Summary
Summary IFRS 9 Financial Instruments
- Course
- Financial Accounting 379
- Institution
- Stellenbosch University (SUN)
Summary of IFRS 9 for third year BAcc course
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By: LydiaG123 • 3 year ago
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IFRS 9: FINANCIAL INSTRUMENTSIAS 32
Is there a financial instrument in terms of IAS 32? (By applying the definition)
If NO – IAS 32 N/A
If YES, what is the primary instrument? (E.g. shares, debentures, loans)
Holder records or issuer records?
Holder: Financial asset (FA)
Apply IFRS 9
Issuer: Equity or/and Financial Liability
Equity: IAS 32
Financial Liability: IFRS 9
Business defitions of general financial instruments
1 Financial instrument
Document (such as a check, draft, bond, share, bill of exchange, futures or options contract) that has a monetary value or
evidences a legally enforceable (binding) agreement between two or more parties regarding a right to payment of money.
See also debt instrument, equity instrument, and financing instrument.
2 Debenture
Promissory note or a corporate bond which (in the US) is backed generally only by the reputation and integrity of the
borrower and (in the UK) by the borrower's specific assets. When unsecured, it is called a bare debenture or naked
debenture; when secured by a charge on a specific property, it is called a mortgage debenture.
3 Share
Evidence of ownership that represents an equal proportion of a firm's capital. It entitles its holder (the shareholder) to an
equal claim on the firm's profits and an equal obligation for the firm's debts and losses. Two major types of shares are (1)
ordinary shares (common stock), which entitle the shareholder to share in the earnings of the firm as and when they occur,
and to vote at the firm's annual general meetings and other official meetings, and (2) preference shares (preference stock)
which entitle the shareholder to a fixed periodic income (interest) but generally do not give him or her voting rights. See
also stock.
4 Futures contract
Binding contract made on the trading floor of a futures exchange to buy or sell a commodity, financial instrument, or
security, on a stated future date at a specified price. These agreements are standardized in terms of quantity, quality,
delivery location, and delivery time for each item, and do not normally result in an actual delivery but are settled (traded
out) through counter-contracts. Used in hedging, futures contracts help mitigate the risk of wild price fluctuations. In
contrast to an option (right to buy or sell an item that lapses if not exercised) a futures contract is an obligation fulfilled
only by the completion of the transaction.
5 Forward contract
Binding contract under which a commodity or financial instrument is bought or sold at the market price (spot price) as on
today (date of making the contract), but is to be delivered on a stated future (forward) date in settlement of the contract.
In contrast, a futures contract is only a formal promise. Also called cash contract.
6 Option
1. Formal contract whereby the writer of the option gives the buyer the right (but not the obligation) to buy-and-sell (or
to buy-or-sell) a specific property or a fixed-quantity of a commodity, currency, or security, at a fixed price (called
exercise price) on or up to a fixed date (called expiration date). The buyer pays down only a fraction (called premium or
option money) of the full value of the contract, thus obtaining an investment leverage. An option to buy (called call option)
is purchased when prices are expected to rise, an option to sell (called put option) when prices are expected to fall, and
an option to buy-or-sell (called double option) when prices may go either way. The most popular types of options are
named American option (exercisable any day up to the expiration date) and European option (exercisable only on the
expiration date). Any option that is not exercised is automatically cancelled and the optionee loses the premium. In
practice, only a few options are exercised and most are bought from or sold to other optioners or optionees before the
expiration date. Since options are legally binding contracts, they have intrinsic value and are freely traded on the futures
exchanges. Futures contracts, in contrast, cannot lapse and their holder have to sell them before their expiration date or
take delivery of the underlying item.
2. Employee stock option where key employees are given a chance to buy the firm's stock at a special price.
7 Foreign exchange contract
Commitment to buy or sell a specified amount of foreign currency on a fixed date and rate of exchange. Such contracts
are used usually by importers as a hedge against exchange rate fluctuations. See also foreign exchange option.
