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2.IAS 39 Financial Instruments Rec and Meas - SELK
2.IAS 39 Financial Instruments Rec and Meas - SELK
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Review of key concepts
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Review of key concepts
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Review of key concepts
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Classification – Financial assets (Four categories)
• Held to maturity
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Classification – Financial liabilities (Two
categories)
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Classification – Financial Assets
At Fair Value Through Profit or Loss (FVTPL)
Available only if either of the 3 criterion met. These criteria are generally
only met by financial institutions and other organisations with sophisticated
treasury operations.
Criterion 2
Criterion 1 Manage as Criterion 3
Accounting a portfolio on Embedded
mismatch a fair value derivative
basis
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Classification - financial assets
Loans and receivables
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Classification - financial assets
Held to maturity
Entity has a
positive
Fixed or
Non- Fixed intention
determinable
derivative maturity and ability
payments
to hold to
maturity
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Classification - financial assets
Available-for-sale
Not
classified in
Non-
any of the
derivative
other
categories
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Why Is Classification Important?
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Measurement of financial assets
• Initial recognition
- When (i.e. timing)
- How much (i.e amount)
- Which account (i.e category)
• Transaction costs
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Transaction costs
All categories
apart from Fair
Value Through
Profit or Loss –
include in initial
measurement
Directly
attributable and
incremental
Fair value
through profit
or loss - expense
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Subsequent Measurement
Held to maturity
At FV through
equity
Available for sale
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Example: Initial fair value
An entity enters into a marketing agreement with another organisation.
As part of the agreement the entity makes a two year £5,000 interest
free loan. Equivalent loans would normally carry an interest rate of 6%,
given the borrower’s credit rating. The entity made the loan in
anticipation of receiving future marketing and product benefits.
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Example: Initial fair value
Solution:
The fair value of the loan can be determined by discounting the future
cash flows to present value using the prevailing market interest rate for
a similar instrument with a similar credit rating. The present value of
the cash flow in two years time at 6% is £4,450 (£5,000 × (1/1.062)). On
initial recognition of the financial asset the entity should recognise a
loss of £550 as follows:
DR Loan £4,450
DR Loss (finance expense) £550
CR Cash £5,000
The difference between this initial amount recognised of £4,450 and the
final amount received of £5,000 should be treated as interest received
and recognised in profit or loss over the two year period.
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Example: At fair value through profit or loss
An entity acquired a derivative on 1 May 20X6 for £200 cash. On 31
December 20X6, the next reporting date, the fair value of the derivative
was £340. On 31 December 20X7 the derivative’s fair value had fallen to
£220.
Set out the journal entries to record these transactions.
Solution:
On 1 May 20X6:
DR Derivative financial asset £200
CR Cash £200
On 31 December 20X6:
DR Derivative financial asset £140
CR Profit or loss – gain on financial asset (£340 – £200) £140
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Example: At fair value through profit or loss
Solution:
On 31 December 20X7:
DR Profit or loss – loss on financial asset (£340 – £220) £120
CR Derivative financial asset £120
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Exercise: Held to maturity
An entity acquires a zero coupon bond with a nominal value of £20,000
on 1 January 20X6 for £18,900.
The bond is quoted in an active market and broker’s fees of £500 were
incurred in relation to the purchase. The bond is redeemable on 31
December 20X7 at a premium of 10%. The effective interest rate on the
bond is 6.49%.
Requirement
Set out the journals to show the accounting entries for the bond until
redemption if it is classified as a held-to-maturity financial asset. The
entity has a 31 December year end.
