FINANCIAL

INSTRUMENTS

PART 2 OF 2

Study Material
• SAICA Handbook (SH) IAS 32 and IFRS 9 – Financial Instruments
• Descriptive Accounting
• GAAP Handbook vol 1
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Other Notes
• Hedging also forms part of IFRS 9, but THE NOTES ARE UNDER IAS
21 – Foreign Exchange
STUDY OUTCOME

 Identify when a financial instrument should be initially recognised;

 Discuss and account for the initial and subsequent measurement of the
various categories of financial assets and liabilities (including the amortised
cost method); including the financial statement item in which adjustments in
measurement must be recognised (p/l vs. OCI);

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CLASSIFICATION AND MEASUREMENT

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IFRS 9 EVOLUTION
 IAS 32 and IAS 39 were the first financial instruments standards issued. IAS
39 has since been improved and replaced by IFRS 9.
 In 2014 only half of IFRS 9 had been written and IAS 39 was used in
conjunction with IFRS 9. From July 2014 IFRS 9 was completed and fully
replaced IAS 39.
 Students may still see references to IAS 39 in old homework questionsast
tests and exams and should be mindful of the above.

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RECAP OF PREVIOUS CLASS
 What is a financial instrument?
 Explain a financial asset, financial liability and equity instrument?

 What is a compound instrument?

 Name two examples of a compound financial instrument

 As what would you classify a redeemable preference share that are

compulsory redeemable by the holder whose dividend is at the discretion of
the entity?
 What happens if its redeemable by the issuer and dividend is compulsory?

 How do you treat transaction costs on equity?

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 Additional
(IFRS 9) IMPORTANT TERMS definitions

 NB!!! Held for trading is a financial instrument where at least one of the
following criteria is satisfied:
 The instrument was acquired primarily with the purpose of trade (sell in
the near future), or
 The instrument is held in a portfolio with evidence of short-term profit-
taking (speculative purposes), or
 It is a derivative
 A financial instrument of which the value changes in response to a change in a
specified external factor, e.g.:
 Interest rate, bond price, commodity price, exchange rate, index
 Requires no or just a small initial investment
 Settled on a future date
 E.g. FECs, interest rate swaps, options, futures, forwards, etc.

 NB!!! A financial liability at fair value through profit or loss is an

instrument that satisfies one of the following criteria:
 It satisfies the definition of held for trading (as defined above), or 6
 At initial recognition it is designated by the entity as at fair value through
profit or loss.
MORE DEFINITIONS &TERMS (IFRS 9) -
CONTINUED
 Amortised cost = Amount of initial recognition less repayments,
plus/minus accumulated amortisation according to the effective
interest method (tip: it is therefore the principle amount
outstanding according to the financial calculator – e.g. 1 Amrt
Balance for the amortised cost at the end of year 1).
 Transaction costs = costs directly attributable to the purchase,
issue or sale of a financial instrument (e.g. legal costs, stamp
duty, etc.)
 Coupon rate = interest/dividend on the NOMINAL value (or FACE
VALUE). It relates specifically to the instrument, not the market
 Effective interest rate = rate that exactly discounts future cash-
flows over the expected life of the financial asset/liability
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 INITIAL RECOGNITION OF FINANCIAL
INSTRUMENTS IFRS 9.3.1

 Recognised when the entity becomes a party to the

contractual provisions of the instrument
 Consider the substance of the transaction rather than the legal
form!
 Trade Date: when entity commits itself to purchase or sell

 Example of journal

Financial Asset DA
Dt Financial Asset (SFP) xxx
Ct Bank (SFP) (xxx)

Financial Liability
Dt Bank (SFP) xxx 8
Ct Financial Liablity(SFP) xxx
DERECOGNITION OF A FINANCIAL ASSET
 you don’t need to know all the details of when to derecognise, but
when it is clear that de-recognition must occur (e.g. asset is sold), then
you must be able to do the accounting treatment (journal) of the de-
recognition.
 Generally de-recognition occurs when the contractual rights expire or
the instrument is transferred to somebody else.
 Gain/loss on de-recognition:
 Proceeds less carrying amount
 Proceeds include new assets acquired less new liabilities assumed

 NB!!! IFRS 9 – De-recognition

 Reclassification from OCI to P/L NOT ALLOWED ito IFRS 9 upon de-
recognition of equity instruments. 9
 Can however transfer to retained earnings if it’s the entity's accounting policy
 Unless it is a mandatorily financial instruments amounts previously recognised in OCI –
may be recycled to p/l
KEY NOTES EXAMPLE ON DE-RECOGNITION

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 CLASSIFICATION AND
SUBSEQUENT MEASUREMENT:
 IAS 32 Classification:
 Classification for presentation purposes
 Where do we present it - in assets liabilities
equity ?
 Where do we present income or expenses
 IFRS 9 Classification:
 Classification according to business model
 Determines subsequent measurement of the
instrument
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CLASSIFICATION OF FINANCIAL
INSTRUMENTS
1. FINANCIAL ASSETS @ AMORTISED
COST

FINANCIAL ASSETS 2. FINANCIAL ASSETS @ FAIR VALUE

THROUGH PROFIT OR LOSS

3. FINANCIAL ASSETS @ FAIR VALUE

THROUGH OCI

1. FINANCIAL LIABILITIES @
AMORTISED COST
FINANCIAL LIABILITIES
2. FINANCIAL LIABILITIES @ FAIR VALUE
THROUGH PROFIT OR LOSS
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 CLASSIFICATION OF FINANCIAL
ASSETS
IFRRS 9
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 ALWAYS REMEMBER THAT CLASSIFICATION UNDER
IFRS 9 IS FOR MEASUREMENT PURPOSES. ASSETS
ARE MEASURED AT 3 DIFFERENT PERIODS
NAMELY:
-INITIAL RECOGNITION
-SUBSEQUENT MEASUREMENT
-DERECOGNITION
THE VALUE AT WHICH THE ASSET WILL BE
REFLECTED WILL DEPEND ON THE CLASSIFICATION.

