IFRS 9 /IAS 32 Financial
Instruments
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Financial instruments
Any contract that gives rise to both:
a financial asset of one entity, and
a financial liability or equity instrument of another entity
Examples
primary instruments (e.g. receivables, payables and equity
securities)
derivative instruments (e.g. financial options, futures and
forwards, interest rate swaps and currency swaps).
Classification (IAS 32)
Any contract that gives rise to
both a financial asset of one
Financial entity and a financial liability
or equity instrument of
instruments another entity
Financial Financial Equity
assets liabilities instruments
(a) Cash Contractual obligation to: Any contract that
(b) Equity instrument of • Deliver cash/another FA evidences a residual
another entity • Exchange FA/FL under interest in the net
(c) Contractual right to: conditions potentially assets of an entity
• Receive cash/another unfavourable
FA
• Exchange FA/FL under
conditions potentially
favourable
Classification (IAS 32)
Financial instruments
Financial Equity
Financial assets
liabilities instruments
Any contract that gives
rise to both a financial
Compound
asset of one entity and a
instruments
financial liability or
equity instrument of
another entity
Derivative
A derivative – a financial instrument:
Value changes in response to the change
in a specified underlying
Requires little or no initial net investment
relative to other types of contracts
Settled at a future date.
Amortised cost
• Amount measured at initial recognition
minus
• Principal repayments
plus or minus
• Cumulative amortisation of any difference
between initial amount and maturity amount
minus
• Any write-down for impairment or
uncollectability.
Effective interest method
A method of calculating amortisation using the
effective interest rate
This rate exactly discounts the expected stream of
future cash outflows to the current net carrying
amount of the financial asset (or liability)
The computation should include all cash flows between
the parties to the contract.
Case Study – Amortised cost
Answer
Presentation (IAS 32)
• Financial instruments should be classified as:
– liabilities, or
– equity
in accordance with their substance on initial
recognition.
Compound instruments – Presentation
• Financial instruments containing both a liability
and an equity element are classified into their
component parts
• Convertible bonds:
– grant an option to the holder to convert them into
equity instruments
– consist of:
• the obligation to repay the bonds (a liability), and
• the option to convert (equity).
Compound instruments – Carrying amounts
• Equity component is the residual amount after
deducting the measurable debt component
based on the PV of the future payments relating
to the instrument
Case Study – Convertible bond
An entity issues 2,000 convertible, $1,000 bonds at par on 1st January 2015.
Interest is payable annually in arrears at a nominal interest rate of 6%. The
prevailing market rates of interest at the date of issue of the bond was 9%.
The bond is redeemable 31st December 2017.
Required:
Calculate the values at which the bond will be included in the financial statements
of the entity at initial recognition.
Convertible bond – Solution
$
Present value of principle
$2,000,000 × 0.772 1,544,000
Present value of interest stream
$120,000 × 2.531 303,720
Total liability component 1,847,720
Equity component (Balancing figure) 152,280
Proceeds of issue 2,000,000
Convertible bond 31 Dec 2015 – Solution
$
Present value of liability 1,847,720
Interest charge at 9% 166,295
Interest paid (120,000)
Liability balance 1,894,015
If this calculation was rolled forward for a further 2 years
the value of the liability would be $2,000,000
Initial Measurement Financial Asset
• On initial recognition, financial assets (except trade receivables) are
measured at fair value. If the financial asset is not classified as fair
value through profit or loss, any directly attributable transaction
costs are adjusted against the fair value.
• Trade receivables, which do not have a major financing element,
are measured at their transaction price in accordance with IFRS 15.
Subsequent Measurement Financial Asset
Once recognised, a financial asset is subsequently
measured at either:
Amortised cost;
Fair value through other comprehensive income; or
Fair value through profit or loss.
Amortised Cost
A financial asset is subsequently measured at amortised
cost if it meets two conditions:
1. It is held within a business model whose objective is
achieved through holding financial assets to collect
contractual cash flows; and
2. Its contractual terms give rise to cash flows on
specified dates which are solely payments of principal
and interest (on the outstanding principal).
Illustration 5 Amortised Cost
An entity purchased a debt instrument for $1,000. The
instrument pays interest of $60 annually and had 10 years
to maturity when purchased. The business model test
was met and the instrument was classified as a financial
asset at amortised cost.
Nine years have passed and the entity is suffering a
liquidity crisis and needs to sell the asset to raise funds.
The sale was not expected on initial classification and
does not affect the classification (i.e. there is no
retrospective reclassification).
Fair Value Through OCI
It meets two conditions:
1. It is held within a business model whose objective is achieved through
collect contractual cash flows and sell financial assets; and
2. Its contractual terms give rise to cash flows on specified dates, which are
solely payments of principal and interest.
Interest/dividends income based on the amortised cost of the asset is
recognised in the SOPL
Any difference in fair value is recognised in other comprehensive income.
Example
An entity anticipates the purchase of a large property in eight years’ time. The
entity invests cash surpluses in short and long-term financial assets. Many of the
financial assets purchased have a maturity in excess of eight years.
The entity holds the financial assets for their contractual cash flows but will sell
them and re-invest the cash for a higher return as and when an opportunity
arises.
The objective of the business model is achieved by collecting contractual cash
flows and selling the financial assets. The entity’s decisions to hold or sell aim to
maximise returns from the portfolio of financial assets.
