FINANCIAL

INSTRUMENTS
Module No. 4

BATHEOAX
Conceptual Framework and Accounting Standards

LEARNING OUTCOMES RELEVANT STANDARDS

At the end of this module, you are expected to: The following standards are essential for this
1. Understand and explain financial module.
instruments, what constitutes it, and the 1. Financial Instruments (PFRS 9)
types of financial instruments 2. Financial Instruments: Presentation (PAS 32)
2. Know, explain when to recognize the 3. Financial Instruments: Recognition and
financial assets and financial liabilities, its Measurement (PAS 39)
measurements, derecognition, and 4. Investments in Associates and Joint
reclassifying financial instruments. Ventures (PAS 28)
 1

Pre-Activity
Try to answer the following questions.
1. Where do you usually invest your savings?

The objective is to establish principles for the financial reporting of financial assets and financial
liabilities that will present relevant and useful information to users of financial statements for their
assessment of the amounts, timing and uncertainty of an entity’s future cash flows.

DEFINITION
Financial Instruments
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.

Financial Asset
A financial asset is any asset that is:

a. cash;
b. an equity instrument of another entity;
c. a contractual right:
i. to receive cash or another financial asset from another entity; or
ii. to exchange financial assets or financial liabilities with another entity under
conditions that are potentially favourable to the entity; or
d. a contract that will or may be settled in the entity’s own equity instruments and is:
i. a non‑derivative for which the entity is or may be obliged to receive a variable
number of the entity’s own equity instruments; or
ii. a derivative that will or may be settled other than by the exchange of a fixed
amount of cash or another financial asset for a fixed number of the entity’s own
equity instruments.

Financial Liability
A financial liability is any liability that is:

a. a contractual obligation:
i. to deliver cash or another financial asset to another entity; or

FINANCIAL INSTRUMENTS | Module No. 4

 2

ii. to exchange financial assets or financial liabilities with another entity under
conditions that are potentially unfavourable to the entity; or
b. a contract that will or may be settled in the entity’s own equity instruments and is:
i. a non‑derivative for which the entity is or may be obliged to deliver a variable
number of the entity’s own equity instruments; or
ii. a derivative that will or may be settled other than by the exchange of a fixed
amount of cash or another financial asset for a fixed number of the entity’s own
equity instruments.

Equity Instrument
An equity instrument is any contract that evidences a residual interest in the assets of an entity
after deducting all of its liabilities.

RECOGNITION
An entity shall recognize a financial asset or a financial liability in its statement of financial
position when, and only when, the entity becomes party to the contractual provisions of the
instrument.

DERECOGNITION OF FINANCIAL ASSET

An entity shall derecognize a financial asset when, and only when:

a. the contractual rights to the cash flows from the financial asset expire, or
b. it transfers the financial asset and the transfer qualifies for derecognition rules.

Transfer of Financial Asset

An entity transfers a financial asset if, and only if, it either:

a. transfers the contractual rights to receive the cash flows of the financial asset, or
b. retains the contractual rights to receive the cash flows of the financial asset, but assumes
a contractual obligation to pay the cash flows to one or more recipient.

When an entity retains the contractual rights to receive the cash flows of a financial asset (the
‘original asset’), but assumes a contractual obligation to pay those cash flows to one or more
entities (the ‘eventual recipients’), the entity treats the transaction as a transfer of a financial
asset if, and only if, all of the following three conditions are met.

a. The entity has no obligation to pay amounts to the eventual recipients unless it collects
equivalent amounts from the original asset.

FINANCIAL INSTRUMENTS | Module No. 4

 3

b. The entity is prohibited by the terms of the transfer contract from selling or pledging the
original asset other than as security to the eventual recipients for the obligation to pay
them cash flows.
c. The entity has an obligation to remit any cash flows it collects on behalf of the eventual
recipients without material delay.

