Financial Instrument Notes

Page 1 of 45
FINANCIAL INSTRUMENT
Financial Instrument is a CONTRACT that gives rise to both a FINANCIAL ASSET of one entity and a
FINANCIAL LIABILITY OR EQUITY INSTRUMENT of another entity
FINANCIAL ASSET
1. Basic Examples of Financial Assets
- Debtors
- Investment in Debts (Loan Receivable, Lease Receivable, Investment in Debt Instruments like
Bonds, Debentures, Preference Shares)
1st two examples reflects the Part definition of IFRS 9 i.e. “A Contractual rights to receive Cash”
More Examples of F.A.
- Investment in Equity Instrument of another entity (Shares, Shares options)

- Derivatives – Like Forward Contracts, Future Contracts, under the favorable condition at reporting
dates
2. Initial Recognition of Financial Assets
IFRS 9 says that an entity should recognise a financial asset 'when, and only when, the entity becomes
party to the contractual provisions of the instrument' (IFRS 9, para 3.1.1).
Examples of this principle are as follows:
 A trading commitment to buy or sell goods is not recognised until one party has fulfilled its
part of the contract. For example, a sales order will not be recognised as revenue and a
receivable until the goods have been delivered.
 Forward contracts are accounted for as derivative financial assets and are recognised on the
commitment date, not on the date when the item under contract is transferred from seller to
buyer.
 Option contracts are accounted for as derivative financial assets and are recognised on the
date the contract is entered into, not on the date when the item subject to the option is
acquired.
3. Accounting for Financial Assets According to the Classification & Measurement of Financial Asset
Page 2 of 45
FINANCIAL ASSET
FA CLASSIFICATION & MEASTUREMENT: REFERENCE BY IFRS 9
Accounting/Reporting of Financial Asset exclusively based on classification criteria.

At initial recognition the entity must have to decide about classification of Financial Asset. (The guide line
about the classification will cover later)
Financial Asset Classification by IFRS 9 as follows:
1. Fair Value:
a. Fair Value Through P/L Account
b. Fair Value Through OCI (Irrevocable Election)
2. Amortized Cost Method (Only Applicable if Criteria Meets For Business Model Test & Cash Flow
Characteristics Test)
Financial Asset Measurement by IFRS 9
INITIAL MEASUREMENT
1. On Initial Recognition, Financial Assets are Measured at Fair Value with consideration of
Transaction Cost.
2. Transaction Cost Adjustments:
a. F.A. Fair Value Through P/L – Transaction Cost Immediately Charge to I/S.
b. F.A. Fair Value Through OCI – Transaction Cost Add with Value of F.A.(Subsequently
Charge to OCI Automatically at Reporting Date)
c. F.A. Amortized Cost Method – Transaction Cost Add with Value of F.A. (Subsequently
Charge to I/S Automatically through Amortization Schedule)
SUBSEQUENT MEASUREMENT
Subsequent Measurement accounting according to the classification of F.A.
1. F.A. Fair Value Through P/L – F.A. will be revalued to Fair Value with the Gain or Loss
Recognized in the P/L.
2. F.A. Fair Value Through OCI – F.A. will be revalued to Fair Value with the Gain or Loss
Recognized in the OCI.
3. F.A. Amortized Cost Method – Amortize Cost Method (Book Value Method).
Page 3 of 45
F.A. CLASSIFICATION AND MEASUREMENT: SIMPLIFIED WAY
Financial Asset Classification can also be made as follows.
1. Accounting for Investments in Equity Instruments

2. Accounting for Investment in Debt Instruments
3. Accounting for Debtors
4. Accounting for Derivatives
1. Accounting for Investments in Equity Instruments (FA)
Classification
Investments in equity instruments (such as an investment in the ordinary shares of another entity) are
measured at either:
a) Fair Value through profit or loss, or
b) Fair value through other comprehensive income.
a. Fair value through profit or loss
The normal expectation is that equity instruments will have the designation of fair value through profit or
loss. These Investments are actually for the purpose of Held for Trading (Short Term Capital Gain
Purpose)
b. Fair value through other comprehensive income
It is possible to designate an equity instrument as fair value through other comprehensive

income, provided that the following conditions are complied with:
• The equity instrument must not be Held for Trading, and

• There must have been an irrevocable choice for this designation upon initial
recognition of the asset.
Measurement
a. Fair value through profit or loss
Investments in equity instruments that are classified as fair value through profit or loss are initially
recognised at fair value. Transaction costs are expensed to profit or loss.
At the reporting date, the asset is revalued to fair value with the gain or loss recorded in the statement of
profit or loss.
Investments in equity instruments that are classified as fair value through other comprehensive income
are initially recognised at fair value plus transaction costs. Transaction costs are initially capitalized.
Page 4 of 45
At the reporting date, the asset is revalued to fair value with the gain or loss recorded in other
comprehensive income. This gain or loss will not be reclassified to profit or loss in future periods.
Reference Questions: 1, 2 & 3
2. Accounting for Investments in Debt Instruments
“Contractual Rights to Receive Cash Flow”

Extracted definition.
Examples:
o Loan Receivable – Non Marketable – The Only Purpose - Hold Till Maturity (Classification
& Measurement By Default A.C. Method)
o Investment in Bonds/Debentures - Marketable - Purpose Either To Hold Till Maturity OR
Capital Gain
Classification
Financial assets that are Debt Instruments can be measured in one of three ways:
a) Amortised cost method

b) Fair value through other comprehensive income
c) Fair value through profit or loss.
a. Amortised Cost method (Quick Revision FR)
Amortised Cost Method Revision
A company purchases loan notes (nominal value $100,000) for $96,394 on 1 January 20X3, incurring
transaction costs of $350. The loan notes carry interest paid annually on 31 December of 4% of nominal
value ($4,000 pa). The loan notes will be redeemed at par on 31 December 20X5. The effective interest
rate is 5.2%.
Requirement: Loan notes working from 1st January/13 to 31st December/15.

Page 5 of 45
More explanation: Amortise cost method
IFRS 9 says that an Investment in a Debt instrument is measured at Amortised Cost if:
The entity's Business Model is to collect the asset's contractual cash flows
– This means that the entity does not plan on selling the asset prior to maturity but
rather intends to hold it until redemption.
The Contractual Terms of the financial asset give rise to cash flows that are solely payments of
principal, and interest on the principal amount outstanding
– For example, the interest rate on convertible bonds is lower than market rate
because the holder of the bond gets the benefit of choosing to take redemption
in the form of cash or shares. The contractual cash flows are therefore not solely
payments of principal and interest on the principal amount outstanding but also
about the market exposure related to the value of shares.
An investment in a debt instrument is measured at fair value through other comprehensive income if:
• The entity's business model involves both collecting contractual cash flows and selling
financial assets
– This means that sales will be more frequent than for debt instruments held at
amortised cost. For instance, an entity may sell investments if the possibility of
buying another investment with a higher return arises.
• The contractual terms of the financial asset give rise to cash flows that are solely payments of
principal and interest on the principal amount outstanding. CASS FLOW CHARACTERSITCS
TEST (Convertible Debts cant’ fall here)
c. Fair value through profit or loss
An investment in a debt instrument that is not measured at amortised cost or fair value through other
comprehensive income will be measured, according to IFRS 9, at fair value through profit or loss.
Investment in marketable debt instrument held for trading purpose.

Reference Question 4
Measurement
Amortised cost
For investments in debt that are measured at amortised cost:

• The asset is initially recognised at fair value plus transaction costs.
• Interest income is calculated using the effective rate of interest.
Page 6 of 45
Fair value through other comprehensive income
For investments in debt that are measured at fair value through other comprehensive income:
• The asset is initially recognised at fair value plus transaction costs.

• Interest income is calculated using the effective rate of interest.
• At the reporting date, the asset will be revalued to fair value with the gain or loss
recognised in other comprehensive income. This will be reclassified to profit or loss
when the asset is disposed.
Fair value through profit or loss
For investments in debt that are measured at fair value through profit or loss:
• The asset is initially recognised at fair value, with any transaction costs expensed to
the statement of profit or loss.
• Interest Income credit to P/L each reporting date.
• At the reporting date, the asset will be revalued to fair value with the gain or loss
recognised in the statement of profit or loss.
Reference Question 5 & 6

Page 7 of 45
FINANCIAL LIABILITY
IFRS 9 “A Contractual obligation to Pay Cash”
Extracted definition.
1. Basic Examples of Financial Liabilities
Creditors: Long Term Loans (Loan Payable, Lease Payable, Issuance of Debt Instruments like
Bonds, Debentures, Preference Shares)
Derivatives: Like Forward Contracts, Future Contracts, under the Unfavorable condition at
reporting dates
2. Initial Recognition of Financial Liabilities
IFRS 9 says that an entity should recognise a financial liability 'when, and only when, the entity becomes
party to the contractual provisions of the instrument'.
Examples of this principle are as follows:
 A trading commitment to buy or sell goods is not recognised until one party has fulfilled its part
of the contract. For example, a purchase order will not be recognised as purchases and a payable
until the goods have been received.
 Loan Payable contracts are accounted for as financial liability and are recognised on the
commitment date.
 Option contracts are accounted for as derivative financial liability (in case of option writer) and
are recognised on the date the contract is entered into, not on the date when the item subject to
the option is acquired.
3. Accounting/Reporting of Financial Liability
REFERENCE BY IFRS 9: Classification & Measurement of Financial Liability
Classification by IFRS 9
At initial recognition the entity must have to decide about classification of Financial Liability.
Financial Liability Classification by IFRS 9 as follows:
Fair Value:
a. Fair Value Through P/L Account
b. Amortized Cost Method
Page 8 of 45
Measurement by IFRS 9
INITIAL MEASUREMENT
1. On Initial Recognition, Financial Liabilities are measured at Fair Value with consideration of
Transaction Cost.
2. Transaction Cost Adjustments:

