The IFRS for SMEs

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Topic 2.1
Section 11 Basic Financial Instruments
Section 12 Other Fin. Inst. Issues
Section 22 Liabilities and Equity

© 2011 IFRS Foundation

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The IFRS Foundation allows individuals and organisations to use this
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may be downloaded from:
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The accounting requirements applicable to small and medium‑sized entities
(SMEs) are set out in the International Financial Reporting Standard (IFRS)
for SMEs, which was issued by the IASB in July 2009.
The IFRS Foundation, the authors, the presenters and the publishers do not
accept responsibility for loss caused to any person who acts or refrains
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© 2011 IFRS Foundation

Sections 11-12 – Introduction

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• Financial instruments split into two
sections:
– Sec. 11 Basic Financial Instruments
– Sec. 12 Other Financial Instruments
Issues
• Together the two sections cover
recognising, derecognising, measuring,
and disclosing financial assets and
financial liabilities
© 2011 IFRS Foundation

Sections 11-12 – Introduction
• Section 11 is relevant to all SMEs
• Section 12 is relevant If:
– SME owns or issues ‘exotic’ financial
instruments – instruments that impose
risks or rewards that are not typical of
basic financial instruments
– SME wants to do hedge accounting

© 2011 IFRS Foundation

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Sections 11-12 – Accounting choice

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• Entity may choose to apply either:
– Sections 11 and 12 in full, or
– Recognition and measurement provisions
of IAS 39 and the disclosure
requirements in Sec 11 & 12
– No option to use IFRS 9
• The option chosen applies to all financial
instruments (not individually)
• To change option, follow Section 10
© 2011 IFRS Foundation

Sections 11-12 – Basic principles

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• Basic principle of Section 11:
– Amortised cost model for all basic FI
except investments in ordinary or
preference shares that are publicly traded
or whose fair value can be measured
reliably – these are fair value through
profit or loss (FVTPL).
• Basic principle of Section 12:
– FI not covered by Section 11 are at
FVTPL
© 2011 IFRS Foundation

Section 11 – Scope

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• All basic financial instruments except
those covered by other sections of IFRS
for SMEs:
– Investments in sub, associate, JV (see
Sections 9, 14, 15)
– Entity’s own equity (see Sec 22, 26)
– Leases (see Section 20)
– Employee benefit assets and liabilities
(see Section 28)
© 2011 IFRS Foundation

Sections 11-12 – Definitions

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• Financial instrument
– Contract that gives rise to a financial
asset of one entity and a financial liability
or equity instrument of another entity
– Includes cash
– But commodities that are ‘near cash’ like
gold are not financial instruments

© 2011 IFRS Foundation

Sections 11-12 – Definitions

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• Basic financial instrument*
– Cash
– Debt instrument (accounts, notes, and
loans receivable and payable) that meet
conditions on next slide
– Ordinary and preference shares that are
not convertible and not puttable
*These notes do not discuss loan commitments
© 2011 IFRS Foundation

Section 11 – Basic debt instruments

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• Debt instruments are in Section 11 if:
– Returns to holder are fixed, variable
referenced to an observable rate, or
combination of fixed and variable
– No special provision could cause holder
to lose principal
– Prepayment conditions are not contingent
on a future event
– No special conditional returns
© 2011 IFRS Foundation

Section 11 – Basic debt instruments

11

• Examples of basic debt instruments:
– Trade accounts and notes receivable and
payable
– Loans from banks and other 3rd parties
– Accounts payable in foreign currency
– Loans to/from subsidiaries or associates
that are due on demand
– Debt instrument that becomes
immediately due if issuer defaults
• All of these measured at amortised cost
© 2011 IFRS Foundation

Section 11 – Basic debt instruments

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• Examples of NOT basic debt instruments:
– Investment in convertible or puttable
shares or debt
– Swaps, forwards, futures, options, rights,
and other derivatives
– Loans with unusual prepayment
conditions (based on tax change,
accounting change, linked to company
performance)
• All of these are FVTPL under Section 12
© 2011 IFRS Foundation

Section 11 – Recognition and measurement

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• Initial recognition:
– When entity becomes a party to the
contractual provisions of the instrument
– IFRS for SMEs allows judgement
regarding ‘trade date’ vs ‘settlement date’
accounting, but be consistent

