IAS 32 and

IFRS 7 & 9
Financial Instruments
18
INTRODUCTION |1

RELEVANT DOCUMENTS
IAS 32 Financial Instruments: Presentation (Definition and Compound FI)
IFRS 7 Financial Instruments: Disclosures
IFRS 9 Financial Instruments (Classification, Recognition and Measurement)
DEFINITIONS
is any contract that gives rise to
Financial
 a financial asset of one entity; and
instruments
 a financial liability or equity instrument of another entity.
is any asset that is:
 cash e.g. cash in hand or at bank
 an equity instrument of another entity e.g. investment in shares or share
options
Financial
 a contractual right to receive cash (or another financial asset) e.g.
asset
receivables, investment in loan
 a contractual right to exchange financial instruments under conditions
that are potentially favourable e.g. favourable forward contract entered
into by a bank
is any liability that is:
 a contractual obligation to deliver cash (or another financial asset) e.g.
Financial payables
liability  a contractual obligation to exchange financial instruments under
conditions that are potentially unfavourable e.g. unfavourable forward
contract entered into by a bank
is any contract that evidences a residual interest in the assets of an entity
Equity
after deducting all of its liabilities e.g. equity shares & share options issued by
instruments
an entity.

SUBSTANCE
Some financial instruments have the legal form of equity but are, in substance, liabilities. For
example an issuer has a contractual obligation to either deliver cash or another financial
asset e.g. redeemable preference shares
RELATED GAIN OR LOSS
Related to Interest, dividends, relating to a financial instrument or a component that is
financial a financial liability shall be recognised as income or expense in profit or
liability loss.
Related to Distributions to holders of an equity instrument shall be debited by the
equity entity directly to equity, net of any related income tax benefit.
Example For example, dividends paid on redeemable preference shares are
recognised in profit or loss as finance costs while dividend paid on ordinary
shares are reported in statement of changes in equity
 ICMAP M4 Financial Accounting

QUESTION 01
Identify the following items as a financial asset, a non-financial asset, a financial liability, a
non-financial liability or an equity instrument.
ITEMS ANSWER
Creditors
Investment in loan notes of another entity
2| Bank loan obtained
Ordinary shares issued
Irredeemable preference shares issued
Unfavourable forward currency contract
Share options issued
Redeemable preference shares issued
Investment in redeemable preference shares
Current tax payable
Inventory
COMPOUND FINANCIAL INSTRUMENTS
Compound Some financial instruments, called compound instruments, have both a
instruments liability and an equity element.
In this case, IAS 32 requires the component parts to be separated from
Requirement each other, with each part accounted for and presented separately
according to its substance.
For example, a convertible debenture has two components:
 one is the financial liability, the issuer’s (entity’s) contractual
Example obligation to pay cash (principal and interest);
 the other is an equity instrument, a call option to convert the debt
security into equity shares.
The separation of components is made at the time the instrument is
issued and is not subsequently revised as a result of a change in interest
Timing
rates, share price, or other event that changes the likelihood that the
conversion option will be exercised.
Transaction Transaction costs on compound financial instrument will be allocated on
costs pro-rata basis of initially recognized amounts.
QUESTION 02
On 1 January 2011 David Limited issued a Rs.50m three-year convertible bond at par.
There were no issue costs. The coupon rate is 10%, payable annually in arrears on 31
December. The bond is redeemable at par on 1 January 2014. Bondholders may opt for
conversion. The terms of conversion are two 25-cents equity shares for every Rs.1 owed to
each bondholder on 1 January 2014.

Bonds issued by similar entities without any conversion rights currently bear interest at 15%.

Split the proceeds of bond at inception into liability and equity component.

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 Class Notes

QUESTION 03
ABC Limited issues a Rs. 10 million 4% three year convertible debenture on 1 January
2011. The market rate of interest for a similar loan without conversion rights is 8%. The
conversion terms are one equity share of Rs. 1 for every Rs. 2 of debenture. Conversion or
redemption at par shall take place on 31 December 2013.

Required: |3
(a) Split the proceeds as debt and equity elements separately.
(b) Extracts of financial statements for all three years before conversion or redemption
(c) How should this be accounted for on 31 December 2013, if all holders elect for the
conversion?
(d) How should this be accounted for on 31 December 2013, if no holders elect for the
conversion?

CLASSIFICATION
FINANCIAL Investment in equity
Investment in debt instruments
ASSETS instruments
It should pass the following two tests:
 Business Model Test (the intention
is to hold the financial asset to
collect the contractual cash flows i.e.
principal and interest, rather than
At amortised gain or loss from fluctuation in fair
cost value)
 Cash Flow Characteristics Model
Test (cash flows consist of solely
interest and principal and timing and
amount of cash flows is reliably
measureable.)
1. It must not be held It should pass the following two tests:
for trading.  Business Model Test (the intention
Fair value 2. There must be an is both collecting contractual cash
through other irrevocable choice flows and selling financial asset)
comprehensive for this  Cash Flow Characteristics Model
income classification upon Test (cash flows consist of solely
(FVTOCI) initial recognition. interest and principal and timing and
amount of cash flows is reliably
measureable.)
Fair value 1. It can be debt or/and equity instrument of another entity
through profit 2. Usually held for trading items are classified here including stand-
or loss alone derivatives.
(FVTPL) 3. Default residual category.

FINANCIAL LIABILITIES
Fair value through profit Liabilities held for trading (usually by banks and finance
or loss companies)
At amortised cost All other liabilities

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 ICMAP M4 Financial Accounting

QUESTION 04
Identify the most likely classification of following items:
ITEMS ANSWER
FINANCIAL ASSETS
Investments held for trading purposes.
Investment in interest bearing debt instruments. The
4| instrument is redeemable in five years. The intention is to
collect cash flows (which are interest and principal amounts
only)
Investment in interest bearing debt instruments. The
instrument is redeemable in five years. The intention is to
collect cash flows (which are interest and principal amounts
only). However, the entity may sell the loan notes earlier if any
good offer is received.
A trade receivable
Derivatives held for speculation purpose
Investment in equity shares. The entity has no intention of
selling these shares in foreseeable future.
Investment in loan notes. The objective is to collect contractual
cash flows which consist of interest, changes in oil prices in
next five years and principal amount at the end of year 5.
Investment in loan notes. The objective is to collect contractual
cash flows which consist of interest, changes in oil prices in
next five years and principal amount at the end of year 5.
However, the entity may sell the loan notes earlier if any good
offer is received.
Investment in convertible debentures
FINANCIAL LIBILITIES
A 12% bank loan obtained by A Limited payable in 5 years’
time.
8% loan notes issued by C Limited
A short term currency swaps agreement entered into by B4-
Bank Limited which is currently unfavourable. These types of
transactions are usual feature of B4-Bank Limited’s business.
Trade payable

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