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Chapter 9 Financial Instruments
LEARNING OBJECTIVES
1. Apply and discuss the recognition and derecognition of a financial asset or financial
liability.
2. Apply and discuss the classification of a financial asset or financial liability and their
measurement.
3. Apply and discuss the treatment of gains and losses arising on financial assets and
financial liabilities.
4. Apply and discuss the treatment of impairment of financial assets.
5. Record the accounting for derivative financial instruments, and simple embeddedderivatives.
6. utline the principle of hedge accounting, and account for fair value hedges and cash
flo! hedges including hedge effectiveness.
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" l a s s i f i c a t i o n
o f # $
R e c o g n i t i o n
o f # $
$ n i t i a l
% e a s u r e m e n t
# a i r & a l u e
' h r o u g h ( r o f i t
o r ) o s s
A t A m o r t i s e d
" o s t
* e b t
$ n s t r u m e n t s
# a i r & a l u e
' h r o u g h ( r o f i t
o r ) o s s
# a i r & a l u e
' h r o u g h t h e r
" o m p r e h e n s i v e
$ n c o m e
+ , u i t y
$ n s t r u m e n t s
- u b s e , u e n t
% e a s u r e m e n t
% e a s u r e m e n t
o f # i n a n c i a l
A s s e t s
# a i r & a l u e
' h r o u g h ( r o f i t
o r ) o s s
A t A m o r t i s e d
" o s t
# a i r & a l u e
p t i o n
- u b s e , u e n t
% e a s u r e m e n t
% e a s u r e m e n t
o f # i n a n c i a l
) i a b i l i t i e s
* e r e c o g n i t i o n $ m p a i r m e n t
% e a s u r e m e n t
* e r i v a t i v e s
# a i r & a l u e
. e d g e
" a s h # l o !
. e d g e
. e d g e
A c c o u n t i n g
* i s c l o s u r e
# i n a n c i a l
$ n s t r u m e n t s
/ # $ 0
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1 Intr!"ucti!n
1.1 'here are four reporting standards that deal !ith financial instruments
/a0 $A- 32 #inancial instruments presentation
*eals !ith the classi#icati!n !# #inancial instrumentsand their presentation
in financial statements.
/b0 $A- 3 #inancial instruments recognition and measurement
*eals !ith ho! financial instruments are measured and !hen they should be
recognied in financial statements.
/c0 $#R- #inancial instruments disclosures
*eals !ith the disclosure of financial instruments in financial statements.
/d0 $#R- #inancial instruments
$ssued on ovember 2 and revised on *ecember 21. $t !ill eventually
replace $A- 3 and effective for accounting periods commencing from 1
7anuary 215.
1.2 istory of $#R-
Time $r!cess
14 7uly 2 $A-8 issues e9posure draft #inancial $nstruments "lassification
and %easurement
12 ovember 2 $A-8 issues $#R- #inancial $nstruments, covering classification
and measurement of financial assets, as the first part of its pro:ect to
replace $A- 3.
2; ctober 21 $A-8 reissues $#R- #inancial $nstruments, incorporating ne!
reuirements on accounting for financial liabilities and carrying
over from $A- 3 the reuirements for derecognition of financial
assets and financial liabilities.
4 August 211 $A-8 publishes an e9posure draft proposing to push bac< the
mandatory effective date of $#R- #inancial $nstruments from 1
7anuary 213 to 1 7anuary 215
16 *ecember 211 $A-8 publishes %andatory +ffective *ate and 'ransition
*isclosures /Amendments to $#R- and $#R- 0, !hich amends
the effective date of $#R- to annual periods beginning on or after
1 7anuary 215, and modifies the relief from restating comparative
periods and the associated disclosures in $#R-
1 7anuary 213 riginal effective date of $#R- , !ith early adoption permitted
starting in 2
1 7anuary 215 Revised effective date of $#R- , !ith early adoption permitted
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% Classi#icati!n !# Financial Instruments &IAS '%(
2.1 )e#initi!ns
/a0 A #inancial instrumentis any c!ntractthat gives rise to a financial asset of
one entity and a financial liability or euity instrument of another entity.
/b0 A #inancial assetsis any asset that is
/i0 cash
/ii0 a contractual right to receive cash or another financial asset from
another entity
/iii0 a contractual right to e9change financial assets=liabilities !ith another
entity under conditions that are potentially favourable to the entity
/iv0 a contract that !ill or may be settled in the entity>s o!n euity
instruments, and is a non?derivative for !hich the entity is or may be
obliged to receive a variable number of the entity>s o!n euity
instruments
/v0 a contract that !ill or may be settled in the entity>s o!n euity
instruments, and is a derivative that !ill or may be settled other than
by the e9change of a fi9ed amount of cash or another financial asset
for a fi9ed number of the entity>s o!n euity instruments.