© 2011 IFRS Foundation

Section 11 – Recognition and measurement
• Initial measurement:
– At transaction price
– Include transaction costs except for FI
that will be measured at FVTPL
– ‘Impute interest’ if payment is deferred
beyond normal terms or below-market
interest

© 2011 IFRS Foundation

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Section 11 – Recognition and measurement

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• Initial recognition-measurement examples:
– Loan made to another entity: Measure
at PV of interest and principal payments
– Goods sold to customer (purchased
from supplier) on normal credit terms:
Measure receivable (payable) at
undiscounted invoice price

© 2011 IFRS Foundation

Section 11 – Recognition and measurement

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• Initial recognition-measurement examples:
– Goods sold (purchased) on 2-year interest free
credit: Measure at current cash sale price or PV of
receivable or payable
Example: We sell goods for 1,000, payment due 2
years, interest-free. Cash price = 857. IRR = 8%.
Journal entries

Debit

At time of sale Receivable
Sales Revenue
End of year 1 Receivable
8% x 857 = 69
Interest Revenue
© 2011 IFRS Foundation

Credit

857
857
69
69

Section 11 – Recognition and measurement

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• Subsequent measurement:
– Debt instruments in the scope of Section
11 (even if publicly traded):

– Amortised cost using the effective
interest method
– Equity instruments in scope of Section 11:

– If publicly traded or FV can be
measured reliably: FVTPL
– All others: cost less impairment
© 2011 IFRS Foundation

Section 11 – Recognition and measurement

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• What is ‘amortised cost’?
– Amount measured at initial recognition
– Minus repayments of principal
– Plus or minus cumulative amortisation of
any difference between initial
measurement and maturity amount (using
effective interest method)
– Minus (for assets) reduction for impairment
or uncollectibility
© 2011 IFRS Foundation

Section 11 – Recognition and measurement

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• What is ‘effective interest method’?
– Effective interest is rate that exactly discounts
future cash payments (receipts) to the carrying
amount
– Also called ‘Internal Rate of Return’

– Amortised cost = PV of future cash receipts
(payments) discounted at effective interest rate
– Interest expense (income) = carrying amount
at beginning of period x effective interest rate

© 2011 IFRS Foundation

Section 11 – Effective interest example

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1/1/X0 buy 5-year bond for 900, transaction cost =
50, cash interest = 40/year, mandatory redemption
at 1,100 at 31/12/X4.
Year Carrying amount Int. income Cash Carrying amt
beginning
at 6.9583%* inflow ending
X0
X1
X2

950.00
976.11
1,004.03

66.10
67.92
69.86

(40)
(40)
(40)

976.11
1,004.03
1,033.89

X3
X4

1,033.89
1,065.83

71.94
74.16

(40)
(40)

1,065.83
1,100.00

*6.9583% is the rate that exactly discounts the cash flows to 950.00
© 2011 IFRS Foundation

Section 11 – Recognition and measurement

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• What is ‘fair value’?
– Amount for which FI could be sold or
settled in an arm’s length transaction
– Best: Quoted market price in an active
market (bid price)
– Next: Price in a recent transaction for
identical asset (unless circumstances have
changed)
– Estimate using a valuation technique (a
model)
© 2011 IFRS Foundation

Section 11 – Impairment

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• Impairment only applies to FI measured at
cost or amortised cost
• At each reporting date, look for evidence
that FV is below carrying amount
– Significant financial difficulty of issuer
– Default or delinquency
– Abnormal concession granted to debtor by
creditor
– Probable debtor bankruptcy or reorg.
© 2011 IFRS Foundation

Section 11 – Impairment

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• Impairment assessment:
– Individually for all equity instruments
– Individually for debt instruments that are
individually significant
– For other debt instruments, either
individually or grouped based on similar risk
characteristics
• Impairment recognition:
– Write-down is recognised in P&L
© 2011 IFRS Foundation

Section 11 – Impairment

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• Measurement of the impairment loss:
– Debt instruments: Difference between
carrying amount and current PV of estimated
cash flows discounted at asset’s original
effective interest rate. (Use current rate if
variable.)
– Equity instruments: Difference between
carrying amount and best estimate
(approximation) of the amount (might be zero)
that entity would receive if asset were sold at
reporting date.
© 2011 IFRS Foundation

