FINANCIAL INSTRUMENT

is any contract that gives rise to both:
Either a financial liability or an equity instrument
of another entity.

A financial asset of one entity

a)
b)
c)

d)

Financial Asset
Cash;
an equity instrument of another entity;
a contractual right:
1.
to receive cash or another financial asset from
another entity; or
2.
To exchange financial assets or financial
liabilities under conditions that are potentially
favorable to the entity
a contract that will or may be settled in the entity’s
own equity instruments and is:
1.
a non-derivative for which the entity is or may
be obliged to receive a variable number of the
entity’s own equity instruments; or
2.
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.

Financial Liability
a)

b)

a contractual obligation:
1.
to deliver cash or another financial asset to
another entity; or
2.
To exchange financial assets or financial
liabilities under conditions that are potentially
unfavorable to the entity
a contract that will or may be settled in the entity’s
own equity instruments and is:
1.
a non-derivative for which the entity is or
may be obliged to deliver a variable number
of the entity’s own equity instruments; or
2.
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.

An
An equity
equity instrument
instrument is
is a
a contract
contract that
that evidences
evidences a
a residual
residual interest
interest in
in the
the assets
assets of
of an
an entity
entity after
after deducting
deducting all
all of
of
its
liabilities
and
represents
a
financial
asset
of
the
holder
and
equity
of
the
issuer.
its liabilities and represents a financial asset of the holder and equity of the issuer.

Debtors
Inventory
Provision for taxes

Bank Loan
Prepayments
Dividends payable

CLASSIFY?
Investment in TFCs
Advances from customers
WPPF payable

TFCs issued
Shares issued
Creditors

The difference between the issue proceeds. To illustrate.Compound Instruments • • Some financial instruments. €2. – Issued at par with a face value of €1. • – One is a financial liability. share price. the issuer’s contractual obligation to pay cash (principal and interest on the bond). and • – The other is an equity instrument. • • Illustration DT plc issues – 2. or other event that changes the likelihood that the conversion option will be exercised. In case this case. The separation of components is made at the time the instrument is issued and is not subsequently revised as a result of a change in interest rates. This is the liability component.000 per bond.000 convertible bonds at the start of 2008 – The bonds have a three‐year term. Income Statement Classification • • Interest.052 Cr. – Interest is payable annually in arrears at 6%.000. Equity 198.000. IAS 32 requires the component parts to be separated from each other.000. losses and gains relating to a financial instrument or a component that is a financial liability shall be recognized as income or expense in profit or loss Distribution to holders of an equity instrument shall be debited by the entity directly to equity. with each part accounted for and presented separately according to its substance. have both a liability and an equity element. Dr. net of any related tax benefit. a convertible bond contains two components. . The present value of bond cash flows at a market rate (say 10%) of interest for a similar financial instrument without the equity conversion option ‐ €1.052 . and the fair value of the liability component is assigned to the equity component €198.948 Issue Cost • • • Issue cost relating to issuance of equity shall be deducted from equity Transaction cost relating to issuance of liability shall be deducted from liability Transaction cost on compound financial instrument will be allocated on prorata basis of initially recognized amounts.948.000 Cr.801. called compound instruments.801. Bank 2. dividends. a call option written to the holder to convert the debt security into common shares. – Each bond is convertible at the holders’ discretion at any time up to maturity into 250 ordinary common shares of DT plc. Financial Liability 1.

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.e.000.a. Shortly after the year end the asset is sold for $70 million. a shorter period.000 nominal value. to the net carrying amount at initial recognition. FVTPL and FV through OCI Comparison Illustration Jones buys an investment for $40 million. or where appropriate. At the year end the value of the asset has risen to $60 million. The effective rate of interest is 12% p.5% redeemable debt. The bond must be redeemed on 1 January 20X6 at a premium of Rs 4.611. The transaction costs amounted to $120.000. Financial Asset ‐ Debt Instrument On 1 January 20X8.25% What investment income should be recorded each year in respect of the debt instrument? . The transaction costs are $1 million. The discount was 16% of nominal value and the costs of issue were Rs 2. Charlton purchased $6m 3. Interest of 5% is payable annually in arrears. Required: How will this be reported in financial statements of James over the period to redemption. i. Effective interest rate is 7. the rate that exactly discounts the estimated future cash flows or receipts through the expected life of the instrument.Effective interest rate method The effective interest rate is the internal rate of return (IRR) or the level yield to maturity. The debt is redeemable on 31 December 20Y3 at a premium of 30%. How should this be accounted for if the investment is classified as: – Fair value through profit and loss – FV through OCI Financial Liability at Amortized Cost ‐ Illustration On January 20X1 James issued a deep discount bond with a Rs 50.

