IFRS Financial Instruments Guide

Gripping IFRS Financial instruments

Chapter 21
Financial Instruments

Reference: IAS 32; IAS 39 and IFRS 7

Contents: Page

1. Introduction 648

2. Definitions 648
Example 1: financial assets 648
Example 2: financial liabilities 649

3. Financial Risks 649
3.1 Overview 649
3.2 Market risk 649
3.2.1 Interest rate risk 649
3.2.2 Currency risk 649
3.2.3 Price risk 650
3.3 Credit risk 650
3.4 Liquidity risk 650
4. Derivatives 650
4.1 Options 650
4.2 Swaps 650
Example 3: swaps 650
4.3 Futures 651

5. Compound financial instruments 651
Example 4: splitting of compound financial instruments 652
Example 5: compulsorily convertible preference shares 653
Example 6: redeemable debentures issued at a discount 654

6. Categories of financial liabilities 656
6.1 Overview 656
6.2 Financial liabilities measured at fair value through profit and loss 656
Example 7: fair value through profit and loss 657
6.3 Financial liabilities not measured at fair value through profit and loss 657
Example 8: other financial liabilities 657

7. Categories of financial assets 658
7.1 Overview 658
7.2 Fair value through profit or loss 658
Example 9: fair value through profit or loss financial assets 658
7.3 Held to maturity financial assets 659
Example 10: held to maturity 659
7.4 Loans and receivables 659
Example 11: loans and receivables 660
7.5 Available for sale financial assets 660
Example 12: available for sale 660

646 Chapter 21


Contents continued: Page

8. Reclassification of financial instruments 661
8.1 Overview 661
8.2 Fair value through profit or loss 661
8.3 Held to maturity 661
8.4 Available for sale 661
8.5 Instruments previously measured at amortised cost 661

9. Impairment of financial instruments 661

10. Offsetting of financial assets and liabilities 661

11. Disclosure 662
Example 13: disclosure of financial instruments 663

12. Summary 666

647 Chapter 21


1. Introduction

Most students find the financial instruments section very difficult, but by simply learning and
understanding the various definitions and rules, it will be made a lot easier. The IAS and
IFRS standards covering the recognition, measurement and disclosure of financial instruments
are very long, and therefore this chapter contains only the most important aspects.

2. Definitions

The definitions that follow may be found in IAS 32 and 39.
Financial instrument: is any contract that gives rise to a financial asset in one entity and a
financial liability or equity instrument in another. The contract need not be in writing.
An equity instrument: is any contract that results in a residual interest in the assets of an
entity after deducting all of its liabilities
A financial asset: is any asset that is:
• cash;
• an equity instrument of another entity;
• a contractual right to receive cash or another financial asset from another entity;
• a contractual right to exchange financial instruments with another entity under conditions
that are potentially favorable to the entity; or
• 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 entities 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.
A financial liability: is a liability that is:
• a contractual obligation to deliver cash or another financial asset to another entity;
• a contractual obligation to exchange financial instruments with another entity under
conditions that are potentially unfavorable to the entity;
• 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.
Compound instruments: are instruments that contain both a liability and equity component.
A derivative: is a financial instrument or other contract with all three of the following
characteristics:
• its value changes in response to a change in a specified interest rate, financial instrument
price, foreign exchange price etc;
• it requires no initial net investment or an initial net investment that is smaller than would
be required for other types of contracts that would be expected to have a similar response
to changes in market factors; and
• is settled at a future date.
Derivatives are commonly used to manage financial risks.

Example 1: financial assets

Discuss whether any of the following are financial assets:
a. Inventory
b. Debtors
c. Cash
d. Property, plant and equipment

648 Chapter 21


Solution to example 1: financial assets
a. No, there is no contractual agreement to receive cash or otherwise simply by holding stock.
b. Yes, there is a contractual right to receive a payment of cash from the debtor.
c. Yes, it is cash
d. No, there is no contractual right to cash or another instrument by owning property, plant and
equipment.

Example 2: financial liabilities

Discuss whether any of the following are financial liabilities:
a. Creditors
b. Redeemable preference shares
c. Warranty obligations
d. Bank loans
Solution to example 2: financial liabilities
a. Yes, the entity is contractually obligated to settle the creditor with cash.
b. Yes, the entity must, in the future, redeem the preference shares with cash.
c. If the entity has to pay the warranty obligation in cash, it is a financial liability. If the entity
merely has to repair the goods, then, since there is no obligation to pay cash or any other
financial instrument, it is not a financial liability.
d. Yes, there is a contractual obligation to repay the bank for the amount of cash received plus
interest.