This will be classified as FV through OCI
Fair Value Through Profit or Loss
• All other financial assets are measured at fair value
through profit or loss.
• On initial recognition an entity may irrevocably elect to
designate an equity instrument at fair value through
other comprehensive income.
• An entity can opt to designate any financial asset at
fair value through profit or loss in order to eliminate an
accounting mismatch .
Question: Financial transactions
Palermo has requested your advice on accounting for the
following financial instrument transactions:
(a) Palermo purchased $50,000 par value of loan notes at
a 10% discount on their issue on 1 January 20X6
intending to hold them until their maturity on 31
December 20X9. An interest coupon of 3% of par
value is paid annually on 31 December. Transaction
costs of $450 were incurred on the purchase. The
annual internal rate of return on the loan notes is
5.6%.
Question: Financial transactions (cont'd)
(b) Palermo purchased some shares in an unquoted
company as an investment for $12,000 during March
20X6. At the year end the directors stated that the
shares might be worth about $13,000, but a formal
valuation was unable to be performed due to lack of
data.
Question: Financial transactions (cont'd)
c) Palermo took out a speculative forward contract to buy
coffee beans for delivery on 30 April 20X7 at an agreed
price of $6,000 intending to settle net in cash. Due to a
surge in expected supply, a forward contract for
delivery on 30 April 20X7 would have cost $5,000 on 31
December 20X6.
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Question: Financial transactions (cont'd)
(d) In July 20X6 Palermo sold 12,000 shares for $16,800 (their
market price at that date). It had purchased the shares through
a broker in 20X5 for $1.25 per share. The quoted price at the
20X5 year end was $1.32 per share. The broker charges
transaction costs of 1% purchase/sale price.
Palermo makes the irrevocable election for the changes in fair value
of investments in equity instruments not held for trading to be
presented in other comprehensive income wherever possible.
Question: Financial transactions (cont'd)
Required
Explain how the above transactions should be
accounted for in the financial statements for the
year ended 31 December 20X6.
Answer: Financial transactions
(a) Loan notes
The loan notes should be held at amortised cost under IFRS 9 as the
company's business model was to hold them until maturity when purchased
and the contractual terms give rise to cash flows that are solely payments of
principal and interest on the principal amount outstanding. They are
therefore held at amortised cost as follows.
$
Cash paid on 1 January 20X6 ((50,000 × 90%) + 450) 45,450
Effective interest income (45,450 × 5.6%) 2,545
Coupon received (50,000 × 3%) (1,500)
Amortised cost at 31 December 20X6 46,495
Consequently, $2,545 of finance income will be recognised in profit or loss for
the year and there will be a $46,495 loan note asset.
Answer: Financial transactions (cont'd)
(b) Unquoted shares
Investments in equity instruments must always
be measured at fair value.
The shares will therefore remain at $12,000 as
an investment asset.
Answer: Financial transactions (cont'd)
(c) Forward contract
A forward contract is accounted for at fair value through profit or loss.
The value of a forward contract at inception is zero.
The value of the contract at the year end is:
$
Market price of forward contract at year end for delivery on 30 April
5,000
Palermo's forward price (6,000)
(1,000)
A financial liability of $1,000 is therefore recognised with a corresponding charge of
$1,000 to profit or loss.
Answer: Financial transactions (cont'd)
(d) Quoted shares sold
The shares are held at fair value through other comprehensive income due to
Palermo's accounting policy of holding investments in equity instruments not held
for trading at fair value through OCI wherever possible. They were originally recorded
at their cost of $15,150 in 20X5 and revalued to market value at the year end with a
gain of $690 reported in other comprehensive income:
$
20X5 Purchase ((12,000 × $1.25) + (1% $15,000)) 15,150
Fair value gain at 31.12.20X5 690
Fair value at 31.12.20X5 (12,000 × $1.32 bid price) 15,840
Answer: Financial transactions (cont'd)
At the date of the derecognition in July 20X6, the shares must first be
remeasured to their fair value (i.e. the sales price as they were sold at
market price) and the gain is reported in other comprehensive income
('items that will not be reclassified to profit or loss’):
DEBIT Financial asset (16,800 – 15,840) $960
CREDIT Other comprehensive income $960
Answer: Financial transactions (cont'd)
On derecognition, the transaction costs are charged to profit or loss:
DEBIT Cash (16,800 – (1% × 16,800)) $16,632
DEBIT Profit or loss (1% × 16,800) $168
CREDIT Financial asset $16,800
Tutorial note. Under IFRS 9, where the irrevocable election is made to hold an
investment in equity instruments not held for trading at fair value through other
comprehensive income, all changes in fair value up to the point of derecognition
are recognised in other comprehensive income and they are not subsequently
reclassified to profit or loss.
Categories of financial liability
• Fair value through profit or loss
• Amortised cost
Financial Liabilities – Initial recognition
• On initial recognition all Financial Liabilities are
measured at FV.
• If measured at amortised cost then any
transaction costs will be deducted
Financial Liabilities – Subsequent recognition
After initial recognition, all financial liabilities should be
measured at amortised cost, with the exception of financial
liabilities at fair value through profit or loss (including most
derivatives). These should be measured at fair value, but
where the fair value is not capable of reliable
measurement, they should be measured at cost.
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Thank You!