+9amples
'rade receivables
ptions
$nvestment in euity shares
/c0 A #inancial lia*ilit+is any liability that is a c!ntractual !*li,ati!n
/i0 to deliver cash or another financial asset to another entity, or
/ii0 to e9change financial instruments !ith another entity under conditions
that are potentially unfavourable, or
/iii0 a contract that !ill or may be settled in the entity>s o!n euity
instruments, and is a non?derivative for !hich the entity is or may be
obliged to deliver a variable number of the entity>s o!n euity
instruments
/v0 a contract that !ill or may be settled in the entity>s o!n euity
instruments, and is a derivative that !ill or may be settled other than
by the e9change of a fi9ed amount of cash or another financial asset
for a fi9ed number of the entity>s o!n euity instruments.
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+9amples
'rade payables
*ebenture loans Redeemable preference shares
/d0 An e-uit+ instrumentis any contract that evidences a residual interest in the
assets of an entity after deducting all of its liabilities.
2.2 E.ample 1
$dentify !hich of the follo!ing are financial instruments
/a0 inventories
/b0 investment in ordinary shares
/c0 prepayments for goods or services
/d0 liability for income ta9es
/e0 a share option /an entity>s obligation to issue its o!n shares0
S!luti!n/
/a0 $nventory /or any other physical asset such as non?current assets0 is n!t a
#inancial instrumentsince there is n! present c!ntractual ri,htto receivecash or other financial instruments.
/b0 An investment in ordinary shares is a #inancial asset since it is an e-uit+
instrument !# an!ther entit+.
/c0 (repayments for goods or services are n!t #inancial instruments since the
future economic benefits !ill be the receipt !# ,!!"s !r ser0ices rather than
a #inancial asset.
/d0 A liability for income ta9es is n!t a #inancial instrumentsince the obligation
is statut!r+ rather than c!ntractual.
/e0 A share option is a financial instrument since a c!ntractual !*li,ati!n "!es
e.ist t! "eli0er an e-uit+ instrument. ote, ho!ever, that an option buy or
sell an asset other than a financial instrument /e.g. a commodity0 !ould not
ualify as a financial instrument.
2.3 'he accounting treatment of interest, dividends, losses and gains relating to a financial
instrument follo!s the treatment of the instrument itself. #or e9ample, dividends paid
in respect of preference shares classified as a liability !ill be charged as a finance
e9pense through profit or loss. *ividends paid on shares classified as euity !ill be
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reported in the statement of changes in euity.
(a) Classification as liabilities and/or equity
2.4 +ntities that issue financial instruments should classify them as either liabilities or
euity. 'his classification should be made in accordance !ith the su*stance, n!t
merel+ the le,al #!rm, of the instrument.
2.5 'he substance of a financial instrument may differ from its legal form. -ome financial
instruments ta
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return it to the issuer for cash or another financial asset. Although the legal
form of such financial instruments often includes a right to the residual
interest in the assets of an entity, the inclusion of an option for the h!l"er t!
put the instrument *ac5 t! the entit+ #!r cash !r an!ther #inancial assetmeans that the instruments meet the "e#initi!n !# a #inancial lia*ilit+, an
!*li,ati!n.
/c0 Share 6arrants !r ri,hts
-hare !arrant or right should be classified as euity. 'here is a contract that is
settled by the issuer delivering a fi9ed number of the issuer>s o!n shares in
e9change for a fi9ed amount of cash or monetary assets.
' Rec!,niti!n !# Financial Assets an" Financial Lia*ilities un"er IFRS
9 an" IAS '9
3.1 Initial rec!,niti!n !# #inancial assets an" #inancial lia*ilities
/a0 An entity should rec!,ni7e a #inancial asset !r a #inancial lia*ilit+ on its
statement of financial position !hen, and only !hen, it *ec!mes a part+ t!
the c!ntractual pr!0isi!nsof the instrument, rather than !hen the contract is
settled. /Applied to $#R- and $A- 30
/b0 At initial recognition, an entity has an !pti!n t! irre0!ca*l+ "esi,nate a#inancial asset !r a #inancial lia*ilit+ as measure" at #air 0alue thr!u,h
pr!#it !r l!ss. 'his option is termed as #air 0alue !pti!nB and is an
accounting policy choice. /nly applied to $#R- 0
3.2 +9amples of this principle are as follo!s
/a0 Cnconditional receivables are recognied !hen the entity becomes a party to
the contract. At that point the entity has a legal right to receive cash.
/b0 "ommitments to sell goods, etc. are not recognied until one party has fulfilledits part of the contract. #or e9ample, a sales order !ill not be recognied as
revenue and a receivable until the goods have been delivered.
/c0 #or!ard contracts are recognied as assets on the commitment date, not on the
date !hen the item under contract is transferred from seller to buyer.
