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Prepared by
John Andrews aka Paddingtonbear
Financial Instruments (FI) :
Financial Assets (FA) & Financial Liabilities (FL)
ACCA. Student Accountant. Article. December 2008. Page 48 - 53. Financial Instruments. Tom Clendon
IAS 32 F.I. Presentation
IAS 39 F.I. Recognition & Measurement
IFRS 7 F.I. Disclosure
http://www.iasplus.com/standard/ias32.htm
http://www.iasplus.com/standard/ias39.htm
http://www.iasplus.com/standard/ifrs07.htm
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FI
FA
FL
Equity - Capital
Debt - Capital
Convertible Bond
Redeemable Preference Share
Categories of FA
H. A. L. F
Category of
asset
Description / features
H eld to Maturity
Fixed payments & maturity that
the entity has intention and
ability to hold until maturity
Valued at amortised cost
using effective ir
Hold a fixed interest or
fixed term bond for whole
of it’s life
A vailable for
sale
Any FA designated as such or
not fitting into any other FA
category
Valued at FV
Changes in FV recognised
in ST of Equity - OCI
Dividends recognised in
SoCI
Long term investment in
equity shares
L oans &
Receivables
Created by the entity by
providing goods, services,
money direct to a debtor
Measured at amortised cost
Trade debtors
F V through
SoCI
Derivatives & FA held/acquired
for selling in the short term
After Initial recognition
Measure at FV
Changes in FV recognised
in SoCI
Equity investment held in
the short term for trading
FV is the amount an asset
could be exchanged, liability
settled, between
knowledgeable, willing parties
in arms length transaction
Accounting treatment
example
Derivative held for
speculation
This is a complex area so the examiner has limited himself to 3 possible topics . . . and said he will never
complicate these issues beyond the descriptions below :
1). Distinguishing Equity & Debt :
Debt contract rights to repayment & Interest . . incl redeemable pref shares
Equity does NOT have a this contractual obligation. . . but has voting rights
2). Accounting for Assets at FV :
Assets at FV are carried at FV . . Gains / losses go to SoCI
3). Convertible Debt :
Slightly complicated . . Examiner expects you to split loan between debt &
equity and unwind the debt (example ?)
--------------------------------------------------------------------------------------------------------------------------------------------------Kaplan tutor said, “in exam you will need to know the following” :
1) Definitions
2) Measurement . . What to record in SoFP & SoCI
3) Difference between a FL and FA
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Definitions :
FI
FA FL
FI = contract that gives rise to FA in one entity and a FL or
equity instrument in another entity
Company A
Company B
Asset
liability / equity
Bank . . Lends loan
loan agreement
takes loan from bank
creates a debtor
Creates a liability
FA has 4 categories
2 debtor balances :
split into 2 groups of asset
types
Cash
2 investment assets
Contract that will / may be settled with entity own
equity . . .
Options
A contractual right to receive cash or another
financial asset from another entity . .
Equity of another entity
Shares
Trade Receivables
Measure debtors at amortised costs
To match value of liability held by the other
company
FL
measurement
reason
Mark to market
SoFP reflects MV of investment
Change in value . .Gains / loss . . Recognised in
SoCI
= any liability that is a contractual obligation to :
Deliver cash or another FA to another entity . . . . . . . . . . . . . . . . . . . . . . Trade Payables
Exchange FA /FL with another entity under unfavourable conditions . . . . .Debenture loans ??
Contract that may be settled in entities own equity . . . . . . . . . . . . . . . . . Redeemable preference shares
e.g. Redeemable preference shares . . to raise finance . . to finance projects . . Fixed dividend paid yearly .
. initial loan repaid at agreed future date . . Show as loan
Substance Over Form principle . . in substance this is a loan . . not equity
(commercial substance of FI may differ from it’s strict legal form . . . some FI takes legal form of equity and others
liability . . . . Other FI combine features of equity and liability) . . . i.e. compound instrument
A company will argue that a convertible should be reflected as equity because of the likely hood of it being
converted at term end . . . this of coarse affects ratios and disclosure favourably . . . Manipulation . . . .off balance
sheet finance . . . financial structure, D/E gearing ratio and caveats
IAS 32 & 39 does not allow this . . . Instead calculate FV of liability component by. . . .
FV = PV of future cash flows from liability
Assume loan will not be converted but repaid at PV of future cash flows . .