 F.A. Fair Value Through P/L – Transaction Cost Immediately Charge to I/S.
 F.A. Amortized Cost Method – Transaction Cost Less with Value of F.L. (Subsequently
Charge to I/S Automatically through Amortization Schedule)
SUBSEQUENT MEASUREMENT
Subsequent Measurement accounting according to the classification of F.L.
1. F.L. Amortized Cost Method – Amortize Cost Method (Book Value Method).
2. F.L. Fair Value through P/L – F.A. will be revalued to Fair Value with the Gain or Loss
recognized in the P/L.
Reference Question 7
Financial Liability - Fair value through profit or loss
It is also possible to measure a financial liability at fair value.
 When it would normally be measured at amortised cost if it would eliminate or reduce

an accounting mismatch.
 Financial liability trades for short-term purpose.
 Out of the money derivatives and liabilities held for trading are measured at fair value
through profit or loss.
In this case, IFRS 9 says that any movement in fair value is split into two components:
1. The fair value change due to own credit risk (the risk that the entity which has issued
the financial liability will be unable to repay or discharge it), which is presented in other
comprehensive income
2. The remaining fair value change,(MARKET ISSUES LIKE CHANGE IN MONETARY POLICY)
which is presented in profit or loss.
Reference Question 8 and 9

Page 9 of 45
EQUITY INSTRUMENT
Definition by IAS 32:
An Equity Instrument is 'any contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities' (Detail Discussion will cover later)
Basic Examples:
- Issuance of Equity Shares
- Issuance of Share options
- Residual Part of Convertible Loan Notes
- Irredeemable preference shares.
In case of issuance of equity instruments, the amount should reflect its fair value and the related
transaction cost must be adjusted with equity (Share premium or Retained Earnings).
Compound/Hybrid Financial Instruments
Compound Instrument has the component of both a FL (Obligation to pay cash) and equity (an Obligation
to issue a fixed number of Entity Own Shares).
At inception Compound Instrument must be split in to two components:
1. A liability Component - PV of future cash commitment (Interest+Prinicipal+Premium,if any) using

market rate of interest at inception date
2. An equity component - Difference b/w the cash receive from Compound Instrument and liability
component.
Subsequently:
1. Financial Liability component measured with amortised cost method
2. Equity Component with its original value.
Reference Question 10,11 & 12

Page 10 of 45
DERIVATIVES
Scope of Discussion:
1. Derivative Contract Definition - by IAS 32

2. Derivative Accounting
3. BASIC Examples
a. Forward Contract
b. Future Contracts
c. Option Contract
d. Swap Contracts
4. Terminologies: Executory Contracts and Non-Executory Contracts (Delivery Contract)
Definition
IFRS 9 says that a derivative is a financial instrument with the following characteristics:
(a) Its value changes in response to the change in a specified interest rate, security price, commodity
price, foreign exchange rate, index of prices or rates, a credit rating or credit index or similar
variable (called the ‘underlying’).
(b) It requires little or no initial net investment relative to other types of contract that have a similar
response to changes in market conditions.
(c) It is settled at a future date.
Note:
 A Contract Designates as Derivatives if seems to settle (IN FUTURE) on net cash basis – Non
Executory Contract.
 Derivatives are used for Hedging or Speculation Purpose.
 Derivatives for Speculation Purpose - Accounting Treatment are to measure at fair value
through P&L Account.
 Derivatives for Hedging Purpose – Hedge Accounting Later Discuss.
Derivatives Accounting – For Speculation Purpose
On initial recognition, derivatives should be measured at fair value. Transaction costs are expensed to the
statement of profit or loss.
At the reporting date, derivatives are remeasured to fair value. Movements in fair value are recognised in
profit or loss.
Page 11 of 45
Examples and More Details of Derivatives
Forward contracts
The holder of a forward contract is obliged to buy or sell a defined amount of a specific underlying asset,
at a specified price at a specified future date.
Example 1
A chocolate manufacturer may be worried that the price of cocoa might increase with an adverse effect
on its cost of production and operating profits.
The company could manage this risk by entering into a forward contract to fix now the price of his
future purchases of cocoa.
By fixing the price now for future purchases, the risk of an adverse movement in the market price of
cocoa is removed.
This contract is not for the purpose to actual buy the inventory – cocoa but to settle the forward contract
with net settlement on cash.
Example 2
Johnson, an investment property company, adopts the fair value model to measure its investment
properties. The fair value of the investment properties is highly dependent on interest rates.
The Finance Director of Johnson has requested your advice on accounting for the following financial
instrument transaction which took place in the year ended 31 December 20X1:
On 1 November 20X1 Johnson took out a speculative forward contract to buy coffee beans for delivery
on 30 April 20X2 at an agreed price of $6,000 intending to settle net in cash.
Due to a surge in expected supply, a forward contract for delivery on 30 April 20X2 would have cost
$5,000 on 31 December 20X1.
Required
Discuss, with suitable calculations, how the above financial instruments should be accounted for in the
financial statements of Johnson for the year ended 31 December 20X1.
SOLUTION
A forward contract not held for delivery of the entity's expected physical purchase, sale or usage
requirements (which would be outside the scope of IFRS 9) and not held for hedging purposes is
accounted for at fair value through profit or loss.
Initial Recognition
The fair value of a forward contract at inception is zero.

Page 12 of 45
Subsequent:
The fair value of the contract at the year end is:

$
Market price of forward contract at year end for delivery on 30 April 5,000
Johnson's forward price (6,000)
Loss (1,000)
A financial liability of $1,000 is therefore recognised with a corresponding charge of $1,000 to profit or
loss.
MORE DISCUSSION: DERIVATIVES FOR NON FINANCIAL ITEMS
Non-financial Item and the assets and liabilities which are outside the scope of IFRS 9.
However the derivative contracts for Non-Financial Items are under the scope of IFRS 9.
A contract to buy or sell a non-financial item (such as inventory or property, plant and equipment) is only
a derivative if:
• It can be settled net in cash (or using another financial asset), and
• The contract was not entered into for the purpose of receipt or delivery EC of the item to meet
the entity's operating requirements.
IFRS 9 says that a contract to buy or sell a non-financial item is considered to be settled net in cash when:
• the terms of the contract permit either party to settle the contract net
• the entity has a practice of settling similar contracts net
• the entity, for similar contracts has a practice of taking delivery of the item and then quickly selling
it in order to benefit from fair value changes
• the non-financial item is readily convertible to cash.
If the contract is not a derivative then it is a simple executory contract (a contract where neither party has
yet performed its obligations). Such contracts are not normally accounted for until the sale or purchase
date.
Page 13 of 45
Example for Clarification:
Peter Apparels Inc enters into two separate independent contracts on 28. September 20X6:
A forward contract to buy 500 pink cotton shirts from Paulo Garments Plc. on 25 December 20X6 at $25
a shirt.
In this situation, Peter Apparels Inc becomes a party to this contract on the date of entering into the
contract. According to IAS 39 Recognition and Measurement of Financial Instruments, an entity may
have a contract to buy or sell a non-financial item that can be settled net in cash or another financial
instrument or by exchanging financial instruments (e.g. a contract to buy or sell a commodity at a fixed
price at a future date). Such a contract is within the scope of this Standard unless it was entered into
and continues to be held for the purpose of delivery of a non-financial item in accordance with the
entity's expected purchase, sale or usage requirements
Assuming the forward contract satisfies the above requirements, it is recorded in Peter's books on 23
September 20X6 i.e. on the date of the forward contract rather than on the date the actual exchange
takes place.
On the same date, Peter Apparels also orders 300 pink cotton shirts from Roger Clothing Plc at $20 a
unit. This contract does not represent a financial instrument. It is an executory contract on delivery; it
will be converted into inventory in the form of physical assets and therefore will not be recognised as a
financial instrument. As a result, this is a trading contract entered into while transacting ordinary
business.
“A derivative contract will or may be settled by the exchange of a variable amount of cash for a fixed
number of the instruments (Equity Instrument/ Entity's own equity Instrument/Commodities/Debt
Instrument etc.)”