3. Financial risks

3.1 Overview

There are three categories of financial risks and they are:
• market risk (affected by price risk, interest rate risk and currency risk);
• credit risk; and
• liquidity risk.

3.2 Market risk (IFRS7; Appendix A)

Market risk is the risk that the fair value or future cash flows of a financial instrument will
fluctuate because of changes in market prices. Market risk comprises of:
• interest rate risk;
• currency risk; and
• other price risk.

3.2.1 Interest rate risk

Interest rate risk is the risk that the value of the instrument will fluctuate with changes in the
market interest rate. A typical example is a bond: a bond of C100 earning a fixed interest of
10% (i.e. C10) would decrease in value if the market interest rate changed to 20%,
(theoretically, the value would halve to C50: C10/ 20%). If the bond earned a variable
interest rate instead, the value of the bond would not be affected by interest rate fluctuations.

3.2.2 Currency risk

Currency risk is the risk that the value of the instrument will fluctuate because of changes in
the foreign exchange rates. A typical example would be where we have purchased an asset
from a foreign supplier for $1 000 and at the date of order, the exchange rate is $1: C10, but
where the local currency weakens to $1: C15. The amount owing to the foreign creditor has
now grown in local currency to C15 000 (from C10 000).

649 Chapter 21


3.2.3 Price risk

Price risk is the risk that the value of the financial instrument will fluctuate as a result of
changes in the market prices. For example: imagine that we committed ourselves to
purchasing 1 000 shares on a certain date in the future, when the share price was C10 on date
of commitment. By making such a commitment, we would be opening ourselves to the risk
that the share price increases (e.g. if the share price increased to C15, we would have to pay
C15 000 instead of only C10 000).

3.3 Credit Risk

This is the risk that the one party to a financial instrument will fail to discharge an obligation
and cause the other party to incur a financial loss. A typical example is a debtor, being a
financial asset to the entity, who may become insolvent and not pay the debt due (i.e. where a
debtor becomes a bad debt).

3.4 Liquidity Risk

This is the risk that the entity will encounter difficulty in raising funds to meet commitments
associated with the financial instrument. An example would be where we (the entity) found
ourselves with insufficient cash to pay our suppliers (i.e. where we become a bad debt to one
of our creditors).

4. Derivatives

There are many types of derivatives of which we discuss a few:

4.1 Options

An option gives the holder the opportunity to buy or sell a financial instrument on a future
date at a specified price. The most common option that we see involves options to buy shares
on a future date at a specific price (strike price). These are often granted to directors or
employees of companies. Another example is an option to purchase currency on a future date
at a specific exchange rate. Options may be used to limit risks (as the exercise price of an
option is always specified) or they may be used for speculative purposes (i.e. to trade with).

4.2 Swaps

A swap is when two entities agree to exchange their future cash flows relating to their
financial instruments with one another. A common such agreement is an ‘interest rate swap’.
For example, one entity (A) has a fixed-rate loan and another entity (B) has a variable-rate
loan. The two entities may agree to exchange their interest rates if A would prefer a variable
rate and B would prefer a fixed rate.

Example 3: swaps

Company A has a loan of C100 000 with a fixed interest rate of 10% per annum.
Company B has a loan of C100 000 with a variable interest rate, which is currently 10% per
annum.
Company A and Company B agree to swap their interest rates.
The variable rate changed to 12% in year 2.
The variable rate changed to 8% in year 3.

Required:
Journalise the receipts/ payments of cash in Company A’s books for year 2 and year 3.

650 Chapter 21


Solution to example 3: swaps

Debit Credit
Year 2
Interest expense (finance charges) 10 000
Bank 10 000
Interest on fixed rate loan paid to lender: 100 000 x 10%

Bank 2 000
Difference between variable and fixed rate loan paid to Company B:
100 000 x (12% - 10%)

Year 3
Bank 10 000
Interest on fixed rate loan paid to lender: 100 000 x 10%

Bank 2 000
Interest income 2 000
Difference between variable and fixed rate loan received from
Company B: 100 000 x (12% - 10%)

4.3 Futures

A future is an agreement by the entity to buy a specified type and quantity of a financial
instrument on a specified future date at a specified price. For example, if A does not have the
cash to purchase shares immediately but believes that they are a worthwhile investment, it
may enter into a futures contract with another entity (B) whereby A commits to buying them
on a future date. The difference between a future and an option is that a future commits the
entity whereas an option does not.