8 Swap
Exchange of one type of asset, cash flow, investment, liability, or payment for another. Common types of swap include:
(1) Currency swap: simultaneous buying and selling of a currency to convert debt principal from the lender's currency to
the debtor's currency. (2) Debt swap: exchange of a loan (usually to a third world country) between banks. (3) Debt to
equity swap: exchange of a foreign debt (usually to a Third World country) for a stake in the debtor country's national
,enterprises (such as power or water utilities). (4) Debt to debt swap: exchange of an existing liability into a new loan,
usually with an extended payback period. (5) Interest rate swap: exchange of periodic interest payments between two
parties (called counter parties) as means of exchanging future cash flows.
▪ IFRS 9 is developed as replacement for IAS 39 (only effective Jan 2018)
OBJECTIVE (1.1)
SCOPE (2.1)
RECOGNITION (3)
− Initial Recognition (3.1)
o Contractual Right – Holder
o Contractual Liability - Issuer
CLASSIFICATION (4)
FINANCIAL ASSETS (4.1):
− In record of the Holder: Dt Financial Asset; Ct Bank
− Financial Assets are split into 4 categories.
o [1] At amortised cost
▪ Requirements: 4.1.2
• 1) Objective if business model to collect contractual CF’s
o Business model: How the entity actually manages it financial assets to
specifically generate cash flows
o Aim is to keep this asset until end of its life, i.e. not for speculation
• 2) CF’s only interest + capital (investment in debt)
o Instrument by instrument approach
o Note: If “interest payments” and other terms fluctuate with factors other
than credit risk, inflation of the present market interest rate…then it is not
only pure interest – does not meet requirement
o Includes:
▪ Variable interest rate, linked to market interest rates
▪ Interest rate is linked to inflation
▪ Debenture convertible into a fixed number of equity instruments
of issuer?
• Value of the investment in debenture fluctuate as market
rate fluctuations
• Not pure capital balance
• Thus speculation
▪ Limitation on when and whether interest is paid, based on certain
factors?
• No, no certainty regarding cash flows
▪ E.g. holder invest in debentures and expect interest (during) & capital (@end).
▪ B4.1.1 – B4.1.6; B4.1.7 – B4.1.13; S4.1.13-14
o [2] Debt instrument at fair value through OCI (loans and debenture)
▪ Requirements: 4.1.2A
• 1) Objective of business model to collect contractual CF’s and selling FA
• 2) CF’s only interest + capital (investment in debt)
▪ Same as amortised costs: PV, Increase with increase at effective interest rate, Recognise
payment
▪ End year amount (CV) vs FV; Adjustment through OCI
▪ 5.7.10-5.7.11
o [3] Equity instrument at fair value through OCI
▪ Requirements: 5.7.5
• 1) Not held for trading (LT)
• 2) Designate as at FV through OCI at initial recognition
▪ At initial recognition an entity can make an irrevocable choice to carry at FV (with changes
in FV through OCI) an investment in equity instruments not held for trading (Therefore LT
investment)
▪ Dividends received still in P/L
▪ “Held for trading” Appendix A
• Speculative in nature
o [4] At fair value through P/L= default
▪ Requirements:
, • 1) “default” held for sale/ ≠ 2 requirements (4.1.4)
• 2) Designate as at FV through P/L at initial recognition (4.1.5)
MEASUREMENT (5)
INITIAL MEASUREMENT OF FINANCIAL ASSETS (5.1)
− [1] At amortised cost: At FV + transaction costs capitalised
− [2] [3] At FV through OCI: At FV + transaction costs capitalised
− [4] At FV through P/L: At FV
o Transaction costs are expensed
− Exception: Trade receivables (from IFRS 15 (HONS) without significant financing elements/terms, receivable
within 12 months: at transaction price (no discounting)
o Value at date of initial recognition = transaction price
− Transaction costs are incremental costs that are directly attributable to the acquisition, issue or disposal of a
financial asset or financial liability
o E.g. contract, lawyer fees
SUBSEQUENT MEASUREMENT OF FINANCIAL ASSETS (5.2)
− FV (through P/L [4] or OCI[2] & [3]) or at Amortised cost [1]
− Apply impairment rules (5.5) to ‘at amortised cost’ [1] and debt instruments carried at FV through OCI [2]
[1] At amortised cost [2] Debt instrument [3] Equity instrument [4] FV through P/L
@ FV through OCI @ FV through OCI (ST)
(LT/ST) (LT)
Initial @ FV @ FV @ FV @ FV
measurement:
Transaction + @FV + @FV + @FV P/L
costs:
Subsequent @ Amortised cost @ FV through OCI @ FV through OCI @ FV though P/L
measurement:
Impairment: Yes Yes (HONS) No No
Fair value determination (IFRS 13)
− [2]; [3]; [4]
− Best indication is quoted price (Price on JSE) in active market (Level 1), otherwise use valuation technique
(Level 2, 3)
o E.g. Market/Income/Cost approach
o Interest rate used to discount back future cash flows = current (market related) rate for similar
instruments (with similar cash flows and risks)
Amortised cost (5.4):
− Gross CV : O/B (PV on day one if in first year) + int – repayments
o Amort cost: Gross CV – allowance for credit losses/impairment
− How do you get the effective interest rate for a fin asset?
