Financial Asset and Financial Liability IAS 32 Financial instruments: presentation, which deals with: The classification of financial instruments between liabilities and equity. Presentation of certain compound instruments (instruments combining debt and equity) IFRS 7 Financial instruments: disclosure IFRS 9 Financial instruments. IFRS 9 deals with recognition, derecognition and measurement of financial assets and liabilities 5-1

Financial Asset and Financial Liability Definitions Financial instrument. Any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. 5-2

Financial Asset and Financial Liability Financial asset. Any asset that is: Cash An equity instrument of another entity A contractual right to receive cash or another financial asset from another entity; or to exchange financial instruments with another entity under conditions that are potentially favourable to the entity 5-3

Financial Asset and Financial Liability Financial liability. Any liability that is: A contractual obligation: I. To deliver cash or another financial asset to another entity, or II. To exchange financial instruments with another entity under conditions that are potentially unfavourable. Examples of financial liabilities include: (a) Trade payables (b) Debenture loans payable (c) Redeemable preference (non-equity) shares 5-4

Financial Asset and Financial Liability Equity instrument. Any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. 5-5

Financial Asset and Financial Liability Initial recognition A financial asset or financial liability should be recognised in the statement of financial position when the reporting entity becomes a party to the contractual provisions of the instrument. On recognition, IFRS 9 requires that financial assets are classified as measured at either: Amortised cost, or Fair value. 5-6

Financial Asset and Financial Liability Initial recognition A financial asset is classified as measured at amortised cost where: The objective of the business model within which the asset is held is to hold assets in order to collect contractual cash flows The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal outstanding 5-7

Financial Asset and Financial Liability Example: amortised cost On 1 January 20X1 Abacus Co purchases a debt instrument for its fair value of $1,000. The debt instrument is due to mature on 31 December 20X5. The instrument has a principal amount of $1,250 and the instrument carries fixed interest at 4.72% that is paid annually. The effective rate of interest is 10%. How should Abacus Co account for the debt instrument over its five year term? 5-8

Financial Asset and Financial Liability Solution Abacus Co will receive interest of $59 (1,250  4.72%) each year and $1,250 when the instrument matures. Abacus must allocate the discount of $250 and the interest receivable over the five year term at a constant rate on the carrying amount of the debt. To do this, it must apply the effective interest rate of 10%. The following table shows the allocation over the years: 5-9

Financial Asset and Financial Liability Viking issues $100,000 5% loan notes on 1 January 20X4, incurring issue costs of $3,000. These loan notes are redeemable at a premium, meaning that the effective rate of interest is 8% per annum. What is the finance cost to be shown in the statement of profit or loss for the year ended 31 December 20X5? A. $8,240 B. $7,981 C. $7,760 D. $8,000 5-10

Financial Asset and Financial Liability Answer B The loan notes should initially be recorded at their net proceeds, being the $100,000 raised less the $3,000 issue costs, giving $97,000. This should then be held at amortised cost, taking the effective rate of interest to the statement of profit or loss. The annual payment will be the coupon rate, which will be 5% x $l00,000 = $5,000 a year. Applying this to an amortised cost table gives $7,981, as shown below. B/f Interest 8% Payment c/f $ $ $ $ 20X4 97,000 7,760 (5,000) 99,760 20X5 99,760 7,981 If you chose C, you have done the calculation you 20X4. If you chose D, you have used 8% of the full $100,000 and done the calculation for 20X4. If you chose A, you have used 8% of the full $100,000 5-11

Financial Asset and Financial Liability Subsequent measurement of equity instruments After initial recognition equity instruments are measured at either fair value through profit or loss (FVTPL) or fair value through other comprehensive income (FVTOCI). If equity instruments are held at FVTPL no transaction costs are included in the carrying amount. 5-12

Financial Asset and Financial Liability Example: What is the default classification for an equity investment? Fair value through profit or loss Fair value through other comprehensive income Amortised cost Net proceeds

Financial Asset and Financial Liability Example: DEF Co has purchased an investment of 15,000 shares on 1 August 20X6 at a cost of $6.50 each. Transaction costs on the purchase amounted to $1,500. As at the year end 30 September 20X6, these shares are now worth $7.75 each. Select the correct gain and the place it will be recorded Gain Where to recorded 17,250 OCI 18,750 Statement of profit or loss

Financial Asset and Financial Liability Financial Assets held for trading will be valued at Fair Value through Profit or Loss. These are therefore valued excluding Any transaction costs (which will be expensed to profit or loss).

