Financial Instruments, Part 1

Contents

1 Rationale and Scope of PFRS 9

2 Nature of Financial Instruments

3 Classification and Measurement

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PFRS 9
Financial Instruments

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1.
Rationale and Scope of
PFRS 9
 IFRS 9
● has been developed by the IASB to replace IAS 39 Financial
Instruments: Recognition and Measurement

● The IASB completed IFRS 9 in July 2014, by publishing a

final standard which incorporates the final requirements of
all three phases of the financial instruments’ projects, being:
○ Classification and Measurement,
○ Impairment, and
○ Hedge Accounting

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 Scope of PFRS 9
● The following are examples of assets and liabilities that fall
within the scope of PFRS 9:
○ Cash
○ Trade receivables/payables
○ Loans receivables/payable
○ Certain loan commitments o Bank borrowings
○ Investments in shares in listed and unlisted companies
○ Investments in convertible notes
○ Derivative financial instruments

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2.
Nature of Financial
Instruments
 Financial Instrument
● any contract that gives rise to a financial asset of one
entity, and a financial liability or equity instrument of
another entity.

● The following are not financial instruments:

○ Items that will be settled through the receipt or delivery
of goods or services
○ Tax assets and liabilities

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 Financial Asset
● any asset that is:
○ Cash
○ A contractual right
■ To receive cash or another financial asset from another
entity
■ To exchange financial assets or financial liabilities
with another entity under conditions that are
potentially favorable to the entity
○ An equity instrument of another entity

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 Financial Asset
● any asset that is:
○ A contract that will or may be settled in the entity’s
own equity instruments and is:
■ 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
■ 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.

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 Financial Liability
● any liability that is:
○ A contractual obligation
■ To deliver cash or another financial asset to another
entity
■ To exchange financial assets or financial liabilities
with another entity under conditions that are
potentially unfavorable to the entity

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 Financial Liability
● any liability that is:
○ A contract that will or may be settled in the entity’s
own equity instruments and is:
■ 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
■ 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.

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 Equity Instrument
● any contract that evidences a residual interest in the assets
of an entity after deducting all of its liabilities.

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PRACTICE!
Brody Company has the following assets on December
31, 2020:
Petty cash fund 10,000
Cash in bank 40,000
Notes receivable130,000
Discount on NR (7,000)
Loan receivable 80,000
Loss allowance on LR(4,000)
Advances to suppliers 12,000
Prepaid income tax 10,000
Prepaid assets 4,000
Inventory 380,000
PRACTICE!
Brody Company has the following assets on December
31, 2020:
Held for trading securities 60,000
Investment in associate 40,000
Deferred tax assets 12,000
Sinking fund 75,000

Compute for the total amount of financial assets.

PRACTICE!
Total Financial Assets
Petty cash fund P10,000
Cash in bank 40,000
Notes receivable123,000
Loan receivable 76,000
Held for trading securities 60,000
Investment in associate 40,000
Sinking fund 75,000
Total Financial Assets P424,000
3.
Classification and
Measurement
 Initial Recognition
● Financial assets are recognized only when the entity
becomes a party to the contractual provisions of the
instrument.

● Financial assets may either be a debt instrument

(bonds) or equity instrument (shares).

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 Classification
● Financial assets are classified as either:
○ Financial assets at amortized cost, or
○ Financial assets at fair value

● Basis of classification
○ The entity’s business model for managing the
financial assets; and
○ The contractual cash flow characteristics of the
financial asset
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 Classification
DEBT INSTRUMENTS
1. Financial asset at amortized cost (FAAC) – both
conditions are met:
a. Hold-to-collect business model
b. Cash flows are solely payments of principal
and interest (SPPI) on the principal amount
outstanding

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 Classification
DEBT INSTRUMENTS
2. Financial asset at fair value through OCI (FAFVOCI)
– both conditions are met:
a. Hold-to-collect and sell business model
b. Cash flows are solely payments of principal
and interest (SPPI) on the principal amount
outstanding