Section 11 – Impairment

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• Reversal of an impairment loss:
– Required if the problem causing the original
impairment reduces
– Write up but not to more than what carrying
amount would have been had no
impairment been recognised (ie not to FV
but to new ‘amortised cost’)
– Reversal recognised in P&L

© 2011 IFRS Foundation

Section 11 – Derecognition

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• Derecognition of a financial asset:
– Derecognition = remove from balance sheet
– Only when:
a. Rights to cash flows expire or settled
b. Substantially all risks and rewards (cash
flows) transferred to other entity
c. Transferred some but not substantially all
risks and rewards, and physical control of
asset transferred to another party who has
the right to sell the asset to an unrelated
third party.
© 2011 IFRS Foundation

Section 11 – Derecognition

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• Derecognition of a financial asset:
– In case (c) above:
– Derecognise old asset entirely, and
– Recognise separately any rights and
obligations retained or created in the transfer
(measure at fair value)
– If transfer does not result in derecognition, keep
transferred asset on books and recognise
financial liability for the consideration received
– Do not offset
© 2011 IFRS Foundation

Section 11 – Derecognition

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• Derecog. of financial asset – examples:
– Must derecognise: Sell receivables to bank
but we continue to collect and remit, for a
handling fee. Bank assumes credit risk.
– May not derecognise: Same facts except
entity agrees to buy back any receivables in
arrears for more than 120 days. Entity
continues to recognise the receivables until
collected or writeoff as uncollectible.
© 2011 IFRS Foundation

Section 11 – Derecognition
• Derecognition of a financial liability:
– Only when extinguished, that is:

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a. Discharged
b. Cancelled
c. Expired

• If existing debt is replaced with new one
with substantially different terms (or there
is a significant modification of terms):
– Treat as new liability and extinguishment of
original liability
© 2011 IFRS Foundation

Section 11 –Disclosure

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• Disclose accounting policies for FI
• Disclose financial assets and liabilities by
categories in the balance sheet:
– Equity or debt at FVTPL
– Debt at amortised cost
– Equity measured at cost less impairment
– Liabilities at FVTPL
– Liabilities at amortised cost
© 2011 IFRS Foundation

Section 11 – Disclosure

© 2011 IFRS Foundation

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Section 11 – Disclosure

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• Items of income, expense, gains and
losses:
– Changes in FV for instruments measured
at FVTPL
– Total interest income and total interest
expense on FI not measured at FVTPL
– Impairment loss by class of financial asset

© 2011 IFRS Foundation

Section 12 – Recognition and measurement 33
• Initial recognition:
– When entity becomes a party to the
contractual provisions of the instrument
• Initial measurement:
– At FV (normally the transaction price)
– Transaction costs are charged to expense

© 2011 IFRS Foundation

Section 12 – Recognition and measurement

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• Subsequent measurement:
– At FVTPL except:
– Equity instrument that is not publicly
traded and cannot get FV reliably, then
measure at cost less impairment
– Also measure a contract linked to such
equity instrument at cost less impairment
– If previously at FVTPL, but now a reliable FV
measure is no longer available, treat most
recent FV measure as ‘cost’ going forward.
© 2011 IFRS Foundation

Section 12 – Hedge accounting

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• ‘Hedging’ and ‘hedge accounting’ are two
different things
• What is hedging?
– Managing risks by using one financial
instrument (‘hedging instrument’) purposely
to offset the variability in FV or cash flows
of a recognised asset or liability, firm
commitment, or future cash flows (‘hedged
item’)
© 2011 IFRS Foundation

Section 12 – Hedge accounting

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• What is hedge accounting?
– Matching the change in FV of the hedging
instrument and the hedged item in the
same income statement
– Hedge accounting is only an issue when
normal accounting would put the two FV
changes in different periods – sometimes
referred to as an ‘accounting mismatch’

© 2011 IFRS Foundation

Section 12 – Hedge accounting

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• The hedger’s accounting dilemma:
– I have a risk in an asset or liability measured at
amortised cost
– Any change in FV or cash flows from that
asset or liability is recognised only when
realised in cash (asset is sold, liability is
settled, cash flows occur)
– To hedge, I buy a derivative, which is measured
at FVTPL at each reporting date