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8 easurement !# Financial Assets un"er IAS '9
81 Initial measurement
4.1.1 Initial measurement !# #inancial assets un"er IAS '9
/a0 A financial asset or liability should initiall+ *e measure" at is #air 0alueupon
initial recognition. o!ever, a financial asset n!t :at #air 0alue thr!u,h
pr!#it !r l!ss;shall be measure" at #air 0alue plus transacti!n c!stthat are
directly attributable to the acuisition or issue of the financial asset or financial
liability.
/b0 'ransaction costs are incremental costs that are directly attributable for the
transaction !hich include commissions paid to agents, advisers, bro securities
/ii0 Edesignated> securities
/b0
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4.2.2 'he four types of financial instruments are measured as follo!s.
Financial
instrument
easurement at
rec!,niti!n
Su*se-uent
measurement
Rec!,niti!n in inc!me
statement = e-uit+#inancial assets
and liabilities at
fair value through
profit or loss
#air value %easured at fair
value !ith changes
in value ta
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At is accounting year?end on 31 *ecember 211, the shares are uoted at the ong
Gong -toc< +9change at the follo!ing prices
/a0 rdinary shares of )% )td H1.5 per shareD and
/b0 rdinary shares of IJK )td H4. per share.
Assume further that at is accounting?year end on 31 *ecember 212, the shares are
uoted on the G-+ at the follo!ing prices
/a0 rdinary shares of )% )td H1.3 per shareD and
/b0 rdinary shares of IJK )td H3.1 per share.
$n this case, the relevant :ournal entries !ill be as follo!s
1> N!0em*er %?11 )r &@( Cr &@(
$nvestment in A#- securities ;;,
"ash ;;,
'1 )ecem*er %?11
$nvestment in A#- securities 142,
#air value reserve 142,
31 *ecember 212
#air value reserve 2,
$nvestment in A#- securities 2,
$n its 211 financial statements
/a0 $nvestment in A#- securities !ill be presented at its fair value of H5, in
the statement of financial position.
/b0 'he fair value gain on investment in A#- securities of H142, !ill be
recognied in other comprehensive income and accumulated in fair value
reserve on A#- securities. 'he fair value reserve on A#- securities of
H142, !ill be presented as part of shareholders> euity in the statement of
financial position.
$n its 212 financial statements
/a0 $nvestment in A#- securities !ill be presented at its fair value of H5, in
the statement of financial position.
/b0 'he fair value loss on investment in A#- securities of H2, !ill be
recognied in other comprehensive income and reduced the fair value reserve
on A#- securities, resulting in a debt balance of H5;, to be presented as
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part of shareholders> euity in the statement of financial position.
> easurement !# Financial Assets un"er IFRS 9
>1 Initial measurement
5.1.1 Initial measurement !# #inancial assets
All financial instruments are initiall+ measure" at #air 0alueplus or minus, in the
case of a financial asset or financial liability not at fair value through profit or loss,
transaction costs.
>% Su*se-uent measurement
5.2.1 T6! classi#icati!ns !# #inancial assets
$#R- divides all financial assets into t!o classifications
/a0 those measure" at am!rtise" c!stD and
/b0 those measure" at #air 0alue.
Classi#icati!nis ma"eat the time the #inancial asset is initiall+ rec!,ni7e", namely
!hen the entity becomes a party to the contractual provisions of the instrument.
(a) Debt instruments
5.2.2 )e*t instruments
*ebt instruments !ould n!rmall+ *e measure" at #air 0alue thr!u,h pr!#it !r l!ss
/#&'()0, *ut c!ul" *e measure" at am!rtise" c!st /net of any !ritedo!n for
impairment0 if the entity chooses to do so, provided the follo!ing t!o tests are
passed
/a0 Business m!"el testL
/i0 +stablishes !hether the entity holds the financial asset to c!llect the
c!ntractual cash #l!6s!r!hether the ob:ective is t! sell the #inancial
asset pri!r t! maturit+ t! reali7e chan,es in #air 0alue.
/ii0 $f it is to c!llect the c!ntractual cash #l!6s, it impliesthat there !ill
be n! !r #e6 sales !# such #inancial assetsfrom a portfolio to their
maturity date.
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/iii0 $f this is the case, the test is passe".
/iv0 $f n!t, it !ould suggest that it may be "isp!se" !# t! resp!n" t!
chan,es in #air 0alue. $n this situation, the test is failed and the
financial asset cann!tbe measure" at am!rtise" c!st./v0 @here an entity chan,es its *usiness m!"el, it may be re-uire" t!
reclassi#+its financial assets as a conseuence, but this is e9pected to
be infreuent occurrence.