5. Compound financial instruments (IAS 32.15 - .16)

Some financial instruments have both equity and liability portions. These are referred to as
compound instruments. These instruments must be split into the two separate elements based
on their substance rather than on their legal form.

The difference between equity and liabilities is that:
• liabilities involve a contractual obligation to deliver cash or exchange financial
instruments with another entity under conditions that are potentially unfavorable; whereas
• equity involves no such obligation.
The method used to split a compound financial instrument is:
• first: find the value of the liability portion; and
• then: balance back to the equity portion (the total value – the value of the liability).

It must be remembered that the classification of an instrument in the statement of financial
position will affect other financial statements too: if, for example, a financial instrument such
as preference shares is treated as partly equity and partly liability, then the portion of the
preference dividend that relates to the equity component will be recognised as a dividend in
the statement of changes in equity, but the portion of the dividend that relates to the liability
component will be recognised as interest (finance costs) in the statement of comprehensive
income.

651 Chapter 21


Example 4: splitting of compound financial instruments

Barmy Limited issued 100 000 cumulative, 10% preference shares on 1 January 20X5 at an
issue price of C5 each (par value). These preference shares are convertible on the 31
December 20X7 into ordinary shares at the option of the holder. If they are not converted
they will be redeemed on this date at par. The market interest rate is 15%.

Required:
Split the compound financial instrument into its equity and liability portions.

Solution to example 4: splitting of compound financial instruments

Comment:
The preference shares that we issued are convertible into ordinary shares. The conversion is at the
option of the shareholder: in order to be prudent, we assume the worst from a cash flow point of view
and therefore assume that all the shareholders will choose to the redemption instead of the conversion.

The potential liability that we have is therefore (1) the interest that we know we will have to pay each
year for three years plus (2) the possible redemption (repayment) of capital after three years. The
liability is measured at the present value of these two cash outflows.

The difference between the amount we receive and the amount we recognise as a liability (measured at
its present value) is recognised as equity.

Step 1: Calculate the liability portion

1.1 Annuity

Interest payment each year for 3 years (100 000 x C5 x 10%) 50 000
Discount factor for 3 years (based on 15%) (15% for a 3-year annuity) * 2.2832
Liability portion 114 160

1.2 Redemption

Lumpsum payment after 3 years (100 000 x C5 x 100%: par value) 500 000
Discount factor after 3 years (based on 15%) (15% after 3-years) * 0.6575

* Discount factor at 15% for a 3-year annuity
1/ 1.15 0.8696
0.870/ 1.15 0.7561
0.756/ 1.15 0.6575
2.2832
1.3 Total liability

Present value of the 3 interest payments W1.1 114 160
Present value of the lump-sum payment W1.2 328 750

Step 2: Calculate the equity portion

Total cash received 100 000 x C5 (par value) 500 000
Less recognised as a liability W1.3 442 910
Recognise as equity Balancing 57 090

652 Chapter 21


Example 5: compulsorily convertible preference shares

Crazee Limited issued 500 000 C15 par value 20% preference shares on 2 January 20X4. The
preference shares were issued at par and are compulsorily convertible into ordinary shares (1
ordinary share for every 5 preference shares) on 31 December 20X6. The appropriate
adjusted market dividend rate for ‘pure’ redeemable preference shares is 25%.

Required:
Prepare journal entries to record the financial instrument over its three-year life in the
accounting records of Crazee Limited. You may ignore the journal entry for its conversion on
31 December 20X6.

Solution to example 5: compulsorily convertible preference shares

Comment:
The preference shares that we issued are convertible into ordinary shares. The conversion is
compulsory. This means that there is definitely no chance that we will have to repay any of the cash
received).

The potential liability that we have is therefore only the interest that we know we will have to pay each
year for three years. The liability is measured at the present value of these cash outflows.

its present value) is recognised as equity.