When an entity transfers a financial asset, it shall evaluate the extent to which it retains the risks
and rewards of ownership of the financial asset. In this case:

a. if the entity transfers substantially all the risks and rewards of ownership of the financial
asset, the entity shall derecognize the financial asset and recognize separately as assets
or liabilities any rights and obligations created or retained in the transfer.
b. if the entity retains substantially all the risks and rewards of ownership of the financial
asset, the entity shall continue to recognize the financial asset.
c. if the entity neither transfers nor retains substantially all the risks and rewards of
ownership of the financial asset, the entity shall determine whether it has retained
control of the financial asset. In this case:
i. if the entity has not retained control, it shall derecognize the financial asset and
recognize separately as assets or liabilities any rights and obligations created or
retained in the transfer.
ii. if the entity has retained control, it shall continue to recognize the financial asset
to the extent of its continuing involvement in the financial asset.

DERECOGNITION OF FINANCIAL LIABILITY

An entity shall remove a financial liability (or a part of a financial liability) from its statement of
financial position when, and only when, it is extinguished—ie when the obligation specified in
the contract is discharged or cancelled or expires.

An exchange between an existing borrower and lender of debt instruments with substantially
different terms shall be accounted for as an extinguishment of the original financial liability and
the recognition of a new financial liability. Similarly, a substantial modification of the terms of
an existing financial liability or a part of it (whether or not attributable to the financial difficulty
of the debtor) shall be accounted for as an extinguishment of the original financial liability and
the recognition of a new financial liability.

The difference between the carrying amount of a financial liability (or part of a financial
liability) extinguished or transferred to another party and the consideration paid, including any
non‑cash assets transferred or liabilities assumed, shall be recognized in profit or loss.

FINANCIAL INSTRUMENTS | Module No. 4

 4

CLASSIFICATION OF FINANCIAL ASSETS

An entity may, at initial recognition, irrevocably designate a financial asset as measured at fair
value through profit or loss if doing so eliminates or significantly reduces a measurement or
recognition inconsistency (sometimes referred to as an ‘accounting mismatch’) that would
otherwise arise from measuring assets or liabilities or recognizing the gains and losses on them
on different bases. Otherwise, it shall classify financial assets as subsequently measured at
amortized cost, fair value through other comprehensive income or fair value through profit or
loss on the basis of both:

a. the entity’s business model for managing the financial assets and
b. the contractual cash flow characteristics of the financial asset.

A financial asset shall be measured at amortized cost if both of the following conditions are met:

a. the financial asset is held within a business model whose objective is to hold financial
assets in order to collect contractual cash flows and
b. 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 amount outstanding.

A financial asset shall be measured at fair value through other comprehensive income if both of
the following conditions are met:

a. the financial asset is held within a business model whose objective is achieved by both
collecting contractual cash flows and selling financial assets and
b. 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 amount outstanding

Financial Asset at Financial Asset at

Financial Asset at
Business Model Fair Value through Fair Value through
Amortized Cost
Profit or Loss OCI
In the form of Equity
Held for Trading Default X X
Not Held for Trading Default By Irrevocable
X
Election
In the form of Debt
Held for Trading Default X X
Held for Collection of By Irrevocable
X Default
Contractual Cash Flows Election

FINANCIAL INSTRUMENTS | Module No. 4

 5

Held for Collection of

By Irrevocable
Contractual Cash Flows Default X
Election
and Sale

CLASSIFICATION OF FINANCIAL LIABILITIES

An entity shall classify all financial liabilities as subsequently measured at amortized cost,
except for:

a. financial liabilities at fair value through profit or loss;

b. financial liabilities that arise when a transfer of a financial asset does not qualify for
derecognition ;
c. financial guarantee contracts;
d. commitments to provide a loan at a below‑market interest rate;
e. contingent consideration recognized by an acquirer in a business combination.

An entity may, at initial recognition, irrevocably designate a financial liability as measured at

fair value through profit or loss when permitted, or when doing so results in more relevant
information, because either:

a. it eliminates or significantly reduces a measurement or recognition inconsistency

(sometimes referred to as ‘an accounting mismatch’) that would otherwise arise from
measuring assets or liabilities or recognizing the gains and losses on them on
different bases; or
b. a group of financial liabilities or financial assets and financial liabilities is managed
and its performance is evaluated on a fair value basis.

RECLASSIFICATION
When, and only when, an entity changes its business model for managing financial assets it
shall reclassify all affected financial assets. An entity shall not reclassify any financial liability.

