Download Financial Assets At Fair Value Through Profit or Loss

IFRS Seminar
IAS 39 Financial Instruments:
Recognition and Measurement
Overview of session
• Review of key concepts
• Classification of financial assets
• Measurement of financial assets
• Impairment of financial assets
• Reclassification and tainting
• Conclusion
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Review of key concepts
A financial instrument is any contract that gives rise to a financial
asset of one entity and a financial liability or equity instrument of
another entity.
An equity instrument is any contract that evidences a residual interest
in the assets of another
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Review of key concepts
A financial asset is any asset that is cash, an equity instrument of
another entity, a contract that (subject to certain conditions) will or may
be settled in the entity’s own equity instruments or a contractual right:
•
To receive cash or another financial asset from another entity; or
•
To exchange financial assets or financial liabilities with another entity
under conditions that are potentially favourable to the entity.
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Review of key concepts
A financial liability is any liability that is a contract that (subject to
certain conditions) will or may be settled in the entity’s own equity
instruments or a contractual obligation:
•
To deliver cash or another financial asset to another entity; or
•
To exchange financial assets or financial liabilities with another entity
under conditions that are potentially unfavourable to the entity
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Classification – Financial assets (Four categories)
• Financial assets at fair value through profit or loss
• Loans and receivables
• Held to maturity
• Available for sale
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Classification – Financial liabilities (Two
categories)
•
Financial liabilities at fair value through profit or loss and
•
Other financial liabilities
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Classification – Financial Assets
At Fair Value Through Profit or Loss (FVTPL)
At fair value through profit or loss
Held for trading
Intention of short term profit;
Derivatives – unless hedges
or financial guarantee contracts
Designated at
inception
3 criteria for designation;
Irrevocable
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Classification – Financial Assets
At Fair Value Through Profit or Loss (FVTPL)
The fair value option
Available only if either of the 3 criterion met. These criteria are generally
only met by financial institutions and other organisations with sophisticated
treasury operations.
Criterion 1
Accounting
mismatch
Criterion 2
Manage as
a portfolio on
a fair value
basis
Criterion 3
Embedded
derivative
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Classification - financial assets
Loans and receivables
Fixed or
Not quoted
Nondeterminable in an active
derivative
payments
market
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Classification - financial assets
Held to maturity
Fixed or
Nondeterminable
derivative
payments
Fixed
maturity
Entity has a
positive
intention
and ability
to hold to
maturity
There are tainting rules that can stop an entity
classifying assets as financial assets held-to-maturity
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Classification - financial assets
Available-for-sale
Nonderivative
Not
classified in
any of the
other
categories
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Why Is Classification Important?
Because it drives subsequent measurement of the financial asset…
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Measurement of financial assets
• Initial recognition
- When (i.e. timing)
- How much (i.e amount)
- Which account (i.e category)
• Transaction costs
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Transaction costs
Directly
attributable and
incremental
All categories
apart from Fair
Value Through
Profit or Loss –
include in initial
measurement
Fair value
through profit
or loss - expense
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Subsequent Measurement
Financial assets at fair value
through profit or loss
Loans and receivables
Held to maturity
Available for sale
At FV through
profit or loss
At amortized cost
At FV through
equity
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Example: Initial fair value
An entity enters into a marketing agreement with another organisation.
As part of the agreement the entity makes a two year £5,000 interest
free loan. Equivalent loans would normally carry an interest rate of 6%,
given the borrower’s credit rating. The entity made the loan in
anticipation of receiving future marketing and product benefits.
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Example: Initial fair value
Solution:
The fair value of the loan can be determined by discounting the future
cash flows to present value using the prevailing market interest rate for
a similar instrument with a similar credit rating. The present value of
the cash flow in two years time at 6% is £4,450 (£5,000 × (1/1.062)). On
initial recognition of the financial asset the entity should recognise a
loss of £550 as follows:
DR Loan
£4,450
DR Loss (finance expense)
CR
Cash
£550
£5,000
The difference between this initial amount recognised of £4,450 and the
final amount received of £5,000 should be treated as interest received
and recognised in profit or loss over the two year period.