This kind of settlement is known as regular way settlement.Recognition of Financial Asset and Financial Liability An entity shall recognise a financial asset or a financial liability in its statement of financial position when. For example a trade executed on 11 May settles on 14 May.003. respectively. such a contract is not recognized as a derivative financial instrument under IFRS 9. The choice of method is an accounting policy. On 4 January 20X3 (settlement date).012. On 31 December 20X2 (financial year-end).013. contracts to buy securities on an exchange) will have standard delivery terms prescribed by the exchange.000 and its amortized cost is CU1. which is its fair value on commitment (trade) date. . However. Purchase of Financial Asset On 29 December 20X1. transactions of securities may be required by the exchange days to be settled three after the trade date – a trade taking place today must be paid for (if purchased) or delivered (if sold) three businesses days from the trade date. as defined in IFRS 9. The asset was acquired one year earlier for CU1.010. the entity becomes party to the contractual provisions of the instrument. Transaction costs are immaterial. it shall classify it as discussed earlier and measure it accordingly. • The standard permits either trade date accounting or settlement date accounting for regular‐way purchases or sales of a financial asset • Trade date accounting’ and ‘settlement date accounting’ refer to methods of recognizing an asset acquired (and any associated liability incurred) and derecognizing an asset sold (and any associated receivable recognized).000. • The fixed price commitment between trade date and settlement date is a forward contract that meets the definition of a derivative. the fair value of the asset is CU1.002 and CU1. For example. an entity commits itself to purchase a financial asset for CU1.000. Regular Way Contracts • Contracts to buy or sell financial assets (for example. When an entity first recognises a financial asset/financial liability. • The method used must be applied consistently for all purchases and sales of financial assets that belong to the same category of financial assets. Sale of Financial Asset On 29 December 20X2 (trade date) an entity enters into a contract to sell a financial asset for its current fair value of CU1. and only when. because of the short duration of the commitment. the fair value is CU1. On 31 December 20X1 (financial year-end) and on 4 January 20X2 (settlement date) the fair value of the asset is CU1.

Traveler now wishes to value the loan at fair value using current market interest rates. Traveler has agreed for the loan to be restructured.IMPAIRMENT OF FINANCIAL ASSET Impairment of Financial Asset At Fair value At Amortized cost Not required separately… FV Gain/Loss to be calculated only Carrying Value Less: PV of revised cash flows using original effective interest rate Example Included in the financial assets of Traveler is a ten-year 7% loan. What amount would be reported in SFP as at 30-Nov-2011 and what amount would be charged as impairment (if any). there will only be three more annual payments of $8 million starting in one year’s time. Current market interest rates are 8%. Traveler has adopted IFRS 9 Financial Instruments and the loan asset is currently held at amortized cost of $29 million. the original effective interest rate is 6·7% and the effective interest rate under the revised payment schedule is 6·3%. At 30 November 2011. the borrower was in financial difficulties and its credit rating had been downgraded. .