If an entity reclassifies financial assets, it shall apply the reclassification prospectively from the
reclassification date. The entity shall not restate any previously recognised gains, losses
(including impairment gains or losses) or interest.

FINANCIAL INSTRUMENTS | Module No. 4

 6

Amortized Cost to Fair Value through Profit or Loss

The financial asset’s fair value is measured at the reclassification date. Any gain or loss arising
from a difference between the previous amortized cost of the financial asset and fair value is
recognized in profit or loss.

Fair Value through Profit or Loss to Amortized Cost

Its fair value at the reclassification date becomes its new gross carrying amount.

Amortized Cost to Fair Value through OCI

Its fair value is measured at the reclassification date. Any gain or loss arising from a difference
between the previous amortized cost of the financial asset and fair value is recognized in other
comprehensive income. The effective interest rate and the measurement of expected credit
losses are not adjusted as a result of the reclassification.

Fair Value through OCI to Amortized Cost

The financial asset is reclassified at its fair value at the reclassification date. However, the
cumulative gain or loss previously recognized in other comprehensive income is removed from
equity and adjusted against the fair value of the financial asset at the reclassification date. As a
result, the financial asset is measured at the reclassification date as if it had always been
measured at amortized cost. This adjustment affects other comprehensive income but does not
affect profit or loss and therefore is not a reclassification adjustment. The effective interest rate
and the measurement of expected credit losses are not adjusted as a result of the reclassification.

Fair Value through Profit or Loss to Fair Value through OCI

The financial asset continues to be measured at fair value.

Fair Value through OCI to Fair Value through Profit or Loss

The financial asset continues to be measured at fair value. The cumulative gain or loss
previously recognized in other comprehensive income is reclassified from equity to profit or
loss as a reclassification adjustment at the reclassification date.

INITIAL MEASUREMENT
Except for trade receivables, at initial recognition, an entity shall measure a financial asset or
financial liability at its fair value plus or minus, in the case of a financial asset or financial
liability not at fair value through profit or loss, transaction costs that are directly attributable to
the acquisition or issue of the financial asset or financial liability. However, if the fair value of
the financial asset or financial liability at initial recognition differs from the transaction price, an
entity shall recognize the asset initially at its fair value on the trade date. An entity shall

FINANCIAL INSTRUMENTS | Module No. 4

 7

measure trade receivables at their transaction price if the trade receivables do not contain a
significant financing component.

SUBSEQUENT MEASUREMENT OF FINANCIAL ASSETS

After initial recognition, an entity shall measure a financial asset in accordance at:

a. amortized cost;
b. fair value through other comprehensive income; or
c. fair value through profit or loss.

An entity shall apply the impairment requirements to financial assets that are measured at
amortized cost and to financial assets that are measured at fair value through other
comprehensive income.

SUBSEQUENT MEASUREMENT OF FINANCIAL

LIABILITIES
After initial recognition, an entity shall measure a financial liability generally at amortized cost
and fair value for financial liabilities at fair value through profit or loss.

Modification of Contractual Cash Flows

When the contractual cash flows of a financial asset are renegotiated or otherwise modified and
the renegotiation or modification does not result in the derecognition of that financial asset in
accordance with this Standard, an entity shall recalculate the gross carrying amount of the
financial asset and shall recognize a modification gain or loss in profit or loss. The gross
carrying amount of the financial asset shall be recalculated as the present value of the
renegotiated or modified contractual cash flows that are discounted at the financial asset’s
original effective interest rate (or credit-adjusted effective interest rate for purchased or
originated credit-impaired financial assets) or, when applicable, the revised effective interest
rate calculated. Any costs or fees incurred adjust the carrying amount of the modified financial
asset and are amortized over the remaining term of the modified financial asset.

Write-Off
An entity shall directly reduce the gross carrying amount of a financial asset when the entity
has no reasonable expectations of recovering a financial asset in its entirety or a portion thereof.
A write-off constitutes a derecognition event.

FINANCIAL INSTRUMENTS | Module No. 4

 8

EXPECTED CREDIT LOSSES

Recognition
At each reporting date, an entity shall assess whether the credit risk on a financial instrument
has increased significantly since initial recognition.