• I need special hedge accounting to fix
this ‘mismatch’
© 2011 IFRS Foundation

Section 12 – Hedge accounting
• The hedger’s accounting dilemma – an
illustration:

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– Entity has note payable at a fixed rate of interest
due in 3 years. Note measured at amortised cost.
– Buys swap to convert receive fixed interest to pay
variable. Swap is measured at FVTPL.
– End of year 1, interest rate declines. Therefore
loss on derivative immediately recognised – but
an offsetting gain (not yet recognised) because
we will be paying the lower variable rate of
interest in future.
© 2011 IFRS Foundation

Section 12 – Hedge accounting

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• Hedge accounting matching the gain (loss)
on the derivative with the loss (gain) on the
hedged item.
• Hedge accounting is optional.

© 2011 IFRS Foundation

Section 12 – Hedge accounting

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• To qualify for hedge accounting:
– Designate and document hedging
relationship up front
– Clearly identify the hedged risk

– Hedged risk is listed in ¶12.17
– Hedging instrument is listed in ¶12.18
– Entity expects hedging instrument to be
‘highly effective’ in offsetting the designated
hedged risk.
© 2011 IFRS Foundation

Section 12 – Hedge accounting

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• Hedged risk must be (12.17):
– Interest rate risk in debt measured at cost
– FX or interest rate risk in firm commitment
or highly probable forecast transaction
– Price risk in a commodity owned or to be
acquired in a firm commitment or highly
probable forecast transaction
– FX risk in a net investment in a foreign
operation
© 2011 IFRS Foundation

Section 12 – Hedge accounting

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• Hedged risk must be (12.17):
– FX risk in debt instrument measured at cost is not
in this list. Why?
– Under ¶30.10 (FX) the debt is translated at
spot rate and FX gain or loss is recognised in
profit or loss
– Change in FV of the swap (hedging
instrument) is also recognised in profit or loss
(measured using forward rate)
– ‘Natural hedge’
© 2011 IFRS Foundation

Section 12 – Hedge accounting

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• Hedging instrument must be (12.18):
– Interest rate swap, FX swap, FX forward,
commodity forward
– Entered into with external party
– Notional amount = principal or notional
amount of hedged item
– Specified maturity not later than maturity or
settlement of hedged item
– Cannot be prepaid or terminated early
© 2011 IFRS Foundation

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Section 12 – Hedge accounting
• Hedge of fixed interest rate risk or
commodity price risk of commodity held
– Recognise hedging instrument as asset or
liability
– Change in FV of hedging instrument in P&L
– Change in FV of hedged item in P&L and
adjustment of carrying amount of hedged
item – even though hedged item is
otherwise measured at cost
This is called Fair Value Hedge in IAS 39.
© 2011 IFRS Foundation

Section 12 – Hedge accounting

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• Hedge of fixed interest rate risk or
commodity price risk of commodity held
(continued)
– If hedged risk was fixed interest in debt
measured at cost, recognise in P&L the
periodic net settlements from the derivative
(interest rate swap) in the period in which
the net settlements occur.

© 2011 IFRS Foundation

Section 12 – Hedge accounting

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• Example – Assumptions:
– Entity borrows 1,000, 3 years, 5% fixed rate,
payable measured at amortised cost
– Hedged with a derivative whose value is linked to
an interest rate index
– End of year 1, market rate = 6%. FV of 1,000
payable 2 years 6% = 1,000 x .889996 = 890, but
this 110 ‘gain’ is not recognised
– Value of the derivative declines to -112
– Note there is small ineffectiveness = 2
© 2011 IFRS Foundation

Section 12 – Hedge accounting

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• Balance sheet at time loan is made:
Cash
1,000
Loan payable
1,000
• Adjust loan end of year 1 to reflect rate change:
Loan payable
110
P&L
2
Derivative (Liability)
112
• Balance sheet end of year 1:
Cash
1,000
Derivative (Liability)
112
Loan payable
890
Equity
(2)
© 2011 IFRS Foundation

Section 12 – Hedge accounting

48

• Conceptual question regarding the
previous example:
– Does the 890 carrying amount of the loan
payable at end of year 1 represent the Fair
Value of the loan?
– Hint: Does the 890 reflect change in credit
risk or prepayment risk?
– If 890 is not Fair Value, what is it?