Page 14 of 45
More Derivative Instruments:
Futures contracts
Futures contracts oblige the holder to buy or sell a standard quantity of a specific underlying item at a
specified future date.
Futures contracts are very similar to forward contracts. The difference is that futures contracts have
standard terms and are traded on a financial exchange, whereas forward contracts are tailor-made and
are not traded on a financial exchange.
Swaps
Two parties agree to exchange periodic payments at specified intervals over a specified time period. For
example, in an interest rate swap, the parties may agree to exchange fixed and floating rate interest
payments calculated by reference to a notional principal amount.
Option Contracts
These give the holder the right, but not the obligation, to buy or sell a specific underlying asset on or
before a specified future date.
Example – Option Contracts
Entity A has a reporting date of 30 September. It enters into an option on 1 June 20X5, to purchase 10,000
shares (CALL OPTION) in another entity on 1 November 20X5 for $10 per share. EX PRICE. The purchase
price of each option is $1 PREMIUM. This is recorded as follows:
Initial Recognition:
Debit FA Call Option (10,000 × $1) $10,000
Credit Cash $10,000
By 30 September the fair value of each option has increased to $1.30.
This increase is recorded as follows:
Debit FA Call Option (10,000 × ($1.30 – 1)) $3,000

Credit Profit or loss $3,000

Page 15 of 45
FINANCIAL INSTRUMENT DEFINITION (IAS 32)

Definitions
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' (IAS 32, para 11).
A Financial Asset is any asset that is:
1. Cash
2. An equity instrument of another entity
3. A contractual right to receive cash or another financial asset from another entity; or
4. A contractual right to exchange financial instruments with another entity under conditions that
are potentially favorable to the entity; or (HOLDER OF FWD/FUTURES/OPTION CONTRACTS)
5. Own Equity Instrument (Execution – Non Derivative Contract)

A contract (non-derivative) that will or may be settled in the entity’s own equity instrument (for
which the entity is or may be obliged to receive a variable number of the entity's own equity
instruments') (IAS 32, Para 11).
6. Derivatives Contracts - Own Equity Instrument (Financial Asset) – Favorable Condition

A Derivative contract that will or may settled – RECEIVE with variable amount of cash (or
another financial asset) for a fixed number of entity’s own equity instruments.
A Financial Liability is any liability that is a:

1. A contractual obligation to deliver cash or another financial asset to another entity or
2. A contractual obligation to exchange financial instruments with another entity under conditions
that are potentially unfavorable. (HOLDER FWD/FUTURES & WRITER OF OPTIONS)
3. Own Equity Instrument (Execution – Non Derivative Contract)

A contract (non-derivative) that will or may be settled in the entity’s own equity instrument (for
which the entity is or may be obliged to deliver a variable number of the entity's own equity
instruments') (IAS 32, Para 11).
4. Derivatives Contracts - Own Equity Instrument (Financial Liability) – Unfavorable Condition

A Derivative contract that will or may settled – PAYMENT with variable amount of cash (or
another financial asset) for a fixed number of entity’s own equity instruments.
An Equity Instrument is 'any contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities' (IAS 32, para 11).
Page 16 of 45
Discussion About Classification & Differences Between Debt and Equity
It is not always easy to distinguish between debt and equity in an entity's statement of financial
position, partly because many financial instruments have elements of both.
IAS 32 Financial instruments: presentation brings clarity and consistency to this matter, so that the
classification is based on principles rather than driven by perceptions of users.
TECHNICAL ISSUE 1
IAS 32 defines an equity instrument as: 'any contract that evidences a residual interest in the assets of
an entity after deducting all of its liabilities'. It must first be established that an instrument is not a
financial liability, before it can be classified as equity.
A key feature of the IAS 32 definition of a financial liability is that it is a contractual obligation to
deliver cash or another financial asset to another entity.
The contractual obligation may arise from a requirement to make payments of principal, interest or
dividends. The contractual obligation may be explicit, but it may be implied indirectly in the terms of
the contract. An example of a debt instrument is a bond which requires the issuer to make interest
payments and redeem the bond for cash.
A financial instrument is an equity instrument only if there is no obligation to deliver cash or other
financial assets to another entity and if the instrument will or may be settled in the issuer’s own equity
instruments.
Examples of E.I.
An example of an equity instrument is ordinary shares, on which dividends are payable at the
discretion of the issuer.
A less obvious example is preference shares required to be converted into a fixed number of ordinary
shares on a fixed date or on the occurrence of an event which is certain to occur.
TECHNICAL ISSUE 2
Entity’s own equity instrument contracts
A contract resulting in the receipt or delivery of an entity’s own shares is not automatically an equity
instrument.
The classification depends on the so-called ‘fixed test’ in IAS 32. A contract which will be settled by the
entity receiving or delivering a fixed number of its own equity instruments in exchange for a fixed
amount of cash is an equity instrument.
The reasoning behind this is that by fixing upfront the number of shares to be received or delivered on
settlement of the instrument in concern, the holder is exposed to the upside and downside risk of
movements in the entity’s share price.
Page 17 of 45
In contrast, if the amount of cash or own equity shares to be delivered or received is variable, and then
the contract is a financial liability or asset.
The reasoning behind this is that using a variable number of own equity instruments to settle a contract
can be similar to using own shares as ‘currency’ to settle what in substance is a financial liability. Such a
contract does not evidence a residual interest in the entity’s net assets. Equity classification is therefore
inappropriate.
IAS 32 gives two examples of contracts require delivery of the number of own equity instruments but
are classified as financial liability:
 A contract to deliver a variable number of own equity instruments equal in value to a fixed
monetary amount on the settlement date is classified as a financial liability.
 For eg: A contract to deliver as many of the entity’s own equity instruments as are equal in
value to $6,000 – This contract is a financial liability
 A contract to deliver as many of the entity’s own equity instruments as are equal in value to
the value of 100 ounces of a commodity results in liability classification of the instrument.
 A contract to deliver as many of the entity’s own equity instruments as are equals in value of
$200,000 value of building.
Other Factors
There are other factors which might result in an instrument being classified as debt.
1) Dividends are non-discretionary.

2) Redemption is at the option of the instrument holder.
3) The instrument has a limited life.
4) Redemption is triggered by a future uncertain event which is beyond the control of both the
issuer and the holder of the instrument.
Other factors which might result in an instrument being classified as equity include the following.
1) Dividends are discretionary.
2) Redemption is at the option of the issuer of instrument
3) The shares are non-redeemable.
4) There is no liquidation date.
Reference question 17 and 18

Page 18 of 45
PERFORMANCE MEASUREMENT ASPECT
Significance of debt/equity classification for the financial statements
The distinction between debt and equity is very important, since the classification of a financial
instrument as either debt or equity can have a significant impact on the entity's reported earnings and
gearing ratio, which in turn can affect debt covenants. Companies may wish to classify a financial
instrument as equity, in order to give a favorable impression of gearing, but this may in turn have a
negative effect on the perceptions of existing shareholders if it is seen as diluting existing equity
interests.
The distinction is also relevant in the context of a business combination where an entity issues financial
instruments as part consideration, or to raise funds to settle a business combination in cash.
Management is often called upon to evaluate different financing options, and in order to do so must
understand the classification rules and their potential effects. For example, classification as a liability
generally means that payments are treated as interest and charged to profit or loss, and this may, in
turn, affect the entity’s ability to pay dividends on equity shares.
Reference question 19 and 20
CONTINGENT SETTLEMENT PROVISION
A financial instrument may require the entity to deliver cash or another financial asset in the event of
occurrence or non-occurrence of uncertain future events that are beyond the control of both the issuer
and holder of the instrument. These are known as contingent settlement provisions and could relate to
changes in stock market index, consumer price index, interest rate, issuer’s future profits or revenues.
Such instruments are classified as financial liability. This is because the issuer does not have an
unconditional right to avoid delivery cash or another financial asset.
The financial instrument would be an equity instrument if it has equity-like features, for example,
obligation arises only in the event of liquidation of the issuer.
Example: Redemption of preference shares
High Growth Bank issues 7% fixed preference shares. The dividends on the preference shares are
cumulative. The terms and conditions of the issue of preference share indicate that they will be
redeemed if the net profit of the bank increases by more than 50% in the next three years.
In this case, the contingent event is outside the control of both the bank and the holder. If the net profit
of the bank increases by more than 50% in the next three years, it does not have the unconditional right
to avoid delivering cash. The preference shares also pay a fixed cumulative dividend and hence are
classified as financial liability.
Reference question 21and 22

Page 19 of 45
DERECOGNITION OF FINANCIAL INSTRUMENTS
De-Recognition of a Financial Assets.
Possible Examples with complications are:

1. Disposal of Investment in shares/Bonds
2. Disposal of Investment in shares/Bonds with Repurchase Agreement
3. Disposal of Investment in shares/Bonds with Call or Put Options
4. Redemption of Loan (marketable or non-marketable)
5. Debtors – (Amount Receive/Factoring – Recourse & No-Recourse)
6. Derivatives (Sell, Expire, Exercise the option)
IFRS 9 – Criteria for Derecognition

An entity shall derecognize a financial asset when and only when:
1. The contractual rights to the cash flows from the financial asset expire; (For example, an option
held by the entity may have lapsed and become worthless.)
a. OR
2. The entity transfers (sale) the financial asset and (Plus) the transfer (sale) qualify for de-
recognition – where substantially all the risks and rewards of ownership transfer from the seller
to the buyer.
Evaluation of the transfer of risks and rewards of ownership
Examples of when an entity has transferred substantially all the risks and rewards of ownership are:
A. An unconditio nal sale of a fi nancial asset;

B. A sale of a financial asset together with an option to repurchase the financial asset at
its fair value at the time of repurchase; and
C. A sale of a financial asset together with a put or call option that is deeply out of the money (i.e.
an option that is so far out of the money it is highly unlikely to go into the money before expiry).
D. No Recourse Factoring
Conclusion: F.A. should be de-recognized and gain or loss should be recognized.
Examples of when an entity has retained substantially all the risks and rewards of ownership are:
A. A sale and repurchase transaction where the repurchase price is a fixed price or the sale price
plus a lender's return;
B. A secur ities lendi ng a greem ent(Pledge);
C. A sale, of a financial asset, together with a total return swap that transfers the market risk
exposure back to the entity;
D. A sale of a financial asset together with a deep in-the-money put or call option (i.e. an option
that is. so far in the money that it is highly unlikely to go out of the money before expiry); and
Page 20 of 45
E. A sale of short-term receivables in which the entity guarantees to compensate the

transferee for credit losses that is likely to occur. (Recourse Factoring)
Conclusion: F.A. should not be de-recognized and any amount received recognized as a liability.
Example
Discuss whether the following financial instruments would be derecognized?
Case 1
AB sells an investment in shares, but retains a call option to repurchase those shares at any
time at a price equal to their current market value at the date of repurchase.
AB should derecognise the asset as it only has an option (rather than an obligation) to purchase.
Case 2
EF enters into a stock lending agreement where an investment is lent to a third party for a fixed
period of time for a fee. At the end of the period of time the investment (or an identical one) is
returned to EF.
EF should not derecognize the asset as it has retained substantially all the risks and rewards of
ownership. The stock should be retained in its books even though the legal title is temporarily
transferred.
Reference questions 23, 24, 25 AND 26