PV requires DF based on ir that would be applied to similar liabilities = effective rate . . . (always higher rate in exam)
Example : Compound Instrument ;
A company issues 20,000 convertible bonds, with 3 year term, issued at par with face value of £100 each, total
proceeds from issue £2m, nominal interest payable annually in arrears at 6%, prevailing market ir for similar debt
without conversion is 9% . . . . . Show how FI will be split ?
Initial recognition :
Yr
1
2
3
cash flow
(6%*32m) 120,000
120,000
2,120,000
DF 9%
.917
.842
.772
(Balancing figure)
Yr
1
2
3
initial recognition
O/b
1,848,000
+
1,895,840
+
1,947,507
+
finance cost - SoCI
effective ir 8%
147,840
151,667
155,800
-
PV
110,000
101,000
1,637,000
1,848,000
152,000
2,000,000
6% interest paid
cash flows
(100,000)
(100,000)
(100,000)
Disclosure
Debt CR SoFP
Equity CR SoFP
Cash DR bank
Liability
Equity
initial cash inflow
c/b
1,895,840
1,947,507
2,000,000
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Disclosure of Compound Instruments :
Using above example : how would this convertible Bond look in the financial statements after the first year?
SoFP - Capital Account
- Equity
SoFP - Long Term Liability - Creditor > 1 year
£ 152,000
£ 1,895,840
SoCI - Finance Cost
£ 147,840
Purpose of disclosure : IAS 32, IAS 39, IFRS 7, and substance over form principle :
Provide information that will enhance understanding of the significance of on-balance-sheet and off-balancesheet FI to the entities overall financial position, performance and cash flows
To help with assessing timing, amounts and certainty of future cash flows associated with those FI
----------------------------------------------------------------------------------------------------------------------------------------------------Amortisation :
In the above example the convertible bond was amortised
The finance cost for yr 1 of £147,840 = amount of amortisation . . obtained using effective ROI of 8% . . this is
taken to SoCI as a finance charge for the year
This amortisation amount is also added to initial recognition . . Which increases CV in the SoFP at end of yr 1
You can see from disclosure above the financial statement extracts . . . And how to treat these items
1).
If we account for land at cost then CV will not change because historic cost does not change
2).
For plant, which has a limited life, we can account for it using depreciated cost . . .although he asset is never
revalued . . CV reduces each year reflecting depn charge
3). If we account for a liability using amortised cost then . . It has not been revalued . . But will increase each year
by the effective rate of interest . . (DR as expense in SoCI - CR liability) this is reduced simultaneously by
amount of nominal interest actually paid each year (Dr liability - CR cash)
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Exercise : which of the following are FI ?
1) inventories
2) investment in ordinary shares
3) prepayments for goods & services
4) liability for income tax
5) a share option
1)
2)
3)
4)
5)
physical assets or NCA are not FI . . .there is no contractual right to receive cash or another FI
is a FA because it is an equity instrument of another entity
not FI because future economic benefit will be receipt of goods/services not an FA
not a FI because obligation is statutory not contractual
is a FI because a contractual obligation exists to deliver equity instrument
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Debt Instrument Amortised Costs :
Debt is issued for £1,000. Redeemable at £1,250. Term of debt is 5 years. Interest is paid at 5.9%. Effective ir is
10%
Required : show amounts charged to finance cost each year and amount to be recognised in SoCI
Yr
1
2
3
4
5
open bal
Cash rec’d
1000
1,041
1,086
1,136
1,191
10% ir
effective
+
+
+
+
+
100
104
108
114
119
545
-
5.9% payment
made
c/b
(59)
(59)
(59)
(59)
(59)
1,041
1,086
1,136
1,191
1,250
£545 = Finance charges to SoCI
_______________________________________________________________________________________
01/10/2004 company issued 50,000 redeemable preference shares with par value £100 each to investors at £55.
Redeemable on30/09/2009 with coupon rate of 2%. Effective ir 15.62%
How would these appear in financial statements for years ending 30/09/2005 and 30/09/2006 ?
Proceeds 50,000 * £55 = £2,750,000
Yr end
o/b
30/09/2005
30/09/2006
2,750
3,080
Annual payments 50,000 * 2% = 3100,000
finance costs
15.62%
430
481
SoFP y/e 30/09/2005
Liabilities > 1 year - pref share
3,080
SoCI - Finance Charge
430
SoFP y/e 30/09/2006
Liabilities > 1 year - pref share
3,461
SoCI - Finance Charge
481
cash paid
2%
(100)
(100)
c/b
3,080
3,461
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