Interest payment each year for 3 years (500 000 x C15 x 20%) 1 500 000
Discount factor for 3 years (based on 25%) (25% for a 3-year annuity) * 1.952
Liability portion 2 928 000

* Discount factor at 25% for a 3-year annuity
1/ 1.25 0.800
0.8/ 1.25 0.640
0.64/ 1.25 0.512
1.952

Step 2: Calculate the equity portion

Total cash received (500 000 x C15) 7 500 000
Less recognised as a liability Step 1 2 928 000
Therefore equity portion Balancing 4 572 000

Step 3: Loan amortisation table

Interest Bank Liability
25%
2 Jan 20X4 2 928 000 (2 928 000)
31 Dec 20X4 732 000 (1 500 000) (2 160 000)
31 Dec 20X5 540 000 (1 500 000) (1 200 000)
31 Dec 20X6 300 000 (1 500 000) 0
1 572 000 (1 572 000)

653 Chapter 21


Journals
Debit Credit
2 January 20X4
Bank 7 500 000
Financial liability (preference shares) 2 928 000
Preference share equity 4 572 000
Issue of convertible preference shares
31 December 20X4
Finance costs 732 000
Financial liability (balancing) 768 000
Bank 1 500 000
Payment of preference dividend
31 December 20X5
Bank 1 500 000
31 December 20X6
Financial liability (balancing) 1 200 000
Bank 1 500 000

Example 6: redeemable debentures issued at a discount

On 2 January 20X4, Redvers Limited issued 10 000 C500 par value debentures, at a discount
of C100 on par value, details of which are as follows:
• These debentures are compulsorily redeemable at a premium of 10% over par value, 4
years later.
• The debentures bear interest at 15% per annum payable in arrears.
• The internal rate of return on the debentures is 25.23262%.

Required:
Prepare journal entries to record the financial instrument over its three-year life in the
accounting records of Redvers Limited.

Solution to example 6: redeemable debentures issued at a discount

Comment: The debentures that we issued are redeemable. There is no possibility of conversion and
therefore there is definitely no equity component.

The liability that we have is therefore (1) the interest that we know we will have to pay each year for
four years plus (2) the definite redemption (repayment) of capital after four years. The liability is
measured at the present value of these two cash outflows.

its present value) is recognised as equity. This will work out to zero since the issue price will have
been worked out based on our rate of return combined with the 15% interest cost and the 10%
premium.

654 Chapter 21



1.1 Annuity

Interest payment each year for 4 years (10 000 x C500 x 15%) 750 000
Discount factor for 4 years (for 25.23262%) (25.23262% for a 4-year annuity)* 2.3518567

1.2 Redemption

Lumpsum payment after 4 years (10 000 x C500 x 110%) 5 500 000
Discount factor after 3 years (for 25.23262%) (15% after 3-years) * 0.4065654

* Discount factor at 25.2326% for a 4-year annuity
1/ 1.252326 0.7985141
0.7985/ 1.252326 0.6376248
0.6376/ 1.252326 0.5091524
0.5092/ 1.252326 0.4065654
2.3518567

1.3 Total liability

Present value of the 4 interest payments W1.1 1 763 890
Present value of the lump-sum payment W1.2 2 236 110

Step 2: Calculate the equity portion (not required: there can be no equity since these are
compulsorily redeemable: calculation provided for interest)

Total cash received 10 000 x C400 (issue value) 4 000 000
Less recognised as a liability W1.3 4 000 000
Recognise as equity Balancing 0

Step 3: Loan amortisation table

Interest Bank Liability
25.23262%
2 Jan 20X4 4 000 000 4 000 000
31 Dec 20X4 1 009 305 (750 000) 4 259 305
31 Dec 20X5 1 074 734 (750 000) 4 584 039
31 Dec 20X6 1 156 673 (750 000) 4 990 712
31 Dec 20X7 1 259 287 (750 000) 5 500 000
(5 500 000)
4 500 000 (4 500 000)

Journals

Debit Credit
2 January 20X4
Bank 4 000 000
Financial liability debentures 4 000 000
Issue of convertible preference shares

655 Chapter 21


Journals continued … Debit Credit
31 December 20X4
Finance costs 1 009 305
Bank 750 000
Finance costs on debentures
31 December 20X5
Bank 750 000
31 December 20X6
Bank 750 000
31 December 20X7
Bank 750 000
Financial liability 5 500 000
Bank 5 500 000
Redemption of debentures

6. Categories of financial liabilities

6.1 Overview (IAS 39.9 and .43)

There are two main categories of financial liabilities, classified based on how they are
measured. Financial liabilities may be measured at:
• Fair value through profit or loss; or
• Not at fair value through profit or loss (‘other financial liabilities’).

Measurement of financial liabilities that are classified as fair value through profit or loss does
not include transaction costs.

Financial liabilities that are not classified as fair value through profit and loss are initially
recognised at the fair value of the consideration received, net of transaction costs. For
example if debentures were issued for C100 000, with C1 000 transaction costs, the entity
would have received a net amount of C99 000 and therefore the debentures would be
recognised at C99 000 in the statement of financial position.

