Unit 7: Financial Instruments –IFRS 7 and 9; IAS 32

7.1 Introduction

Accounting for financial instruments is extremely complex and dealt with by three separate
accounting standards as follows:

1. IFRS 9, Financial Instruments (replaces IAS 39, Financial Instruments: Recognition and
Measurement, from 1 January 2018);
2. IFRS 7, Financial Instruments: Disclosures;
3. IAS 32, Financial Instruments: Presentation.

IFRS 9, IFRS 7 and IAS 32 establish principles for the financial reporting of financial assets and
financial liabilities that will present relevant and useful information to users of financial
statements for their assessment of the amounts, timing and uncertainty of an entity’s future cash
flows.

7.2 Definitions
a. Financial instrument.
Any contract which gives rise to both a financial asset of one entity and a financial
liability or equity instrument of another entity.
b. Financial asset.
A financial asset is any asset that is:
1. Cash.
2. An equity instrument of another entity.
3. A contractual right:
i. To receive cash or another financial asset from another entity; or
ii. To exchange financial instruments with another entity under conditions that
are potentially favorable.
4. A contract that will be settled in the reporting entity’s own equity instruments and is:
i. A non-derivative for which the entity is, or may be obligated, to receive a
variable number of its own equity instruments; or
ii. A derivative that will, or may, be settled other than by the exchange of a fixed
amount of cash or another financial asset for a fixed number of the entity’s
own equity instruments (which excludes puttable financial instruments
classified as equity and instruments that are themselves contracts for the
future receipt or delivery of the entity’s equity instruments).
c. Financial liability.
Any liability which meets either of the following criteria:
1. A contractual obligation:
a. To deliver cash or another financial asset to another entity; or
b. To exchange financial instruments with another entity under conditions which are
potentially unfavorable to the entity.

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2. A contract that will, or may, be settled in the entity’s own equity instruments and is:
a. A non-derivative for which the entity is, or may, be obligated to deliver a variable
number of its own equity instruments; or
b. A derivative that will, or may, be settled other than by the exchange of a fixed
amount of cash or another financial asset for a fixed number of the entity’s own
equity instruments (which excludes puttable financial instruments classified as
equity and instruments that are themselves contracts for the future receipt or
delivery of the entity’s equity instruments).

Examples of financial assets and financial liabilities

Financial asset/Financial
liability
Currency (cash) is a financial
asset
A deposit of cash with a bank or
similar financial institution is a obtain cash from the institution or to draw a cheque or
financial asset
Common financial assets and
financial liabilities
- trade accounts receivable and
payable
- loans receivable and payable
A financial gurantee
Reason
It represents the medium of exchange and is therefore
the basis on which all transactions are measured and
recognised in annual financial statements.
It represents the contractual right of the depositor to
similar instrument against the balance in favour of a
creditor in payment of a financial liability.
In each case, one party's contractual right to receive (or
obligation to pay) cash is matched by the other party's
corresponding obligation to pay (or right to receive).
It is a contractual right of the lender to receive cash
from the guarantor, and a corresponding
contractual obligation of the guarantor to pay the
lender, if the borrower defaults. The contractual
right and obligation exist because
of a past transaction or event (assumption of
the guarantee), even though the lender's ability
to exercise its right and the requirement for the
guarantor to perform under its obligation are
both contingent on a future act of default by the
borrower. A contingent right and obligation meet
the definition of a financial asset and a
financial liability, even though such assets and
liabilities are not always recognised in the
annual financial statements.

The following are NOT financial assets and financial liabilities – IAS 32
Item Reason
Physical assets such as: Control of such physical and intangible assets creates
- Inventories an opportunity to generate an inflow of cash or

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 - Property, plant and equipment
Leased assets (operating lease)
Prepaid expenses
another financial asset, but it does not give rise to a
present right to receive cash or another financial
asset.
An operating lease is an uncompleted contract
committing the lessor to provide the use of an asset in
future periods in exchange for consideration similar
to a fee for a service. The lessor continues to account
for the leased asset itself (rather than any amount
receivable in the future under the contract, i.e. a
finance lease).
The future economic benefit is the receipt of goods or
services, rather than the right to receive cash or
another financial asset.