An entity shall recognize a loss allowance for expected credit losses on a financial assets at fair
value through OCI, financial assets at amortized cost, a lease receivable, a contract asset or a
loan commitment and a financial guarantee contract to which the impairment requirements
apply.

At each reporting date, an entity shall measure the loss allowance for a financial instrument at
an amount equal to the lifetime expected credit losses if the credit risk on that financial
instrument has increased significantly since initial recognition.

An entity may assume that the credit risk on a financial instrument has not increased
significantly since initial recognition if the financial instrument is determined to have low credit
risk at the reporting date. If, at the reporting date, the credit risk on a financial instrument has
not increased significantly since initial recognition, an entity shall measure the loss allowance
for that financial instrument at an amount equal to 12‑month expected credit losses.

An entity shall recognize in profit or loss, as an impairment gain or loss, the amount of expected
credit losses (or reversal) that is required to adjust the loss allowance at the reporting date to the
amount that is required to be recognized.

Measurement
An entity shall measure expected credit losses of a financial instrument in a way that reflects:

a. an unbiased and probability‑weighted amount that is determined by evaluating a range

of possible outcomes;
b. the time value of money; and
c. reasonable and supportable information that is available without undue cost or effort at
the reporting date about past events, current conditions and forecasts of future economic
conditions.

GAINS AND LOSSES

Arising from Financial Instruments Measured at Fair Value
A gain or loss on a financial asset or financial liability that is measured at fair value shall be
recognized in profit or loss unless:

FINANCIAL INSTRUMENTS | Module No. 4

 9

a. it is part of a hedging relationship;

b. it is an investment in an equity instrument and the entity has elected to present gains
and losses on that investment in other comprehensive income;
c. it is a financial liability designated as at fair value through profit or loss and the entity is
required to present the effects of changes in the liability’s credit risk in other
comprehensive income; or
d. it is a financial asset measured at fair value through other comprehensive income and
the entity is required to recognize some changes in fair value in other comprehensive
income.

Dividends
Dividends are recognized in profit or loss only when:

a. the entity’s right to receive payment of the dividend is established;

b. it is probable that the economic benefits associated with the dividend will flow to the
entity; and
c. the amount of the dividend can be measured reliably.

Arising from Financial Instruments Measured at Amortized Cost

A gain or loss on a financial asset that is measured at amortized cost and is not part of a
hedging relationship shall be recognized in profit or loss when the financial asset is
derecognized, reclassified, through the amortization process or in order to recognize
impairment gains or losses.

A gain or loss on a financial liability that is measured at amortized cost and is not part of a
hedging relationship shall be recognized in profit or loss when the financial liability is
derecognized and through the amortization process.

Arising from Liabilities Designated as at Fair Value through Profit or Loss

An entity shall present a gain or loss on a financial liability that is designated as at fair value
through profit or loss as follows:

a. the amount of change in the fair value of the financial liability that is attributable to
changes in the credit risk of that liability shall be presented in other comprehensive
income; and
b. the remaining amount of change in the fair value of the liability shall be presented in
profit or loss

Arising from Assets Measured at Fair Value through OCI

A gain or loss on a financial asset measured at fair value through other comprehensive income
in accordance with paragraph 4.1.2A shall be recognized in other comprehensive income, except

FINANCIAL INSTRUMENTS | Module No. 4

 10

for impairment gains or losses and foreign exchange gains and losses, until the financial asset is
derecognized or reclassified. When the financial asset is derecognized, the cumulative gain or
loss previously recognized in other comprehensive income is reclassified from equity to profit
or loss as a reclassification adjustment. Interest calculated using the effective interest method is
recognized in profit or loss. If a financial asset is measured at fair value through other
comprehensive income, the amounts that are recognized in profit or loss are the same as the
amounts that would have been recognized in profit or loss if the financial asset had been
measured at amortized cost.

PRESENTATION
Liabilities and Equity
The issuer of a financial instrument shall classify the instrument, or its component parts, on
initial recognition as a financial liability, a financial asset or an equity instrument in accordance
with the substance of the contractual arrangement and the definitions of a financial liability, a
financial asset and an equity instrument.

Compound Financial Instruments

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, financial assets or equity
instruments.

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 recognized 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 recognized directly in equity.