/vi0 $f reclassification does occur, it is accounted for from the first day of
the accounting period in !hich reclassification ta
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$n this case, the carrying amount of the investment and the interest income for each
relevant year !ill be determined, using the effective interest method, as follo!s
ear Openin,
*alance
E##ect interest
rate >
Interest
recei0e"
Cl!sin, *alance
H H H H
211 14,33 5,216 /6,0 13,546
212 13,546 5,1 /6,0 12,23
213 12,23 5,136 /6,0 11,;5
214 11,;5 5,3 /6,0 1,52
215 1,52 5,4; /6,0 1,
25,6 /3,0
'o $ncome
statement
'o -tatement
of cash flo!s
'o -tatement of
financial position
'he relevant :ournal entries are as follo!s
1 Januar+ %?11 )r &@( Cr &@(
$nvestment in bond 14,33
"ash 14,33
'1 )ecem*er %?11
"ash 6,
$nvestment in bond /6, L 5,2160 ;4
$nterest income 5,216
'1 )ecem*er %?1%
"ash 6,
$nvestment in bond /6, L 5,10 ;23
$nterest income 5,1
'1 )ecem*er %?1'
"ash 6,
$nvestment in bond /6, L 5,1360 ;64
$nterest income 5,136
'1 )ecem*er %?18
"ash 6,
$nvestment in bond /6, L 5,30
$nterest income 5,3
'1 )ecem*er %?1>
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"ash 6,
$nvestment in bond /6, L 5,4;0 52
$nterest income 5,4;
"ash 1,$nvestment in bond 1,
(b) Equity instruments
5.2.6 E-uit+ instruments
+uity instruments are measured at either
/a0 #air 0alue thr!u,h pr!#it !r l!ss, or
/b0 #air 0alue thr!u,h !ther c!mprehensi0e inc!me.
5.2. 'he n!rmal e.pectati!nis that euity instruments !ill have the designation of #air
0alue thr!u,h pr!#it !r l!ss, !ith the price paid to acuire the financial asset initially
regarded as fair value.
5.2.; 'his could include unuoted euity instruments, !hich may present problems in
arriving at a reliable fair value at each reporting date. o!ever, $#R- does n!t
inclu"e a ,eneral e.cepti!n #!r un-u!te" e-uit+ in0estments to be measured at
costD rather it provides guidance on !hen cost may, or may not, be regarded as a
reliable indicator of fair value.
5.2. E.ample > E-uit+ in0estment measure" at #air 0alue
A8" )td acuires the follo!ing shares in the ong Gong -toc< +9change on 15
ovember 211, !hich it intends to sell in early 212 to ta
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$n this case, the shares are financial assets at fair value through profit or loss as it is
held for trading, and the relevant :ournal entries !ill be as follo!s
1> N!0em*er %?11 )r &@( Cr &@(
$nvestment in trading securities ;,+9pense ;,
"ash ;;,
'1 )ecem*er %?11
$nvestment in trading securities 15,
#air value gain 15,
$n the statement of financial position as at 31 *ecember 211, the investment in
trading securities !ill be presented at its fair value of H5,.
$n the statement of comprehensive income for the year ended 31 *ecember 211, the
fair value gain on trading securities of H15, and the e9pense of H;, !ill be
recognied in profit or loss for the year.
5.2.1 Fair 0alue thr!u,h !ther c!mprehensi0e inc!me
/a0 $t is possible to designate an entity instrument as #air 0alue thr!u,h !ther
c!mprehensi0e inc!me, provided speci#ie" c!n"iti!ns ha0e *een c!mplie"
6ithas follo!s
/i0 the euity instrument cann!t *e hel" #!r tra"in,, and
/ii0 there must be an irre0!ca*le ch!icefor this designation upon initial
recognition.
/b0 $n this situation, initial rec!,niti!n!ill also inclu"e "irectl+ attri*uta*le
transacti!ns c!sts. 'his may apply, for e9ample, to strategic investments to
be held on a continuing basis !hich are not held to ta
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easurement !# Financial Lia*ilities
6.1 $#R- !as updated in ctober 21 to include accounting for financial liabilities. $n
principle, the recognition and measurement criteria contained in $A- 3 have been
retained !ithin $#R- .
6.2 T6! classes !# #inancial lia*ilities
/a0 #inancial liabilities at #air 0alue thr!u,h pr!#it !r l!ss, and
/b0 Other #inancial lia*ilities. 'his is the default class for financial liabilities if
they are not at fair value through profit or lossD these financial liabilities are
measured at am!rtise" c!st. 8orro!ing !ould normally be classed under this
heading.
6.3 -ummary of t!o classes of financial liabilities
Financial
instrument
easurement at
rec!,niti!n
Su*se-uent
measurement
Rec!,niti!n in
statement !#
c!mprehensi0e inc!me
#inancial liabilities at
fair value through
profit or loss
#air value %easured at fair
value !ith changes in
value ta
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/d0 'he full finance cost !ill be charged over the life of the instrument so as to
give a constant periodic rate of interest.