then the entity must assess whether it has relinquished control of the asset or not.to recognise the asset to the extent to which it has a continuing involvement in the asset. Would the answer have been different if Bell’s sale contract had provided Bell with a call option and Candle with a put option over the investment. but has assumed a contractual obligation to pass those cash flows on under an arrangement that meets the following three conditions: • the entity has no obligation to pay amounts to the eventual recipient unless it collects equivalent amounts on the original asset • the entity is prohibited from selling or pledging the original asset (other than as security to the eventual recipient). Would the answer have been different if Bell’s purchase contract had contained a put option giving Bell the power to sell the investment back to Book at market value on 31 December 20X8? 3. How should this be accounted for? 2. it then determines whether or not it has transferred substantially all of the risks and rewards of ownership of the asset. then At the31entity continues Bell buys an investment for trading purposes Book. If the entity has neither retained nor transferred substantially all of the risks and rewards of the asset.De‐recognition of Financial Asset The basic premise for the derecognition model in IFRS 9 is to determine whether the asset under consideration for derecognition is: • an asset in its entirety or • specifically identified cash flows from an asset (or a group of similar financial assets) or • a fully proportionate (pro rata) share of the cash flows from an asset (or a group of similar financial assets). • the entity has an obligation to remit those cash flows without material delay Once an entity has determined that the asset has been transferred. An asset is transferred if either the entity has transferred the contractual rights to receive the cash flows.20X7. If the entity does not control the asset then Example derecognition is appropriate. or the entity has retained the contractual rights to receive the cash flows from the asset. On 1 June 20X8 Bell sold the investment to Candle for its market value of $100 million. or • a fully proportionate (pro rata) share of specifically identified cash flows from a financial asset (or a group of similar financial assets) Once the asset under consideration for derecognition has been determined. each at a price of $105 million over the next 12 months? . however if thefrom entity has Itretained asset. 1. whether the transfer of that asset is subsequently eligible for derecognition. cost $10control million of at the 1 January December 20X7. and if so. the asset is derecognised. derecognition of the asset is precluded. If substantially all the risks and rewards have been transferred. the investment had a fair value of $30 million. an assessment is made as to whether the asset has been transferred. If substantially all the risks and rewards have been retained.

Relevant details are as follows: Balance amount of the principal would be paid at the end of the loan’s term i.Summer 2012 Zee Power Limited (ZPL) has been facing short term liquidity issues during the financial year ended on 31 December 2011. ZPL sold its investment in listed Term Finance Certificates (TFCs) to Vee Investment Company Limited with an agreement to buy them back in 10 days. As a result. ZPL sold its investment in listed Term Finance Certificates (TFCs) to Vee Investment Company Limited with an agreement to buy them back in 10 days.e. On 1 January 2011.183. the bank agreed to facilitate ZPL as follows: On 27 December 2011. 100 million at 10% per annum.144. on 31 December 2013.000 Buy back price 10.163.332 Market price as on 31 December 2011 10. ZPL had obtained a bank loan of Rs. ii On 1 January 2009.337 Value in ZPL’s books as on 27 December 2011 10.150. . Relevant details are as follows: Sale price 10. the following transactions were undertaken: i On 27 December 2011. The interest was payable annually on 31 December and principal amount was repayable in five equal annual installments commencing from 31 December 2009.125 ZPL intends to hold these TFCs till maturity.

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when the obligation is: Discharged An obligation is discharged if an entity delivers: – Cash – Other financial assets – Equity instruments of entity (IFRIC .De recognition of Financial Liabilities Generally a financial liability is derecognized only when it is relinquished. Cancelled Cancellation of an obligation only occurs through a process of law whereby an entity is legally released from its primary obligation to pay the creditor. i.e. Expired An obligation expires due to the passage of time.Gain/Loss deferred and amortized over . Derecognition of Financial Liability Extinguishment Restructuring Substanti al change in terms Other than substantia l change >= 10% change in new PV (calculated using new terms) and CV < 10% change in new PV (calculated using new terms) and CV Derecognize old liability and record new liability Gain/Loss in PL Adjust CV of old liability .19) – Other goods Which the counterparty accepts as suitable compensation.