o This is the rate at which expected future cash flows (ignoring credit losses) can be discounted back to
the carrying value on Day 1
− Interest income is calculated by applying the eff interest rate (as calculated on Day 1) to the Gross CV (i.e.
before allowance for credit losses)
o Gross CV/PV (day 1) x effective int. rate OR 1 INPUT 1 2nf AMORT
EXAMPLE 1: FINANCIAL ASSETS AND LIABILITIES SUMMARY
1. Financial Assets
Primary instrument Derivate
Debt instrument Equity instrument
1.1 INVESTMENT IN DEBT INSTRUMENTS (e.g. debentures, government bonds, loans) [primary
instruments that have interest in its life and capital redemption at the end – cash flows are
remuneration for interest and capital]
, E.g. Buy debentures at beginning of Year 1 at R90 FV on day 1 = Issue price, transaction cost of R4.
Capitalise except [4] @FV through P/L. Coupon interest of R10 is receivable annually at the end of
the year, Actual receipt per instrument used for CF’s → PMT and the debenture is redeemable after 5
years at R100. Used for CF’s → Future Value (redemption amount) FV is R98 on year-end 1 and R96
on year-end 2. [2];[3];[4] The balance of the Allowance for credit losses (if applicable) [1] amounts to
R5 on year-end 1 and R6 on year-end 2. You may assume that all coupons were received when
planned. Unless otherwise indicated you may assume that the asset was not “credit-impaired” (HONS)
at any stage.
1.1.1 If held in business model to collect contractual cash flows – carry at AMORTISED COST
On day 1:
1. Capitalise asset at FV [FV = CP except if information states otherwise]
2. Capitalise transaction cost, if any [NB this changes the fair value capitalised]
3. Work out effective interest rate [interest rate on calculator when you input PV (FV + transaction
cost), pmt (Coupon interest), FV (redemption amount) and N (life)) – market and effective are
the same in the absence of transaction costs
In the rest of the year:
4. Capitalise interest at effective interest rate worked out in (3) (dr Asset cr Interest income) –
this interest accrues over time, technically happens every day [NB Amount = CA x effective
interest rate x y/12 OR 1 INPUT 1 2nd FUNCTION AMORT x y/12]
5. Account for coupon interest, if any is received [NB this happens on a specific date and does
not accrue over time] (dr Bank cr Asset)
6. Assess if value of asset decreased (only applicable to cat 1)
What are the journals for Year 1 and 2?
Year 1:
Day 1 (initial recognition journal): Recognised at FV (R90) + Transaction costs (R4)
Dt Gross CV Asset (SFP) [Financial asset/Investment in Debentures] R94
Ct Bank (SFP) R94
Working out the effective interest rate:
FV 100 (inflow)
PV -94 (outflow)
PMT 10 (inflow)
P/YR 1
N 5
I/YR ? = 11.65%
@ Y/E
Dt Gross CV Asset (SFP) 10.95
Ct Interest income (P/L) 10.95
(nb: effective interest rate to recognise interest) market related interest
Interest = PV x I/YR = R94 x 11.65% Or 1 INPUT 1 2ndf Amort
Repayment received - Actual receipt (PMT)
Dt Bank (SFP) 10
Ct Gross CV Asset (SFP) 10
Allowance for credit losses (only for @ amortised cost)
Dt Movement in allowance (P/L) 5
Ct Allowance for credit losses (SFP) 5
Gross CV: 94 + 10.95 - 10 = 94.95
Allowance (5)
Amortised cost: 89.95 → SFP balance
Year 2:
Dt Gross CV Asset (SFP) 11.06
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