FINANCIAL INSTRUMENTS

FINANCIAL INSTRUMENTS
2/7/2012

Content 1AS 32: Financial Instruments: Presentation
IAS 39: Financial Instruments: Recognition and Measurement IFRS 7:Financial Instruments: Disclosures 2/7/2012

IAS 32 Scope Definitions Treasury Shares
Financial Instruments Financial Asset Financial Liability Equity Instrument Compound Financial Instrument Treasury Shares Interest, Dividends, Gains and Losses Off-setting 2/7/2012

Scope of the standard The IAS deals with all types of financial instruments, both recognized and unrecognized. A financial instrument is any contract that gives rise to both a financial asset of one enterprise and a financial liability or equity instrument of another. 2/7/2012

Exclusions from Scope Interest in subsidiaries Interest in Associate
Interest in Joint Ventures Pensions and other post-retirement benefits Employee stock options and stock purchase plans Insurance contracts 2/7/2012

Financial Instrument Any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another. Examples Cash and timed deposit Trade payables and receivables Loans payables and receivables Debts and equity investment Convertible debt instruments Investments in shares issued by other entities Preference shares Derivatives [interest rate swaps and foreign exchange contracts] 2/7/2012

Financial Asset A financial asset is any asset that is:
cash (e.g., deposit at a bank), a contractual right to receive cash or a financial asset (e.g., a debtor and derivative instrument). A contractual right to exchange financial instruments under potentially favourable conditions, or An equity instrument of another enterprise (e.g., investment in shares). 2/7/2012

Examples An entity deposits GHS20,000 of cash with a bank for a fixed term of three years. The GHS20,000 is a financial asset of the entity as it has a contractual right to receive the cash in three years’ time 2/7/2012

Financial Liability A contractual obligation to:
deliver any financial asset (e.g., a creditor and derivative instrument), or exchange financial instruments under potentially unfavorable conditions. Liabilities imposed by statutory requirements (e.g., income taxes) are not financial liabilities because they are not contractual. 2/7/2012

In 2008 an entity entered into a contract that required it to issue shares to the value of GHS10,000 on 1 January 2011. This is a financial liability since the entity is required to settle the contract by issuing a variable number of shares based on fixed monetary amount If the number of shares were fixed, it would not meet the definition of a financial liability and should be presented as an equity instrument 2/7/2012

An Equity Instrument Any contract that evidences a residual interest in the assets of an enterprise after deducting all of its liabilities. An obligation to issue an equity instrument is not a financial liability because it results in an increase in equity and cannot result in a loss to the enterprise. 2/7/2012

Special Case of Preference Shares
Provides the holder with the right to receive an annual dividend [usually of a pre-determined and unchanging amount. In substance the fixed level of dividend is interest and the redemption amount is repayment of a loan. Redeemable preference shares is presented as a liability In practical terms, only irredeemable preference shares are included in equity. 2/7/2012

Compound Financial Instrument
The issuer of a non-derivative financial instrument shall evaluate the terms of the financial instrument to determine whether it contains both a liability and an equity component. Such components shall be classified separately as financial liabilities, or equity instruments 2/7/2012

An entity recognises separately the components of a financial instrument that creates a financial liability of the entity and grants an option to the holder of the instrument to convert it into an equity instrument of the entity. 2/7/2012

For example, a bond or similar instrument convertible by the holder into a fixed number of ordinary shares of the entity is a compound financial instrument. From the perspective of the entity, such an instrument comprises two components: a financial liability (a contractual arrangement to deliver cash or another financial asset) and an equity instrument (a call option granting the holder the right, for a specified period of time, to convert it into a fixed number of ordinary shares of the entity). 2/7/2012

The issuer determines the carrying amount of the liability component by measuring the fair value of a similar liability (including any embedded non-equity derivative features) that does not have an associated equity component. The carrying amount of the equity instrument represented by the option to convert the instrument into ordinary shares is then determined by deducting the fair value of the financial liability from the fair value of the compound financial instrument as a whole. 2/7/2012

Illustration- Compound Instrument
ABC Ltd issued 5,000 convertible bonds at the beginning of The bonds have a three year term and are issued at par with a face value of GHS1,000 per bond given total proceeds of GHS 5,000, Interest is payable annually in arrears at a nominal annual interest rate of 20% . Each bond is convertible at any time up to maturity into 500 shares. When the bonds were issued, the prevailing market interest rate for similar debt without conversion option was 30% Required Determine the equity component of the compound instrument. 2/7/2012