6.2 Financial liabilities that are measured at fair value through profit or loss (IAS
39.9)

These financial liabilities are essentially liabilities that are:
• held for trading (i.e. purchased with the intention to sell or repurchase in the short term;
derivatives other than hedging instruments or are part of a portfolio of financial
instruments where there is a recent actual evidence of short-term profiteering or are
derivatives); or
• designated by the entity as fair value through profit and loss. This designation is only
allowed where it provides more relevant information:

656 Chapter 21


• through eliminating measurement or recognition inconsistency, or
• because the financial liability is evaluated by the entity’s key management personnel
(e.g. board of directors) on a fair value basis in accordance with its documented risk
management or investment strategy.

The designation of fair value through profit and loss is not allowed if
• the contract including the financial liability includes embedded derivatives that do not
significantly change the cash flows otherwise required by the contract, or where the
separation of the embedded derivative is not allowed; and
• it involves an equity instrument that does not have an active market in which it has a
quoted market price and whose fair value cannot be measured reliably.

Fair value through profit or loss financial liabilities are carried at fair value and any changes
in fair value from one year to the next are recognised in profit or loss.

Example 7: fair value through profit or loss

Mousse Limited issued 100 000 debentures on the 1 January 20X5, proceeds totaled
C200 000. On the 31 December 20X5 the debentures had a fair value of C300 000. Mousse
Limited designated these debentures to be held at ‘fair value through profit or loss’.

Required:
Provide the necessary journal entries to show how Mousse Limited should account for the
change in the fair value of the debentures.

Solution to example 7: fair value through profit or loss
1 January 20X5 Debit Credit
Bank 200 000
Debentures (liability) 200 000
Issue of debentures
31 December 20X5
Loss on financial liabilities held at fair value (expense) 100 000
Debentures (liability) 100 000
Re-measurement of debentures at year-end

6.3 Financial liabilities that are not measured at fair value through profit or loss

A liability that is not held for trading, (and not otherwise designated as fair value through
profit or loss on acquisition) is measured at amortised cost using the effective interest rate
method. This ensures that all the finance costs incurred are recognised over the life of the
financial liability.

Example 8: other financial liabilities

Tempo Limited issued 200 000 debentures on the 1 January 20X5 at par of C7. The
debentures are redeemable on the 31 December 20X7 for C10.

Required:
Calculate the finance costs and the carrying amount of the debentures for each affected year.

657 Chapter 21


Solution to example 8: other financial liabilities

The effective interest rate is calculated using a financial calculator as 12.6248%
PV = -7 FV=10 N= 3 COMP i

Date Finance Costs @ 12,6248% Carrying Amount
1 Jan 20X5 1 400 000 200 000 x C7
31 Dec 20X5 176 747 1 576 747
31 Dec 20X6 199 061 1 775 808
31 Dec 20X7 224 192 2 000 000
Redemption (2 000 000)

7. Categories of financial assets

7.1 Overview (IAS 39.9)
There are four main categories of financial assets and they are:
• Fair value through profit or loss;
• Held to maturity;
• Loans and receivables; and
• Available for sale.

7.2 Fair value through profit or loss (IAS 39.9; .11A and .50)
These financial assets are essentially assets that are:
• held for trading, being:
• acquired with the intention to sell in the short term;
• acquired as part of a selling portfolio; or
• derivatives; or
• designated by the entity as fair value through profit and loss. This designation is only
allowed where it provides more relevant information:
• through eliminating measurement or recognition inconsistency, or
• because the financial asset is evaluated by the entity’s key management personnel
(e.g. board of directors) on a fair value basis in accordance with its documented risk
management or investment strategy.
The designation of fair value through profit and loss is not allowed if:
• the contract including the financial asset includes embedded derivatives that do not
significantly change the cash flows otherwise required by the contract, or where the
separation of the embedded derivative is not allowed; and
• it involves an equity instrument that does not have an active market in which it has a
quoted market price and whose fair value cannot be measured reliably.

Any financial asset may be deemed by the entity, when acquired, to be held for trading, but
may not be later reclassified.

Fair value through profit or loss financial assets are carried at fair value and any changes in
fair value from one year to the next are recognised as income or expenses.

Example 9: fair value through profit or loss financial assets

Grime Limited purchased 25 000 debentures at a total cost of C 25 000 on the
1 November 20X5.
At the year end (31 December 20X5) the fair value of the debentures was C55 000.
Grime Limited purchased these debentures with the intention to sell in the short term.