© 2011 IFRS Foundation

Section 12 – Hedge accounting
• Hedge of fixed interest rate risk and
commodity price risk (continued)
– Discontinue hedge accounting when:
– Hedging instrument expires
– Hedge no longer meets conditions
– Entity revokes designation

– Any gain or loss that was included in the
carrying amount of the hedged item is
amortised to P&L over remaining life of
hedged item.
© 2011 IFRS Foundation

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Section 12 – Hedge accounting

50

• Hedge of variable interest rate risk, FX or
commodity price risk of commodity held,
highly probable forecast transaction, or net
investment in foreign operation
– Recognise change in FV of hedging
instrument in OCI (assuming it was
effective; ineffectiveness reported in P&L)
– 'Recycle' amount recognised in OCI when
hedged item hits P&L or hedging
relationship ends.
© 2011 IFRS Foundation

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Section 12 – Hedge accounting
• Hedge of variable interest rate risk, FX or
commodity price risk of commodity held,
highly probable forecast transaction, or net
investment in foreign operation (continued)
– If hedged risk was variable interest in debt
measured at cost, recognise in P&L the
periodic net settlements from the interest
rate swap in the period in which the net
settlements occur.
This is called Cash Flow Hedge in IAS 39.
© 2011 IFRS Foundation

Section 12 – Hedge accounting

52

• Example – Assumptions:
– Entity sells goods for 1,000 floating rate 3year note receivable
– Interest rate risk managed with a derivative
(interest rate swap)
– End of year 1 interest rates increase – PV
of cumulative cash flows increase by 100
– But FV of swap decreases by 105
– Note: Some hedge ineffectiveness
© 2011 IFRS Foundation

Section 12 – Hedge accounting
• Opening balance sheet:
Receivable
Equity

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1,000
1,000

• Ineffective portion of hedge:
P&L*
5*
OCI (Equity)
100
Derivative (Liability)
105
*Ineffective portion of hedge
example continued next slide...
© 2011 IFRS Foundation

Section 12 – Hedge accounting
• Closing balance sheet:

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Receivable
1,000
Equity (OCI)*
100*
Derivative (Liability)
105
Equity
995
*Effective portion of the hedge (loss on
derivative), which will be amortised to P&L as
the higher floating rate interest payments are
earned and recognised in P&L in years 2 & 3

© 2011 IFRS Foundation

Section 12 – Hedge accounting

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• Hedge of variable interest rate risk etc...
– Discontinue hedge accounting when:



Hedging instrument expires
Hedge no longer meets conditions
Forecast transaction no longer probable
Entity revokes designation

– Any prior gain or loss on forecast
transaction that was recognised in OCI is
recycled to P&L
© 2011 IFRS Foundation

Section 12 – Hedge accounting

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• Disclosures relating to hedge accounting
– For each type of hedge: Description of hedge
(risk, hedged item, instrument)
– Special disclosures for hedge of fixed interest
rate risk and commodity price risk of commodity
held
– Special disclosures for hedge of variable interest
rate risk, FX or commodity price risk of
commodity held, highly probable forecast
transaction, or net investment in foreign operation
© 2011 IFRS Foundation

Section 22 – Liabilities and equity

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• Scope of Section 22
– Principles for classifying an instrument as
debt or equity
– Original issuance of shares and other
equity instruments
– Sale of options, rights, warrants
– Bonus issues and share splits
– Issuance of convertible debt
continues...
© 2011 IFRS Foundation

Section 22 – Liabilities and equity

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• Scope of Section 22, continued
– Treasury shares
– Distributions to owners
– Non-controlling interest and transactions in
shares of a consolidated subsidiary

© 2011 IFRS Foundation

Section 22 – Liabilities and equity

59

• Principles for classifying an instrument as
debt or equity
– Equity = residual interest in assets minus
liabilities
– Liability is a present obligation (entity does
not have a right to avoid paying cash)

© 2011 IFRS Foundation

Section 22 – Liabilities and equity

60

• The following are equity:
– Puttable instrument that entitles holder to
pro rata share of net assets on liquidation
– Instrument that is automatically redeemed
if an uncertain future event occurs or death
or retirement of holder
– Subordinated instrument payable only on
liquidation