Treasury Shares If an entity reacquires its own equity instruments, those instruments (‘treasury shares’) shall be deducted from equity. No gain or loss shall be recognised in profit or loss on the purchase, sale, issue or cancellation of an entity’s own equity instruments. Such treasury shares may be acquired and held by the entity or by other members of the consolidated group. Consideration paid or received shall be recognised directly in equity. 2/7/2012

Treasury Shares The amount of treasury shares held is disclosed separately either on the face of the statement of financial position or in the notes in accordance with IAS 1 Presentation of Financial Statements. An entity provides disclosure in accordance with IAS 24 Related Party Disclosures if the entity reacquires its own equity instruments from related parties. 2/7/2012

Interest, dividends, losses and gains
Interest, dividends, losses and gains relating to a financial instrument or a component that is a financial liability shall be recognised as income or expense in profit or loss. Distributions to holders of an equity instrument shall be debited by the entity directly to equity, net of any related income tax benefit. Transaction costs of an equity transaction,[ other than costs of issuing an equity instrument that are directly attributable to the acquisition of a business (which shall be accounted for under IFRS 3)], shall be accounted for as a deduction from equity, net of any related income tax benefit. 2/7/2012

The classification of a financial instrument as a financial liability or an equity instrument determines whether interest, dividends, losses and gains relating to that instrument are recognised as income or expense in profit or loss. Thus, dividend payments on shares wholly recognised as liabilities are recognised as expenses in the same way as interest on a bond. Similarly, gains and losses associated with redemptions or refinancing of financial liabilities are recognized in profit or loss, whereas redemptions or refinancing of equity instruments are recognised as changes in equity. 2/7/2012

Changes in the fair value of an equity instrument are not recognised in the financial statements. An entity typically incurs various costs in issuing or acquiring its own equity instruments. Those costs might include registration and other regulatory fees, amounts paid to legal, accounting and other professional advisers, printing costs and stamp duties. 2/7/2012

Interest, Dividends, Gains and Losses
The transaction costs of an equity transaction are accounted for as a deduction from equity (net of any related income tax benefit) to the extent they are incremental costs directly attributable to the equity transaction that otherwise would have been avoided. The costs of an equity transaction that is abandoned are recognised as an expense. 2/7/2012

Transaction costs that relate to the issue of a compound financial instrument are allocated to the liability and equity components of the instrument in proportion to the allocation of proceeds. The related amount of income taxes recognised directly in equity is included in the aggregate amount of current and deferred income tax credited or charged to equity that is disclosed under IAS 12 Income Taxes. 2/7/2012

Dividends classified as an expense may be presented in the income statement either with interest on other liabilities or as a separate item. In some circumstances, because of the differences between interest and dividends with respect to matters such as tax deductibility, it is desirable to disclose them separately in the income statement. Disclosures of the tax effects are made in accordance with IAS 12. 2/7/2012

Interest, Dividends, Losses and Gains
Gains and losses related to changes in the carrying amount of a financial liability are recognised as income or expense in profit or loss Under IAS 1 the entity presents any gain or loss arising from re-measurement of such an instrument separately on the face of the income statement when it is relevant in explaining the entity’s performance. 2/7/2012

Offsetting a financial asset and a financial liability
A financial asset and a financial liability shall be offset and the net amount presented in the Statement of Financial Position when, and only when, an entity: currently has a legally enforceable right to set off the recognized amounts; and intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously. 2/7/2012

IAS 39 Scope Initial Recognition De-recognition
Subsequent Measurement of FA Subsequent Measurement of FL Impairment of Financial Asset 2/7/2012

IAS 39: SCOPE This Standard shall be applied by all entities to all types of financial instruments except: those interests in subsidiaries, associates and joint ventures rights and obligations under leases . employers’ rights and obligations under employee benefit plans, financial instruments issued by the entity that meet the definition of an equity instrument rights and obligations under an insurance contract contracts for contingent consideration in a business combination 2/7/2012