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:

a. currently has a legally enforceable right to set off the recognized amounts; and
b. intends either to settle on a net basis, or to realize the asset and settle the liability
simultaneously.

FINANCIAL INSTRUMENTS | Module No. 4

 11

The objective of is to prescribe the accounting for investments in associates and to set out the
requirements for the application of the equity method when accounting for investments in associates.

INVESTMENTS IN ASSOCIATES
An associate is an entity over which the investor has significant influence.

SIGNIFICANT INFLUENCE
Significant influence is the power to participate in the financial and operating policy decisions
of the investee but is not control or joint control of those policies.

Prima Facie Threshold

If an entity holds, directly or indirectly (e.g. through subsidiaries), 20 percent or more of the
voting power of the investee, it is presumed that the entity has significant influence, unless it
can be clearly demonstrated that this is not the case. Conversely, if the entity holds, directly or
indirectly (e.g. through subsidiaries), less than 20 percent of the voting power of the investee, it
is presumed that the entity does not have significant influence, unless such influence can be
clearly demonstrated. A substantial or majority ownership by another investor does not
necessarily preclude an entity from having significant influence.

Evidences
The existence of significant influence by an entity is usually evidenced in one or more of the
following ways:

a. representation on the board of directors or equivalent governing body of the investee;

b. participation in policy-making processes, including participation in decisions about
dividends or other distributions;
c. material transactions between the entity and its investee;
d. interchange of managerial personnel; or
e. provision of essential technical information.

Potential Voting Rights

An entity may own share warrants, share call options, debt or equity instruments that are
convertible into ordinary shares, or other similar instruments that have the potential, if
exercised or converted, to give the entity additional voting power or to reduce another party’s
voting power over the financial and operating policies of another entity (i.e. potential voting

FINANCIAL INSTRUMENTS | Module No. 4

 12

rights). The existence and effect of potential voting rights that are currently exercisable or
convertible, including potential voting rights held by other entities, are considered when
assessing whether an entity has significant influence.

In assessing whether potential voting rights contribute to significant influence, the entity
examines all facts and circumstances (including the terms of exercise of the potential voting
rights and any other contractual arrangements whether considered individually or in
combination) that affect potential rights, except the intentions of management and the financial
ability to exercise or convert those potential rights.

Loss of Significant Influence

An entity loses significant influence over an investee when it loses the power to participate in
the financial and operating policy decisions of that investee. The loss of significant influence can
occur with or without a change in absolute or relative ownership levels. It could occur, for
example, when an associate becomes subject to the control of a government, court,
administrator or regulator. It could also occur as a result of a contractual arrangement.

EQUITY METHOD
Features
Under the equity method, on initial recognition the investment in an associate venture is
recognized at cost, and the carrying amount is increased or decreased to recognize the
investor’s share of the profit or loss of the investee after the date of acquisition. The investor’s
share of the investee’s profit or loss is recognized in the investor’s profit or loss. Distributions
received from an investee reduce the carrying amount of the investment. Adjustments to the
carrying amount may also be necessary for changes in the investor’s proportionate interest in
the investee arising from changes in the investee’s other comprehensive income. Such changes
include those arising from the revaluation of property, plant and equipment and from foreign
exchange translation differences. The investor’s share of those changes is recognized in the
investor’s other comprehensive income.

Application
An entity with significant influence over an investee shall account for its investment in an
associate using the equity method except when that investment qualifies for exemption.

Exemption
An entity need not apply the equity method to its investment in an associate if the entity is a
parent that is exempt from preparing consolidated financial statements by the scope exception
in paragraph 4(a) of PFRS 10 or if all the following apply:

FINANCIAL INSTRUMENTS | Module No. 4

 13

a. The entity is a wholly-owned subsidiary, or is a partially-owned subsidiary of another

entity and its other owners, including those not otherwise entitled to vote, have been
informed about, and do not object to, the entity not applying the equity method.
b. The entity’s debt or equity instruments are not traded in a public market (a domestic or
foreign stock exchange or an over-the-counter market, including local and regional
markets).
c. The entity did not file, nor is it in the process of filing, its financial statements with a
securities commission or other regulatory organization, for the purpose of issuing any
class of instruments in a public market.
d. The ultimate or any intermediate parent of the entity produces financial statements
available for public use that comply with PFRSs, in which subsidiaries are consolidated
or are measured at fair value through profit or loss in accordance with PFRS 10.