7.3 Recognition
Initial recognition
An entity shall recognise a financial asset or a financial liability on its statement of financial
position when, and only when, the entity becomes a party to the contractual provisions of the
instrument.
Example 1
At what stage shall an entity recognise the following items on its statement of financial
position?
1. Unconditional receivables and payables
Recognized 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.
2. Assets to be acquired and liabilities to be incurred as a result of a firm commit-ment to
purchase or sell goods or services
It is 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.
 If a firm commitment to buy or sell non-financial items is within the scope of this
standard, its net fair value is recognised as an asset or liability on the commitment
date.
3. Planned future transactions
No matter how likely they are, they are not assets and liabilities because the entity has not
become a party to a contract.

7.4 Measurement of Financial Instruments

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7.4.1 Definitions
a. Fair value
Fair value is of a instrument would be the price/amount at which the asset (or
liability) could be bought or sold in a current transaction between willing parties, or
transferred to an equivalent party.
b. 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.
7.4.2 Classification of financial assets and financial liabilities
Financial assets
An entity shall classify financial assets as subsequently measured at either amortised
cost or fair value on the basis of both:
a. An entity’s business model for managing financial assets
b. The contractual cash flow characteristics of the financial asset
A financial asset shall be measured at fair value unless it is measured at amortised cost.
The following financial asset categories will be dealt with:
 Financial assets measured at fair value through profit or loss and
 those measured at fair value through other comprehensive income.
7.4.3 Initial measurement of financial assets and financial liabilities
Financial asset category Initial measurement
 Financial assets/liability at fair  At fair value, excluding
value through profit or loss. transaction costs
 Financial assets at fair value  At fair value + transaction costs
through other comprehensive
income (Investments in equity
– not held for trading)

The fair value of a financial instrument on initial recognition is normally the transaction
price (i.e. the fair value of the consideration given or received).
Example 2
M Ltd bought 1 000 ordinary shares in N Ltd at E 5.00 per share. Transaction cost
amounted to E 500.
Required:
Journal entries at initial recognition in the financial records of A Ltd when the financial
asset is recognised at:
a. At fair value through other comprehensive income
b. At fair value through profit or loss

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 Solution
At fair value through other comprehensive income: Dr Cr
E E
Financial asset (SFP) [(1 000 x E 5.00) + E 500] 5500
Bank (SFP) 5500

At fair value through profit or loss:

Financial asset (1000 x E5.00) (SFP) 5000
Transaction cost (P/L) 500
Bank (SFP) 5500
7.4.4 Subsequent measurement of financial assets
After initial recognition, an entity shall measure a financial asset at:
 Amortised cost (not dealt with in this module); or
 Fair value through profit or loss; or
 Fair value through other comprehensive income.

The accounting treatment of financial assets can be summarised as follows:

Financial asset Initial measurement Subsequent Gain and losses on

category measurement re-mesurement
Financial Cost (being fair value but Fair value Recognised in profit
assets at fair excluding transaction costs) or loss
value
through
profit or loss
Financial assets at Cost (being fair value Fair value Recognised in other
fair value through including transaction costs) comprehensive
other income and
comprehensive accumulated in equity
income (mark-to-market
(Investments in reserve)
equity – not held
for trading)
Example 3
Mix Ltd. acquired 2 000 shares in Max Ltd at a price of E 10.00 per share. The shares were
acquired on 1 January 2019 and are held for trading. Transaction costs amounted to E 700. At
year-end (31 December), the market value of one Waterloo Ltd share was E 14.00.
Required
Journal entries to account for the investment in the financial records of Mix Ltd for the year
ended 31 December 2019 in accordance with the requirements of International Financial
Reporting Standards (IFRS).
Solution
Dr Cr

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Initial measurement 1 January 2019 E E
Investment in shares (2000x10) [SFP] 20 000
Transaction cost (Profit/loss) 700
Bank (SFP) 20 700
Subsequent measurement 31 December 2019
Investment in shares [(2000x14)-20 000] (SFP) 8 000
Fair value adjustment (profit/loss) 8 000