Initial Recognition An enterprise should recognise a financial asset on its statement of financial position when, and only when, it becomes a party to the contractual provisions of the instrument. 2/7/2012

De-recognition An entity shall derecognise a financial asset when and only when : The contractual rights to the cash flows from the financial asset expires, or It transfers the financial asset and the transfer qualifies for de-recognition. 2/7/2012

Initial Measurement When a financial asset is recognised initially, an entity shall measure it at its fair value plus transaction costs that are directly attributable to the acquisition of the financial asset. In the case of financial assets fair value through profit or loss, the transaction cost is not added to the fair value. 2/7/2012

Subsequent Measurement of Financial Assets
For the purpose of measuring a financial asset after initial recognition, FA are classified into 4 categories as ff: FA at fair value through profit or loss Held to maturity investment Loans and Receivables; and Available-for-sale financial assets 2/7/2012

A financial asset at fair value through profit or loss
It is a financial asset that meets either of the following conditions: It is classified as held for trading; Upon initial recognition, it is designated by the entity as at fair value through profit or loss. 2/7/2012

Example -FAFVTPL At the end of the reporting period,:
FAFVTPL should be re-measured at fair value without deduction for transaction cost Changes in fair value should be recognised in income statement 2/7/2012

Set out the journal entries to record these transactions
An entity acquired a derivative on 1 May 2010 for GHS2000 cash. On 31 December 2010, the next reporting date, the fair value of the derivative was GHS3,400. On 31 December 2011, the derivative’s fair value had fallen to GHS2,200. Set out the journal entries to record these transactions 2/7/2012

Cr Income Statement(Gain on financial asset) 1,400
On 1 May 2010 Dr: Financial Asset Cr: Cash 2000 On 31 December 2010 Dr Financial Asset ( ) Cr Income Statement(Gain on financial asset) 1,400 On 31 December 2011 Dr: Income Statement ( ) Cr: Financial Asset 1,200 2/7/2012

Held-to-maturity investments
They are non-derivative financial assets with fixed or determinable payments and fixed maturity that an entity has the positive intention and ability to hold to maturity other than: those that the entity upon initial recognition designates as at fair value through profit or loss; those that the entity designates as available for sale; and those that meet the definition of loans and receivables. 2/7/2012

H-T-M FAs are measured at amortised cost using effective interest method
Amortised cost is: The initial amount recognised for the financial asset; Less any repayments of principal sum; Plus any amortisation The EIR is the rate that exactly discounts estimated future cash payments or receipts through the effective useful life of the instrument or when appropriate, a shorter period to the carrying amount of the FA of FL 2/7/2012

Illustration An entity acquires a zero coupon bond with a nominal value of GHS20,000 on 1 Jan for GHS18,900. The bond is quoted in an active market and broker’s fees of GHS 500 were incurred in relation to the purchase. The bond is redeemable on 331 December at a premium of 10%. The effective interest rate is thus 6.49% 2/7/2012

Solution On 1 January 2010 DR: FA (18,900+500) CR Cash 19400
On 31 December 2010 DR: FA (19,400 X 6.49%) CR: Investment Income (IS) 1,259 On 31 December 2011 DR: FA ( ) X 6.49%] CR: Investment Income DR: Cash CR: FA 1,341 22,000 2/7/2012

Available-for-sale financial assets
They are those non-derivative financial assets that are designated as available for sale or are not classified as (a) loans and receivables, (b) held-to-maturity investments or (c) financial assets at fair value through profit or loss 2/7/2012

AFSFA should be measured at fair value at the end of each reporting period
Any gain arising an increase in value should be recognised in OCI and held in equity. Any loss arising from a decrease in fair value should be recognised in OCI and held in equity. The only exception is that when there is evidence that the asset is impaired, any loss held in equity should be recognised as an expense in profit or loss. 2/7/2012

When AFSFA is disposed of, the cumulative gains or losses held in equity should be presented as part of profit or loss on disposal recognised in profit or loss This process is known as a reclassification adjustment For a cumulative gain: DR: OCI CR: Profit or Loss For a cumulative loss: DR: Profit or loss CR: OCI 2/7/2012

Loans and Receivables A financial asset classified as a loan receivable shd be measured at amortised cost using the effective interest method. Amortisation shd be recognised as an income in profit or loss Most finaaacial assets that meet this classification are simple receivables and loan transactions . Most entities chose to classify them in this category unless they are held for trading 2/7/2012

