Financial Instruments
Financial instrument
A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.
There are four reporting standards that deal with financial instruments:
-IAS 32 financial instruments: presentation
-IAS 39 financial instruments: recognition and measurement
-IFRS 7 financial instruments: disclosure
-IFRS 9 Financial Instruments
Financial Assets
IFRS 9 deals with recognition and measurement of financial assets.
Financial Assets:
-Cash
-A contractual right to receive cash or another financial asset from another entity.
Financial Assets:
-A contractual right to exchange financial assets/liabilities with another entity under conditions that are potentially favourable.
-An equity instrument of another entity.
Examples of financial assets include:
-Trade receivables
-Options
-Investment in equity shares.
Initial Measurement of Financial Assets
At initial recognition, all financial assets are measured a fair value. This is likely to be the purchase consideration paid to acquire the financial asset. (Transaction costs are excluded if the asset is fair value through profit or loss and included if categorised at fair value through other comprehensive income or amortised cost- see below).
Equity Instruments
Purchases of shares in other entities, and measured either:
-Fair value either through profit or loss (FVPL)-transaction cost are expenses, or
-Fair value through other comprehensive income- transaction cost are capitalised.
Debt Instruments
Debt instruments ( purchase of bonds and redeemable preference shares) would also normally be measured at fair value through profit or loss.
Again, an entity could choose to adopt an alternative position. This position is called amortised cost, and requires that the following two tests are passed:
–The business model test- hold the financial asset to collect the contractual cash flows ( rather than to sell prior to its maturity).
–The contractual cash flow characteristics test- rise on specified dates to cash flows that are solely payments of principle and interest on the principle outstanding.
| Amortised Cost | |||
| Asset balance b/f
x |
Interest income
x |
Payment received
(x) |
Asset balance c/f
x |
Financial Liabilities
Financial Liabilities
A financial liability is any liability that is a contractual obligation:
-To deliver cash or another financial asset to another entity, or
-To exchange financial instruments with another entity under conditions that are potentially unfavourable, or
-That will or may be settled in the entity’s own equity instruments.
Examples of financial liabilities include:
-Trade payables
-Debenture loans
-Redeemable preference shares
Initial Recognition of Financial Liabilities- At initial recognition an entity shall measure a financial liability at its fair value.
Subsequent measurement of financial liabilities- Classify all financial liabilities ( other than liabilities held for trading and derivatives that are liabilities) at amortised cost.
Preference Shares
If preference shares are irredeemable: They are classified as equity ( unless the terms of the share carries a fixed dividend, in which case they are considered to be a financial liability).
If preference shares are redeemable: They are classified as a financial liability.
Compound Instrument
A compound instrument is a financial instrument that has characteristics of both equity and liabilities, such as a convertible loan.
These are to be accounted for using split accounting, recognizing both the equity and liability components of the instrument.
Reference:
-ACCA, F7 Financial Reporting by KAPLAN PUBLISHING
-ACCA, F7 Financial Reporting by BPP