Page 21 of 45
De-Recognition of Financial Liabilities:
A financial liability should be derecognized when the obligation become extinguished i.e. discharged,
cancelled or expires.
- Debtor discharge the liability
- Debtor is legally released from primary responsibility of liability
Accounting Treatment
The difference between:
The Carrying Amount of a liability discharged

And
The cash amount paid for it (including and non-cash asset transferred and any new liabilities)
Included in the profit and loss account
Example 1: FL De-Recognition
ABC has issued bonds (F.L.) with the measurement by amortize cost method $100,000 with 5 years
redemption time.
At start of 3rd year, when the market value of these bonds $140,000, the company has purchase (buy
back) 40% of bonds at its market value.
How to report the transaction?
Market value of 40% Bonds ($140,000 X 40%) = $56,000
F.L (DR) – 40% with Amortised Cost $40,000

P/L Account Charge (DR) $16,000 BALANCE
Bank (CR) $56,000
Example 2: FL De-Recognition
Entity A has borrowed $10 million from a bank to invest in commercial development. However, due to
a recession, the shops built didn’t yield the expected rental income and Entity A can’t service the
debt.
It negotiates with the bank to transfer the ownership of the development to the bank in settlement of
the outstanding debt.
The market value of the development is $7 million. The development’s carrying amount was $7
million as it was measured at fair value.
Solution:
This is the case about the extinguishment of FL. As a result of the transfer, Entity A should extinguish
the liability with a gain of $3 m in P/L account.
Page 22 of 45
The gain arises with the difference b/w the CA of the liability ($10m) and the value of NFA of the
development ($7m) that was transferred to the bank
Modification of the Financial Liability
If the liability is renegotiated with the original lender at substantial different terms, then the original
liability will be de-recognized and new liability will be recognized.
Any difference after the settlement with cash/NFA the difference should be adjusted with P/L
account.
Page 23 of 45
RE-CLASSIFICATION OF FINANCIAL INSTRUMENTS

Reclassification of Financial Assets
1. Investment in Equity Instrument: The only reclassification allow is fair value through P/L to fair
Value through OCI but any election to measure at fair value through OCI is an irrevocable one.
2. Derivatives: The only accounting (other than hedge accounting) is fair value through P/L and no
re-classification is allowed.
3. Investment in Debt Instruments: Financial assets are reclassified under IFRS 9 when, and only
when, an entity changes its business model for managing financial assets.
Although on initial recognition financial instruments must be classified in accordance with the
requirements of IFRS 9, in some cases they may be subsequently reclassified.
The reclassification should be applied prospectively from the reclassification date.
Examples: Reclassification permitted
Reclassification is permitted in the following circumstances, because a change in the business model
has taken place:
1. An entity has a portfolio of commercial loans that it holds to sell in the short term. The entity
acquires a company that manages commercial loans and has a business model that holds the
loans in order to collect the contractual cash flows. The portfolio of commercial loans is no
longer for sale, and the portfolio is now managed together with the acquired commercial loans
and all are held to collect the contractual cash flows.
2. A financial services firm decides to shut down its retail mortgage business. That business no
longer accepts new business and the financial services firm is actively marketing its mortgage
loan portfolio for sale.
Examples: Reclassification not permitted
Reclassification is not permitted in the following circumstances, because a change in the business
model has not taken place:
1. A change in intention related to particular financial assets (even in circumstances of significant

changes in market conditions);
2. A temporary disappearance of a particular market for financial assets; or

3. A transfer of financial assets between parts of the entity with different business models.
Gains and losses on reclassification of financial assets

Page 24 of 45
If a financial asset is reclassified from amortised cost to fair value, any gain or loss arising from a
difference between the previous carrying amount and fair value is recognised in profit or loss.
If a financial asset is reclassified from fair value to amortised cost, fair value at the date of
reclassification becomes the new carrying amount.
Reclassification of Financial Liability
Reclassification of financial liabilities is not permitted.

Page 25 of 45
FINANCIAL ASSET IMPAIRMENT
SCOPE
IFRS 9's impairment rules apply to:
1. Investments in debt instruments measured at amortised cost (business model: objective -

to collect contractual cash flows of principal and interest)
2. Investments in debt instruments measured at fair value through other comprehensive

income (OCI) (business model: objective - to collect contractual cash flows of principal and
interest and to sell financial assets)
3. Trade Receivable: Contract assets within the scope of IFRS 15 Revenue from Contracts with
Customers & Lease receivables within the scope of IFRS 16 Leases
4. Financial guarantee contracts
5. Commitments to provide loans at below-market interest rate.
6. Purchased ‘credit-impaired’ Financial Asset

Page 26 of 45
Investments in debt instruments measured at amortised cost

(Business model: objective - to collect contractual cash flows of principal and
interest)
Examples:
1. Bank’s Portfolio of Loan Receivable
2. Investment Company having investment portfolio of Bonds with an intention to hold till maturity.
Indications of Credit Impairment
IFRS 9 says that the following events may suggest the asset is credit – impaired:
 Significant financial difficulty of the issuer of the borrower

 A breach of contract such as a defaults
 The borrower being granted concessions
•
 It becoming probable that the borrower will enter bankruptcy I
Impairment of Financial Assets (IFRS 9)
IFRS 9 uses a forward-looking impairment model. Under this model future expected credit losses are
recognized. This is different to the impairment model used in IAS 36 Impairment of Assets in which an
impairment loss is only recognized when objective evidence of impairment exists.
IFRS 9 - FA IMPAIRMENT - "EXPECTED CREDIT LOSS (ECL) APPROACH"
IFRS 9 requires that credit losses on financial assets are measured and recognised using the 'expected
credit loss (ECL) approach’.
The ECL approach results in the early recognition of credit losses i.e. loss allowance because it includes,
not only losses that have already been incurred, but also expected future credit losses – it is a forward
looking model.
Forward Looking Model - it's not ONLY based of objective evidence.
LOSS ALLOWANCE: The allowance for expected credit loss on financial assets.
CREDIT LOSSES are the difference between the present value (PV) of all contractual cash flows and the
PV of expected future cash flows. This is often referred to as the ‘cash shortfall’. The present values are
discounted at the original effective interest rate.
EXPECTED CREDIT LOSSES (ECLs) are then calculated using the weighted average of credit losses with
the respective risks of a default occurring as the weights.
Page 27 of 45
ECLs are further classified into
1. Lifetime ECLs
The ECL that result from all possible default events over the expected life of a F.I.
2. 12-Months ECL.
The portion of the Life Time ECL that represent ECL that result from the default events on
F.I. that are possible with in the 12 months after the reporting date.
Under the approach required by IFRS 9, it is no longer necessary for a loss event to have occurred but
instead an entity is required to account for ECLs on initial recognition of the financial asset (the ECL
could be nil) and then separately account for changes in the ECL at each reporting date.
FA Impairment ECL Method (3 Step Model)
The below diagram will support you for better understanding of ECL Model:
Stage 1 Stage 2 Stage 3
No Significant Significant
Assessment at Increase in Increase in Objective
Reporting Credit Risk Credit Risk Evidence of
Date since Initial since Initial Impairment.
Recognition. Recognition.
Recognise Recognise Recognise

Credit Loss
12-Month ECL Life Time ECL Life Time ECL
Impairment Impairment
Loss Impairment
Loss = Loss =
Allowance Loss = Adjust
Separate Separate
Allowance Allowance with CA of FA
Effective Effective
Interest Interest = Effective
Interest =
Income Gross CA of Interest = Net
Gross CA of
CA of FA
FA FA
Page 28 of 45
Explanation
Impairment Loss Measurement
The amount of the impairment to be recognised on these financial Instruments depends on whether or
not they have significantly deteriorated since their initial recognition. For this purpose, financial
instrument are classified into three stages as follows:
Stage 1
Financial instrument whose credit quality has not significantly deteriorated since their initial recognition.
On initial recognition, the entity must create a credit loss allowance provision equal to 12 months’ ECL.
This is calculated by multiplying the probability of a default concurring in the next twelve months by the
total lifetime expected credit losses that would result from that default. (This is not the same as the
expected cash shortfalls over the next twelve months).
Stage 1 contains loans from all risk classes except ‘credit impaired loans.
Stage 2
Financial Instruments whose credit quality has significantly deteriorated since their Initial
recognition.
In subsequent years if the credit risk increases significantly since initial recognition this amount will be
replaced by lifetime ECL (From Stage1 to Stage 2).
This is calculated by total lifetime expected credit losses that would result from that default.
NOTE
If the credit quality subsequently improves and the lifetime expected credit losses criterion is no longer
met, the 12-months ECL basis is reinstated (From Stage2 to Stage 1).
Stage 3
Financial Instruments for which there is objective evidence of impairment at the reporting date.
This is also calculated by total lifetime expected credit losses that would result from that default.
Quick Review
For stage 1 financial Instruments, the impairment represents the present value of expected credit losses
that will result if a default occurs in the 12 months after the reporting date (12 months expected credit
losses).
Page 29 of 45
For stage 2 or 3 financial instruments, an impairment loss is recognised at the present value of expected
credit shortfalls over their remaining life (lifetime expected credit loss).
Reporting
Impairment Loss Adjustment
For Stage 1 & Stage 2
Expected credit losses would be recognized in profit and held in a separate allowance account (although
this would not be required to be shown separately on the face of the statement of financial position).
For Stage 3
Entities are required to reduce the gross carrying amount of a financial asset in the period in which they
no longer have a reasonable expectation of recovery.
Interest Income
The ECL approach also impacts on the calculation of interest revenue recognised from the financial asset
(see below).
For Stage 1 & Stage 2:
Interest revenue for Stage 1 and Stage 3 financial instruments will be calculated on their gross carrying
amounts (same as before impairment)
For Stage 3:
Interest revenue for stage 3 financial instruments would be recognized on a net basis (i.e. after deducting
expected credit losses from theory carrying amount)
Page 30 of 45
Example
On 1 January 20X2 Dexter Lee plc originated a loan of £500,000. It classified the financial asset as
measured at amortised cost. The loan is fully repayable at the end of Year 5. The effective interest rate is
4% per annum (payable at the end of each year).
On initial recognition, the loan as a low credit risk and the probability of default in the next 12 months is
1% with lifetime credit losses estimated at £125,000.
At 31 December 20X2, there has been no significant deterioration in credit quality and the loan is
considered to be low credit risk. The probability of default increases to 1.5% due to marginal increase in
credit risk of the borrower. The lifetime credit losses estimated at £125,000.
At 31 December 20X3, there has been significant deterioration in credit quality but there is no objective
evidence of impairment loss. The expected credit losses over the remaining life of the loan are
estimated at £50,000.
At 31 December 20X4, there is evidence of loss event and the loan defaults. The actual impairment loss
is estimated at £125,000.
Requirement
Explain how the loan should be accounted for under IFRS 9 including the following:
(a) Impairment loss allowance to be recognized on organization of the loan and at the end of each
year ended 31 December 20X2, 20X3 and 20X4 with relevant journal entries.
(b) Amount of interest income to be recognized in each of the years ended 31 December 20X2 to
20X5.
SOLUTION
Impairment loss recognised at initial recognition and adjust subsequesntly for changes in Credit Risk.
INITIAL RECOGNITION DATE 1/1/X2 - LOAN IS CLASSIFIED IN STAGE 1
Debit : F.A. 500,000