Example NPK Financial Services has agreed to lend a customer GHS9,500 on 1 January 2010 subject to the following terms: The loan is repaid on 31 December 2012 Three interest payments of GHS1,000 are paid on 31 Deceember each year. NPK incurred GHS250 of legal fees in agreeing the loan documentation with the customer. The effective rate of interest is thus calculated as 9.48% Demonstrate by journal entries how the loan should be recorded in the financial statements of NPK for the year ended 31 Dec 2010 and the subsequent years 2/7/2012

Solution 1 Jan 2010 DR: Loan (9500+250) CR: Cash 9,750
31 December 2010 DR: Cash CR: Interest Income (9750 X 9.48%) CR:Loan (balancing figure) Note: The loan balance is now GHS9,674( ) 1,000 924 76 31 December 2011 CR: Interest Income(9674 x 9.48%) CR: Loan (bal figure) Note: The loan balance is now GHS9,591 ( ) 917 83 31 December 2012 DR:Cash (9, ) CR: Interest Income CR: Loan (bal fig) 10,500 909 9,591 2/7/2012

Investment in Equity Instruments
These are F/A that do not have a quoted market price in an active market and whose fair value cannot be reliably measured shall be measured at cost 2/7/2012

Summary of treatment of Financial Assets
Description Measurement Recording of change FAFVTPL FA held for the purpose of selling in the short term. This include derivatives Fair Value Profit or loss AFSFA Non-derivative FA available for sale or any such asset not classified in one of the other 3 categories Fair value OCI except for interest on assets and impairment losses Loans and Receivables Non-derivative FAs with fixed or determinable payments that are not quoted in an active market, not designated as held for trading and not available for sale Amortised Cost Profit or Loss Held –to-maturity Investment Intention and ability to hold to maturity and not classified in any of the above categories 2/7/2012

Amortised Cost The amortised cost of a financial asset is the amount at which the financial asset is measured at initial recognition minus principal repayments, plus or minus the cumulative amortization using the effective interest method of any difference between that initial amount and the maturity amount, and minus any reduction (directly or through the use of an allowance account) for impairment or uncollectibility. 2/7/2012

Effective Interest Rate
The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset or financial liability. 2/7/2012

Effective Interest Method
The effective interest method is a method of calculating the amortised cost of a financial asset or a financial liability (or group of financial assets or financial liabilities) and of allocating the interest income or interest expense over the relevant period 2/7/2012

Amortised Cost On 1 January 2007, ABA Bank purchased a debt instrument for its fair value of GHS10,000. The debt instrument is due to mature on 31 December The instrument will be redeemed at GHS12,023 and the instrument carries fixed interest at 12% per annum that is paid annually. The effective interest rate is thus calculated as 15% p.a ) How should ABC account for the debt instrument over its five year term? 2/7/2012

Solution- Amortised Cost
ABC will receive GHS1,200 each year (12% of GHS10,000 and GHS12,023 when it matures. ABC must allocate the redemption premium of GHS2,023 and the interest receivable over the 5 year term at a constant rate on the carrying amount of the debt. To do this, it must apply the effective rate of 15%. The table below shows the allocation over the years. 2/7/2012

Solution Yr Am. Co Interest Interest Am. Cost
at beg Earned Rece at yr end 1 10, , , ,300 , , , ,645 , , , ,042 , , , ,498 , , , ,023 Each year the carrying amount of the financial asset is increased by the interest earned and reduced by the interest received 2/7/2012

Amortised Cost - Loan ABC Bank granted a loan of GHS10,000 to Addo in January at an annual interest rate of 20%. The loan is payable on equal instalment over 12 months. Ignore transaction cost. Determine the amortised cost of this FA to be disclosed in the SoFP of ABC Bank at the end of every month. 2/7/2012

Solution Month AC at beg Interest Payment AC at close Jan 10,000 167
(927) 9240 Feb 154 8467 March 141 7681 April 128 6882 May 115 6069 June 101 5244 July 87 4044 August 73 3550 Sept 59 2683 Oct 45 1800 Nov 30 903 Dec 15 (918) 2/7/2012

