21 Financial Instruments Version 2010 1

8/8/2019 21 Financial Instruments Version 2010 1

1/13

International Financial Reporting StandardsInternational Financial Reporting Standards

Copyright2010 IASC Foundation.All rights reserved.

2The IFRS for SMEs

Section 11 Basic Financial Instruments

Section 12 Other Fin. Inst. Issues

Section 22 Liabilities and Equity

Paul Pacter

Day 2 08:0010:00 and 10:3011:30

3Sections 11-12 Introduction

Financial instruments split into twosections:

Sec. 11 Basic Financial Instruments

Sec. 12 Other Financial InstrumentsIssues

Together the two sections coverrecognising, derecognising, measuring,

and disclosing financial assets andfinancial liabilities

4Sections 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 ofbasic financial instruments

SME wants to do hedge accounting

5Sections 11-12 Accounting choice

Entity may choose to apply either:

Sections 11 and 12 in full, or

Recognition and measurement provisions

of IAS 39 and the disclosure requirementsin Sec 11 & 12

No option to use IFRS 9

The option chosen applies to all financialinstruments (not individually)

To change option, follow Section 10

6Sections 11-12 Basic principles

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 throughprofit or loss (FVTPL).

Basic principle of Section 12:

FI not covered by Section 11 are at

FVTPL


2/13

7Section 11 Scope

All basic financial instruments exceptthose covered by other sections of IFRSfor SMEs:

Investments in sub, associate, JV (seeSections 9, 14, 15)

Entitys own equity (see Sec 22, 26)

Leases (see Section 20)

Employee benefit assets and liabilities(see Section 28)

8Sections 11-12 Definitions

Financial instrument

Contract that gives rise to a financial

asset of one entity and a financial liabilityor equity instrument of another entity

Includes cash

But commodities that are near cash likegold are not financial instruments

9Sections 11-12 Definitions

Basic financial instrument*

Cash

Debt instrument (accounts, notes, and

loans receivable and payable) that meetconditions on next slide

Ordinary and preference shares that are

not convertible and not puttable

*These notes do not discuss loan commitments

10Section 11 Basic debt instruments

Debt instruments are in Section 11 if:

Returns to holder are fixed, variable

referenced to an observable rate, orcombination of fixed and variable

No special provision could cause holder

to lose principal

Prepayment conditions are not contingenton a future event

No special conditional returns


Examples of basic debt instruments:

Trade accounts and notes receivable andpayable

Loans from banks and other 3rd parties

Accounts payable in foreign currency

Loans to/from subsidiaries or associatesthat are due on demand

Debt instrument that becomesimmediately due if issuer defaults

All of these measured at amortised cost


Examples of NOT basic debt instruments:

Investment in convertible or puttableshares

Swaps, forwards, futures, options, rights,and other derivatives

Loans with unusual prepayment

conditions (based on tax change,

accounting change, linked to companyperformance)

All of these are FVTPL under Section 12


3/13

13Section 11 Recognition and measurement

Initial recognition: When entity becomes a party to thecontractual provisions of the instrument

IFRS for SMEs allows judgement

regarding trade date vs settlement dateaccounting, but be consistent


Initial measurement: At transaction price

Include transaction costs except for FIthat will be measured at FVTPL

Impute interest if payment is deferred

beyond normal terms or below-marketinterest


Initial recognition-measurement examples:

Loan made to another entity: Measureat PV of interest and principal payments

Goods sold to customer (purchased

from supplier) on normal credit terms:

Measure receivable (payable) at

undiscounted invoice price


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 Credit

At time of sale Receivable 857

Sales Revenue 857

End of year 1 Receivable 69

8% x 857 = 69 Interest Revenue 69


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 bemeasured reliably: FVTPL

All others: cost less impairment


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 (usingeffective interest method)

Minus (for assets) reduction for impairmentor uncollectibility


4/13


5/13

25Section 11 Impairment

Reversal of an impairment loss:

Required if the problem causing the originalimpairment reduces

Write up but not to more than what carrying

amount would have been had no

impairment been recognised (ie not to FVbut to new amortised cost)

Reversal recognised in P&L

26Section 11 Derecognition

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.