Credti: Bank 500,000
Debit : Impairment Loss 1,250

Credit : Loss Allowance 1,250
(Based on 12 months expected credit loss = 1% of 125,000)
REPORTING DATE 31/12/X2 - LOAN IS CLASSIFIED IN STAGE 1
Debit : Impairment Loss 625

Credit : Loss Allowance 625
Page 31 of 45
(based on 12 months expected credit loss = 1.5% of 125,000 less 1,250 previously recognised = 625)
Interest Income = 4% of 500,000 = 20,000
REPORTING DATE 31/12/X3 - LOAN IS CLASSIFIED IN STAGE 2

(based on Life time expected credit loss = [50,000 less (1,250+625=1,875) previously recognised =
48,125)
REPORTING DATE 31/12/X4 - LOAN IS CLASSIFIED IN STAGE 3 (Objective Evidence)

(Based on Life time expected credit loss = [125,000 less 50,000 previously recognised = 75,000)

SFP: FA(500,000-125,000) = 375,000
REPORTING DATE 31/12/X5
Interest Income in the year ended 31 Decemebr X5 = (500,000 - 125,000) X 4% = 15,000
The loan qualify for Stage 3 at the year end 31/12/X4 and the interest subsequently calculated on the
Net amount of the loan with accumulated loss allowance.
Reference Questions: 27 to 31
Page 32 of 45
Trade Receivable and Lease Receivables – Simplified Approach
TRADE RECEIVABLE = F.A. = TIME VALUE OF MONEY NOT EFFECTED (IF IT’S NOT LONG-TERM).
For trade receivables (that do not have an IFRS 15 financing element), the loss allowance is measured at
the lifetime expected credit losses (STAGE 2), from initial recognition.
OTHER TRADE RECEIVABLE & LEASE RECEIVABLE = F.A = TIME VALUE OF MONEY EFFECTED (IT’S LONG-
TERM).
For other trade receivables (LONG TERM that do have an IFRS 15 financing element) and for lease
receivables, the entity can choose (as a separate accounting policy for LONG TERM trade receivables and
for lease receivables) to apply the 3 Stage approach (AS THE NORNMAL RULE OF IFRS 9) or to recognise
an allowance for lifetime expected credit losses (STAGE 2) from initial recognition.
(IFRS 9: Chapter 5, para. 5.5.15)
Past due: a financial asset is post due when a counterparty (CUSTOMER) has failed to make a payment
when that payment was contractually due.
Example: Trade Receivable Provision Matrix
On 1 June 20X4, Kredco sold goods on credit to Detco for $200,000. Detco has a credit limit with Kredco
of 60 days. Kredco applies IFRS 9, and uses a pre-determined matrix for the calculation of allowances for
receivables as follows.
Days overdue Expected loss provision

Nil – WITH IN 60 DAYS 1%
1 to 30 5%
31 to 60 15%
61 to 90 20%
90 + 25%
Detco had not paid by 31 July 20X4, and so failed to comply with its credit term, and Kredco learned that
Detco was having serious cash flow difficulties due to a loss of a key customer.
The finance controller of Detco has informed Kredco that they will receive payment. No objective
evidence till now = still continue life time ECL since initial recognition.
Ignore sales tax.
Required Show the accounting entries on 1 June 20X4 and 31 July 20X4 to record the above, In accordance
with the expected credit loss model In IFRS 9.
Page 33 of 45
Solution
Trade receivables are financial assets and are normally measured at amortised cost in accordance with
IFRS 9 Financial Instruments. A loss allowance is required for debtors that are measured at amortised
cost.
Kredco’s expected credit losses can be calculated by multiplying the carrying amount of its receivables
with the expected risk of default over their life. Calculation of expected credit losses must use
information about past events and current economic conditions as well as forecasts of future economic
conditions and therefore Kredco’s is correct to have adjusted its historical default rates for future
estimates. Discounting will not be required as the receivables are short-term.
On 1 June 20X4
The entries in the books of Kredco will be:
DEBIT Trade receivables $200,000

CREDIT Revenue $200,000
Being initial recognition of sales
An expected credit loss allowance, based on the matrix above, would be calculated as follows:
DEBIT Expected credit losses $2,000

CREDIT Allowance for receivables $2,000
Being expected credit loss: $200,000 × 1%
On 31 July 20X4
Applying Kredco’s matrix, Detco has moved into the 5% bracket, because it has exhausted its 60-day
credit limit. (Note that this does not equate to being 60 days overdue!) Despite assurances that Kredco
will receive payment, the company should still increase its credit loss allowance to reflect the increased
credit risk.
Kredco will therefore record the following entries on 31 July 20X4
DEBIT Expected credit losses $8,000

CREDIT Allowance for receivables $8,000
Being expected credit loss: $200,000 × 5% – $2,000

Page 34 of 45
Debt instruments at fair value through other comprehensive income
“There is no separate loss allowance account for financial assets at fair value through OCI.”
These assets are held at fair value at the reporting date and therefore the loss allowance (IMPAIRMENT
LOSS) should not reduce the carrying amount of the asset in the statement of financial position. Instead,
the allowance is recorded against other comprehensive income.
Any impairment on these assets is automatically recognised in OCI as part of the fair value adjustment.
In other words, part of the movement in fair value would be due to impairment.
A second double entry is then made to recognise the movement in the loss allowance in profit or loss
with the other side of the entry in OCI. In effect, this transfers that part of the fair value movement which
was due to impairment into P&L.
Example
An entity purchases a debt instrument for $1,000 on 1 January 20X1. The interest rate on the bond is the
same as the effective rate. After accounting for interest for the year to 31 December 20X1, the carrying
amount of the bond is still $1,000.
At the reporting date of 31 December 20X1, the fair value of the instrument has fallen to $950.
There has not been a significant increase in credit risk since inception so expected credit losses should be
measured at 12-month expected credit losses. This is deemed to amount to $30.
Required:
Explain how the revaluation and impairment of the financial asset should be accounted for.
Solution
A loss of $50 ($1,000 - $950) arising on the revaluation of the asset to fair value will be recognised in
other comprehensive income.
Dr. OCI $50

Cr Financial asset $50
The 12-month expected credit losses of $30 will be debited to profit or loss.
The credit entry is not recorded against the carrying amount of the asset but rather against other
comprehensive income:
Dr Impairment loss (P/L) $30

Cr OCI $30
There is therefore a cumulative loss in OCI of $20 (the fair value change of $50 offset by the impairment
amount of $30).
Page 35 of 45
Financial Guarantee Contracts

Financial guarantee contracts are a form of financial insurance.
The entity (Bank/Parent) guarantees it will make a payment to another party if a specified debtor does
not pay that other party.
A contract that requires the issuer to make specified payments to reimburse the holder for a loss it incurs
because a specified debtor fails to make payment when due in accordance with the original or modified
terms of the debt instrument.
Measurement
On initial recognition the fair value of the 'premiums' received (less any transaction costs) are
recognised as a liability.
This is then amortised as income to profit or loss over the period of the guarantee, representing the
revenue earned as the performance obligation (i.e. providing the guarantee) is satisfied, thereby
reducing the liability to zero over the period of cover if no compensation payments are actually made.
However, if, at the year end, the expected impairment loss (credit loss of defaults) that would be
payable on the guarantee exceeds the remaining liability, the liability is increased to this amount.
Higher of:
- Amount initial recognised (Less) Amount amortised to P/L
OR
- Impairment loss allowance
Example
On 1st January Year 1, P Ltd gave a guarantee of a $50m loan taken by its subsidiary, S Ltd on that date.
S Ltd was to repay the loan in four equal annual instalments (to cover the $50m principal together with
related interest) on 31st December in Years 1 to 4.
Under the terms of the guarantee, P Ltd would be called on to repay the principal amount of the loan in
the event of S Ltd defaulting on any of these payments.
The fair value of the guarantee at inception was assessed as $1.6m.
P Ltd’s reporting date is 31 December.