Illustration 3 BBB Ltd purchased a five year Government Bond for its fair value of GHS100,000 on 1 January The bond is to be redeemed on 31 December The instrument has a redeemable amount of GHS126,440 and carries fixed interest at 10% p.a. paid annually in arrears. The effective interest rate is thus calculated as 14% p.a. How should BBB Ltd account for this financial asset? 2/7/2012

Amortised Cost YEAR Amortised Cost at beginning
I/S: Interest Cash Book: Interest Received at 10% Amortised Cost at year end 2009 100,000 14,000 (10,000) 104,000 2010 14,560 108,560 2011 15,298 113,758 2012 15,926 119,684 2013 16,756 (126,440) redeemed 2/7/2012

Measurement of Financial Liability
After initial recognition, an enterprise should measure all financial liabilities, [other than liabilities held for trading and derivatives that are liabilities,] at amortised cost using effective interest method Liabilities held for trading and derivatives that are liabilities, should generally be measured at fair value. Gains and losses from their movements should be reognised in profit or loss 2/7/2012

Example Bonds with a nominal value of GHS200,000 were issued at GHS157,763 on 1 January The coupon rate is 4% while the effective interest rate is 9.5%. Interest is paid annually in arrears. Redemption is at par in five years. Issue costs are immaterial Calculate the carrying amount of the bonds in the SoFP at 31 December 2010 and at each subsequent year end until maturity 2/7/2012

Solution Period Amortised Cost at beginning Interest @ EIR of 9.5%
Interest Amortised Cost at year end GHS 2010 157,763 14,988 (8,000) 164,751 2011 15,651 172,402 2012 16,378 180,780 2013 17,174 189,954 2015 18,046 200,000(Redeemed) 2/7/2012

ABC Ltd issued a bond for GHS500,000 on 1 January 2008
ABC Ltd issued a bond for GHS500,000 on 1 January No interest is payable on the bond, but it will be held and redeemed on 31 December 2010 for GHS702,464. The bond has not been designated as fair value through profit or loss Required Calculate the charge to income statement for the years ended 31 December 2008,2009and 2010 and the balance outstanding on statement of financial position as at 31 December 2008 and 2009 2/7/2012

Thus = GHS702,464/ GHS500,000 = 1.404928 over three years
The bond is a deep discount bond and is a financial liability of ABC Ltd. It is measured at amortised cost. Although there is no interest as such, the difference between the initial cost of the bond and the price at which it will be redeemed is a finance cost. This must be allocated over the term of the bond at a constant rate on the carrying amount. To calculate the amortised cost, we need to calculate the effective interest rate of the bond Thus = GHS702,464/ GHS500,000 = over three years To calculate the annual rate, we find the cube root of = 1.12, so the annual effective interest rate is 12%. 2/7/2012

Amortised Cost Year Amortised Cost at beginning
Interest at EIR of 12% p.a Amortised Cost at close 2008 500,000 60,000 560,000 2009 67,200 627,200 2010 75,264 702,464 2/7/2012

Illustration 2 On 1 January 2009, QRS Ltd secured a GHS100,000 loan from PYC Financial Services . Processing fee and insurance premium of 4% were deducted at source. Interest would not be paid until 31 December 2010 when the loan would be redeemed at an amount of GHS145,238. Required Calculate the effective interest rate of the loan note What is the finance costs in respect of the loan note for the years ended 31 December 2009 and 2010 2/7/2012

Solution to Illustration 3
The premium on redemption of the loan note represents a finance cost ( has the same effect as accumulated interest charges over the two year period. The effective rate of interest must be applied so that the debt is measured at amortised cost. At the time of issue, the loan notes are recognized at their net proceeds of GHS 96,000 (100, ) The effective interest rate is calculated as : 145,238/96 ,000 = (for two years) Annual rate is square root of = 1.23 = or 23% 2/7/2012

Solution Year Amortised cost at start Interest at EIR of 23% p.a
Amortised Cost at close GHS 2009 96, 000 22,080 118,080 2010 27,158 145,238 (Redeemed) 2/7/2012

Illustration On 1 January 2009, PPP Ltd issued 3,000 GHS6,000 debenture stocks with a coupon rate of 15% at par value . The issue costs amounted to GHS 600,000. The debenture stocks will all be in issue for 4 years and will be redeemed on 31 December 2012 at a premium of 5% of the nominal value. Required: Determine the total amount of finance costs associated with the financial liability. 2/7/2012