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Example: At fair value through profit or loss
An entity acquired a derivative on 1 May 20X6 for £200 cash. On 31
December 20X6, the next reporting date, the fair value of the derivative
was £340. On 31 December 20X7 the derivative’s fair value had fallen to
£220.
Set out the journal entries to record these transactions.
Solution:
On 1 May 20X6:
DR Derivative financial asset
£200
CR Cash
£200
On 31 December 20X6:
DR Derivative financial asset
£140
CR Profit or loss – gain on financial asset (£340 – £200)
£140
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Example: At fair value through profit or loss
Solution:
On 31 December 20X7:
DR Profit or loss – loss on financial asset (£340 – £220)
CR Derivative financial asset
£120
£120
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Exercise: Held to maturity
An entity acquires a zero coupon bond with a nominal value of £20,000
on 1 January 20X6 for £18,900.
The bond is quoted in an active market and broker’s fees of £500 were
incurred in relation to the purchase. The bond is redeemable on 31
December 20X7 at a premium of 10%. The effective interest rate on the
bond is 6.49%.
Requirement
Set out the journals to show the accounting entries for the bond until
redemption if it is classified as a held-to-maturity financial asset. The
entity has a 31 December year end.
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Exercise: Held to maturity
Solution:
On 1 January 20X6
DR Financial asset (£18,900 plus £500)
CR Cash
£19,400
£19,400
On 31 December 20X6
DR Financial asset (£19,400
6.49%)
CR Interest income
£1,259
£1,259
On 31 December 20X7
DR Financial asset ((£19,400+£1,259) x 6.49%)
CR Interest income
DR Cash
CR Financial asset
£1,341
£1,341
£22,000
£22,000
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Held to maturity and Available for sale
clasifications
Example:
An entity acquired a 6% £1,000 par value financial asset for its fair
value of £970 at the beginning of Year 1. Interest of 6% was receivable
annually in arrears. The financial asset was redeemable at the end of
Year 3 at £1,030, a premium of 3% to par value. The financial asset is
quoted in an active market and was classified as held to maturity by the
entity.
Held-to-maturity financial assets should be measured at amortised cost.
The effective interest rate of the financial instrument can be calculated
at 8.1%. The rate is higher than the coupon rate, because it amortises
the discount on issue and the premium on redemption.
The amortised cost carrying amount should be determined as follows.
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Amortised cost and effective interest method
Solution:
Year
Opening
Interest @ 8.1%
Cash flow
Closing balance
balance
in profit or loss
£
£
£
£
1
970
78
(60)
988
2
988
80
(60)
1,008
3
1,008
82
(1,090)
0
If the entity had classified the financial asset as available for sale, the
asset should have been measured at fair value at each reporting date.
If the fair values of the financial asset at the end of Year 1 and Year 2
were £1,100 and £1,050, the financial asset should have been
recognised at the following amounts.
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Amortised cost and effective interest method
Solution:
If the entity had classified the financial asset as available for sale, the asset
should have been measured at fair value at each reporting date.
If the fair values of the financial asset at the end of Year 1 and Year 2 were
£1,100 and £1,050, the financial asset should have been recognised at the
following amounts.
Gain/(loss) in
Other
Opening Interest @ 8.1%
Compreh.
Year Balance in profit or loss Cash flow income (bal)
Closing
balance – fair
value
£
£
£
£
£
1
970
78
(60)
112
1,100
2
1,100
80
(60)
(70)
1,050
3
1,050
82
(1,090)
(42)
0
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Fair value measurement
IAS 39 defines fair value as:
“the amount for which an asset could be exchanged, or a liability
settled, between knowledgeable, willing parties in an arm’s length
transaction.”
Fair value = Transaction price (fair value of consideration given or
received)
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Fair value measurement
Example 1 – Interest free loan to an employee
An entity grants an interest free loan of € 1,000 to an employee for a
period of two years. The market rate of interest to this individual for a
two year loan payable at maturity is 10%.
What is the initial fair value?
Consideration given to employee consists of two assets:
• The fair value of the loan = €1,000/(1.10)2 = €826
• Difference of €174 is accounted for as employee compensation in
accordance with IAS 19, ‘Employee benefits’
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Fair Value Hierarchy
Active market –
Published quotations
No active market –
Valuation
Techniques
No active market –
Unreliable fair
value for equity
instrument – cost
less any
impairment
Best evidence
Alternative
Very rare
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Fair value measurement
Question 1
• Star owns 15% of shares of Moon.
