Financial Instruments Version

8/12/2019 Financial Instruments Version

1/71

2011 IFRS Foundation

1The IFRS fo r SMEs

Topic 2.1

Section 11 Basic Financial Ins truments

Section 12 Other Fin . Inst . IssuesSection 22Liabi l i ties and Equ ity


2/71


2

This PowerPoint presentation was prepared by IFRS Foundation educationstaff as a convenience for others. It has not been approved by the IASB.

The IFRS Foundation allows individuals and organisations to use thispresentation to conduct training on the IFRS for SMEs. However, if youmake any changes to the PowerPoint presentation, your changes should beclearly identifiable as not part of the presentation prepared by the IFRSFoundation education staff and the copyright notice must be removed fromevery amended page .

This presentation may be modified from time to time. The latest versionmay be downloaded from:http://www.ifrs.org/IFRS+for+SMEs/SME+Workshops.htm

The accounting requirements applicable to small and medium-sized entities(SMEs) are set out in the Intern ational Financ ial Repor ting Standard (IFRS)for SMEs, which was issued by the IASB in July 2009.

The IFRS Foundation, the authors, the presenters and the publishers do notaccept responsibility for loss caused to any person who acts or refrainsfrom acting in reliance on the material in this PowerPoint presentation,whether such loss is caused by negligence or otherwise.
http://www.ifrs.org/IFRS+for+SMEs/SME+Workshops.htmhttp://www.ifrs.org/IFRS+for+SMEs/SME+Workshops.htm


3/71


3Sections 11-12Introduction

Financial instruments split into twosections:

Sec. 11 Basic Financial Instruments

Sec. 12 Other Financial InstrumentsIssues

Together the two sections cover

recognising, derecognising, measuring,

and disclosing financial assets andfinancial liabilities


4/71


4Sections 11-12Introduction

Section 11 is relevant to all SMEs Section 12 is relevant If:

SME owns or issues exotic financial

instrumentsinstruments that impose

risks or rewards that are not typical of

basic financial instruments

SME wants to do hedge accounting


5/71


5Sections 11-12Accounting choice

Entity may choose to apply either: Sections 11 and 12 in full, or

Recognition and measurement provisions

of IAS 39 and the disclosure requirements

in Sec 11 & 12

No option to use IFRS 9

The option chosen applies to all financial

instruments (not individually) To change option, follow Section 10


6/71


6Sections 11-12Basic principles

Basic principle of Section 11:

Amortised cost model for all basic FI

except investments in ordinary or

preference shares that are publicly traded

or whose fair value can be measuredreliablythese are fair value through

profit or loss (FVTPL).

Basic principle of Section 12:

FI not covered by Section 11 are at

FVTPL


7/71


7Section 11Scope

All basic financial instruments exceptthose covered by other sections of IFRS

for SMEs:

Investments in sub, associate, JV (see

Sections 9, 14, 15) Entitys own equity (see Sec 22, 26)

Leases (see Section 20)

Employee benefit assets and liabilities(see Section 28)


8/71


8Sections 11-12Definitions

Financial instrument

Contract that gives rise to a financial

asset of one entity and a financial liability

or equity instrument of another entity

Includes cash But commodities that are near cash like

gold are not financial instruments


9/71


9Sections 11-12Definitions

Basic financial instrument*

Cash

Debt instrument (accounts, notes, and

loans receivable and payable) that meet

conditions on next slide Ordinary and preference shares that are

not convertible and not puttable

*These notes do not discuss loan commitments


10/71


10Section 11Basic debt instruments

Debt instruments are in Section 11 if:

Returns to holder are fixed, variable

referenced to an observable rate, or

combination of fixed and variable

No special provision could cause holderto lose principal

Prepayment conditions are not contingent

on a future event No special conditional returns


11/71



Examples of basic debt instruments:

Trade accounts and notes receivable and

payable

Loans from banks and other 3rd parties

Accounts payable in foreign currency Loans to/from subsidiaries or associates

that are due on demand

Debt instrument that becomes

immediately due if issuer defaults All of these measured at amortised cost


12/71



Examples of NOT basic debt instruments:

Investment in convertible or puttable

shares or debt

Swaps, forwards, futures, options, rights,

and other derivatives Loans with unusual prepayment

conditions (based on tax change,

accounting change, linked to company

performance) All of these are FVTPL under Section 12


13/71


13Section 11Recognition and measurement

Initial recognition:

When entity becomes a party to the

contractual provisions of the instrument

IFRS for SMEsallows judgement

regarding trade date vs settlement dateaccounting, but be consistent


14/71



Initial measurement:

At transaction price

Include transaction costs except for FI

that will be measured at FVTPL

Impute interest if payment is deferred

beyond normal terms or below-market

interest


15/71



Initial recognition-measurement examples:

Loan made to another entity: Measure

at PV of interest and principal payments

Goods sold to customer (purchased

from supplier) on normal credit terms:Measure receivable (payable) at

undiscounted invoice price


16/71



Initial recognition-measurement examples:

Goods sold (purchased) on 2-year interest freecredit: Measure at current cash sale price or PV

of receivable or payable

Example: We sell goods for 1,000, payment due

2 years, interest-free. Cash price = 857. IRR =8%.

Journal entries Debit Credit

At time of sale Receivable 857

Sales Revenue 857

End of year 1 Receivable 69

8% x 857 = 69 Interest Revenue 69


17/71



Subsequent measurement:

Debt instruments in the scope of Section

11 (even if publicly traded):

Amortised cost using the effective

interest method Equity instruments in scope of Section 11:

If publicly traded or FV can be

measured reliably: FVTPLAll others: cost less impairment


18/71



What is amortised cost?

Amount measured at initial recognition

Minus repayments of principal

Plus or minus cumulative amortisation of

any difference between initial

measurement and maturity amount (using

effective interest method)

Minus (for assets) reduction for impairmentor uncollectibility


19/71



What is effective interest method?

Effective interest is rate that exactlydiscounts future cash payments (receipts) to

the carrying amount Also called Internal Rate of Return

Amortised cost = PV of future cash receipts

(payments) discounted at effective interest

rate

Interest expense (income) = carrying amountat beginning of period x effective interest rate


20/71


20Section 11Effective interest example

1/1/X0 buy 5-year bond for 900, transaction cost =

50, cash interest = 40/year, mandatory redemptionat 1,100 at 31/12/X4.

Year Carrying amount

beginning

Int. income

at 6.9583%*

Cash

inflow

Carrying amt

ending

X0 950.00 66.10 (40) 976.11X1 976.11 67.92 (40) 1,004.03

X2 1,004.03 69.86 (40) 1,033.89

X3 1,033.89 71.94 (40) 1,065.83

X4 1,065.83 74.16 (40) 1,100.00

*6.9583% is the rate that exactly discounts the cash flows to 950.00


21/71



What is fair value?

Amount for which FI could be sold or

settled in an arms length transaction

Best: Quoted market price in an active

market (bid price) Next: Price in a recent transaction for

identical asset (unless circumstances have

changed)

Estimate using a valuation technique (amodel)


22/71


22Section 11Impairment

Impairment only applies to FI measured at

cost or amortised cost

At each reporting date, look for evidence

that FV is below carrying amount

Significant financial difficulty of issuer

Default or delinquency

Abnormal concession granted to debtor by

creditor Probable debtor bankruptcy or reorg.


23/71



Impairment assessment:

Individually for all equity instruments

Individually for debt instruments that are

individually significant

For other debt instruments, eitherindividually or grouped based on similar risk

characteristics

Impairment recognition: Write-down is recognised in P&L


24/71



Measurement of the impairment loss:

Debt instruments: Difference betweencarrying amount and current PV of estimated

cash flows discounted at assets original

effective interest rate. (Use current rate if

variable.)

Equity instruments: Difference between

carrying amount and best estimate

(approximation) of the amount (might be zero)that entity would receive if asset were sold at

reporting date.


25/71



Reversal of an impairment loss:

Required if the problem causing the original

impairment reduces

Write up but not to more than what carrying

amount would have been had noimpairment been recognised (ie not to FV

but to new amortised cost)

Reversal recognised in P&L


26/71


26Section 11Derecognition

Derecognition of a financial asset:

Derecognition = remove from balance sheet

Only when:a. Rights to cash flows expire or settled

b. Substantially all risks and rewards (cashflows) transferred to other entity

c. Transferred some but not substantially all

risks and rewards, and physical control of

asset transferred to another party who hasthe right to sell the asset to an unrelated

third party.