Solution i) Nominal value of financial liability at initial recognition = 3,000 x GHS6,000 = GHS18 million ii) Premium on redemption =5% of GHS18 million = GHS900,000 Total Finance Cost GHS Issue Cost ,000 Interest payable (GHS18m X 15% x4 years 10,800,000 Premium on redemption (5% of GHS18 million) ,000 12,300,000 ======= 2/7/2012

Impairment and un-collectability of financial assets
An entity shall assess at the end of each reporting period whether there is any objective evidence that a financial asset or group of financial assets is impaired. Indications of impairment include the following: 2/7/2012

Indications of Impairment
Significant financial difficulty of the issuer or obligor; A breach of contract, such as a default or delinquency in interest or principal payments; The lender, for economic or legal reasons relating to the borrower’s financial difficulty, granting to the borrower, a concession that the lender would not otherwise consider; 2/7/2012

It becoming probable that the borrower would enter bankruptcy or other financial re-organisation; The disappearance of an active market for that financial asset because of financial difficulties; or Observable data indicating that there is a measurable decrease in the estimated future cash flows from a group of financial assets 2/7/2012

Accounting Treatment of Impairment: FA carried at amortised cost
Impairment loss on loans and receivables or held-to-maturity investments carried at amortised cost is measured as the difference b/n the assets carrying amount and the present value of the estimated future cash flows(excluding future credit losses that have not been incurred) discounted at the financial asset’s original effective interest rate; The carrying amount of the asset shall be reduced either directly or through use of allowance account; The amount of the loss shall be recognised in profit or loss. 2/7/2012

Reversal of impairment loss previously recognised
If in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised (such as improvement in the debtor’s credit rating), the previously recognised impairment loss shall be reversed either directly or by adjusting an allowance account. The amount of the reversal shall be recognised in profit or loss 2/7/2012

Accounting Treatment of Impairment loss: Financial Assets carried at cost
Impairment loss on unquoted equity instrument carried at cost is measured as the difference b/n the carrying amount of the F/A and the present value of the estimated future cash flows discounted at the current market rate of return for a similar financial asset Such impairment losses shall not be reversed 2/7/2012

Impairment loss on AFSFA
When a decline in the fair value of an AFSFA has been recognised in other comprehensive income and there is objective evidence that the asset is impaired, the cumulative loss that had been recognised in other comprehensive income shall be re-classified from equity to profit or loss as a reclassification adjustment even though the financial asset has not been de-recognised 2/7/2012

The amount of the cumulative loss that is reclassified from equity to profit or loss shall be the difference between the acquisition cost (net of any principal repayment and amortisation) and the current fair value, less any impairment loss on that F/A previously recognised in profit or loss. Impairment loss recognised in P/L for an investment in equity instrument classified as AFSFA shall not be reversed through profit or loss 2/7/2012

Additional Issues about impairment calculations
Cash flows relating to short term receivables are not discounted if the effect of discounting is immaterial The process for estimating impairment considers all credit exposure, not only those of low credit quality The process for estimating the amount of an impairment loss may result in either in a single amount or in a range of possible amounts. In the latter case the entity recognises an impairment loss equal to the best estimate within the range. 2/7/2012

For the purpose of collective evaluation of impairment , financial assets are grouped on the basis of similar credit risk that are indicative of the debtor’s ability to pay all amounts due ( by asset type, industry, geographical location, collateral type, etc) 2/7/2012

Disclosures The carrying amount of each category of financial asset should be disclosed separately. When FA are impaired by credit losses and the entity records the loss in a separate account(e.g allowance account) rather than directly reducing the carrying amount of the FA, it shall disclose a reconciliation of changes in the account during the period for each class of financial asset. The amount of any impairment loss for each class of financial asset Other Quantitative and Qualitative disclosures [IFRS 7] 2/7/2012

BOG IMPAIRMENT PROVISION
Status % No of Days of Delinquent Current 1 0 – Less than 30 days OLEM days Sub-Std days Doubtful days Loss and above *Other Liabilities Exceptionally Mentioned 2/7/2012

