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Financial Asset and Financial Liability
IAS 32 Financial instruments: presentation, which deals
with:
I. The classification of financial instruments between
liabilities and equity.
II. Presentation of certain compound instruments
(instruments combining debt and equity)
IFRS 7 Financial instruments: disclosure
IFRS 9 Financial instruments.
IFRS 9 deals with recognition, derecognition and
measurement of financial assets and liabilities
5-1
Financial Asset and Financial Liability
Definitions
Financial instrument. Any contract that gives rise to
both a financial asset of one entity and a financial liability
or equity instrument of another entity.
5-2
Financial Asset and Financial Liability
Financial asset. Any asset that is:
(a)Cash
(b)An equity instrument of another entity
(c)A contractual right to receive cash or another financial
asset from another entity; or to exchange financial
instruments with another entity under conditions that are
potentially favourable to the entity
5-3
Financial Asset and Financial Liability
Financial liability. Any liability that is:
A contractual obligation:
I. To deliver cash or another financial asset to another
entity, or
II. To exchange financial instruments with another entity
under conditions that are potentially unfavourable.
Examples of financial liabilities include:
(a) Trade payables
(b) Debenture loans payable
(c) Redeemable preference (non-equity) shares
5-4
Financial Asset and Financial Liability
Equity instrument. Any contract that evidences a residual
interest in the assets of an entity after deducting all of its
liabilities.
5-5
Financial Asset and Financial Liability
Initial recognition
A financial asset or financial liability should be recognised
in the statement of financial position when the reporting
entity becomes a party to the contractual provisions of the
instrument.
On recognition, IFRS 9 requires that financial assets are
classified as measured at either:
Amortised cost, or
Fair value.
5-6
Financial Asset and Financial Liability
Initial recognition
A financial asset is classified as measured at amortised cost
where:
a) The objective of the business model within which the
asset is held is to hold assets in order to collect
contractual cash flows
b) The contractual terms of the financial asset give rise on
specified dates to cash flows that are solely payments of
principal and interest on the principal outstanding
5-7
Financial Asset and Financial Liability
Example: amortised cost
On 1 January 20X1 Abacus Co purchases a debt instrument
for its fair value of $1,000. The debt instrument is due to
mature on 31 December 20X5. The instrument has a
principal amount of $1,250 and the instrument carries fixed
interest at 4.72% that is paid annually. The effective rate of
interest is 10%.
How should Abacus Co account for the debt instrument over
its five year term?
5-8
Financial Asset and Financial Liability
Solution
Abacus Co will receive interest of $59 (1,250 4.72%) each
year and $1,250 when the instrument matures.
Abacus must allocate the discount of $250 and the interest
receivable over the five year term at a constant rate on the
carrying amount of the debt. To do this, it must apply the
effective interest rate of 10%.
The following table shows the allocation over the years:
5-9
Financial Asset and Financial Liability
Viking issues $100,000 5% loan notes on 1 January 20X4,
incurring issue costs of $3,000. These loan notes are
redeemable at a premium, meaning that the effective rate of
interest is 8% per annum.
What is the finance cost to be shown in the statement of
profit or loss for the year ended 31 December 20X5?
A. $8,240
B. $7,981
C. $7,760
D. $8,000
5-10
Financial Asset and Financial Liability
Answer B
The loan notes should initially be recorded at their net proceeds, being
the $100,000 raised less the $3,000 issue costs, giving $97,000. This
should then be held at amortised cost, taking the effective rate of interest
to the statement of profit or loss. The annual payment will be the coupon
rate, which will be 5% x $l00,000 = $5,000 a year.
Applying this to an amortised cost table gives $7,981, as shown below.
B/f
Interest 8%
Payment
c/f
$
$
$
$
20X4
97,000
7,760
(5,000)
99,760
20X5
99,760
7,981
If you chose C, you have done the calculation you 20X4.
If you chose D, you have used 8% of the full $100,000 and done the
calculation for 20X4.
If you chose A, you have used 8% of the full $100,000
5-11
Financial Asset and Financial Liability
Subsequent measurement of equity instruments
After initial recognition equity instruments are measured at
either fair value through profit or loss (FVTPL) or fair
value through other comprehensive income (FVTOCI).
If equity instruments are held at FVTPL no transaction costs
are included in the carrying amount.
5-12
Financial Asset and Financial Liability
Example:
What is the default classification for an equity
investment?
A. Fair value through profit or loss
B. Fair value through other comprehensive income
C. Amortised cost
D. Net proceeds
Financial Asset and Financial Liability
Example:
DEF Co has purchased an investment of 15,000 shares on 1 August
20X6 at a cost of $6.50 each. Transaction costs on the purchase
amounted to $1,500.
As at the year end 30 September 20X6, these shares are now worth
$7.75 each.
Select the correct gain and the place it will be recorded
Gain
Where to recorded
17,250
OCI
18,750
Statement of profit or loss
Financial Asset and Financial Liability
Financial Assets held for trading will be valued at Fair Value
through Profit or Loss. These are therefore valued excluding
Any transaction costs (which will be expensed to profit or
loss).
