Financial Instruments
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
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