BOG PROVISIONING REQUIREMENT VRS IFRS REQUIREMENT
Banks should comply with IFRS Impairment Rules Where IFRS Impairment Rules result in a lower provision than would be the case if the BOG prudential norms were applied, the difference should be charged to Income Surplus and credited to a Credit Risk Reserve. The CRR so created is not available for inclusion in the adjusted capital base for purposes of the Capital Adequacy computation 2/7/2012

Additional Disclosures – Semi Annually
Capital adequacy ratio Non-performing loan ratio (Sub-standard to loss loans/Total Gross Loans x 100) Dominant risks of the bank and how they arise, giving an indication as to whether they are increasing, decreasing or stable over a three-year period Objectives, policies and processes for managing these risks; Methods used to measure the risks afore-mentioned Defaults in statutory liquidity and accompanying sanctions, if any 2/7/2012

Illustration Loans and Receivable 1000,000
PV of future cash flows ,000 BOG provisioning 120,000 Impairment recognised: Dr : SoCI 50,000 Cr L&R or AL for Impairment 50,000 Dr Income Surplus 70,000 Cr Credit Risk Reserve 70,000 2/7/2012

HEDGING Hedge accounting recognises symmetrically the offsetting effects on net profit or loss of changes in the fair values of the hedging instrument and the related item being hedged. Hedge accounting is required under IAS 39 provided that the hedging relationship is clearly defined, measurable, and actually effective. 2/7/2012

Hedge Relationships Hedging relationships are of three types:
Fair Value Hedge Cash Flow Hedge Hedge of a net investment in a foreign enterprise 2/7/2012

Fair Value Hedge A hedge of the risk of changes in the fair value of a recognised asset or liability. For example, the fair value of fixed rate debt will change as a result of changes in interest rates. 2/7/2012

Cash Flow Hedge A hedge of the exposure to the variability in cash flows that is attributable to a particular risk associated with a recognized asset or liability ( such as all or some future interest payments on variable rate debt) or a highly probable forecast transaction( such as anticipated purchase or sale) , and that could affect profit or loss 2/7/2012

Hedge of a net investment in a foreign enterprise
– Exposure of a net investment in a foreign operation to exposure to changes in the fair value of a recognized asset. 2/7/2012

Conditions under which hedge accounting can be applied
Before a hedging relationship qualifies for hedge accounting, all of the following conditions must be met: a) The hedging relationship must be designated at its inception as a hedge based on the entity’s risk management objective and strategy. There must be formal documentation (including identification of the hedged item, the hedging instrument , the nature of the risk that is to be hedged and how the entity will be assess the hedging instrument’s effectiveness in offsetting the exposure to changes in the hedged item’s fair value or cash flows attributable to the hedged risk) 2/7/2012

The effectiveness of the hedge can be measured reliably.
The hedge is expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk . The cash flow hedges, a forecast transaction that is subject of the hedge must be highly probable and must present an exposure to variations in cash flows that ultimately affect profit or loss The effectiveness of the hedge can be measured reliably. The hedge is assessed on an on-going basis (preferably annually) and has been effective during the reporting period. 2/7/2012

Accounting Treatment If a fair value hedge relationship satisfies the conditions of being clearly defined, measurable and effective, then: the gain or loss from re-measuring the hedging instrument at fair value should be recognised immediately in net profit or loss the gain or loss on the hedged item attributable to the hedged risk should adjust the carrying amount of the hedged item and be recognised immediately in net profit or loss. 2/7/2012

IFRS 7: DISCLOSURES The standard requires qualitative and quantitative disclosures about exposure to risks arising from financial instruments and specifies minimum disclosures about credit risks, liquidity risks and market risks. 2/7/2012

Risk Management Policies
Describe the financial risk management objectives and policies, including the following: Policy for hedging each major type of forecasted transaction. Price risk (currency, interest rate, and market risk). Credit risk. Liquidity risk. Cash flow risk. 2/7/2012

Risks arising from financial instruments
currency risk—the risk that the value of a financial instrument will fluctuate because of changes in foreign exchange rates. fair value interest rate risk—the risk that the value of a financial instrument will fluctuate because of changes in market interest rates. price risk— risk that the value of a financial instrument will fluctuate as a result of changes in market prices, whether those changes are caused by factors specific to the individual instrument or its issuer or factors affecting all instruments traded in the market. Market risk embodies not only the potential for loss but also the potential for gain. 2/7/2012