Page 36 of 45
Situation 1
S Ltd makes all payments in accordance with the terms of the loan.
P Ltd
Initial Recognition (1st January Year 1)
Dr. P/L 1.6

Cr. F.L 1.6
31st December Years 1 to 4
Dr. F.L 0.4

Cr. P/L 0.4
The amortization of the guarantee over its life reflects the recognition of income as the service is
provided as performance obligation satisfied.
Situation 2
S Ltd made the first payment in accordance with the loan but failed in Year 2.
P Ltd
Initial Recognition (1st January Year 1)
Dr. P/L 1.6

Cr. F.L 1.6
31st December Year 1 1.6 – 0.4 = 1.2
Dr. F.L 0.4

Cr. P/L 0.4
31st December Year 2
Dr. P/L 36.3 TOTAL FL = 37.5

Cr. F.L 36.3
[50 – 12.5 – (1.6 – 0.4)] = 36.3
This results in a liability at the end of year 2 = 37.5

Page 37 of 45
Purchased credit-impaired financial asset and credit adjusted EIR
POCI receivables are receivables that are already impaired at the time when they are purchased or
originated. For these contracts it is assumed that the capital returns will not meet the requirements of
the contractually agreed cash flow. This is taken into account in risk provision, where the risk-adjusted
expected cash flow is used to determine the impairment.
Interest income is calculated on such assets using the credit-adjusted effective interest rate and it
incorporates all the contractual terms of the financial asset as well as expected credit losses. In other
words, the higher the expected credit losses, the lower the credit adjusted effective interest rate.
Since credit losses anticipated at inception will be recognised through the credit-adjusted effective
interest rate, the loss allowance on purchased or originated credit-impaired financial assets should be
measured only as the change in the lifetime expected credit losses since initial recognition.
Example
1/1/2003 Investment date

5,000 Price Paid
10,000 Facevalue
600 Coupon
12/31/2006 Contractual redemption date
Contractual cash flows Expected cash flows

Date Amount Date Amount
1/1/2003 600 1/1/2003 -
12/31/2003 600 12/31/2003 -
12/31/2004 600 12/31/2004 -
12/31/2005 600 12/31/2005 -
12/31/2006 10,600 12/31/2006 8,000
33.3% Contractual EIR 12.5% Credit Adjstd. EIR
Date Amount Date Amount

1/1/2003 (5,000) 1/1/2003 (5,000)
1/1/2003 600 <- past due coupon 1/1/2003 -
12/31/2003 600 12/31/2003 -
12/31/2004 600 12/31/2004 -
12/31/2005 600 12/31/2005 -
12/31/2006 10,600 12/31/2006 8,000
Page 38 of 45
Schedule for amortised cost using credit adjusted EIR
opening closing
balance impairment interest in balance
year 1 Jan gain P/L cash flow 31 Dec
2003 5,000 - 623 - 5,623
2004 5,623 - 701 - 6,325
2005 6,325 - 789 - 7,113
2006 7,113 - 887 (8,000) (0)
On 1 January 20X6, Entity A revises its estimates and expects to receive 8.500 which it finally receives on
31 December 20X6.
Schedule for amortised cost using credit adjusted EIR - after revision to cash flows
opening closing
balance balance
year 1 Jan impairment gain interest in P/L cash flow 31 Dec
2003 5,000 - 623 - 5,623
2004 5,623 - 701 - 6,325
2005 6,325 - 789 - 7,113
2006 7,113 445 942 (8,500) -
Page 39 of 45
HEDGE ACCOUNTING
What is Hedging?
Hedging is the process of entering into a transaction in order to reduce risk. Companies may use
derivatives to establish ‘positions’, so that gains or losses from holding the position in derivatives will
offset losses or gains on the related item that is being hedged.
Basic example to develop the mind set about the topic:
An entity has inventories of gold that cost $8m but whose value has increased to $10m.
The entity is worried that the fair value of this inventory will fall by the year end (31 st December 20X1), so
enters into a futures contract (Derivatives) on 1 October 20X1 to sell the inventory for $10m in 6 months'
time.
By the reporting date of 31 December 20X1:

The fair value of the inventory had fallen from $10m to $9m.
There was a $1m increase in the fair value of the futures (derivative).
Reporting without Hedge Accounting:
In accordance with IFRS 9, the $1 m gain on the derivative will be recognised through profit or loss:
Dr Derivative $1m
Cr Profit or loss $1m
In accordance with IAS 2 inventory will report by $8m and the $1 m decline in the inventory's fair value
will not be recognised because inventories are measured at the lower of cost ($8m) and NRV ($9m,
assuming no selling costs).
Investor Perspective Analysis:
The derivative has created volatility in profit or loss, which will also make 'earnings per share' volatile.
Potential investors may be deterred by this, because they may assume that their dividend receipts will
also be volatile. Although some investors are risk-seeking, others prefer steady and predictable returns.
If the entity had chosen to apply hedge accounting, this volatility would have been eliminated. But How?
Page 40 of 45
What is Hedge Accounting?
The objective of hedge accounting is to represent the effect of an entity's risk management activities
that use financial instruments to manage exposures arising from particular risks that could affect P/L
or OCI (IFRS 9.6. 1.1).
Moreover, reduce the volatility in financial statement and reducing the accounting also considerable.
Reporting with Hedge Accounting:
Hedging for the managing the risk for recognized item (asset or liability) designated as a fair value
hedge.
Under a fair value hedge, the movement in the fair value of the inventory (hedge item) and future
contract (Hedge Instrument) since the inception of the hedge are accounted for. The gains and losses
will be recorded in profit or loss. The $1 m gain on the future and the $1m loss on the inventory will be
accounted for as follows:
With hedging – Inventory
Dr Profit or loss $1m

Cr Inventory $1m
With hedging – Future Contract (Derivatives)
Dr Derivative $1m
Cr Profit or loss $1m
The loss would be reported in profit or loss
Analysis
By applying hedge accounting, the profit impact of re-measuring the derivative to fair value has been
offset by the movement in the fair value of the inventory. Volatility in profits and 'earnings per share'
has, in this example, been eliminated.
This may make the entity look less risky to current and potential investors. Note that the inventory will
now be held at $7m (cost of $8m – $1m fair value decline). This is neither cost nor NRV. The normal
accounting treatment of inventory has been changed by applying hedge accounting rules.
However, when you apply hedge accounting, you show to the readers of your financial statements:
 That your company faces certain risks.

 That you perform certain risk management strategies in order to mitigate those risks.
 How effective these strategies are.
In fact, with hedge accounting, your profit and loss statement is less volatile, because you basically
match these gains and losses with gains / losses on your hedged item.
Page 41 of 45
Hedge Accounting – More Details
Hedge accounting is a method of managing risk by designating one or more hedging instruments so that
their change in fair value is offset, in whole or in part, by the change in fair value or cash flows of a
hedged item.
A hedged item is an asset or liability that exposes the entity to risks of changes in fair value or future
cash flows (and is designated as being hedged).
There are 3 types of hedged item:
1. A recognised asset or liability
2. An unrecognised firm commitment – a binding agreement for the exchange of a specified

quantity of resources at a specified price on a specified future date
3. A highly probable forecast transaction – an uncommitted but anticipated future transaction.
A hedging instrument is a designated derivative, or a non-derivative financial asset or financial liability,

whose fair value or cash flows are expected to offset the risk for the changes in fair value or future cash
flows of the hedged item.
Criteria for Hedge Accounting
Under IFRS 9, hedge accounting rules can only be applied if the hedging relationship meets the following
criteria:
1. The hedging relationship consists only of eligible hedging instruments and eligible hedged
items; = NEGATIVE CORRELATION
2. At its inception there must be formal documentation of how this hedge fits into the company's
strategy (including identification of hedge item, instrument, nature of the risk that is to be
hedged, assessment of hedge instrument effectiveness.)
3. The hedging relationship meets all of the following hedge effectiveness requirements (Discuss
later).
Practically however, hedge accounting is effectively optional in that an entity can choose whether to set
up the hedge documentation at inception or not.
Types of Hedge Accounting
IFRS 9 identifies different types of hedges which determines their accounting treatment. The hedges
examinable are:
1. Fair value hedges; and
2. Cash flow hedges.
Page 42 of 45
Fair Value Hedge
Hedge for risk of change in fair value of a recognised asset or liability (or unrecognised firm
commitment) that could affect profit or loss.
For example:
1. Oil held in inventory (hedge item) could be hedged with an oil forward contract (hedge
instrument)to hedge the exposure to a risk of a fall in oil sales prices; or
2. Hedging by future contracts (hedge instrument) for the fair value of Investment in equity shares
(hedge item) due to changes in economic depression.
Accounting treatment at reporting date:
Both hedge item and instrument must be reported at its fair value.
All gains and losses on both the hedged item and hedging instrument are recognised as follows:
 Immediately in profit or loss (except for hedges of investments in equity instruments held at fair
value through other comprehensive income).
 Immediately in other comprehensive income if the hedged item is an investment in an equity