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, keeptransferred asset on books and recognise financial

liability for the consideration received

Do not offset



Transferor gives noncash collateral: If transferee can sell or repledge the

collateral: Transferor must show the asset

separately in its balance sheet

If transferee sells: It must recognise a

liability to return the collateral If transferor defaults: It derecognises the

collateral, and transferee recognise it at FV

(or if it has already sold it, derecognise the

liability)


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.


Derecognition of a financial liability:

Only when extinguished, that is:a. Discharged

b. Cancelled

c. Expired

If existing debt is replaced with new one

with substantially different terms (or

there is a significant modification ofterms):

Treat as new liability and extinguishment oforiginal liability


6/13

31Section 11 Disclosure

Disclose accounting policies for FI

Disclose financial assets and liabilities bycategories 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



Items of income, expense, gains, and

losses:

Changes in FV for instruments measured atFVTPL

Total interest income and total interestexpense on FI not measured at FVTPL

Impairment loss by class of financial asset

34Section 12 Scope

All FI not covered by Section 11 (and not

scoped out of Sections 11 and 12)

Contract to buy or sell non-financial item

(commodity, inventory, PP&E) is not a FI.

But if it has exotic feature and acts as aderivative, it is in scope of Sec 12.

Also it is in Sec 12 if it can be settled net incash and was not entered into to buy or sell

non-financial item to meet the entitysexpected sale or usage requirements.

35Section 12 Recognition and measurement Initial recognition:

When entity becomes a party to thecontractual provisions of the instrument

Initial measurement:

At FV (normally the transaction price)

Transaction costs are charged to expense

36Section 12 Recognition and measurement 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 mostrecent FV measure as cost going forward.


7/13


8/13

43Section 12 Hedge accounting

Hedged risk must be (12.17):

Interest rate risk in debt measured at cost

FX or interest rate risk in firm commitmentor highly probable forecast transaction

Price risk in a commodity owned or to be

acquired in a firm commitment or highlyprobable forecast transaction

FX risk in a net investment in a foreignoperation


Hedged risk must be (12.17):

FX risk in debt instrument measured at cost is not

in this list. Why?

Under Sec 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


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 orsettlement of hedged item

Cannot be prepaid or terminated early


Hedge of fixed interest rate risk and

commodity price risk of commodity held

Recognise hedging instrument as asset orliability

Change in FV of hedging instrument in P&L

Change in FV of hedged item in P&L and

adjustment of carrying amount of hedgeditem even though hedged item isotherwise measured at cost



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 whichthe net settlements occur.


Example Assumptions:

Entity borrows 1,000, 3 years, 5% fixed rate,

payable measured at amortised cost

Hedged with a derivative whose value is linked toan 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


9/13


Balance sheet at time loan is made:

Cash 1,000Loan 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

Equity 2


Loan payable 890


Conceptual question regarding theprevious example:

Does the 890 carrying amount of the loan

payable at end of year 1 represent the FairValue of the loan?

Hint: Does the 890 reflect change in creditrisk or prepayment risk?

If 890 is not Fair Value, what is it?



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 thecarrying amount of the hedged item is

amortised to P&L over remaining life ofhedged item.


Hedge of variable interest rate risk, FX or

commodity price risk of commodity held,

highly probable forecast transaction, or netinvestment in foreign operation

Recognise change in FV or 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 hedgingrelationship ends.


Hedge of variable interest rate risk, FX or

commodity price risk of commodity held,

highly probable forecast transaction, or netinvestment 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 netsettlements occur.


Example Assumptions:

Entity sells goods for 1,000 floating rate 3-year note receivable

Interest rate risk managed with a derivative(interest rate swap)

End of year 1 interest rates increase PVof cumulative cash flows increase by 100

But FV of swap decreases by 105

Note: Some hedge ineffectiveness


10/13


Opening balance sheet:

Receivable 1,000

Equity 1,000

Ineffective portion of hedge:

P&L* 5*

OCI (Equity) 100


*Ineffective portion of hedge

example continued next slide...


Closing balance sheet:

Receivable 1,000

Equity (OCI)* 100*


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


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 isrecycled to P&L


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

59Section 22 Liabilities and equity

Scope of Section 22

Principles for classifying an instrument asdebt or equity

Original issuance of shares and otherequity instruments

Sale of options, rights, warrants

Bonus issues and share splits

Issuance of convertible debt

continued...