/e0 'he full cost include
/i0 issue costs
/ii0 deep discount on issue
/iii0 annual interest payments
/iv0 premium on redemption
6.5 E.ample )eep "isc!unt *!n"
n 1 7anuary 212 A8" "o issued a deep discount bond !ith a H5, nominal
value. 'he discount !as 16M of nominal value, and the costs of issue !ere H2,.
$nterest of 5M of nominal value is payable annually in arrears. 'he bond must be
redeemed on 1 7anuary 21 /after 5 years0 at a premium of H4,611. 'he effective
rate of interest is 12M pa.
Re-uire"/
o! !ill this be reported in the financial statements of A8" "o over the period to
redemptionN
S!luti!n/
#irstly, !e must establish at !hat amount the bond !ill be initially recognied in the
statement of financial position. 'he calculation set out belo!, also !or
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6,111
T!tal #inance c!st 2,111
-econdly, !e set up a table /similar to that used for compound instruments0 to !or Cl!sin, *alance
H H H H
1 4, 4,; /2,50 42,3
2 42,3 5,6 /2,50 44,;6
3 44,;6 5,3;5 /2,50 4,61
4 4,61 5,31 /2,50 5,2
5 5,2 6,11 /2,50 54,611
2,111 /12,50
'o $ncome
statement
'o -tatement
of cash flo!s
'o -tatement of
financial position
'he finance charge ta
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'here !ere no issue costs.
'he coupon rate is 1M, payable annually in arrears on 31 *ecember.
'he bond is redeemable at par on 1 7anuary 215.
8ondholders may opt for conversion. 'he terms of conversion are t!o 25?centeuity shares for every H1 o!ed to each bondholder on 1 7anuary 215.
8onds issued by similar entities !ithout any conversion rights currently bear
interest at 15M.
Assume that all bondholders opt for conversion in full.
Re-uire"/
o! !ill this be accounted for by 88" "oN
S!luti!n/
n initial recognition, the method if splitting the bond bet!een euity and liabilities
is as follo!s.
"alculate the present value of the debt component by discounting the cash flo!s
at the mar $V
@??? @???31 *ec 12 $nterest 5, .;6 4,34.;
31 *ec 13 $nterest 5, .56 3,;.
31 *ec 14 $nterest 5, .65; 3,2;.6
1 7an 15 (rincipal 5, .65; 32,;5.;
(& /the liability component0 A 44,21.
As the net proceeds of issue !ere 8 5,.
-o the euity component is /8 L A0 5,;.1
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% The annual #inance c!sts an" +ear en" carr+in, am!unts
ear Openin,
*alance
E##ect interest
rate 1>
$a+ments
1?
Cl!sin, *alance
H H H H
212 44,21. 6,643.; /5,0 45,35.
213 45,35. 6,;.4 /5,0 4,;26.1
214 4,;26.1 ,13. /5,0 5,.
' The c!n0ersi!n !# the *!n"
'he carrying amounts at 1 7anuary 212
H
+uity 5,;.1
)iability L bond 5,.
55,;.1
'he conversion terms are t!o 25?cent euity shares for every H1, so H5m O 2 P
H1m shares, !hich have a nominal value of H25m. 'he remaining H3,;,1
should be classified as the share premium, conversion has e9tinguished it.
uesti!n 1
+psilon is a listed entity. Jou are the financial controller of the entity and its consolidated
financial statements for the year ended 3 -eptember 21 are being prepared. Jour
assistant, !ho has prepared the first draft of the statements, is unsure about the correct
treatment of a number of transactions and has as
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increase the effective interest rate on such loan notes to Q45M.
'he follo!ing information regarding discount rates may be relevant
)isc!unt rate $resent 0alue !# @1 recei0a*le
at the en" !# +ear 1?
Cumulati0e present 0alue !# @1
recei0a*le at the en" !# +ears 1 1?
5M 61 cents H.2
M 42 cents H6.42
Re-uire"/
#or the above transaction prepare e9tracts from the financial statements for the year ended
3 -eptember 21. Jour e9tracts should be supported by appropriate e9planations. /6
mar
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'herefore the instrument?specific element of $RR is 3M /M L 6M0.
At 31 *ecember 212, )$8R has moved to 5.5M, thus ma $V
ear @ @
1 L 6 2, 4.5533 122,3
6 3, .612 1;3,;
36,;
$V at mar5et rate ' Cash #l!6 )F ' $V
ear @ @
1 L 6 2, 4.5;; 123,6;2
6 3, .61 1;5,1
3,52
'herefore, the change in the fair value of the liability !hich is not due to the change
in the benchmar< rate must be due to the change in the liability>s credit ris
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ther comprehensive income 2,;3
$#R- reuires that this change in fair value relating to the change in the liability>s
credit ris< is ta
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D )erec!,niti!n !# Financial Instruments
.1 'he derecognition reuirements of $A- 3 have been transferred to $#R- .