at a minimum. and effectiveness can be reliably measured. highly probable forecast transactions. highly probable transaction. • a held-to-maturity investment for foreign currency or credit risk (but not for interest risk or prepayment risk). An external non-derivative financial asset or liability may not be designated as a hedging instrument except as a hedge of foreign currency risk. the spot price being the designated risk. However. or net investments in foreign operations with similar risk characteristics. . • a portion of the cash flows or fair value of a financial asset or financial liability. and how the entity will assess the hedging instrument's effectiveness. firm commitments. • in a portfolio hedge of interest rate risk (Macro Hedge) only. the interest element and the spot price of a forward can also be separated. the intrinsic value and the time value of an option contract may be separated. the changes in the fair value or cash flows of the hedged item attributable to the hedged risk must be expected to be highly effective in offsetting the changes in the fair value or cash flows of the hedging instrument on a prospective basis. • a group of assets. A proportion of the derivative may be designated as the hedging instrument.Hedge Accounting IAS 39 permits hedge accounting under certain circumstances provided that the hedging relationship is: • formally designated and documented. All hedge ineffectiveness is recognized immediately in the income statement (including ineffectiveness within the 80% to 125% window). Hedgedwith Items A hedged item can be: • a single recognized asset or liability. the nature of the risk being hedged. Hedging Instruments All derivative contracts with an external counterparty may be designated as hedging instruments except for some written options. or a net investment in a foreign operation. or • a non-financial item for foreign currency risk only or the risk of changes in fair value of the entire item. Generally. identification of the hedging instrument. liabilities. the hedged item. including the entity's risk management objective and strategy for undertaking the hedge. Similarly. at each reporting date. Hedge Effectiveness To qualify for hedge accounting at the inception of a hedge and. with only the intrinsic value being designated. a portion of the portfolio of financial assets or financial liabilities that share the risk being hedged. and on a retrospective basis where actual results are within a range of 80% to 125%. and • expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk as designated and documented. specific cash flows inherent in a derivative cannot be designated in a hedge relationship while other cash flows are excluded. firm commitment.

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this change in fair value of the instrument will be recognised in profit or loss. At the same time. Assuming market prices of shares fall to $960. The machine will still cost 1 million euros so the company concludes that the hedge is 100% effective. The instrument is classified as FV changes in OCI therefore the decrease in fair value would normally be recorded directly in reserves. The forward contract is designated as a cash flow hedge. the company determines that the fair value of the put options has increased by $. the company enters into a forward contract to purchase 1 million euros in 1 year for a fixed amount (GBP 650. It expects to purchase a piece of plant for 1 million euros in one year from 1 May 20X6. Example – 2 Fair Value Hedge A company purchases an equity instrument for $1 million. since the instrument is a hedged item in a fair value hedge.000).000. terminated. However. Any decline in the fair value of the instrument should be offset by opposite increases in the fair value of the derivative instrument. In order to offset the risk of increases in the euro rate. the hedge no longer meets the hedge accounting criteria .for example it is no longer effective. Since the swap is a derivative. The changes in fair value of the hedged item and the hedging instrument exactly offset each other: the hedge is 100% effective and the net effect on profit or loss is zero.Discontinuation of Hedge Accounting Hedge accounting must be discontinued prospectively if: • • • • the hedging instrument expires or is sold. Thus the entire change in the fair value of the hedging instrument is recognised directly in reserves. the forward contract has a fair value of zero. Example 1 (Cash Flow Hedge) A company trades in GBP.000. the amounts accumulated in equity will be retained in equity until the hedged item affects profit or loss.000. The company is exposed to a price risk of the decline in the fair value of the instrument if the market behavior changes. At the year end of 31 October 20X6. if hedge is effective. The instrument is not held for trading and company designated it to be measured at fair value with changes to be recognised through other comprehensive income. If hedge accounting ceases for a cash flow hedge relationship because the forecast transaction is no longer expected to occur. the euro has appreciated and the value of 1 million euros is GBP 660. If the transaction is still expected to occur and the hedge relationship ceases. gains and losses deferred in equity must be taken to the income statement immediately. . 40. The company purchases put options in order to offset the risk of a decline in fair value. or exercised. it is measured at fair value with changes in fair value recognised in profit or loss. or the entity revokes the hedge designation. At inception. for cash flow hedges the forecast transaction is no longer expected to occur.

PAST PAPER ANALYSIS TOPICS Sum Winte Sum Winter Sum Winter Sum Winter Sum Winter Sum 2014 r 2013 2013 2012 2012 2011 2011 2010 2010 2009 2009 Measurement of Financial Asset Q (2) Measurement of Financial Liability   Compound Financial Instrument  Q (1) Derecognition of Financial Asset   Extinguishment / Rescheduling of Financial Liability   Impairment of Financial Asset Q (3)(b) Regular way purchase/sale   Hedging   Q                     Q (4) ii           Q (2) b               Q (6)     Q (2)               (7)     Q (4) i     Q (5)           Q (2) a             Q (2)   Not tested THANK YOU AND BEST OF LUCK Not tested Not tested .