Required:
Show the necessary journal entries to record the change in fair value.

658 Chapter 21


Solution to example 9: fair value through profit or loss financial assets

1 November 20X5 Debit Credit
Debentures (asset) Given 25 000
Bank 25 000
Purchase of debentures
31 December 20X5
Debentures (asset) 55 000 – 25 000 30 000
Profit on financial liabilities held at fair value 30 000
Re-measurement of debentures at year-end

7.3 Held to maturity financial assets (IAS 39.9)

These assets include:
• non-derivatives;
• fixed rate instruments;
• fixed maturity instruments; and
• assets that the entity has both the ability and intention to hold until maturity.

If, however, one of these assets has been sold by the entity in the past 2 years that type of
asset is now tainted and may not be classified as held to maturity.

Held to maturity financial assets are held at amortised cost using the effective interest rate.

Example 10: held to maturity

Eternity Ltd purchased 10% debentures for C 200 000 on 1 January 20X5, (redeemable on the
31 December 20X6). They intended to hold them to maturity, (and had the ability to do so).
They had never held such debentures before. The fair value on 31 December 20X5 was
C400 000.

Required:
Prepare the necessary journal entries to show how Eternity Ltd should account for the
debentures for the year ended 31 December 20X5.

Solution to example 10: held to maturity

Debit Credit
1 January 20X5
Debentures (asset) Given 200 000
Bank 200 000
Purchase of debentures
31 December 20X5
Debentures (asset) 200 000 x 10% 20 000
Interest earned on debentures
Notice that no entry is made for the increase in fair value.

7.4 Loans and receivables (IAS 39.9)
These assets are:
• Non-derivatives
• Involving fixed/ determinable payments
• That are not quoted in an active market.
These assets include, for example, debtors, loans granted to a third party, and bank deposits.

659 Chapter 21


Loans and receivables are carried at amortised cost using the effective interest rate method.

Example 11: loans and receivables

Obliged Limited lent C50 000 to Grateful Limited on 30 June 20X5.
Interest as per the agreement was charged at 20%.
No repayments were made on the loan.

Required:
Show the necessary journals to account for the loan for the year ended 31 December 20X5.

Solution to example 11: loans and receivables

Debit Credit
30 June 20X5
Loan to Grateful Limited (asset) Given 50 000
Bank 50 000
Loan granted to Grateful Ltd
31 December 20X5
Loan to Grateful Limited (asset) 50 000 x 20% x 6 / 12 months 5 000
Interest charged for the year ended 31 December 20X5

7.5 Available for sale financial assets (IAS 39.9)

Available for sale financial assets are all those non derivative financial assets that are
designated as Available for Sale or are classified into any of the three other categories.
Available for sale financial assets are recorded at fair value, with the resultant changes in fair
value recognised in other comprehensive income (i.e. equity).

Example 12: available for sale

Dilly Limited purchased 500 000 shares in Sane Limited on the 31 March 20X5.
They were purchased for C1 000 000.
On the 31 December the fair value of these shares was C2 000 000.
These shares were classified as available for sale.

Required:
Prepare the necessary journal entries to show how Dilly Limited should account for these
shares.

Solution to example 12: available for sale

31 March 20X5 Debit Credit
Shares in Sane Limited (asset) Given 1 000 000
Bank 1 000 000
Purchase of shares in Sane Limited
31 December 20X5
Shares in Sane Limited (asset) 2 000 000 – 1 000 000 1 000 000
Equity: gain on revaluation of shares 1 000 000
Shares in Sane Limited revalued to fair value

660 Chapter 21


8. Reclassification of financial instruments

8.1 Overview

There are a variety of situations where financial instruments may need to be re-classified.
The most important issues are stated below.

8.2 Fair value through profit or loss (IAS 39.50)

An entity is not allowed to reclassify a financial instrument into or out of the ‘fair value
through profit or loss’ category whilst it is held or issued.

8.3 Held to maturity (IAS 39.51)

If, as a result of a change in intention or ability, it is no longer appropriate to classify an
instrument as ‘held to maturity’, it shall be reclassified as ‘available for sale’ and re-measured
at fair value. The difference between carrying amount and fair value must be recognised in
other comprehensive income.

8.4 Available for sale (IAS 39.54)

If, as a result of a change in intention or ability (or the fair value is no longer able to be
reliably measured), it becomes appropriate to measure at cost or amortised cost rather that at
fair value, then the previous fair value carrying amount becomes the de facto cost or
amortised cost from that date onwards. Any gain or loss recognised in other comprehensive
income whilst it was measured as available for sale must be recognised in profit or loss:
• over the remaining life of the financial asset if it has a fixed maturity;
• when the financial asset is sold or otherwise disposed of.