*erecognition is currently part of the $A-8 !or< plan for the development of
reporting standards, !hich includes a continuing commitment to convergence of $#R-
!ith C- FAA(. 'hese reuirements may be changed at some future date, as practical
issues associated !ith derecognition of financial instruments become apparent.
.2 )erec!,niti!n
/a0 A #inancial asset should be derecognied if one of the follo!ing criteria
occur
/i0 the c!ntractual ri,hts t! the cash #l!6sof the financial asset ha0e
e.pire", e.g. !hen an option held by the entity has e9pired !orthless,
or
/ii0 the financial asset has been sold and the transfer ualifies for
derecognition because su*stantiall+ all the ris5s an" re6ar"s !#
!6nership ha0e *een trans#erre"from the seller to the buyer.
'he anal+sis !# 6here the ris5s an" re6ar"s !# !6nership lie after the
transaction is critical. #or e9ample if an entity sells an investment in sharesand enters into a total return s!ap !ith the buyer, the buyer !ill return any
increases in value to the entity or the entity !ill pay the buyer for any decrease
in value. $n this case the entity has retained substantially all of the ris
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.3 E.ample 9 )erec!,niti!n
'ech "o has t!o receivables that it has factored to a ban< in return for immediate
cash proceeds of less than the face value of the invoices. 8oth receivables are due
from long standing customers !ho are e9pected to pay in full and on time. 'ech "ohas agreed a three?month credit period !ith both customers.
'he first receivable is for H2, and in return for assigning the receivable 'ech
"o has :ust received from the factor H1;,. Cnder the terms of the factoring
arrangement, the only money that 'ech "o !ill receive regardless of !hen or even if
the customer settles the debt, i.e. the factoring arrangement is said to be !ithout
recourseB.
'he second receivable is for H1, and in return for assigning the receivable 'ech
"o has :ust received H,. Cnder the terms of this, factoring arrangement if the
customer settles the account on time then a further H5, !ill be paid by the
factoring ban< to 'ech "o, but if the customer does not settle the account in
accordance !ith the agreed terms then the receivable !ill be reassigned bac< to 'ech
"o !ho !ill then be obliged to refund the factor the original H, plus a further
H1,. 'his factoring arrangement is said to be !ith recourseB.
Re-uire"/
*iscuss 'ech "o>s accounting treatment of the monies received under the terms of
the t!o factoring arrangements.
S!luti!n/
'he principle of derecognition here is that it needs to "etermine 6hether the ris5
an" re6ar"s !# !6nership !# the #act!rin, arran,ement has passe"from 'ech "oto the factoring ban
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$n the second arrangement the H, is simply a payment on account. %ore may be
received by 'ech "o implying that Tech C! retains an element !# re6ar". 'he
monies received are refundable in the event of default and as such represent anobligation. 'his means that the ris5 !# sl!6 pa+ment an" *a" "e*t remains 6ith
Tech C!!ho is liable to repay the monies so far received. As such despite the
passage of legal title, the asset /i.e. receivable0 should remain rec!,ni7e" in the
acc!unts !# Tech C!. $n substance 'ech "o has *!rr!6e" @D?3??? an" this l!an
sh!ul" *e rec!,ni7e" imme"iatel+. 'his !ill increase the gearing of 'ech "o.
Impairment !# Financial Assets
;.1 Impairment !# #inancial assets
$mpairment of financial assets !ill, in due course, be included !ithin updated
reuirements of $#R- . 'he present situation as at August 21 is as follo!s
/a0 Financial assetsthat are measured at #air 0alue thr!u,h pr!#it !r l!ssare
n!t su*Hect t! an impairment re0ie6. Remeasurement !# #air 0alueat each
reporting date !ill aut!maticall+ ta5e acc!unt !# an+ impairment.
/b0 -imilarly, #inancial assets measured at #air 0alue thr!u,h !ther
c!mprehensi0e inc!me are n!t su*Hect t! an impairment re0ie6. Anychanges in fair value, including those !hich may relate to impairment, are
recognied in other comprehensive income. 'here is no recognition or
recycling of impairment to profit or loss.
/c0 #or #inancial assets measure" at am!rtise" c!st, $A- 3 re-uires that an
assessment be made, at e0er+ rep!rtin, "ate, as to 6hether there is an+
!*Hecti0e e0i"ence that a #inancial asset is impaire", i.e. !hether an event
has occurred that has had a negative impact on the e9pected future cash flo!s
of the asset.
/d0 'he e0ent causin, the ne,ati0e impact must ha0e alrea"+ happene" . An
event causing an impairment in the future shall not be anticipated.