Discontinuance of Use
An entity shall discontinue the use of the equity method from the date when its investment
ceases to be an associate or a joint venture as follows:

a. If the investment becomes a subsidiary, the entity shall account for its investment in
accordance with PFRS 3 Business Combinations and PFRS 10.
b. If the retained interest in the former associate is a financial asset, the entity shall measure
the retained interest at fair value. The fair value of the retained interest shall be regarded
as its fair value on initial recognition as a financial asset in accordance with PFRS 9. The
entity shall recognize in profit or loss any difference between:
i. the fair value of any retained interest and any proceeds from disposing of a part
interest in the associate or joint venture; and
ii. the carrying amount of the investment at the date the equity method was
discontinued.
c. When an entity discontinues the use of the equity method, the entity shall account for all
amounts previously recognized in other comprehensive income in relation to that
investment on the same basis as would have been required if the investee had directly
disposed of the related assets or liabilities.

Changes in Ownership Interest

If an entity’s ownership interest in an associate or a joint venture is reduced, but the investment
continues to be classified either as an associate or a joint venture respectively, the entity shall
reclassify to profit or loss the proportion of the gain or loss that had previously been recognized
in other comprehensive income relating to that reduction in ownership interest if that gain or
loss would be required to be reclassified to profit or loss on the disposal of the related assets or
liabilities.

FINANCIAL INSTRUMENTS | Module No. 4

 14

Intercompany Transactions
Gains and losses resulting from ‘upstream’ and ‘downstream’ transactions between an entity
(including its consolidated subsidiaries) and its associate are recognized in the entity’s financial
statements only to the extent of unrelated investors’ interests in the associate. The investor’s
share in the associate’s or joint venture’s gains or losses resulting from these transactions is
eliminated.

‘Upstream’ transactions are, for example, sale of assets from an associate or a joint venture to
the investor. ‘Downstream’ transactions are, for example, sales or contributions of assets from
the investor to its associate or its joint venture.

When downstream transactions provide evidence of a reduction in the net realizable value of
the assets to be sold or contributed, or of an impairment loss of those assets, those losses shall be
recognized in full by the investor. When upstream transactions provide evidence of a reduction
in the net realizable value of the assets to be purchased or of an impairment loss of those assets,
the investor shall recognize its share in those losses.

Statement Dates
The most recent available financial statements of the associate are used by the entity in applying
the equity method. When the end of the reporting period of the entity is different from that of
the associate, the associate prepares, for the use of the entity, financial statements as of the same
date as the financial statements of the entity unless it is impracticable to do so.

When the financial statements of an associate used in applying the equity method are prepared
as of a date different from that used by the entity, adjustments shall be made for the effects of
significant transactions or events that occur between that date and the date of the entity’s
financial statements. In any case, the difference between the end of the reporting period of the
associate or joint venture and that of the entity shall be no more than three months. The length
of the reporting periods and any difference between the ends of the reporting periods shall be
the same from period to period.

The entity’s financial statements shall be prepared using uniform accounting policies for like
transactions and events in similar circumstances.

Investee’s Preference Shares

If an associate has outstanding cumulative preference shares that are held by parties other than
the entity and are classified as equity, the entity computes its share of profit or loss after
adjusting for the dividends on such shares, whether or not the dividends have been declared.

FINANCIAL INSTRUMENTS | Module No. 4

 15

Excessive Losses
If an entity’s share of losses of an associate equals or exceeds its interest in the associate, the
entity discontinues recognizing its share of further losses. The interest in an associate is the
carrying amount of the investment in the associate determined using the equity method
together with any long-term interests that, in substance, form part of the entity’s net investment
in the associate.

After the entity’s interest is reduced to zero, additional losses are provided for, and a liability is
recognized, only to the extent that the entity has incurred legal or constructive obligations or
made payments on behalf of the associate. If the associate subsequently reports profits, the
entity resumes recognizing its share of those profits only after its share of the profits equals the
share of losses not recognized.