27/71



Derecognition of a financial asset:

In case (c) above:

Derecognise old asset entirely, and

Recognise separately any rights and

obligations retained or created in the transfer(measure at fair value)

If transfer does not result in derecognition, keep

transferred asset on books and recognise

financial liability for the consideration received Do not offset


28/71



Derecog. of financial assetexamples:

Must derecognise: Sell receivables to bank

but we continue to collect and remit, for a

handling fee. Bank assumes credit risk.

May not derecognise: Same facts exceptentity agrees to buy back any receivables in

arrears for more than 120 days. Entity

continues to recognise the receivables until

collected or writeoff as uncollectible.


29/71



Derecognition of a financial liability:

Only when extinguished, that is:a. Discharged

b. Cancelled

c. Expired

If existing debt is replaced with new onewith substantially different terms (or

there is a significant modification of

terms): Treat as new liability and extinguishment of

original liability


30/71


30Section 11Disclosure

Disclose accounting policies for FI

Disclose financial assets and liabilities bycategories in the balance sheet:

Equity or debt at FVTPL

Debt at amortised cost Equity measured at cost less impairment

Liabilities at FVTPL

Liabilities at amortised cost


31/71



Terms, conditions, and restrictions of

financial assets and liability For those at FVTPL, details of how FV was

determined

Details of transfer of financial asset thatdid not qualify for derecognition

Details of financial assets pledged as

collateral

Details of defaults and breaches on loanspayable continued next slide...


32/71



Items of income, expense, gains and

losses:

Changes in FV for instruments measured at

FVTPL

Total interest income and total interestexpense on FI not measured at FVTPL

Impairment loss by class of financial asset


33/71



Initial recognition:

When entity becomes a party to thecontractual provisions of the instrument

Initial measurement:

At FV (normally the transaction price) Transaction costs are charged to expense


34/71



Subsequent measurement:

At FVTPL except: Equity instrument that is not publicly

traded and cannot get FV reliably, then

measure at cost less impairmentAlso measure a contract linked to such

equity instrument at cost less impairment

If previously at FVTPL, but now a reliable FV

measure is no longer available, treat mostrecent FV measure as cost going forward.


35/71


35Section 12Hedge accounting

Hedging and hedge accounting are two

different things

What is hedging?

Managing risks by using one financial

instrument (hedging instrument) purposelyto offset the variability in FV or cash flows

of a recognised asset or liability, firm

commitment, or future cash flows (hedged

item)


36/71



What is hedge accounting?

Matching the change in FV of the hedging

instrument and the hedged item in the

same income statement

Hedge accounting is only an issue whennormal accounting would put the two FV

changes in different periodssometimes

referred to as an accounting mismatch


37/71



The hedgers accounting dilemma:

I have a risk in an asset or liability measured atamortised cost

Any change in FV or cash flows from that

asset or liability is recognised only when

realised in cash (asset is sold, liability issettled, cash flows occur)

To hedge, I buy a derivative, which is measured

at FVTPL at each reporting date

I need special hedge accounting to fix

this mismatch

S i 12 H d i


38/71



The hedgers accounting dilemma an

illustration: Entity has note payable at a fixed rate of interest

due in 3 years. Note measured at amortised cost.

Buys swap to convert receive fixed interest to pay

variable. Swap is measured at FVTPL.

End of year 1, interest rate declines. Therefore

loss on derivative immediately recognisedbut

an offsetting gain (not yet recognised) because

we will be paying the lower variable rate of

interest in future.

S ti 12 H d ti


39/71



Hedge accounting matching the gain (loss)

on the derivative with the loss (gain) on thehedged item.

Hedge accounting is optional.

S ti 12 H d ti


40/71



To qualify for hedge accounting:

Designate and document hedgingrelationship up front

Clearly identify the hedged risk

Hedged risk is listed in 12.17 Hedging instrument is listed in 12.18

Entity expects hedging instrument to be

highly effective in offsetting the designatedhedged risk.

S ti 12 H d ti


41/71



Hedged risk must be (12.17):

Interest rate risk in debt measured at cost

FX or interest rate risk in firm commitment

or highly probable forecast transaction

Price risk in a commodity owned or to beacquired in a firm commitment or highly

probable forecast transaction

FX risk in a net investment in a foreignoperation

S ti 12 H d ti


42/71



Hedged risk must be (12.17):

FX risk in debt instrument measured at cost is notin this list. Why?

