DAYANANDA SAGAR UNIVERSITY

SCHOOL OF COMMERCE AND MANAGEMENT

STUDIES

Pavan Pandri
CMS22BC0037
BCOM ACCA V’TH SEM
STRAGIC BUSINESS REPORTING
ASSIGNMENT- 1
FINANCIAL INSTRUMENTS - IFRS 9
 IFRS 9 FINANCIAL INSTRUMENTS
DEFINITION:
Financial instrument – any contract which gives rise to both a financial asset of
one entity and a financial liability or equity instrument of another entity.
Instruments include:
• primary instruments (e.g. receivables, payables and equity securities); and
• derivative instruments (e.g. financial options, futures and forwards, interest
rate swaps and currency swaps).

HISTORY:
The development of accounting for financial instruments has a history which
stretches
back more than 30 years:
• IAS 32 Financial Instruments: Disclosure and Presentation (1995).
• IAS 39 Financial Instruments: Recognition and Measurement (1998).
• IFRS 7 Financial Instruments: Disclosures (2005) to replace the disclosure
issues in IAS 32.
IAS 32 is now solely concerned with presentation issues. The first
exposure draft on financial instruments (1991) included requirements
for disclosure, presentation, recognition and measurement in one
standard. However, the time difference between the initial issue of IAS
32 and IAS 39 reflects the complexity of the recognition and
measurement issues. The IASB's project to replace IAS 39 with a new
standard, IFRS 9 Financial Instruments, which started in 2009 was finally
completed in 2014. IFRS 9 deals with the following:
➢ Recognition and measurement of financial assets and liabilities;
➢ Derecognition of financial assets and liabilities;
➢ Impairment of certain financial assets; and
➢ Hedging and hedge accounting.

APPLICATION AND SCOPE:

IAS 32: Deals with the classification of financial instruments between:
 ➢ financial assets;
➢ financial liabilities; and
➢ equity instruments.
It prescribes the presentation and offset of financial instruments and the
related
interest, dividends, losses and gains.
IFRS 9: Deals with the disclosure of:
➢ factors affecting the amount, timing and certainty of cash flows;
➢ the use of financial instruments and the business purpose they serve;
and
➢ the associated risks and management's policies for controlling those
risks.

FINANCIAL ASSETS - any asset which is:

➢ cash;
➢ a contractual right to receive cash or another financial asset from
another entity;
➢ a contractual right to exchange financial instruments with another entity
under conditions which are potentially favourable;
➢ an equity instrument of another entity; or
➢ certain contracts which will (or may) be settled in the entity's own equity
instruments

FINANCIAL LIABILITIES - any liability which is a contractual obligation:

➢ to deliver cash or another financial asset to another entity;
➢ to exchange financial instruments with another entity under conditions
that are potentially unfavourable; or
➢ certain contracts that will (or may) be settled in own equity instruments.
EQUITY INSTRUMENTS - any contract which evidences a residual interest in
the assets of an entity after deducting all of its liabilities.

RECOGNITION OF FINANCIAL ASSETS AND LIABILITIES:

In accordance with IFRS 9, Financial Instruments, a company recognises a
financial asset or a financial liability when the company becomes party to the
contractual provisions of the instrument. For example, if a company receives a
firm order for goods from a customer, it should delay recognition of the trade
receivable until at least one of the parties has performed under the
agreement. This would normally be when the goods are shipped or delivered.
In contrast, however, a forward contract or option is recognised on the
commitment date if it falls within the scope of IFRS 9. Except for trade
receivables, a company measures a financial asset or financial liability on initial
recognition at its fair value. The treatment of transaction costs directly
attributable to the acquisition or issue depends on the instrument’s
measurement category.