Scope of Section 22, continued

Treasury shares

Distributions to owners

Non-controlling interest and transactions inshares of a consolidated subsidiary


11/13


Principles for classifying an instrument asdebt or equity

Equity = residual interest in assets minusliabilities

Liability is a present obligation (entity doesnot have a right to avoid paying cash)


The following are equity:

Puttable instrument that entitles holder topro rata share of net assets on liquidation

Instrument that is automatically redeemed if

an uncertain future event occurs or death orretirement of holder

Subordinated instrument payable only onliquidation


The following are liabilities:

Instrument is payable on liquidation, but

the amount is subject to a maximumceiling

Entity is obliged to make payments beforeliquidation such as mandatory dividend

Mandatorily redeemable preference shares


Members shares in a cooperative are

equity only if:

Coop has unconditional right to refuseredemption of members shares, or

Redemption is unconditionally prohibitedby law or entitys charter

Otherwise liability

65Section 22 Liabilities and equity Original issuance of shares and other equity

instruments

Recognise when equity is issued and subscriberis 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


Sale of options, rights, warrants

Same principles as for original issuance ofshares (previous slide)

Transaction costs in issuing equityinstruments

Accounted for as a reduction of equity (notan expense)


12/13


Bonus issues (stock dividends) and sharesplits

These do not change equity

Accounted for as reclassification of

amounts within equity (out of retainedearnings and into permanent capital)

Amounts reclassified should be based onlocal laws


Issuance of convertible debt

Must account separately for debt component andequity component (conversion right)

Split proceeds between debt and equity

Debt proceeds = FV of similar risk debt withoutconversion feature (PV calculation)

Equity proceeds are the residual

Recorded at issuance; not subsequently revised

Subsequently, debt discount = additional interest

expense (effective interest method)


Issuance of convertible debt - Example

1/1/X1 issue at par a 4% convertible bond,par and maturity amount = 50,000

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 45,788Credit equity (conversion right) 4,212


Date Inter-

est

paid

Interest

expense

@ 6%

Amort. of

discount

Bond

dis-

count

Net bond

liability

1/1/X1 4,212 45,788

31/12/X1 2,000 2,747 747 3,465 46,535

31/12/X2 2,000 2,792 792 2,673 47,327

31/12/X3 2,000 2,840 840 1,833 48,167

31/12/X4 2,000 2,890 890 943 49,057

31/12/X5 2,000 2,943 943 0 50,000

31/12/X1: Debit interest expense 2,747Credit financial liability 747

Credit cash 2,000


Treasury shares

Equity instruments entity has issued andlater reacquired

Measure at cash paid or FV of otherconsideration given to acquire \

Present as deduction from equity (notasset)

No gain or loss recognised on purchase,sale, or cancellation


Distributions to owners

If cash measurement = cash paid

If non-cash measurement = FV of assetsdistributed

Amount reduces equity

If entity gets tax deduction for dividend, taxbenefit is adjustment of equity

Not reduction of income tax expense

If entity pays withholding tax on dividendspaid, tax reduces equity as part of dividend


13/13


Non-controlling interest (NCI) and

transactions in shares of a consolidatedsubsidiary

In consolidated balance sheet NCI is part ofequity (not liability or in between)

Change in parents 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 assetsor goodwill

2010 IASC Foundation | 30 Cannon Street | London EC4M 6XH | UK | www.iasb.org

74Questions or comments?

Expressions of individual views by members

of the IASB and its staff are encouraged.

The views expressed in this presentation are

those of the presenter.

Official positions of the IASB on accounting

matters are determined only after extensive

due process and deliberation.

75

This presentation may be modified from time to time. Thelatest version may be downloaded from:http://www.iasb.org/Conferences+and+Workshops/IFRS+for+SMEs+Train+the+trainer+workshops.htm

The accounting requirements applicable to small andmedium-sized entities (SMEs) are set out in theInternational Financial Reporting Standard (IFRS) for SMEs,which was issued by the IASB in July 2009.

The IASC Foundation, the authors and the publishers do notaccept responsibility for loss caused to any person who actsor refrains from acting in reliance on the material in thisPowerPoint presentation, whether such loss is causedby negligence or otherwise.

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21 Financial Instruments Version 2010 1