Under 30.10 (FX) the debt is translated at

spot rate and FX gain or loss is recognised in

profit or loss

Change in FV of the swap (hedging

instrument) is also recognised in profit or loss

(measured using forward rate)

Natural hedge

Section 12 Hedge accounting


43/71



Hedging instrument must be (12.18):

Interest rate swap, FX swap, FX forward,commodity forward

Entered into with external party

Notional amount = principal or notionalamount of hedged item

Specified maturity not later than maturity or

settlement of hedged item Cannot be prepaid or terminated early



44/71



Hedge of fixed interest rate risk or

commodity price risk of commodity held Recognise hedging instrument as asset or

liability

Change in FV of hedging instrument in P&L

Change in FV of hedged item in P&L and

adjustment of carrying amount of hedged

itemeven though hedged item is

otherwise measured at costThis is called Fair Value Hedge in IAS 39.



45/71



Hedge of fixed interest rate risk or

commodity price risk of commodity held(continued)

If hedged risk was fixed interest in debt

measured at cost, recognise in P&L theperiodic net settlements from the derivative

(interest rate swap) in the period in which

the net settlements occur.

46Section 12 Hedge accounting


46/71



ExampleAssumptions:

Entity borrows 1,000, 3 years, 5% fixed rate,payable measured at amortised cost

Hedged with a derivative whose value is linked to

an interest rate index

End of year 1, market rate = 6%. FV of 1,000

payable 2 years 6% = 1,000 x .889996 = 890, but

this 110 gain is not recognised

Value of the derivative declines to -112 Note there is small ineffectiveness = 2



47/71



Balance sheet at time loan is made:

Cash 1,000

Loan payable 1,000

Adjust loan end of year 1 to reflect rate change:

Loan payable 110

P&L 2

Derivative (Liability) 112

Balance sheet end of year 1:

Cash 1,000


Loan payable 890

Equity (2)



48/71



Conceptual question regarding the

previous example: Does the 890 carrying amount of the loan

payable at end of year 1 represent the Fair

Value of the loan? Hint: Does the 890 reflect change in credit

risk or prepayment risk?

If 890 is not Fair Value, what is it?



49/71



Hedge of fixed interest rate risk and

commodity price risk (continued) Discontinue hedge accounting when:

Hedging instrument expires

Hedge no longer meets conditions Entity revokes designation

Any gain or loss that was included in the

carrying amount of the hedged item is

amortised to P&L over remaining life ofhedged item.



50/71



Hedge of variable interest rate risk, FX or

commodity price risk of commodity held,highly probable forecast transaction, or net

investment in foreign operation

Recognise change in FV of hedginginstrument in OCI (assuming it was

effective; ineffectiveness reported in P&L)

'Recycle' amount recognised in OCI when

hedged item hits P&L or hedgingrelationship ends.



51/71



Hedge of variable interest rate risk, FX or

commodity price risk of commodity held,highly probable forecast transaction, or net

investment in foreign operation (continued)

If hedged risk was variable interest in debt

measured at cost, recognise in P&L theperiodic net settlements from the interest

rate swap in the period in which the net

settlements occur.This is called Cash Flow Hedge in IAS 39.



52/71



ExampleAssumptions:

Entity sells goods for 1,000 floating rate 3-year note receivable

Interest rate risk managed with a derivative

(interest rate swap) End of year 1 interest rates increasePV

of cumulative cash flows increase by 100

But FV of swap decreases by 105

Note: Some hedge ineffectiveness



53/71



Opening balance sheet:

Receivable 1,000Equity 1,000

Ineffective portion of hedge:

P&L* 5*

OCI (Equity) 100


*Ineffective portion of hedge

example continued next slide...


54/71



55/71


g g

Hedge of variable interest rate risk etc...

Discontinue hedge accounting when: Hedging instrument expires

Hedge no longer meets conditions

Forecast transaction no longer probable Entity revokes designation

Any prior gain or loss on forecast

transaction that was recognised in OCI is

recycled to P&L



56/71


g g

Disclosures relating to hedge accounting

For each type of hedge: Description of hedge(risk, hedged item, instrument)

Special disclosures for hedge of fixed interest

rate risk and commodity price risk of commodity

held

Special disclosures for hedge of variable interest

rate risk, FX or commodity price risk of

commodity held, highly probable forecast

transaction, or net investment in foreign operation

57Section 22Liabilities and equity


57/71


q y

Scope of Section 22

Principles for classifying an instrument asdebt or equity

Original issuance of shares and other

equity instruments Sale of options, rights, warrants

Bonus issues and share splits

Issuance of convertible debtcontinues...