MEASUREMENT OF FINANCIAL ASSETS:

A financial asset is measured at fair value through profit or loss (FVTPL) unless
it is measured at amortised cost or at fair value through other comprehensive
income
(FVTOCI). Classification depends on both the company’s business model for
managing the financial assets and the contractual cash flow characteristics of
the financial asset.
A financial asset is measured at amortised cost if:
(i) the financial asset is held within a business model whose objective is to hold
financial
assets in order to collect contractual cash flows; and
(ii) the contractual terms of the financial asset give rise on specified dates to
cash flows that
are solely payments of principal and interest on the principal amount
outstanding.
A financial asset is measured at FVOCI if:
(i) the financial asset is held within a business model whose objective is
achieved by both
collecting contractual cash flows and selling financial assets; and
(ii) the contractual terms of the financial asset give rise on specified dates to
cash flows that are solely payments of principal and interest on the principal
amount outstanding. A company can make an irrevocable election at initial
recognition for investments in equity instruments to be measured at FVOCI if
they are not held for trading.

MEASUREMENT OF FINANCIAL LIABILITIES:

Measurement of financial liabilities is easier than financial assets. Almost all
financial liabilities are measured at amortised cost, meaning that a finance cost
is reported in profit or loss based on the effective rate of interest. Financial
liabilities held for trading, including derivative liabilities, are measured at
FVTPL. As with financial assets, a company can designate, at initial recognition,
a financial liability to be measured at FVTPL if it would eliminate or significantly
reduce an ‘accounting mismatch’.

DERECOGNITION OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES:

Derecognition is the removal of all or part of an asset or liability from the
statement of
financial position.
DERECOGNITION OF FIN. ASSETS:
A company derecognises a financial asset when the contractual rights to the
cash flows
from the financial asset have expired, or it transfers the financial asset such
that it
qualifies for derecognition. A company transfers a financial asset where it
transfers the contractual rights to receive the cash flows of the financial asset,
or where it retains the contractual rights to receive the cash flows of the
financial asset but assumes a contractual obligation to pay the cash flows to a
third party. The company also evaluates the extent to which it retains the risks
and rewards of ownership of the financial asset. On derecognition of a financial
asset, the difference between the carrying amount and the consideration
received is recognised in profit or loss. If a company neither transfer, nor
retains substantially all the risks and rewards of ownership of a transferred
asset, and retains control of the transferred asset, the company continues to
recognize the transferred asset to the extent of its continuing involvement.
DERECOGNITION OF FIN. LIABILITIES:
A company should derecognise a financial liability from its statement of
financial position when the obligation is discharged, cancelled or has expired.
An exchange between an existing borrower and lender of debt instruments
with substantially different terms is accounted for as extinguishing the original
financial liability and recognition of a new financial liability. Similarly, a
substantial modification of the terms of the existing financial liability is
accounted for by extinguishing the original financial liability and recognising a
new financial liability. The terms are substantially different if the present value
of the cash flows under the new terms (including any fees paid net of any fees
received) when discounted using the original effective interest rate is at least
10 per cent different from the present value of the remaining cash flows of the
original financial liability. The difference between the carrying amount of a
financial liability extinguished or transferred to another party and the
consideration paid is recognised in profit or loss.
IMPAIRMENT:
Except for investments in equity instruments, financial assets classified as
amortised cost or FVTOCI must be tested for impairment at the end of each
reporting period. IFRS 9 has a general approach for impairment that
distinguishes between ‘12-month expected credit losses’ and ‘lifetime
expected credit losses’. Expected credit losses are the present value of all cash
shortfalls (the difference between the cash flows that are due to an entity and
the cash flows that the entity expects to receive) over the expected life of the
financial instrument. Expected credit losses should be measured in a way that
reflects an unbiased and probability-weighted amount that is determined by
evaluating a range of possible outcomes, the time value of money and
reasonable and supportable information.