instrument held at fair value through other comprehensive income.
This ensures that hedges of investments of equity instruments held at fair value through other
comprehensive income can be accounted for as hedges.
In both cases, the gain or loss on the hedged item adjusts the carrying amount of the hedged item.
Refer Question 32 and 33
FIRM COMMITMENT
It means a binding agreement for the exchange of a specified quantity of resources at a specified price
on a specified future date. Other than hedge accounting, firm commitments are not recognized.
Firm commitments can be hedged and for fair value hedges the gain or loss attributable to the hedged
risk is recognised as an asset or liability in its own right as (Hedge Item). In such a case carrying amount
of an asset (or liability) that results from the firm commitment is adjusted to include change in the fair
value of the hedged item recognised in profit and loss account. The other side of derivative (Hedge
Instrument) is also account for as fair value profit and loss account.
Refer Question 34
Page 43 of 45
Cash Flow Hedge
Hedge for the risk of change in value of future cash flows from a recognised asset or liability (or highly
probable forecast transaction) that could affect profit or loss.
Example
Hedges relating to future cash flows from interest payments or foreign exchange receipts are common
cash flow hedges.
 Future US dollar sales of airline seats by a UK company might be hedged by a US$/£ forward
contracts to manage changes in exchange rates. (Cash Flow Hedge for highly probable forecast
transaction)
 Floating rate debt issued by a company might be hedged using an interest rate swap to manage
increases in interest rates. (Cash Flow Hedge for recognized transaction)
Accounting treatment at reporting date:
Hedge Instrument:
The hedging instrument is accounted for as follows:
1. Effective Portion
The portion of the gain or loss on the hedging instrument that is effective (ie up to the value of
the loss or gain on cash flow hedged) is recognised in other comprehensive income ('items that
may be reclassified subsequently to profit or loss') and the cash flow hedge reserve.
2. Ineffective Portion
Any excess is recognised immediately in profit or loss.
Refer Question 35
Hedge Item Subsequently Recognise and Adjustment of CFHR

The amount that has been accumulated in the cash flow hedge reserve is subsequently accounted for
as follows:
Non-Financial Items
If a hedged forecast transaction subsequently results in the recognition of a non-financial asset or non-
financial liability, the amount of the cash flow reserve must be directly adjusted with the initial cost or
carrying amount of the asset or liability. This isn’t the reclassification adjustment and therefore it
doesn’t affect OCI.
Financial Items
If a hedged forecast transaction subsequently results in the recognition of a financial asset or financial
liability, the amount shall be reclassified from other comprehensive income to profit or loss in the
same period(s) that the hedged expected future cash flows affect profit or loss (eg in the period when
the hedged forecast sales occur).
Refer Question 35, 36 & 37

Page 44 of 45
Hedge Effectiveness
Hedge accounting can only be used if the hedging relationship meets all effectiveness requirements.
According to IFRS 9, an entity must assess at the inception of the hedging relationship, and at each
reporting date, whether a hedging relationship meets the hedge effectiveness requirements.
The assessment should be forward-looking.
There is an economic relationship between the hedged item and the hedging instrument; ie both have
values that generally move in the opposite direction.
For example, if the price of a share falls below $10, the fair value of a futures contract to sell the share
for $10 rises.
The effect of credit risk does not dominate the value changes that result from that economic
relationship. Credit risk may lead to erratic fair value movements in either the hedged item or the
hedging instrument.
For example, if the counterparty of a derivative experiences a decline in credit worthiness, the fair value
of the derivative (the hedging instrument) may fall substantially. This movement is unrelated to changes
in the fair value of the item and would lead to hedge ineffectiveness.
The appropriate hedge ratio to be maintained. The hedge ratio of the hedge relationship is based on
actual quantities of hedged item and the actual quantities of hedging instrument.
Example Airlines
Kevin has kindly permitted me to add one more example for you, so what follows is actually written by
me (Silvia).
A local airline plans to buy 50 000 units of fuel in 6 months. The airline is worried about constantly rising
prices of fuel and therefore, it wants to hedge its exposure.
The perfect match would be to get some derivative related to fuel, however, no such a thing is available
on the market and therefore, the airline decides to hedge its exposure by getting commodity derivative –
futures for crude oil.
Similarly as in the above example, the airline cannot buy 1 unit of crude oil future to hedge 1 unit of fuel.
Page 45 of 45
Why not?
The reason is that crude oil is just one part of fuel’s total composition.
In reality, hedging managers need to examine what’s the best fit to hedge certain exposure. For example,
they would perform a regression analysis to find out the correlation between the prices of crude oil and
the prices of fuel.
If there is some correlation, well, then crude oil futures can be used to hedge fuel, but certainly not in 1:1
ratio, as there are two different things and there’s no perfect match.
Let’s say that the airlines hedging experts calculated that crude oil trades approximately at 15% discount
compared to the fuel prices (a side note – sorry if that’s not true, I just made these numbers up).
As a result, the hedge ratio is set to 0.85:1 and in other words, to hedge 50 000 units of fuel, the airline
buys commodity futures for 58 823 (50 000/0.85) units of crude oil (hint: as futures are standardized
contract, buying the exact amount would be probably hard).
P a g e |1
Embedded Derivatives
A hybrid is made up of two components, a host and an embedded derivative.
Hybrid Instrument = Non-derivative host contract + Embedded Derivative
In a broader term, non-derivative contract might include terms that cause some of its cash flows to
behave in the same way as those of a derivative. Such a contract is described as being a hybrid.
Examples:
1. Investment in a convertible bond, which can be converted into a fixed number of equity shares
at a specified future date. The bond is a non-derivative host contract and the option to convert
to shares is therefore a derivative element.
2. A company borrows $25m and agrees to pay interest at a rate that is linked to oil price.
(Therefore, the borrowing has some kind of oil derivative embedded in it).
Accounting Treatment
Split the embedded derivative from its host and account for each separately.
The result is that the embedded derivative would be measured at fair value though profit and loss in the
same way as any other derivative.
But this will not always the case.
Whether an embedded derivative is separated, depends on whether its host is an asset within the scope
of IFRS 9, and if not, whether certain criteria are met.
Hosts which are financial assets within the scope of IFRS 9
An embedded derivative embedded in a financial asset host that is within the scope of IFRS 9 is not
separated.
The normal rules of classification and accounting would apply to such a contract. A financial asset is
measured at FVPL if any of its cash flows do not represent payments of principal and interest.The
presence of a derivative embedded in a financial asset prevents its cash flows being solely payments of
principal and interest.
This means that existence of an embedded derivative (if any) would result in the whole financial asset
being measured at fair value through profit or loss.
P a g e |2
Example:
An entity has an investment in a convertible bond, which can be converted into a fixed number of
equity shares at a specified future date. The bond is a non-derivative host contract and the option to
convert to shares is therefore a derivative element.
The host contract, the bond, is a financial asset and so is within the scope of IFRS 9. This means that the
rules of IFRS 9 must be applied to the entire contract.
The bond would fail the contractual cash flow characteristics test and therefore the entire contract
should be measured at fair value through profit or loss.
Other hybrid contracts
If a hybrid contract contains a host that is not an asset within the scope of IFRS 9, an embedded
derivative must be separated from the host and accounted for as a derivative if, and only if:
 The economic characteristics and risks of the embedded derivative are not closely related to the
economic characteristics and risks of the host (in other words it is unusual in the context of the
host contract);
 A separate instrument with the same terms as the embedded derivative would meet the
definition of a derivative; and
 The hybrid contract is not measured at fair value profit or loss.
When these conditions are met, the embedded derivative is separated from the host contract and
accounted for like any other derivative. The host contract is accounted for in accordance with the
relevant accounting standard, separately from the derivative.
Example
A company borrows $25m and agrees to pay interest at a rate that is linked to oil price. (Therefore, the
borrowing has some kind of oil derivative embedded in it).
This is not an asset that is in the scope of IFRS 9 (it is a liability). Therefore, the entity needs to decide if
the embedded derivative should be separated and measured at fair value through profit or loss.
The economic characteristics and risks of the embedded derivative are not closely related to those of
the host. (Oil price is different to interest rates).
The derivative should be separated and measured at FVPL.

P a g e |3
SBR: March/June 2019
Crypto operates in the power industry.
On 1 April 20X7, Crypto entered into a contract to purchase a fixed quantity of electricity at 31
December 20X8 for 20 million euros. Both Crypto and the supplier have a functional currency of dollars.
The electricity will be used in Crypto’s production processes.
Crypto has separated out the foreign currency embedded derivative from the electricity contract and
measured it at fair value through other comprehensive income (FVTOCI). However, on 31 December
20X7, there was a contractual modification, such that the contract is now an executory contract
denominated in dollars. At this date, Crypto calculated that the embedded derivative had a negative fair
value of 2 million euros.
The directors of Crypto would like advice as to whether they should have separated out the foreign
currency derivative and measured it at FVTOCI, and how to treat the modification in the contract.
(5 marks)
Answer
Embedded derivative
The contract is a hybrid contract. It contains a host contract, which is an executory contract to purchase
electricity at a price of 20 million euros. The contract also contains an embedded derivative to sell
dollars in the future to buy 20 million euros.
The host contract is not a financial asset. As such the embedded derivative is only separated out if the
economic characteristics and risks of the embedded derivative are not closely related to those of the
host contract. This would seem to be the case, because neither party to the contract has a functional
currency of Euros. As such, it is acceptable to separate the embedded derivative but it should have been
measured at fair value through profit or loss, rather than at fair value through other comprehensive
income.
Tutorial note Remember that derivatives are always measured at fair value through profit or loss unless
hedge accounting is applied
Note that it is not mandatory to separate the embedded derivative. Instead the entire hybrid contract
can be measured at fair value through profit or loss.
At the date of the modification of the contract, there is a significant change to the contract. The contract
no longer contains an embedded derivative and is instead an executory contract (outside the scope of
IFRS 9). The embedded derivative component that has been accounted for separately must therefore be
derecognised.
Tutorial note According to the Conceptual Framework, an executory contract is one where neither party
has performed any of its obligations (e.g. a purchase contract where the purchaser has not paid and the
seller has not started to satisfy the performance obligations in the contract). The contract will be
P a g e |4
unrecognised until an entity starts to perform – i.e. Crypto will record electricity at the cost of purchase
when received from the supplier.
Chapter 7: Financial instruments
IFRS 7: Disclosure
 Objectives of IFRS 7
 Significance of financial instruments for financial position and performance
 Nature and extent of risks arising from financial instruments
9 IFRS 7: Disclosure
9.1 Objectives of IFRS 7

