on 31 December 20X4. Interest is payable at EURIBOR
plus 200 points (20X1: EURIBOR plus 200 points).
The calculations and explanatory notes below do not form part of the answer to this case study:
(q)
Interest income on loan to employee and loan to associate:
20X1: CU33.10 + CU250 = CU283.10
20X2: CU34.02 + CU226.76 = CU260.78
(r)
Finance costs:
20X1: CU631.30 + CU44 + CU250 = CU925.30
20X2: CU633.29 + CU55 + CU225 = CU913.29
IFRS Foundation: Supporting Material for the IFRS for SMEs® Standard (version 2018-08)
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