EXAMPLES OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES

1. FINANCIAL ASSETS (AMORTISED COSTS)
An entity purchased a debt instrument for $1,000. The instrument pays
annual interest of $60 and had 10 years to maturity when purchased. As
 the business model test was met, the instrument was classified as a
financial asset at amortised cost. Nine years have passed and the entity
is suffering a liquidity crisis and needs to sell the asset to raise funds. The
sale was not expected on initial classification and does not affect the
classification (i.e. there is no retrospective reclassification)

2. FINANCIAL LIABILITY (LOAN NOTES)

Oviedo Co issued $10m 5% loan notes on 1 January 20X1, incurring
$200,000 issue costs. These loan notes are repayable at a premium of
$1m on 31 December 20X3. The effective interest rate is 8.85%. Show
how the interest expense will accrue over the three years. Hint: Prepare
a summary of the movements on the loan liability. The movements on
the loan liability over three years are summarised as follows

Over the three years, the total amount of finance cost recognised is $2.7m
(867 + 900 +933), which is:
• three years’ annual interest at 5%;
• the $1m additional finance cost (the difference between borrowing $10m
and repaying $11m); and
• $200,000 issue costs

INDUSTRY PROBLEMS FACED BY IFRS 9

IFRS 9 has introduced several challenges and problems for industries dealing
with financial instruments.
➢ Complexity in Classification and Measurement: The criteria for
classifying financial assets and liabilities can be complex, leading to
inconsistencies in application across entities. The business model and
cash flow characteristics need careful consideration, which can be
subjective.
 ➢ Expected Credit Loss (ECL) Model: The forward-looking ECL model
requires entities to make significant judgments and estimates about
future economic conditions, which can lead to volatility in financial
statements. Companies may struggle with data availability and the
modeling of credit losses.
➢ Hedge Accounting Challenges: While IFRS 9 offers more flexible hedge
accounting, aligning hedge relationships with risk management practices
can be difficult. Companies may need to overhaul their hedge
documentation and processes, which can be resource-intensive.
➢ Implementation Costs: Transitioning to IFRS 9 often involves significant
costs related to system upgrades, staff training, and changes in
processes. Smaller entities may find these burdens particularly
challenging.
➢ Impact on Financial Ratios: Changes in how financial instruments are
measured and recognized can affect key financial ratios, potentially
impacting covenants, credit ratings, and investor perceptions.
➢ Regulatory Compliance: Companies need to ensure compliance with
both IFRS 9 and local regulations, which can sometimes lead to
conflicting requirements and additional complexity. Overall, while IFRS 9
aims to improve transparency and consistency in financial reporting, its
implementation has posed significant challenges for many organizations

ADVANTAGES AND DISADVANTAGES

Advantages
➢ Liquidity: Financial instruments like stocks and bonds can often be
bought and sold quickly in financial markets, providing liquidity to
investors. • Risk Management: Instruments such as derivatives (options,
futures) allow businesses and investors to hedge against risks, protecting
against adverse price movements.
➢ Access to Capital: Companies can raise funds through the issuance of
equity or debt instruments, enabling them to finance operations,
expansion, or innovation.
➢ Portfolio Diversification: Investors can diversify their portfolios by
including a variety of financial instruments, which helps spread risk.
➢ Price Discovery: Financial markets provide a mechanism for determining
the value of instruments, aiding in the efficient allocation of resources.
 ➢ Income Generation: Instruments like bonds and dividend-paying stocks
provide regular income, which can be attractive to income-focused
investors
➢ . • Flexibility: A wide range of financial instruments allows investors and
companies to choose products that best meet their risk appetite and
investment goals
. Disadvantages
➢ Complexity: Some financial instruments, particularly derivatives, can be
complex and difficult to understand, leading to potential misuse or
mispricing. • Market Risk: Financial instruments are subject to market
fluctuations, which can lead to significant losses for investors.
➢ Liquidity Risk: While many instruments are liquid, some can be illiquid,
making it difficult to sell them without incurring losses.
➢ Credit Risk: The risk that a counterparty will default on their obligations
can affect the value of certain instruments, particularly bonds and
derivatives.
➢ Cost: Trading financial instruments can incur various costs, including
transaction fees, management fees, and taxes, which can erode returns.
➢ Regulatory Risk: Changes in regulations can impact the value and trading
of financial instruments, creating uncertainty for investors and
companies.