14 FINANCIAL ASSETS
MEASUREMENT CLASSES
Financial assets can be classified into 3 different classes namely:

 Amortised cost
 Fair value through other comprehensive income(FVTOCI)

 Fair value through profit or loss (FVTPL)

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AMORTISED COST
Contractual Cash flow characteristics Test
Measurement
&Business model test

The contractual terms of the financial asset Initial measurement:

give rise on specified dates to cash flows that
are sorely payment of principal and interest Fair value (using effective interest
on the outstanding amount of instrument. rate method) + transaction costs
Asset is held within a business model whose
objective is to HOLD asset in order to
Which assets are valued under this
COLLECT contractual cash-flows
method?
e.g. a loan issued earn interest at 10% per Debt instruments.
annum and is repayable end of year 2
Assess the cash flows? 16
FAIR VALUE THROUGH OTHER
COMPREHENSIVE INCOME
conditions measurement

 Both debt and equity instruments Initial measurement:

can be classified under this. Fair value + transaction costs
Conditions for classification
- SPPI test

- Should not be classified under

FVTPL

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FAIR VALUE THROUGH PROFIT OR LOSS
MANDATORY CLASSIFICATIONS OPTIONAL

 Derivatives  Debt
 Asset with an embedded derivative  equity

 Assets bought for trading

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DEBT INSTRUMENTS
 Optional –FVTPL
 Pass CCT &BMT- Amortised cost

 Pass SPPI & not elected to use FVTPL- FVTOCI

 None of the above-FVTPL

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 ACCOUNTING TREATMENT DEBT
INSTRUMENTS
Amortised cost FVTOCI FVTPL

INITIAL MEASUREMENTS INITIAL MEASUREMENT INITIAL MEASUREMENT

Fair value + transaction costs Fair value + transaction costs Fair value, transaction costs go to
P/L

SUBSEQUENT MEASUREMENT SUBSEQUENT MEASUREMENT SUBSEQUENT MEASUREMENT

1. Interest income using effective Interest is recorded in Profit or RECORDED IN Profit or loss
rate is recorded in P/L loss

2. Change in value-IGNORE Change in value-recorded in OCI

IMPAIRMENT IMPAIRMENT IMPAIRMENT
Calculated based on expected Calculated based on expected No impairment
loss model loss model
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DERECOGNITION DERECOGNITION DERECOGNITION
Derecognition gain/loss is Gain or loss transferred from OCI Gain or loss recorded in P/L
EQUITY INSTRUMENTS
 Held for trading-FVTPL
 FVTOCI-optional

 None of the above- FV

TPL

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ACCOUNTING TREATMENT-EQUITY
INSTRUMENT
AMORTISED COST FVTOCI FVTPL
INITIAL MEASUREMENT INITIAL MEASUREMENT INITIAL MEASUREMENT
N/A Fair value + transaction costs Fair value , transaction costs go
to P/L
SUSEQUENT MEASUREMENT SUBSEQUENT MEASUREMENT SUBSEQUENT MEASUREMENT
1. N/A Dividend recorded in P/L Dividend recorded in P/L
2.N/A Change in FV- recorded in OCI Change in FV recorded in P/L
IMPAIRMENT IMPAIRMENT IMPAIRMENT
-N/A Expected loss model No impairment
DERECOGNITION DERECOGNITION DERECOGNITION
-N/A Gains /losses cannot be P/L
transferred to P/L so goes
through OCI
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 CLASSIFICATION OF
23 FINANCIAL LIABILITIES
IFRS 9
CLASSIFICATION & U can
designate
MEASUREMENT any Asset or
Liability @
FINANCIAL LIABILITIES FV p/l
 Initial Measurement (IFRS 9 Chapter 5.1)
 Initially measured at Fair Value LESS Transaction costs
 Transaction costs are deducted UNLESS designated @ FV through p/l or at subsequent
measurement
 Subsequent measurement (IFRS 9 Chapter 5.3, 4.2)
 Also driven by the classification of the instrument. All financial liabilities are
classified and subsequently measured at amortised cost, except:
 Financial liabilities at fair value through profit/loss (as defined previously). Such
liabilities are measured at fair value and fair value adjustments are recognised in p/l.

A financial liability at fair value through profit or loss

satisfies one of the following criteria:
• It satisfies the definition of held for trading (as
defined above), or
• At initial recognition it is designated by the 24
entity as at fair value through profit or loss
INITIAL MEASUREMENT (ASSETS AND
LIABILITIES) – EXAMPLE AS PER KEY NOTES

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INITIAL MEASUREMENT (ASSETS AND LIABILITIES) –
EXAMPLE AS PER KEY NOTES (SOLUTION)

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EXAMPLE FROM KEY NOTES –
CLASSIFICATION

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ANY QUESTIONS??
YOU CAN POST ON FORUM ON MOODLE

Further reading material:

Gripping GAAP
GAAP Handbook vol 1
Descriptive Accounting

Thank you

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