#or e9ample, on the last day of its financial year a ban< lends a customer
H1,. 'he ban< has consistently e9perienced a default rate of 5M across
all its loans. 'he *an5 is n!t permitte" imme"iatel+ t! 6rite this l!an
"!6n to H5, based on its past e9perience, because no default has
occurred at the reporting date.
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;.2 +9amples of ob:ective evidence of impairment at the reporting date include significant
financial difficulty of the borro!er, and the failure of the borro!er to ma
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;.4 Re0ersal !# an impairment l!ssis !nl+ permitte"as a result of an e0ent !ccurrin,
a#ter the impairment l!ss has *een rec!,ni7e". An e9ample !ould be the credit
rating of a customer being revised up!ards by a credit rating agency.
;.5 Re0ersal !# impairment l!ssesin respect of #inancial assets measure" at am!rtise"
c!st are rec!,ni7e" in pr!#it !r l!ss.
9 )eri0ati0es
.1 A derivative is a financial instrument !ith the follo!ing characteristics
/a0 $ts 0alue chan,es in resp!nse t! the chan,e in a speci#ie" interest rate,
security price, commodity price, foreign e9change rate, inde9 of prices or
rates, a credit rating or credit inde9 or similar 0aria*le /called the
un"erl+in,0.
/b0 $t reuires little !r n! initial net in0estmentrelative to other types of contract
that have a similar response to changes in mar
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.3.1 easurement !# "eri0ati0es
/a0 n recognition, derivatives should initiall+ *e measure" at #air 0alue.
/b0 Su*se-uent measurement"epen"s !nho! the derivative is cate,!ri7e". $n
many cases, this !ill involve the derivative being measure" at #air 0alue
6ith chan,es in the #air 0alue rec!,ni7e" in pr!#it !r l!ss.
/c0 o!ever, i# the "eri0ati0e is use" as a he",e, then the chan,es in #air 0alue
sh!ul" *e rec!,ni7e" in e-uit+.
.3.2 E.ample 11 easurement !# "eri0ati0es
+ntity A enters into a call option on 1 7une 212, to purchase 1, shares in
another entity on 1 ovember 212 at a price of H1 per share. 'he cost of each
option is H1. +ntity A has a year end of 3 -eptember.
8y 3 -eptember the fair value of each option has increased to H1.3 and by 1
ovember to H1.5, !ith the share price on the same date being H11. +ntity A
e9ercises the option on 1 ovember and the shares are classified as at fair value
through profit or loss.
n 1 7une 212, the cost of the option is recognied
*r. /H0 "r. /H0
"all option /1, O H10 1,
"ash 1,
n 3 -eptember the increase in fair value is recorded
*r. /H0 "r. /H0
"all option T1, O /H1.3 L H10U 3,
(rofit or loss 3,
n 1 ovember the option is e9ercise, the shares recognied and the call option
derecognied. As the shares are financial assets at fair value through profit or loss,
they are recognied at H11, /1, O H110
*r. /H0 "r. /H0
$nvestment in shares at fair value 11,
+9pense L loss on call option
T/1, S 3, S 1,0 L 11,U 3,
"ash 1,
242
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"all option 13,
243
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1?
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(a) ccountin! for a fair value "ed!e
1.2.2 Cnder $A- 3 hedge accounting rules can only be applied to a fair value hedge if the
hedging relationship meets #!ur criteria.
/a0 At the inception of the hedge there must be #!rmal "!cumentati!nidentifying
the hedged item and the hedging instrument.
/b0 'he hedge is e9pected to be hi,hl+ e##ecti0e.
/c0 'he e##ecti0eness !# the he",e can *e measure" relia*l+ /i.e. the fair
value=cash flo!s of the item and the instrument can be measured reliably0.
/d0 'he hedge has been assesse" !n an !n4,!in, *asis an" is "etermine" t!
ha0e *een e##ecti0e.
1.2.3 $t should be noted at the outset that !hether or not to hedge, and !hether or not to
apply hedge accounting are t!o separate issues. nce an entity decides to hedge, it
still has to decide !hether or not to apply hedge accounting.
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1.2.6 E.ample 1%
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As long as either one of the t6! measures a*!0e #alls 6ithin the ran,e ?
1%>3 the he",e is re,ar"e" as e##ecti0e.
1.2. Acc!untin, treatment #!r #air 0alue he",e
/a0 'he he",in, instrument!ill be remeasure" at #air 0alue, !ith all ,ains
an" l!ssesbeing rep!rtin, in pr!#it !r l!ss #!r the +ear .