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Exercise: Held to maturity
Solution:
On 1 January 20X6
DR Financial asset (£18,900 plus £500) £19,400
CR Cash £19,400
On 31 December 20X6
DR Financial asset (£19,400 6.49%) £1,259
CR Interest income £1,259
On 31 December 20X7
DR Financial asset ((£19,400+£1,259) x 6.49%) £1,341
CR Interest income £1,341
DR Cash £22,000
CR Financial asset £22,000
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Held to maturity and Available for sale
clasifications
Example:
An entity acquired a 6% £1,000 par value financial asset for its fair
value of £970 at the beginning of Year 1. Interest of 6% was receivable
annually in arrears. The financial asset was redeemable at the end of
Year 3 at £1,030, a premium of 3% to par value. The financial asset is
quoted in an active market and was classified as held to maturity by the
entity.
Held-to-maturity financial assets should be measured at amortised cost.
The effective interest rate of the financial instrument can be calculated
at 8.1%. The rate is higher than the coupon rate, because it amortises
the discount on issue and the premium on redemption.
If the entity had classified the financial asset as available for sale, the
asset should have been measured at fair value at each reporting date.
If the fair values of the financial asset at the end of Year 1 and Year 2
were £1,100 and £1,050, the financial asset should have been
recognised at the following amounts.
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Amortised cost and effective interest method
Solution:
If the entity had classified the financial asset as available for sale, the asset
should have been measured at fair value at each reporting date.
If the fair values of the financial asset at the end of Year 1 and Year 2 were
£1,100 and £1,050, the financial asset should have been recognised at the
following amounts.
Gain/(loss) in
Other Closing
Opening Interest @ 8.1% Compreh. balance – fair
Year Balance in profit or loss Cash flow income (bal) value
£ £ £ £ £
1 970 78 (60) 112 1,100
2 1,100 80 (60) (70) 1,050
3 1,050 82 (1,090) (42) 0 25
Fair value measurement
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Fair value measurement
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Fair Value Hierarchy
Active market –
Published quotations
Best evidence
No active market –
Valuation
Techniques Alternative
No active market –
Unreliable fair
value for equity
Very rare
instrument – cost
less any
impairment 28
Fair value measurement
Question 1
• Star owns 15% of shares of Moon.
• Shares quoted on a local stock exchange, trading volume indicates
sufficiently active market.
• The quoted market price is €100 per share.
• If decided to sell entire block of shares, the price they believe they
would be able to obtain would be €80 per share.
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Fair value measurement
Question 2
• Star purchases an AFS equity security for €100 and pays purchase
commission of €2.
• At the end of Star’s financial year, the security’s quoted market price
is €105. Commission of €3 would be payable if the security was sold on
that date.
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Impairment of financial assets
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Impairment of financial asset
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Impairment Indicators for debt instruments
Disappearance
Significant Breach of
of active
difficulty of the contract for
market
issuer failure to pay
because of
interest or
financial
principal
difficulties
Lender grants
borrower in National or local economic conditions
financial that correlate with defaults (eg a
difficulty a decrease in property prices for
concession mortgages in a relevant area)
that the
lender would
not otherwise High
consider probability of
bankruptcy
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Impairment Indicators for AFS equity investments
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Impairment AFS equity instruments
Significant
Judgement
Volatility relative to
current fair value Decline consistent
with market
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Impairment AFS equity instruments
Prolonged
Judgement
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Impairment Calculation - Example
Impairment X1 = 100 – 70 = 30
X2 = 100 – 68 – 30 = 2
X3 = 100 – 69 – 32 = (1) no impairment in PL
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Reclassification between categories
Held-to-maturity Available-for-sale
Available-for-sale Held-to-maturity
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Reclassification out of HTM to AFS - Tainting
Exceptions:
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Reclassification out of AFS
To HTM :
• Entity intends and has the ability to hold the loan to
maturity.
• When the tainted held-to-maturity portfolio has been
‘cleansed’ at the end of the second financial year
following tainting.
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Reclassification out of Held for Trading
To loans and receivables:
The Held for Trading asset meets the criteria to be
classified as loans and receivables at the date of
reclassification and the entity has the intention and the
ability to hold the financial asset for the foreseeable future
or until maturity.
To HTM or AFS
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Conclusion
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Thank you!
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