•
Shares quoted on a local stock exchange, trading volume indicates
sufficiently active market.
• The quoted market price is €100 per share.
•
If decided to sell entire block of shares, the price they believe they
would be able to obtain would be €80 per share.
What value should be placed on the shares?
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Fair value measurement
Question 2
• Star purchases an AFS equity security for €100 and pays purchase
commission of €2.
• At the end of Star’s financial year, the security’s quoted market price
is €105. Commission of €3 would be payable if the security was sold on
that date.
What amount is recognised initially and at the end of the
financial year?
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Impairment of financial assets
Impairment occurs when
Carrying amount > Recoverable amount
Only relevant for financial assets carried at cost
or amortised cost and AFS financial assets
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Impairment of financial asset
Step 1 – Objective evidence of impairment
Step 2 – Calculate recoverable amount / fair value
Step 3 – Record impairment in profit & loss
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Impairment Indicators for debt instruments
Significant
difficulty of the
issuer
Lender grants
borrower in
financial
difficulty a
concession
that the
lender would
not otherwise
consider
Breach of
contract for
failure to pay
interest or
principal
Disappearance
of active
market
because of
financial
difficulties
National or local economic conditions
that correlate with defaults (eg a
decrease in property prices for
mortgages in a relevant area)
High
probability of
bankruptcy
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Impairment Indicators for AFS equity investments
In addition to impairment indicators for debt
instruments, indicators that are specific to equity
instruments include:
Significant adverse changes
that have taken place in the
technological, market,
economic or legal environment
in which the issuer operates.
Significant or
prolonged decline
in fair value below
cost
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Impairment AFS equity instruments
Significant
How do we define “significant”? Share price
subsequent to
year end?
Percentage
decline?
Judgement
Volatility relative to
current fair value
Decline consistent
with market
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Impairment AFS equity instruments
Prolonged
How do we define “prolonged”?
Length of time
held
Judgement
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Impairment Calculation - Example
AFS equity investment
Year
X0
X1
X2
X3
Fair Value
100
70
68
69
Impairment X1 = 100 – 70 = 30
X2 = 100 – 68 – 30 = 2
X3 = 100 – 69 – 32 = (1)  no impairment in PL
Start with ORIGINAL cost
Further decline in value is assessed against the original cost
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Reclassification between categories
Held-to-maturity
Available-for-sale
Available-for-sale
Held-to-maturity
Held for trading
Loans and
receivables
Reclassification out of FVTPL designated on initial recognition
is prohibited under any circumstances
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Reclassification out of HTM to AFS - Tainting
Entity sells more than an insignificant amount of HTM
investments
• Reclassify all investments to AFS at fair value.
• Entire HTM portfolio is tainted.
• Further classification not permitted for two years after sale.
Exceptions:
• The sale is close to maturity.
• Substantially all of the original principal collected before
sale.
• The sale is an isolated event outside the control of the entity.
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Reclassification out of AFS
To HTM :
•
Entity intends and has the ability to hold the loan to
maturity.
When the tainted held-to-maturity portfolio has been
‘cleansed’ at the end of the second financial year
following tainting.
•
To loans and Receivables:
The AFS asset meets the criteria to be classified as loans
and receivables at the date of reclassification and the
entity has the intention and the ability to hold the
financial asset for the foreseeable future or until maturity.
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Reclassification out of Held for Trading
To loans and receivables:
The Held for Trading asset meets the criteria to be
classified as loans and receivables at the date of
reclassification and the entity has the intention and the
ability to hold the financial asset for the foreseeable future
or until maturity.
To HTM or AFS
Transfer permitted only for assets that do not meet the
definition of loans and receivables at the date of
reclassification and only in ‘rare’ circumstances.
Rare -- Single event that is unusual and unlikely to recur in the
near term.
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Conclusion
Key points to remember
• Classification drives measurement
• Mixed measurement model – fair value or amortised cost
• Fair value hierarchy - quoted price best evidence of fair
value
• Impairment only if objective evidence
• Reclassifications are permitted only in certain
circumstances.
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Thank you!
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