© 2011 IFRS Foundation

Section 22 – Liabilities and equity

61

• The following are liabilities:
– Instrument is payable on liquidation, but
the amount is subject to a maximum
ceiling
– Entity is obliged to make payments before
liquidation – such as mandatory dividend
– Mandatorily redeemable preference
shares

© 2011 IFRS Foundation

Section 22 – Liabilities and equity

62

• Members’ shares in a cooperative are
equity only if:
– Coop has unconditional right to refuse
redemption of members’ shares, or
– Redemption is unconditionally prohibited
by law or entity’s charter

• Otherwise – liability

© 2011 IFRS Foundation

Section 22 – Liabilities and equity

63

• Original issuance of shares and other equity
instruments
– Recognise when equity is issued and subscriber
is obligated to invest
– If equity is issued before the entity gets cash, the
receivable is an offset to equity (not an asset)
– If entity gets (nonrefundable) cash before equity
is issued, equity is increased
– No increase in equity is recognised for subscribed
shares that have not been issued and entity has
not received cash
© 2011 IFRS Foundation

Section 22 – Liabilities and equity

64

• Sale of options, rights, warrants
– Same principles as for original issuance of
shares (previous slide)
• Transaction costs in issuing equity
instruments
– Accounted for as a reduction of equity (not
an expense)

© 2011 IFRS Foundation

Section 22 – Liabilities and equity

65

• Bonus issues (stock dividends) and share
splits
– These do not change equity
– Accounted for as reclassification of
amounts within equity (out of retained
earnings and into permanent capital)
– Amounts reclassified should be based on
local laws

© 2011 IFRS Foundation

Section 22 – Liabilities and equity

66

• Issuance of convertible debt
– Must account separately for debt component and
equity component (conversion right)
– Debt proceeds = FV of similar risk debt without
conversion feature (PV calculation)
– Equity proceeds are the residual
– Recorded at issuance; not subsequently revised
– Subsequently, debt discount = additional interest
expense (effective interest method)

© 2011 IFRS Foundation

Section 22 – Liabilities and equity

67

• Issuance of convertible debt - Example
– 1/1/X1 issue at par a 4% convertible bond, par and
maturity amount = 50,000, maturity in 5 years
– If no conversion feature, would have paid 6%
– Calculate present value of cash flows at 6%:
– PV 50,000 due in 5 years @ 6% = 37,363
– PV annuity 2,000/year 5 years @ 6% = 8,425
– Total PV = 45,788
Debit cash
50,000
Credit financial liability
45,788
Credit equity (conversion right) 4,212
© 2011 IFRS Foundation

Section 22 – Liabilities and equity
Date

Inter- Interest Amort. of
est expense discount
paid
@ 6%

1/1/X1
31/12/X1 2,000
31/12/X2 2,000
31/12/X3 2,000
31/12/X4 2,000
31/12/X5 2,000

2,747
2,792
2,840
2,890
2,943

747
792
840
890
943

31/12/X1: Debit interest expense
Credit financial liability
Credit cash © 2011 IFRS Foundation

68

Bond
discount

Net bond
liability

4,212
3,465
2,673
1,833
943
0

45,788
46,535
47,327
48,167
49,057
50,000

2,747
747
2,000

Section 22 – Liabilities and equity

69

• Treasury shares
– Equity instruments entity has issued and
later reacquired
– Measure at cash paid or FV of other
consideration given to acquire \
– Present as deduction from equity (not
asset)
– No gain or loss recognised on purchase,
sale, or cancellation
© 2011 IFRS Foundation

Section 22 – Liabilities and equity

70

• Distributions to owners
– If cash – measurement = cash paid
– If non-cash – measurement = FV of assets
distributed
– Amount reduces equity
– If entity gets tax deduction for dividend, tax
benefit is adjustment of equity
– Not reduction of income tax expense
– If entity pays withholding tax on dividends
paid, tax reduces equity as part of dividend
© 2011 IFRS Foundation

Section 22 – Liabilities and equity

71

• Non-controlling interest (NCI) and
transactions in shares of a consolidated
subsidiary
– In consolidated balance sheet NCI is part of
equity (not liability or ‘in between’)
– Change in parent’s controlling interest that does
not result in loss of control is a transaction with
owners
– Equity adjustment, not through P&L
– No adjustment of carrying amounts of assets
or goodwill
© 2011 IFRS Foundation