Credit risk—the risk that one party to a financial instrument will fail to discharge an obligation and cause the other party to incur a financial loss. Liquidity risk (also referred to as funding risk)—the risk that an entity will encounter difficulty in raising funds to meet commitments associated with financial instruments. Liquidity risk may result from an inability to sell a financial asset quickly at close to its fair value. 2/7/2012

Interest rate risk—the risk that the future cash flows of a financial instrument will fluctuate because of changes in market interest rates. In the case of a floating rate debt instrument, for example, such fluctuations result in a change in the effective interest rate of the financial instrument, usually without a corresponding change in its fair value. Past Due: A F/A is past due when a counter party has failed to make a payment when contractually due 2/7/2012

Terms and Conditions For each class of Financial asset, financial liability, and equity instrument, disclose: Information about the extent and nature, including significant terms and conditions that may affect the amount, timing and certainty of future cash flows, for example: Principal/notional amounts Rates or amounts of interest and dividends Dates of maturities or execution Collateral held Early settlement options & periods Foreign currency information Conversion options Covenants, etc. Amounts and timing of future receipts or payments 2/7/2012

Accounting Policies Accounting policies, including recognition criteria and measurement bases, such as: Methods and assumptions applied in estimating fair value, separately for classes of financial assets and financial liabilities. Whether gains/losses on re-measurement of available-for-sale financial assets are included in profit or loss for the period or recognized directly in equity. Whether ‘regular way’ financial asset purchases and sales are accounted for at trade date or settlement date (for each of the categories of financial assets). 2/7/2012

Interest rate risk For each class of Financial asset and financial liability, disclose: Contractual re-pricing or maturity dates, whichever dates are earlier. Effective interest rates. Other information about exposure to interest rate risk. 2/7/2012

Credit Risk For each of financial asset, disclose:
The amount that best represents its maximum credit risk exposure without taking account of the fair value of collateral. Significant concentrations of credit risk. Other information about exposure to credit risk. 2/7/2012

Fair Values For class of financial asset and financial liability, disclose information about fair value: Fair value for traded instruments: - Asset held or liability to be issued: bid price. - Asset to be acquired or liability held: offer price. For an instrument not traded, it may be appropriate to disclose a range of amounts. When impracticable to determine the fair value reliably, the fact is disclosed together with information about the principal characteristics of the underlying financial instruments pertinent to its fair value. 2/7/2012

Financial assets in excess of fair value
For financial assets carried in excess of fair value, disclose: Carrying amount and fair value, individually or for appropriate grouping of those assets. Reasons for not reducing the carrying amount, including evidence supporting recoverability of the amount. 2/7/2012

Statement of financial position
Carrying amount of financial assets and liabilities by IAS 39 classifications Reasons for any classification b/n fair value and amortised cost (and vice versa) Details of the assets and exposure to risk The carrying value of FA the entity has pledged as collateral When FA are impaired and the impairment is recorded in a separate allowance account, it must disclose a reconciliation of changes in the account during the accounting period. Defaults and breaches 2/7/2012

Statement of Comprehensive Income
Net gains/losses by IAS 39 category( broken down as appropriate eg. Interest, dividend, fair value changes) Impairment losses by class of financial assets Interest income/expenses 2/7/2012

Qualitative disclosure
For each type of risk arising from financial instruments, an entity must disclose: The exposure to risk and how they arise Its objectives, policies, and processes for managing the risks and the methods used to measure the risk 2/7/2012

Quantitative Disclosures
Summary quantitative data about risk exposure must be disclosed. Information about credit risk must be disclosed by class of financial instrument Maximum exposure at the year end Any collateral pledged as security A description of collateral pledged as security and credit enhancement Info about credit quality of FAs that are neither past due nor impaired FA that are past due or impaired, giving age analysis and a description of collateral held as security 2/7/2012

For liquidity risk, an entity must disclose:
A maturity analysis of financial liabilities A description of the way risk is managed For a market risk, an entity must disclose: Sensitivity analysis showing the effect of profit or loss of changes in each market risk Assumptions and limitations of the sensitivity must be disclosed 2/7/2012