8.5 Instruments previously measured at amortised cost (IAS 39.53)

If a reliable measure becomes available for a financial instrument which was previously not
available, and the financial instrument would have been measured at fair value had fair value
been available, such financial instrument shall be re-measured at fair value. The difference
between its fair value and its carrying amount must be taken directly to equity. [IAS 39.53]

9. Impairment of financial instruments (IAS 39.58 – 70)

The entity must assess whether its financial assets are impaired at the end of the reporting
period. A financial asset (or group of financial assets) is only impaired at the end of a
reporting period if there is objective evidence that suggests:
• that one or more events occurred after the initial recognition;
• where the event causes loss; and where
• this ‘loss event’ has an impact on estimated future cash flows of the financial asset or
group of financial assets; and
• the amount of the loss can be reliably estimated.

10. Offsetting of financial assets and liabilities (IAS 32.42 - .50)

Financial assets and liabilities may not be offset against one another unless:
• the entity has a legal right to set off the two amounts; and
• the entity intends to settle the two instruments simultaneously or on a net basis.

661 Chapter 21


11. Disclosure

The following narrative disclosure is required (required by IFRS 7):
• For credit risk:
- Amount of maximum credit risk
- Collateral held as security
- Other credit enhancements
- Credit quality of financial assets (not past due)
- Carrying amount of financial assets past due/ impaired/ re-negotiated.
• For liquidity risk:
- Maturity analysis for financial liabilities
- Description of how liquidity risk is managed.
• For market risk
- Sensitivity analysis for each market risk
- Methods and assumptions used in the analysis
- Any changes in the above assumptions, together with reasons for the changes.
• For each class of financial assets and liabilities:
- The criteria for recognition;
- Basis for measurement
- Methods and assumptions made to determine fair value
- Fair value of the financial instrument (or the reasons why it cannot be determined,
information about the related market and the range of possible fair values).

The following figures must be separately disclosed:
• finance costs from financial liabilities must be presented as a separate line item.
• the total change in fair value of the instruments reported in the statement of
comprehensive income
• the changes in fair value that were taken directly to equity.

The following is a suggested layout that you may find useful.

Name of Company
Statement of changes in equity
For the year ended 31 December 20X5 (extracts)
Ordinary Share Available for Retained Total
share premium sale financial earnings
capital assets
C C C C C
Balance: 1 January 20X5 xxx xxx xxx xxx xxx
Ordinary shares issued xxx xxx xxx
Total comprehensive income xxx xxx xxx
Balance: 31 December 20X5 xxx xxx xxx xxx xxx

Name of Company
Statement of financial position (extracts)
As at 31 December 20X5
Note 20X5 20X4
C C
EQUITY AND LIABILITIES or ASSETS
Loan xxx xxx
Financial instruments 39 xxx xxx
Preference shares xxx xxx

662 Chapter 21


Name of Company
Statement of comprehensive income (extracts)
For the year ended 31 December 20X5
Note 20X5 20X4
C C
Profit before finance costs xxx xxx
Finance costs:
• Fair value adjustment of financial instruments xxx xxx
Profit before tax xxx xxx
Taxation expense xxx xxx
Profit for the year xxx xxx
Other comprehensive income
• Gain/ (loss) on available for sale financial asset xxx xxx
o Gains arising during the year xxx xxx
o Less reclassification adjustment:gains now recognised in profit/ (xxx) (xxx)
loss
Total comprehensive income xxx xxx

Name of Company
Notes to the financial statements of
For the year ended 31 December 20X5 (extracts)
1. Statement of compliance
2. Accounting policies
2.1 Financial Instruments
The following recognition criteria are used for financial instruments…
The fair value of the financial instruments are determined with reference to …
39. Financial instruments
The company uses … to manage Financial Risks.
Such risks and methods are:
• We are exposed to Currency risk in … and Foreign Currency risk is managed by …
• We are exposed to Interest rate risk in … and Interest rate risk is managed by …
• We are exposed to Market risk in … and Market risk is managed by …
• We are exposed to Credit risk in … and Credit risk is managed by …
• We are exposed to Liquidity Risk in … and Liquidity Risk is managed by …

Example 13: disclosure of financial instruments

On 1 January 20X5 Nic Limited issued 10 000 C20 par value 10% compulsory redeemable
debentures at par.