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 Classification
DEBT INSTRUMENTS
3. Financial asset at fair value through PL (FAFVPL)
a. Residual – do not qualify to be measured at
amortized cost or FVOCI
b. Fair value option – entity elects to measure at
FAFVPL to avoid accounting mismatch;
irrevocable election

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 Classification
EQUITY INSTRUMENTS
1. Financial asset at fair value through PL (FAFVPL)
a. Held for trading
b. Residual – those that were not elected to be
classified at FVOCI

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 Classification
EQUITY INSTRUMENTS
2. Financial asset at fair value through OCI (FAFVOCI)
– irrevocable election at initial recognition for
instruments that are not held for trading

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 Initial Measurement

Financial asset at Fair value plus transaction

amortized cost (FAAC) costs
Financial asset at FVOCI Fair value plus transaction
(FAFVOCI) costs
Financial at FVPL Fair value
(FAFVPL) (transaction costs are
expensed)

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Subsequent Measurement

Financial asset at Amortized cost

amortized cost (FAAC)
Financial asset at FVOCI Fair value – changes
(FAFVOCI) through OCI
Financial at FVPL Fair value – changes
(FAFVPL) through profit or loss

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PRACTICE!
Benedetta Company had the following investment
transactions:
Dec. 3 Acquired 12,000 shares of Lunox Company
at P3.00 per share. Benedetta incurred P1,800
brokerage commission.

Dec. 31 Lunox Company’s shares have a quoted price

of P5.00 per share.

Jan. 16 Benedetta Company sold all the shares at

P8.00 per share. Benedetta incurred sale
transaction costs of P4,800.
PRACTICE!
Investment is held for trading (FAFVPL)

Dec. 3 FAFVPL 36,000

Cash 36,000

Expense 1,800
Cash 1,800
PRACTICE!
Investment is held for trading (FAFVPL)

Dec. 31 FAFVPL 24,000

Unrealized gain - PL 24,000

Fair value – 12/31 (12,000 sh x 5) P60,000

Initial cost (12,000 sh x 3) 36,000
Increase in FV P24,000
PRACTICE!
Investment is held for trading (FAFVPL)

Jan. 16 Cash 91,200

FAFVPL 60,000
Gain on sale 31,200

Cash proceeds (12,000 x 8) 96,000

Transaction costs (4,800)
Net proceeds P91,200
PRACTICE!
Investment is irrevocably elected at FVOCI

Dec. 3 FAFVOCI 37,800

Cash 37,800

Fair value at initial recognition P36,000

Transaction costs 1,800
Total initial measurement P37,800
PRACTICE!
Investment is irrevocably elected at FVOCI

Dec. 31 FAFVOCI 22,200

Unrealized gain - OCI 22,200

Fair value – 12/31 (12,000 sh x 5) P60,000

Initial cost 37,800
Increase in FV P22,200
PRACTICE!
Investment is irrevocably elected at FVOCI

Jan. 16 FAFVOCI 31,200

Unrealized gain – OCI 31,200

Cash 91,200
FAFVOCI 91,200

Unrealized gain – OCI 53,400

Retained earnings 53,400
 TEST YOUR KNOWLEDGE!
Under PFRS 9, financial assets are classified
A. on the basis of the entity’s business model or contractual cash flow
characteristics of the financial asset
B. as financial assets subsequently measured either at fair value or at
amortized cost
C. as fair value through profit or loss, loans and receivables, available-for-
sale securities or held-to-maturity securities
D. Both A and B

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 TEST YOUR KNOWLEDGE!
On January 1, 2020, Ling Company purchased 1,000 shares of Lancelot
Company for P250,000. Commission paid to broker amounted to P10,000. The
equity securities were designated by management to be measured at fair value
through profit or loss. On December 31, 2020, the shares are quoted at P200 per
share. It was estimated that transaction cost of P20 per share will be incurred if
the shares were sold on that date. How much is the unrealized gain (loss) on
change in fair value recognized in the 2020 profit or loss?
A. P70,000 loss
B. P50,000 loss
C. P40,000 loss
D. P60,000 gain

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Thanks!
AJ Cresmundo
@ajcresmundo

Sir AJ Cresmundo

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