Financial Asset and Financial Liability IFRS9 Equity instruments can be held at FVTOCI if: They are not held for trading (ie the intention is to hold them for the long term to collect dividend income) An irrevocable election is made at initial recognition to measure the investment at FVTOCI If the investment is held at FVTOCI, all changes in fair value go through other comprehensive income. Only dividend income will appear in profit or loss.

Financial Asset and Financial Liability Example: ABC Co purchased 10,000 shares on 1 September 20X4, Making the election to use the alternative treatment under IFRS 9. The shares cost $3.50 each. Transaction costs associated with the purchase were $500. At 31 December 20X4, the shares are trading at $4.50 each. What is the gain to be recognised on these shares for the year ended 31 December 20X4?

Financial Asset and Financial Liability Answer: The investment should be classified as Fair Value through Other comprehensive income. As such, they will initially be valued inclusive of transaction costs. Therefore, the initial value is 10,000 x $3.50 = $35,000 + $500 = $35,500. At year-end, these will be revalued to fair value of $4.50 each, therefore 10,000*$4.50 =$45,000. The gain is therefore $45,000 - $35,500 = $9,500.

Financial Asset and Financial Liability Example: For which category of financial instruments are transaction costs excluded from the initial value, and instead expensed to profit or loss? Financial Liabilities at amortised cost Financial Assets at fair value through profit or loss Financial Assets at fair value through other comprehensive income D. Financial Assets at amortised cos

Financial Asset and Financial Liability IFRS 9 Summary Financial Instrument IFRS9 Classification Initial and subsequent measurenent Value changes Debt instrument Amortized cost Not relevant FVTPL FV TPL Equity Instrument FVTOCI-if irrecovable election made on initial recognition TOCI Financial Liability

Financial Asset and Financial Liability Compound financial instruments Some financial instruments contain both a liability and an equity element. In such cases, IAS 32 requires the component parts of the instrument to be classified separately, according to the substance of the contractual arrangement and the definitions of a financial liability and an equity instrument.

Financial Asset and Financial Liability Compound financial instruments One of the most common types of compound instrument is convertible debt. This creates a primary financial liability of the issuer and grants an option to the holder of the instrument to convert it into an equity instrument (usually ordinary shares) of the issuer. This is the economic equivalent of the issue of conventional debt plus a warrant to acquire shares in the future.

Financial Asset and Financial Liability Example: Rathbone Co issues 2,000 convertible bonds at the start of 20X2.The bonds have a three year term, and are issued at par with a face value of $1,000 per bond, giving total proceeds of $2,000,000. Interest is payable annually in arrears at a nominal annual interest rate of 6%. Each bond is convertible at any time up to maturity into 250 ordinary shares. When the bonds are issued, the prevailing market interest rate for similar debt without conversion options is 9%. Required What is the value of the equity component in the bond?

Financial Asset and Financial Liability Solution Principal $2,000,000 discounted at 9% over 3 years: 2,000,000 ÷ 1.09 ÷ 1.09 ÷ 1.09 1,544,367 Interest Year 1 120,000 ÷ 1.09 110,091 Year 2 110,091 ÷ 1.09 101,002 Year 3 101,002 ÷ 1.09 92,662 303,755 Value of liability component 1,848,122 Equity component (balancing figure) 151,878 Proceeds of bond issue 2,000,000

Financial Asset and Financial Liability Question: A company issues $20m of 4% convertible loan notes at par on 1 January 2009. The loan notes are redeemable for cash or convertible into equity shares on the basis of 20 shares per $100 of debt at the option of the loan note holder on 31 December 2011. Similar but non-convertible loan notes carry an interest rate of 9%.The present value of $1 receivable at the end of the year based on discount rates of 4% and 9% can be taken as: Required Show how these loan notes should be accounted for in the financial statements at 31 December 2009

Financial Asset and Financial Liability 4% 9% $ $ End of year 1 0.96 0.92 2 0.93 0.84 3 0.89 0.77 Cumulative 2.78 2.53

Financial Asset and Financial Liability Solution: $ Statement of profit or loss Finance costs (W2) 1,568 Statement of financial position Equity – option to convert (W1) 2,576 Non-current liabilities 4% convertible loan notes (W2) 18,192

Financial Asset and Financial Liability Solution: Working 1: Equity and liability elements $'000 3 years interest (20,000 × 4% × 2.53) 2,024 Redemption (20,000 × 0.77) 15,400 Liability element 17,424 Equity element (β) 2,576 Proceeds of loan notes 20,000

Financial Asset and Financial Liability Solution: Working 2: Loan note balance $'000 Liability element (W1) 17,424 Interest for the year at 9% 1,568 Less interest paid (20,000 × 4%) (800) Carrying value at 31 December 2009 18,192