All companies are exposed to various types of financial risk. Some risks are obvious
from looking at the statement of financial position. For example, a loan requiring
repayment in the next year is reported as a current liability, and users of the
financial statements can assess the risk that the company will be unable to repay the
loan.
However, there are often many other risks that a company faces that are not
apparent from the financial statements. For example if a significant volume of a
company’s sales are made overseas, there is exposure to the risk of exchange rate
movements.
Example
A UK company has an investment of units purchased in a German company’s

floating rate silver-linked bond. The bond pays interest on the capital, and part of
the interest payment represents bonus interest linked to movements in the price of
silver.
There are several financial risks that this company faces with respect to this
investment.
 It is a floating rate bond. So if market interest rates for bonds decrease, the
interest income from the bonds will fall.
 Interest is paid in euros. For a UK company there is a foreign exchange risk
associated with changes in the value of the euro. If the euro falls in value against
the British pound, the value of the income to a UK investor will fall.
 A bonus is linked to movements in the price of silver. So there is exposure to
changes in the price of silver.
 There is default risk. The German company may default on payments of interest
or on repayment of the principal when the bond reaches its redemption date.
IFRS 7 requires that an entity should disclose information that enables users of the
financial statements to ‘evaluate the significance of financial instruments’ for the
entity’s financial position and financial performance.
© Emile Woolf International Limited 275

Strategic Business Reporting (SBR)
There are two main parts to IFRS 7:

 A section on the disclosure of ‘the significance of financial instruments’ for the
entity’s financial position and financial performance
 A section on disclosures of the nature and extent of risks arising from financial
instruments.
9.2 Significance of financial instruments for financial position and

performance
Statement of financial position disclosures

The carrying amounts of financial instruments must be shown, either in the
statement of financial position or in a note to the financial statements, for each class
of financial instrument:
 Financial assets at fair value through profit or loss
 Financial assets at amortised cost
 Financial liabilities at fair value through profit or loss
 Financial liabilities measured at amortised cost.
Other disclosures relating to the statement of financial position are also required.
These include the following:
 Collateral. A note should disclose the amount of financial assets that the entity
has pledged as collateral for liabilities or contingent liabilities.
 Allowance account for credit losses. When financial assets (such as trade
receivables) are impaired by credit losses and the impairment is recorded in a
separate account (such as an allowance account for irrecoverable trade
receivables), the entity should provide a reconciliation of changes in the account
during the period, for each class of financial assets.
 Defaults and breaches. For loans payable, the entity should disclose details of
any defaults during the period in the loan payments, or any other breaches in
the loan conditions.
Statement of profit or loss disclosures

An entity must disclose the following items either in the statement of profit or loss
or in notes to the financial statements:
 Net gains or losses on financial assets or financial liabilities at fair value through
profit or loss.
 Net gains or losses on available-for-sale financial assets, showing separately:
 The gain or loss recognised in other comprehensive income (and so directly
in equity) during the period, and
 The amount removed from equity and reclassified from equity to profit and
loss through other comprehensive income in the period.
 Net gains or losses on held-to-maturity investments.
 Net gains or losses on loans and receivables.
276 © Emile Woolf International Limited

Chapter 7: Financial instruments
 Net gains or losses on financial liabilities measured at amortised cost.

 Total interest income and total interest expense, calculated using the effective
interest method, for financial assets or liabilities that are not at fair value through
profit or loss.
 Fee income and expenses arising from financial assets or liabilities that are not at
fair value through profit or loss.
 The amount of any impairment loss for each class of financial asset.
Other disclosures
IFRS 7 also requires other disclosures. These include the following:
 Information relating to hedge accounting, for cash flow hedges, fair value
hedges and hedges of net investments in foreign operations. The disclosures
should include a description of each type of hedge, a description of the financial
instruments designated as hedging instruments and their fair values at the
reporting date, and the nature of the risks being hedged.
 With some exceptions, for each class of financial asset and financial liability, an
entity must disclose the fair value of the assets or liabilities in a way that permits
the fair value to be compared with the carrying amount for that class. (An
important exception is where the carrying amount is a reasonable approximation
of fair value, which should normally be the case for short-term receivables and
payables.)
9.3 Nature and extent of risks arising from financial instruments

IFRS 7 also requires that an entity should disclose information that enables users of
its financial statements to evaluate the nature and extent of the risks arising from its
financial instruments.
These risks typically include, but are not restricted to:
 credit risk
 liquidity risk, and
 market risk.
For each category of risk, the entity should provide both quantitative and
qualitative information about the risks.
 Qualitative disclosures. For each type of risk, there should be disclosures of the
exposures to risk and how they arise; and the objectives policies and processes
for managing the risk and the methods used to measure the risk.
 Quantitative disclosures. For each type of risk, the entity should also disclose
summary quantitative data about its exposures at the end of the reporting
period. This disclosure should be based on information presented to the entity’s
senior management, such as the board of directors or chief executive officer.
© Emile Woolf International Limited 277

Strategic Business Reporting (SBR)
Credit risk
Credit risk is the risk that someone who owes money (a trade receivable, a
borrower, a bond issuer, and so on) will not pay. An entity is required to disclose
the following information about credit risk exposures:
 A best estimate of the entity’s maximum exposure to credit risk at the end of the
reporting period and a description of any collateral held.
 For each class of financial assets, a disclosure of assets where payment is ‘past
due’ or the asset has been impaired.
Liquidity risk
Liquidity risk is the risk that the entity will not have access to sufficient cash to meet
its payment obligations when these are due. IFRS 7 requires disclosure of:
 A maturity analysis for financial liabilities, showing when the contractual
liabilities fall due for payment
 A description of how the entity manages the liquidity risk that arises from this
maturity profile of payments.
Market risk
Market risk is the risk of losses that might occur from changes in the value of
financial instruments due to changes in:
 exchange rates,
 interest rates, or
 market prices.
An entity should provide a sensitivity analysis for each type of market risk to which
it is exposed at the end of the reporting period. The sensitivity analysis should show
how profit or loss would have been affected by a change in the market risk variable
(interest rate, exchange rate, market price of an item) that might have been
reasonably possible at that date.
Alternatively, an entity can provide sensitivity analysis in a different form, where it

uses a different model for analysis of sensitivity, such as a value at risk (VaR)
model. These models are commonly used by banks.
278 © Emile Woolf International Limited

Financial Instrument Notes

Uploaded by

Copyright:

Available Formats

Financial Instrument Notes

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Financial Instrument Notes

Uploaded by

Copyright:

Available Formats

Page 1 of 45

1. Basic Examples of Financial Assets

More Examples of F.A.

- Investment in Equity Instrument of another entity (Shares, Shares options)

2. Initial Recognition of Financial Assets

Examples of this principle are as follows:

Accounting/Reporting of Financial Asset exclusively based on classification criteria.

Financial Asset Classification by IFRS 9 as follows:

Financial Asset Measurement by IFRS 9

Subsequent Measurement accounting according to the classification of F.A.

F.A. CLASSIFICATION AND MEASUREMENT: SIMPLIFIED WAY

Financial Asset Classification can also be made as follows.

1. Accounting for Investments in Equity Instruments

1. Accounting for Investments in Equity Instruments (FA)

a. Fair value through profit or loss

b. Fair value through other comprehensive income

It is possible to designate an equity instrument as fair value through other comprehensive

• The equity instrument must not be Held for Trading, and

a. Fair value through profit or loss

b. Fair value through other comprehensive income

Reference Questions: 1, 2 & 3

2. Accounting for Investments in Debt Instruments

“Contractual Rights to Receive Cash Flow”

a) Amortised cost method

a. Amortised Cost method (Quick Revision FR)

Amortised Cost Method Revision

Requirement: Loan notes working from 1st January/13 to 31st December/15.

More explanation: Amortise cost method

b. Fair value through other comprehensive income

c. Fair value through profit or loss

Investment in marketable debt instrument held for trading purpose.

For investments in debt that are measured at amortised cost:

Fair value through other comprehensive income

• The asset is initially recognised at fair value plus transaction costs.

Fair value through profit or loss

Reference Question 5 & 6

1. Basic Examples of Financial Liabilities

2. Initial Recognition of Financial Liabilities

Examples of this principle are as follows:

3. Accounting/Reporting of Financial Liability

REFERENCE BY IFRS 9: Classification & Measurement of Financial Liability

Financial Liability Classification by IFRS 9 as follows:

2. Transaction Cost Adjustments:

Subsequent Measurement accounting according to the classification of F.L.

Financial Liability - Fair value through profit or loss

It is also possible to measure a financial liability at fair value.

 When it would normally be measured at amortised cost if it would eliminate or reduce

Reference Question 8 and 9

Compound/Hybrid Financial Instruments

At inception Compound Instrument must be split in to two components:

1. A liability Component - PV of future cash commitment (Interest+Prinicipal+Premium,if any) using

Reference Question 10,11 & 12

1. Derivative Contract Definition - by IAS 32

Derivatives Accounting – For Speculation Purpose

Examples and More Details of Derivatives

The fair value of a forward contract at inception is zero.

The fair value of the contract at the year end is:

MORE DISCUSSION: DERIVATIVES FOR NON FINANCIAL ITEMS

• the entity has a practice of settling similar contracts net