Financial Asset and Financial Liability
IFRS9
Equity instruments can be held at FVTOCI if:
a) They are not held for trading (ie the intention is to hold
them for the long term to collect dividend income)
b) An irrevocable election is made at initial recognition to
measure the investment at FVTOCI If the investment is
held at FVTOCI, all changes in fair value go through
other comprehensive income. Only dividend income will
appear in profit or loss.
Financial Asset and Financial Liability
Example:
ABC Co purchased 10,000 shares on 1 September 20X4,
Making the election to use the alternative treatment under
IFRS 9. The shares cost $3.50 each. Transaction costs
associated with the purchase were $500.
At 31 December 20X4, the shares are trading at $4.50 each.
What is the gain to be recognised on these shares for
the year ended 31 December 20X4?
Financial Asset and Financial Liability
Answer:
The investment should be classified as Fair Value through
Other comprehensive income.
As such, they will initially be valued inclusive of transaction
costs.
Therefore, the initial value is 10,000 x $3.50 = $35,000 +
$500 = $35,500.
At year-end, these will be revalued to fair value of $4.50
each, therefore 10,000*$4.50 =$45,000.
The gain is therefore $45,000 - $35,500 = $9,500.
Financial Asset and Financial Liability
Example:
For which category of financial instruments are
transaction costs excluded from the initial value, and
instead expensed to profit or loss?
A. Financial Liabilities at amortised cost
B. Financial Assets at fair value through profit or loss
C. Financial Assets at fair value through other
comprehensive income
D. Financial Assets at amortised cos
Financial Asset and Financial Liability
IFRS 9 Summary
Financial Instrument
Initial and
IFRS9 Classification subsequent
measurenent
Value changes
Debt instrument
Amortized cost
Amortized cost
Not relevant
Debt instrument
FVTPL
FV
TPL
Equity Instrument
FVTOCI-if
irrecovable election
FV
made on initial
recognition
TOCI
Equity Instrument
FVTPL
FV
TPL
Financial Liability
FVTPL
FV
TPL
Financial Liability
Amortized cost
Amortized cost
Not relevant
Financial Asset and Financial Liability
Compound financial instruments
Some financial instruments contain both a liability and an
equity element. In such cases, IAS 32 requires the
component parts of the instrument to be classified
separately, according to the substance of the contractual
arrangement and the definitions of a financial liability and an
equity instrument.
Financial Asset and Financial Liability
Compound financial instruments
One of the most common types of compound instrument is
convertible debt. This creates a primary financial liability of
the issuer and grants an option to the holder of the
instrument to convert it into an equity instrument (usually
ordinary shares) of the issuer. This is the economic
equivalent of the issue of conventional debt plus a warrant to
acquire shares in the future.
Financial Asset and Financial Liability
Example:
Rathbone Co issues 2,000 convertible bonds at the start of
20X2.The bonds have a three year term, and are issued at
par with a face value of $1,000 per bond, giving total
proceeds of $2,000,000. Interest is payable annually in
arrears at a nominal annual interest rate of 6%. Each bond is
convertible at any time up to maturity into 250 ordinary
shares.
When the bonds are issued, the prevailing market interest
rate for similar debt without conversion options is 9%.
Required
What is the value of the equity component in the bond?
Financial Asset and Financial Liability
Solution
Principal
$2,000,000 discounted at 9% over 3 years:
2,000,000 ÷ 1.09 ÷ 1.09 ÷ 1.09
1,544,367
Interest
Year 1 120,000 ÷ 1.09
110,091
Year 2 110,091 ÷ 1.09
101,002
Year 3 101,002 ÷ 1.09
92,662
303,755
Value of liability component
1,848,122
Equity component (balancing figure)
151,878
Proceeds of bond issue
2,000,000
Financial Asset and Financial Liability
Question:
A company issues $20m of 4% convertible loan notes at par
on 1 January 2009. The loan notes are redeemable for cash
or convertible into equity shares on the basis of 20 shares
per $100 of debt at the option of the loan note holder on 31
December 2011. Similar but non-convertible loan notes
carry an interest rate of 9%.The present value of $1
receivable at the end of the year based on discount rates of
4% and 9% can be taken as:
Required
Show how these loan notes should be accounted for in
the financial statements at 31 December 2009
Financial Asset and Financial Liability
End of year 1
2
3
Cumulative
4%
$
0.96
0.93
0.89
2.78
9%
$
0.92
0.84
0.77
2.53
Financial Asset and Financial Liability
Solution:
$
Statement of profit or loss
Finance costs (W2)
Statement of financial position
Equity – option to convert (W1)
Non-current liabilities
4% convertible loan notes (W2)
1,568
2,576
18,192
Financial Asset and Financial Liability
Solution:
Working 1:
Equity and liability elements
3 years interest (20,000 × 4% × 2.53)
Redemption (20,000 × 0.77)
Liability element
Equity element (β)
Proceeds of loan notes
$'000
2,024
15,400
17,424
2,576
20,000
Financial Asset and Financial Liability
Solution:
Working 2:
Loan note balance
Liability element (W1)
Interest for the year at 9%
Less interest paid (20,000 × 4%)
Carrying value at 31 December 2009
$'000
17,424
1,568
(800)
18,192