/b0 'he he",e" p!rti!nof the hedged item !ill be remeasure" at #air 0alue,
!ith all ,ains an" l!sses *ein, rep!rte" in pr!#it !r l!ss #!r the +ear
1.2.; E.ample 1' Fair 0alue he",e
G )td /a company incorporated in G and !ith 31 *ecember accounting year?
ends0 has, on 1 April 211, sold goods to #" )td /a company incorporated in a
foreign country0 invoiced at #" 1, payable 3 -eptember 211.
'he e9change rates bet!een #" and H at the relevant dates are as follo!s
n 1 April 211
-pot rate #"1. P H.65
-i9?month rate #"1. P H.63
n 3 -eptember 211
-pot rate #"1. P H.55
Scenari! A
G )td decides not to hedge the foreign currency e9posure. 'he relevant :ournal
entries !ill be as follo!s
1 April %?11 *r. /H0 "r. /H0
'rade receivable /#"1, O H.650 65,
-ales 65,
'? Septem*er %?11
"ash 55,
+9change loss 1,
'rade receivable 65,
*ue to unfavourable shift in the e9change rate, G )td suffers an e9change loss of
24
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H1,.
Scenari! B
G )td decides to hedge the foreign currency e9posure by entering into a for!arde9change contract on 1 April 211 to sell #"1, on 3 -eptember 211.
G )td further decides to apply hedge accounting. 'his is a fair value hedge under
$A- 3.
Csing the for!ard rate as the basis of measurement, the :ournal entries to record the
transactions !ill be as follo!s
1 April %?11 *r. /H0 "r. /H0
'rade receivable /#"1, O H.630 63,
-ales 63,
/'o record sales0
o :ournal entry is reuired for the for!ard e9change contract. 7ust a memorandum
entry to record the fact that a for!ard e9change contract has been entered into as a
fair value hedge.
'? Septem*er %?11
"ash 55,
#air value loss ;,
'rade receivable 63,
/'o record receipt of #"1,0
ther receivables ;,
#air value gain ;,
/'o record fair value ad:ustment for contract receivable0"ash ;,
ther receivables ;,
/'o record net settlement of for!ard e9change contract0
ote that, !ith the fair value hedge, G )td is protected from the foreign currency
ris
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loss on the trade receivable !ill be e9actly offset by the fair value gain on the
for!ard e9change contract.
ote ho!ever that there is a cost involved, namely, the margin made by the foreigncurrency dealer of H.2 /H.65 L H.630. 'his may be more evidently reflected in the
alternative treatment sho!n belo!.
1 April %?11 *r. /H0 "r. /H0
'rade receivable /#"1, O H.650 65,
-ales 65,
/'o record sales0
"ontract receivable 63,
(remium 2,
"ontract payable 65,
/'o record for!ard e9change contract0
'? Septem*er %?11
"ash 55,
#air value loss 1,
'rade receivable 65,
/'o record receipt of #"1,0
"ontract payable 1,
#air value gain 1,
/'o record fair value ad:ustment for contract payable0
"ash ;,
"ontract payable 55,
"ontract receivable 63,
/'o record net settlement of for!ard e9change contract0
ote that, due to the fair value hedge, G )td is able to loc
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he",e3 plus
/e0 the transaction ,i0in, rise t! the cash #l!6 ris5 is hi,hl+ pr!*a*le an"!ill
ultimatel+ a##ect pr!#ita*ilit+.
1.2.1 Acc!untin, treatment #!r cash #l!6 he",e
/a0 'he hedging instrument !ill be remeasure" at #air 0alue. 'he ,ain !r l!ss
on the portion of the instrument that is "eeme" t! *e an e##ecti0e he",e!ill
be ta5en t! e-uit+and recognied in the statement of changes in euity.
/b0 'he ine##ecti0e p!rti!n !# the ,ain !r l!ss!ill be rep!rte" imme"iatel+ in
the inc!me statement.
/c0 $f the he",e" item e0entuall+ results in the rec!,niti!n !# a n!n4#inancial
asset !r lia*ilit+, the ,ain !r l!ss hel" in e-uit+must be rec+cle" in !ne !#
the t6! #!ll!6in, 6a+s.
/i0 the ,ain=l!ss ,!es t! a"Hust the carr+in, am!unt !# the n!n4
#inancial assets=lia*ilit+.
/ii0 the ,ain=l!ss is trans#erre" t! pr!#it an" l!ss in line 6ith the
c!nsumpti!n !# the n!n4#inancial assets=lia*ilit+.
1.2.11 E.ample 18 Cash #l!6 he",e
A8" "o has contracted to buy one hundred tonnes of ra! materials from a Ferman
entity. 'he materials !ill cost V5,, and !ill be delivered and paid for in +uros
on 3 7une 212. A8" "o ta
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*iscuss the accounting principles involved in accounting for the above transaction and ho!
the above transaction should be treated in the financial statement of -eltec. /14 mar
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11.4.2 uantitative disclosures L this disclosures provide information about the e9tent to
!hich the entity is e9posed to riss