Example 4
Mix Ltd. acquired 2 000 shares in Max Ltd at a price of E 10.00 per share. The shares were
acquired on 1 January 2019 and are NOT held for trading. Transaction costs amounted to E 700.
At year-end (31 December), the market value of one Waterloo Ltd share was E 14.00.
Required
Journal entries to account for the investment in the financial records of Mix Ltd for the year
ended 31 December 2019 in accordance with the requirements of International Financial
Reporting Standards (IFRS).
Solution
Initial measurement 1 January 2019 E E
Investment in shares (2000x10) + 700 [SFP] 20 700
Bank (SFP) 20 700
Subsequent measurement 31 December 2019
Investment in shares [(2000x14)-20 700] (SFP) 7 300
Fair value adjustment (profit/loss) 7 300

7.4.5 Subsequent Measurement of Financial Liabilities

The accounting treatment of financial liabilities can be summarised as follows:

Financial liability Initial measurement Subsequent Gain and losses on

category measurement remeasurement
Financial liability at At cost (being fair Fair value Recognised in profit
fair value through value but excluding or loss (unless the FV
profit or loss transaction costs) changes are due to
credit risk then in
other comprehensive
income)
Amortised cost At cost (being fair Fair value Not applicable, but an
value interest component
including transaction will be recognised in
costs) profit or loss.

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7.5 Derecognition
7.5.1 Derecognition of a financial asset
Derecognition is the removal of a previously recognised financial asset from an entity's
statement of financial position. An entity shall derecognise a financial asset when, and only
when:
a. the contractual rights to the cash flows from the financial asset expire; or
b. the financial asset is transferred and the transfer qualifies for derecognition.
Financial assets recognized as “at fair value through other comprehensive income” or “at fair
value through profit or loss” must first be restated to fair value before recognition. This will
result in no additional profit or loss on derecognition provided that the asset was sold at fair
value.
7.5.2 Derecognition of a financial liability
An entity shall remove a financial liability (or a part of a financial liability) from its statement of
financial position when, and only when, it is extinguished, that is, when the obligation specified
in the contract is:
a. settled/discharged; or b) cancelled; or
b. expires.
A financial liability (or a part of it) is extinguished when the debtor either:
a. discharges the liability (or part of it) by paying the creditor, normally with cash, other
financial assets, goods or services; or
b. is legally released from primary responsibility for the liability (or part of it) either by
process of law or by the creditor. (If the debtor has given a guarantee this condition may
still be met.)
c. An exchange between an existing borrower and lender of debt instruments with
substantially different terms.
d. A change to the conditions of an existing debts instrument.

7.5 Presentation
7.5.1 Liabilities and equity
The issuer of a financial instrument shall classify the instrument, or its component parts,
on initial recognition as a financial liability, a financial asset or an equity instrument in
accordance with:
 the substance of the contractual arrangement, and
 the definitions of a financial liability, a financial asset and an equity instrument.
A critical feature in differentiating a financial liability from an equity instrument is the
existence of a contractual obligation of one party to the financial instrument (the issuer)
either to:
 deliver cash or another financial asset to the other party (the holder), or
 to exchange financial assets or financial liabilities with the holder under
conditions that are potentially unfavourable to the issuer.