58/71


q y

Scope of Section 22, continued

Treasury shares Distributions to owners

Non-controlling interest and transactions in

shares of a consolidated subsidiary



59/71


q y

Principles for classifying an instrument as

debt or equity Equity = residual interest in assets minus

liabilities

Liability is a present obligation (entity doesnot have a right to avoid paying cash)



60/71


The following are equity:

Puttable instrument that entitles holder topro rata share of net assets on liquidation

Instrument that is automatically redeemed if

an uncertain future event occurs or death orretirement of holder

Subordinated instrument payable only on

liquidation



61/71


The following are liabilities:

Instrument is payable on liquidation, butthe amount is subject to a maximum

ceiling

Entity is obliged to make payments beforeliquidationsuch as mandatory dividend

Mandatorily redeemable preference shares



62/71


Members shares in a cooperative are

equity only if: Coop has unconditional right to refuse

redemption of members shares, or

Redemption is unconditionally prohibitedby law or entitys charter

Otherwiseliability



63/71


Original issuance of shares and other equity

instruments Recognise when equity is issued and subscriber

is obligated to invest

If equity is issued before the entity gets cash, the

receivable is an offset to equity (not an asset) If entity gets (nonrefundable) cash before equity

is issued, equity is increased

No increase in equity is recognised for subscribed

shares that have not been issued and entity has

not received cash



64/71


Sale of options, rights, warrants

Same principles as for original issuance ofshares (previous slide)

Transaction costs in issuing equity

instrumentsAccounted for as a reduction of equity (not

an expense)



65/71


Bonus issues (stock dividends) and share

splits These do not change equity

Accounted for as reclassification of

amounts within equity (out of retainedearnings and into permanent capital)

Amounts reclassified should be based on

local laws



66/71


Issuance of convertible debt

Must account separately for debt component andequity component (conversion right)

Debt proceeds = FV of similar risk debt without

conversion feature (PV calculation)

Equity proceeds are the residual

Recorded at issuance; not subsequently revised

Subsequently, debt discount = additional interest

expense (effective interest method)



67/71


Issuance of convertible debt - Example

1/1/X1 issue at par a 4% convertible bond, par and

maturity amount = 50,000, maturity in 5 years

If no conversion feature, would have paid 6%

Calculate present value of cash flows at 6%:

PV 50,000 due in 5 years @ 6% = 37,363 PV annuity 2,000/year 5 years @ 6% = 8,425

Total PV = 45,788

Debit cash 50,000

Credit financial liability 45,788Credit equity (conversion right) 4,212



68/71


Date Inter-

est

paid

Interest

expense

@ 6%

Amort. of

discount

Bond

dis-

count

Net bond

liability

1/1/X1 4,212 45,788

31/12/X1 2,000 2,747 747 3,465 46,535

31/12/X2 2,000 2,792 792 2,673 47,32731/12/X3 2,000 2,840 840 1,833 48,167

31/12/X4 2,000 2,890 890 943 49,057

31/12/X5 2,000 2,943 943 0 50,000

31/12/X1: Debit interest expense 2,747

Credit financial liability 747

Credit cash 2,000



69/71


Treasury shares

Equity instruments entity has issued andlater reacquired

Measure at cash paid or FV of other

consideration given to acquire \ Present as deduction from equity (not

asset)

No gain or loss recognised on purchase,

sale, or cancellation



70/71


Distributions to owners

If cashmeasurement = cash paid If non-cashmeasurement = FV of assets

distributed

Amount reduces equity

If entity gets tax deduction for dividend, taxbenefit is adjustment of equity

Not reduction of income tax expense

If entity pays withholding tax on dividendspaid, tax reduces equity as part of dividend



71/71


Non-controlling interest (NCI) and

transactions in shares of a consolidatedsubsidiary

In consolidated balance sheet NCI is part of

equity (not liability or in between)

Change in parents controlling interest that doesnot result in loss of control is a transaction with

owners

Equity adjustment, not through P&L

No adjustment of carrying amounts of assetsor goodwill

Documents

Financial Instruments Version