The debentures will be redeemed on 31 December 20X9. Interest is paid annually in arrears
on 31 December.

Tiff Limited purchased all 10 000 debentures on the 1 January 20X5. The debentures were
classified as available for sale.

The ex-dividend market value of the debentures is as follows:
Date Market price (C)
31/12/20X5 22
31/12/20X6 24
31/12/20X7 25
31/12/20X8 27
31/12/20X9 30

663 Chapter 21


The following information was extracted from Tiff Limited accounting records (year ended
31 December):
20X5 20X7 20X9
Revenue 1 000 000 2 000 000 4 000 000
Cost of sales (500 000) (1 000 000) (1 500 000)

The investment in Nic Limited’s debentures is Tiff Limited’s only investment.

Required:
Disclose the above information in the financial statements of Tiff Limited in accordance with
IFRSs for the years ended 31 December 20X5, 20X7 and 20X9.

Solution to example 13: disclosure of financial instruments

Tiff Limited
Statement of comprehensive income
For the year ended 31 December
20X9 20X7 20X5
C C C
Revenue 4 000 000 2 000 000 1 000 000
Cost of sales (1 500 000) (1 000 000) (500 000)
Gain on redemption 100 000
Profit for the year 2 600 000 1 000 000 500 000
Other comprehensive income
• Available for sale financial asset (70 000) 10 000 20 000
• gains arising during the year 30 000 10 000 20 000
• less reclassification adjustment: gain (100 000)
now included in profit or loss

Total comprehensive income 2 530 000 1 010 000 520 000

Tiff Limited
Statement of changes in equity (extract)
For the year ended 31 December
Retained Available for sale Total
earnings financial asset
C C C
Balance: 1/1/20X5 xxx xxx xxx
Total comprehensive income 500 000 W1 20 000 520 000
Balance: 1/1/20X6 xxx 20 000 xxx
Total comprehensive income xxx W1 20 000 xxx
Total comprehensive income 1 000 000 W1 10 000 1 010 000
Total comprehensive income xxx W1 20 000 xxx
Total comprehensive income 2 600 000 W1 (70 000) 2 530 000
Balance: 31/12/20X9 xxx 0 xxx

664 Chapter 21


Tiff Limited
Statement of financial position (extract)
As at 31 December
20X9 20X7 20X5
ASSETS C C C
Non-current assets
Financial assets 0 250 000 220 000

W1. Calculation of gains recognised in other comprehensive income
C
Financial asset initially measured: 1/1/20X5 10 000 x 20 200 000
Fair value adjustment Balancing 20 000
Fair value on 31/12/20X5 10 000 x 22 220 000
Fair value on 31/12/20X6 10 000 x 24 240 000
Fair value on 31/12/20X7 10 000 x 25 250 000
Fair value on 31/12/20X8 10 000 x 27 270 000
Fair value on 31/12/20X9 10 000 x 30 300 000

Total fair value adjustments 20 000 + 20 000 + 10 000 + 20 000 100 000
+ 30 000

665 Chapter 21


12.Summary

Financial risks

Market risk Credit risk Liquidity risk
Risk that the value of Risk that one party to Risk that the entity
the financial the financial instrument will encounter
instrument will will default causing the difficulty in raising
fluctuate due to: other party to incur funds to meet its
• Currency risk financial loss obligations associated
• Interest rate risk with financial
• Price risk instruments

Accounting for
Financial Liabilities

Fair value through profit or loss Other financial liabilities
Measured at fair value with changes Measured at amortised cost using the
in fair value taken to profit and loss effective interest rate method
(i.e. the statement of comprehensive
income)

Accounting for
Financial Assets

Fair value Held to Loans and Available for
through profit maturity receivables sale
or loss
Measured at Measured at Measured at Measured at
fair value with amortised cost amortised cost fair value with
changes in fair using the using the changes in fair
value taken to effective effective value taken
profit and loss interest rate interest rate directly to
(i.e. the method method equity
statement of
comprehensive
income)

666 Chapter 21

IFRS Financial Instruments Guide

Empfohlen

Empfohlen

Weitere ähnliche Inhalte

Was ist angesagt?

Was ist angesagt? (15)

Ähnlich wie IFRS Financial Instruments Guide

Ähnlich wie IFRS Financial Instruments Guide (20)

Mehr von Sajid Ali

Mehr von Sajid Ali (9)

Kürzlich hochgeladen

Kürzlich hochgeladen (20)

IFRS Financial Instruments Guide