This summary takes the lecture notes, textbook notes, IFRS and my own input into consideration to turn accounting for financial instruments into something simpler to understand. This summary outlines all the basics that you need to know in order to be able to answer a question on this section. This...
Introduction
o IAS 32: classification of financial instruments as financial assets, financial liabilities & equity
instruments from the POV of issuer
o IFRS 9: recognition, measurement & impairment of financial instruments
o IFRS 7: disclosures of financial instruments (& risks involved)
Definitions
o Financial Instrument: any contract that gives rise to a financial asset of 1 entity & 1
financial liability/equity of another entity
o Contract: agreement between 2/more parties that has clear economic consequences
that parties have little/no discretion to avoid - usually because agreement is legally
enforceable but doesn’t need to be in writing
o Financial Asset:
§ Cash
§ Equity instrument of another entity (investment in shares)
§ Contractual right to
Þ Receive cash/another financial asset
Þ Exchange financial assets/liabilities under potentially favourable
conditions
o Financial Liability: contractual obligation to
§ Deliver cash/another financial asset
§ Exchange financial assets/liabilities under potentially unfavourable conditions
Classification
o Issuer of financial instrument classifies it
Economic substance /
§ On initial recognition Legal form
§ In accordance with
§ Substance of contractual agreement and
§ Definitions IFRS 9 doesn’t apply
o Financial instrument is only equity instrument if it doesn’t meet any of the elements of the
definition of financial liability
§ I.e., there isn’t a contractual obligation to do certain things like deliver cash etc...
§ Eg: dividends on shares aren’t usually a compulsory payment (unless specified as
such in a contract à preference shares)
, o Financial instrument is a financial liability when entity doesn’t have unconditional right to
avoid delivery of cash/financial asset
Initial Recognition
o General Rule: recognize when entity becomes party to contract
§ Exception: when financial assets are traded on an exchange, then entity can
decide to recognize when cashflows occur
o Amount: Fair Value +/- directly attributable costs
§ Trade receivables that don’t have significant financing component are initially
recognized @ transaction price IFRS 15
o Fair Value: price that would be received/paid to sell/transfer asset/liability in an orderly
transaction between market participants @ measurement date
§ Usually the same as the transaction price, but if not then use FV & recognize
difference in p/l as day 1 gain/loss
o Transaction Costs: usually recognize @ FV +/- transaction costs
§ Unless @ FV à p/l
§ Then recognize FV only & separately deal with transaction costs in p/l
o Classification of financial instrument has impact on initial recognition
Financial Liabilities
o Classification automatic
§ Amortised cost (effective interest method)
§ FV à p/l
mandatory
Þ Held for trading
Þ Designated irrevocably
o Measurement
§ Amortised cost: work out I/YR or IRR, then calc interest & balance using AMRT
function
Þ If transaction costs need to be capitalized, then only PV changes to calc
new I/YR or IRR
Þ Impact (profits & losses) of amortization process is recognized in p/l
§ Mandatorily @ FV à p/l: gains & losses recognized in p/l
Þ Gains & losses from accrual of interest & other risk factors
Þ Entity can choose to distinguish interest expense from other movements
Þ If doesn’t disclose separately then everything = FV adjustment
§ Designated @ FV à p/l: profits & losses recognized in p/l except for component
which relates to liabilities credit risk à OCI Enlarges/
Þ Don’t have to apply OCI requirements if creates an accounting mismatch
in p/l
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