Excess of Fair Value over Cost

In case the fair value of the net assets acquired over the investee exceeds the cost of the
investment, the excess shall be recorded as an investment income at the date of purchase.

IMPAIRMENT LOSSES
After application of the equity method, including recognizing the associate’s losses, the entity
determines whether there is any objective evidence that its net investment in the associate is
impaired. The net investment in an associate is impaired and impairment losses are incurred if,
and only if, there is objective evidence of impairment as a result of one or more events that
occurred after the initial recognition of the net investment (a ‘loss event’) and that loss event (or
events) has an impact on the estimated future cash flows from the net investment that can be
reliably estimated.

Objective evidence that the net investment is impaired includes observable data that comes to
the attention of the entity about the following loss events:

a. significant financial difficulty of the associate;

b. a breach of contract, such as a default or delinquency in payments by the associate;
c. the entity, for economic or legal reasons relating to its associate’s financial difficulty,
granting to the associate a concession that the entity would not otherwise consider;
d. it becoming probable that the associate or joint venture will enter bankruptcy or other
financial reorganization; or
e. the disappearance of an active market for the net investment because of financial
difficulties of the associate.

FINANCIAL INSTRUMENTS | Module No. 4

 16

The disappearance of an active market because the associate’s or joint venture’s equity or
financial instruments are no longer publicly traded is not evidence of impairment. A
downgrade of an associate’s or joint venture’s credit rating or a decline in the fair value of the
associate or joint venture, is not of itself, evidence of impairment, although it may be evidence
of impairment when considered with other available information.

The recoverable amount of an investment in an associate shall be assessed for each associate,
unless the associate does not generate cash inflows from continuing use that are largely
independent of those from other assets of the entity.

FINANCIAL INSTRUMENTS | Module No. 4

 17

Self-Check
Basing on your readings, answer the following questions.
1. What are the conditions that shall be met for a financial asset to be measured at
amortized cost?
2. What is a financial liability?
3. What are the different classification of financial assets?
4. When shall dividends be recognized in profit or loss?
5. Cite at least 3 scenarios that indicate the existence of significant influence.

Exercise 1.1 TRUE OR FALSE

Determine whether the following statements are true or false.
___________1. An entity may, at initial recognition, irrevocably designate a financial liability
as measured at fair value through profit or loss when permitted, or when
doing so results in more relevant information.
___________2. An entity shall directly reduce the gross carrying amount of a financial asset
when the entity has reasonable expectations of recovering a financial asset in
its entirety or a portion thereof.
___________3. Financial liabilities at fair value through profit or loss shall be subsequently
measured at amortized cost.
___________4. An entity shall not apply the impairment requirements to financial assets that
are measured at fair value through profit or loss.
___________5. Dividends received from an investee reduce the carrying amount of the
investment.
___________6. Held for trading financial assets shall be initially classified at fair value
through profit or loss unless irrevocably designated at fair value through OCI.
___________7. The loss of significant influence can occur with or without a change in
absolute or relative ownership levels.
___________8. The investor’s share in the associate’s or joint venture’s gains or losses
resulting from intercompany transactions shall be totally eliminated.
___________9. If an entity’s share of losses of an associate equals or exceeds its interest in the
associate, the entity discontinues recognizing its share of further losses.
___________10. If the investment becomes a subsidiary, the entity shall discontinue the use of
equity method.
___________11. Investment is equity securities cannot be designated as financial assets at
amortized cost because cash flows resulting from said securities cannot pass
the contractual cash flow test.

FINANCIAL INSTRUMENTS | Module No. 4

 18

Exercise 1.2 IDENTIFICATION

Identify the terminologies best described by the following statements.
___________1. This refers to own equity instruments acquired by the entity.
___________2. The power to participate in the financial and operating policy decisions of the
investee but is not control or joint control of those policies.
___________3. This shall be assessed by the entity on a financial instrument at each reporting
date whether it has increased significantly since initial recognition.
___________4. This shall be recorded when the fair value of the net assets acquired over the
investee exceeds the cost of investment.
___________5. Sales or contributions of assets to associate or join venture from its investors is
an example of?

FINANCIAL INSTRUMENTS | Module No. 4