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 Although the holder of an equity instrument may be entitled to receive a pro rata share of
any dividends or other distributions of equity, the issuer does not have a contractual
obligation to make such distributions because it cannot be required to deliver cash or
another financial asset to another party.
For example, a preference share that provides for mandatory redemption by the issuer for
a fixed or determinable amount at a fixed or determinable future date, or gives the holder
the right to require the issuer to redeem the instrument at or after a particular date for a
fixed or determinable amount, is a financial liability.
Example 5
Mix Ltd issued 1 000 redeemable preference shares on 1 January 2019. The shares are
redeemable in cash at the option of the holder. If the options are not exercised, the shares will be
redeemable on 31 December 2019.
Must the preference shares be presented as a financial liability or equity in the annual financial
statements of Mix Ltd?
The preference share redeemable in cash at the option of the holder, or redeemable by the issuer
on 31 December 2019, creates an obligation on the part of the issuer to deliver cash to the holder.
Therefore it meets the definition of a financial liability.
Example 6
Mix Ltd issued 1 000 redeemable preference shares on 1 January 2019. Mix Ltd has the option to
redeem the shares at any time.
Must the preference shares be presented as a financial liability or equity in the annual financial
statements of Lula-Lee Ltd?
Mix Ltd does not have a present obligation to transfer cash or financial assets to the holder and
therefore it does not meet the definition of a financial liability. The preference shares will be
presented as equity in the annual financial statements of Mix Ltd.
Example 6
M Ltd issued 1 000 convertible preference shares on 1 January 2019. The shares will be
converted to ordinary shares on 31 December 2022.
Must the preference shares be presented as a financial liability or equity in the annual financial
statements of MixLtd?
If the criteria for classification of an equity instrument is applied:
 the instrument includes no contractual obligation to deliver cash or another financial
asset, or to exchange financial asset, or to exchange financial asset or liabilities; and
 the instrument will be settled in the entity's own equity instruments (ordinary shares)
Therefore this is an equity instrument.
The latter represents a non-derivative that presents no contractual obligation to be settled by the
issuer by issuing a variable number of its ordinary shares (equity instruments).
If any entity does not have an unconditional right to avoid delivering cash or another financial
asset to settle a contractual obligation, the obligation meets the definition of a financial liability.
(IAS 32.19)

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A financial instrument that does not explicitly establish a contractual obligation to deliver cash or
another financial asset may establish an obligation indirectly through its terms and conditions.
For example:
a. a financial instrument may contain a non-financial obligation that must be settled if, and
only if:
 the entity fails to make distributions, or
 to redeem the instrument.
If the entity can avoid a transfer of cash or another financial obligation only by settling the non-
financial obligation, the financial instrument is a financial liability;

b. financial instrument is a financial liability if it provides that on settlement the entity

will deliver either:
 cash or another financial asset, or
 its own shares whose value is determined to exceed substantially the value of the
cash or other financial asset. (IAS 32.20)

7.5.2 Interest, Dividends, Losses and Gains

Items such as interest, dividends, losses and gains relating to a financial instrument or a
component that is a financial liability shall be recognised as income or expense in profit or loss.
Dividend payments on shares wholly recognised as liabilities are recognised as expenses in the
same way as interest on a bond.
Gains and losses associated with redemption or refinancing of financial liabilities are recognised
in profit or loss.
Redemption or refinancing of equity instruments are recognised as changes in equity.
Changes in fair value of the entitys’ equity instruments are not recognised in the annual financial
statements.
7.6 Disclosure
Disclosure of financial instruments is covered in IFRS 7
Example 7
Max Ltd owns 50 000 ordinary shares in Mix Ltd. These shares were purchased for E 50 000.
Transaction costs amounted to E1 000. These shares trade on the ESE (Eswatini Stock
Exchange) and the market value at year end were E 3 per share. These shares are held for
speculative purposes.
Required
Discuss how the above transaction will be disclosed in the financial statements.
Solution
Step 1: Identify category; At fair value through profit or loss
 Measurement: Fair value (Excl. transaction cost)
 Initial recognition: E 50 000
 Year-end @ fair value: 50 000 shares x E3 = E150 000
 Fair value adjustment on year end: E150 000 – E50 000 = E100 000.
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Disclosure:
 Recognise the fair value adjustment in “profit or loss” in SOCI and profit before tax
note
 Investments will disclosed at fair value under “Current assets” in the statement of
financial position
Example 7
Max Ltd owns 50 000 ordinary shares in Mix Ltd. These shares were purchased for E 50
000. Transaction costs amounted to E 1 000. These shares trade on the ESE and the
market value at year end were E3 per share. This investment was designated as not-held-
for-trading.
Required
Discuss how the above transaction will be disclosed in the financial statements.
Solution
Identify category: At fair value through other comprehensive income
 Measurement: Fair value (Incl. transaction costs)
 Initial recognition: E50 000 + E1 000 = E51 000
 Measurement at year end @ fair value: 50 000 shares x E3 = E150 000
 Fair value adjustment: E150 000 – E51 000 = E99 000.
Disclosure:
 Recognise the fair value adjustment in “other comprehensive income” in SOCI
and mark-to-market reserve in SOCE
 Investments will be disclosed at fair value under Non-current assets in the
statement of financial position

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