Financial Instruments
A financial instrument is any contract that gives rise to a financial asset of one entity and a
financial liability or equity instrument of another entity
A financial asset is any asset that is:
* cash • an equity instrument of another entity • a contractual right to receive cash or another
financial asset from another entity • a contractual right to exchange financial assets or
liabilities with another entity under conditions that are potentially favourable
A financial liability is any liability that is a:
* contractual obligation to deliver cash or another financial asset to another entity.
To exchange financial assets or liabilities with another entity under conditions that are
potentially unfavourable • that will or may be settled in the 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.
Reporting standards
• IAS 32 Financial Instruments: Presentation
• IFRS 7 Financial Instruments: Disclosures
• IFRS 9 Financial Instruments – Measurement
FINANCIAL LIABILITY
Financial liability can be classified into two:
a. Derivatives and Liabilities held for trading
b. Borrowings and Loan notes
IM - Fair value; Transaction cost is deducted from fair value
YM - Amortised cost method using effective interest method
Compound instruments
A compound instrument is a financial instrument that has characteristics of both equity and
liabilities. E.g. Convertible loan note.
Presentation and measurement of compound instruments
IAS 32 requires compound financial instruments be split into two components:
✓ a financial liability:
IM - Measured at present value of cash outflows discounted at a market rate of interest for a
similar instrument without conversion rights.
YM - Amortised cost method
✓ an equity instrument (the option to convert into shares):
IM - difference between the cash proceeds from the issue of the instrument and the value of
the liability component.
YM - Not remeasured.
Note: Upon conversion, Equity and Liability gets cancelled.
If the shares are not converted, the liability gets cancelled and OCE remains with equity
under non-distributable reserve.
EQUITY INSTRUMENTS WE WILL INVEST IN SHARES
DEFAULT METHOD ALTERNATIVE METHOD
FAIR VALUE THROUGH P/L FAIR VALUE THROUGH OCI
FOR TRADING PURPOSE FOR BECOMING AN OWNER
CASH FLOWS = FROM GAIN ON LOSS ON
CASHFLOWS = FROM DIVIDENDS
TRADE
WHEN YOU INVEST==>> INCURE WHEN YOU INVEST==>> INCURE
TRANSACTION COST TRANSACTION COST
TRANSACTION COST => EXPENSE TRANSACTION COST => CAPATLISE
YEAR END WE MUST CHANGE TO = FV YEAR END WE MUST CHANGE TO = FV
GAIN/ LOSS = P/L GAIN/ LOSS = OCI
a. FVTPL
By default
IM - at Fair value; Transaction costs are expensed
YM- at Fair value, G/L in SOPL
b. FVTOCI
irrevocable choice
IM at Fair value; Transaction costs are capitalised
YM IS at Fair value; G/L in OCl and it cannot be reclassified to SOPL. When the FVOCI
instrument is sold, the reserve can be left in equity, or transferred into retained earnings.
DEBT INVESTMENTS
Financial assets that are debt instruments can be measured in one of three ways:
• Amortised cost
• Fair value through other comprehensive income
• Fair value through profit or loss
Business model test - This test evaluates the objective of the purchase of the debt investment
by the company.
Contractual cash flow test - This test checks whether 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
Measurement
Amortised cost
For investment in debt that are measured at amortised cost:
IM – Fair value; transaction cost is capitalised
YM - Amortised cost method using effective interest method
QUESTION 1
On 01/01/01 AB Co. issues a 6% loan note at its nominal value of $200,000. They are issued
at a 5% discount
and $1,700 of issue costs are incurred. The loan notes will be repayable at a premium of 10%
after 4 years.
The effective interest is 10% Prepare the extracts of SOPL and SOFP for each of the 4 year.
QUESTION 2
On 01 Jan 2010 AB Co, issues a 6% redeemable preference shares at its nominal value of
$100,000. They are issued at a 10% discount
and $2000 of issue costs are incurred. The loan notes will be repayable at a premium after 4
years.
The effective interest is 10%. Calculate the finance cost for the year ended 31 Dec 2011.
QUESTION 3
A company issues $10m of 5% convertible loan notes at par on 1 January 2010.
The loan notes are redeemable for cash or convertible into equity shares on the basis of 20
shares per $100 of debt
at the option of the loan note holder on 31 December 2013. Similar but non-convertible loan
notes carry an interest rate of 9%.
The present value of $1 receivable at the end of the year based on discount rates of 9% can be
taken as:
9%
YEAR 1 0.92
YEAR 2 0.84
YEAR 3 0.77
YEAR 4 0.71
Required: Show how these loan notes should be accounted for in the financial statements at
31 December 2011
QUESTION 4
A company issues $20m of 4% convertible loan notes at par on 1 January 2009.
The loan notes are redeemable for cash or convertible into equity shares on the basis of 20
shares per $100 of debt
at the option of the loan note holder on 31 December 2011. Similar but non-convertible loan
notes carry an interest rate of 9%
The present value of $1 receivable at the end of the year based on discount rates of 4% and
9% can be taken as:
4% 9%
YEAR 1 0.96 0.92
YEAR 2 0.92 0.84
YEAR 3 0.89 0.77
Required: Show how these loan notes should be accounted for in the financial statements at
31 December 2009
QUESTION 5
In April 2008 a company purchased 50,000 $1 listed equity shares at a price of $10 per share.
Transaction costs were $5,000. At the year end of 31 December 2008, these shares were
trading at $15.
A dividend of 50c per share was received on 30 August 2008.
Show the financial statement extracts at 31 December 2008 relating to this investment on the
basis that:
(a) The shares were bought for trading (conditions for FVTOCI have not been met)
(b) Conditions for FVTOCI have been met
QUESTION 6
In November 2008 a company invested in 25,000 shares of a listed company at a price of
$4.50 per share.
Transaction costs were $1,500. At the year end of 31 December 2008, these shares were
trading at $5.20.
Show the financial statement extracts at 31 December 2008 relating to this
investment on the basis that:
a) The shares were bought for trading (conditions for FVTOCI have not been met)
(b) Shares are held for non-trading purpose
QUESTION 7
A co purchases a 6% Loan note at their nominal value of $20000. Issue cost is $1000
on 01 JAN 2010.
They are repayable at a premium after 5 years. The effective rate of interest is 10% Prepare
the FS for 31 DEC 2011
QUESTION 8
On 1 January 20X1 Chelsea Co purchases a debt instrument for its fair value of $5,000.
The debt instrument is due to mature on 31 December 20X5. The instrument has a principal
amount of $5500
and the instrument carries fixed interest at 6% that is paid annually.
The effective rate of interest is 10%.
Show the FS for 31 December 20X1.