NATIONAL UNIVERSITY

JUNIOR PHILIPPINE INSTITUTE OF ACCOUNTANTS

PFRS 9 &PAS 32 Financial Instrument

CONCEPTUAL FRAMEWORK AND REPORTING STANDARD
PREPARED BY: CELI, DOLLY
REVIEWEDBY:

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PAS 32 Financial instrument

- any contract that gives rise to both a financial asset of one entity and a financial liability or equity
instrument of another entity.

Financial asset - any asset that is:

• Cash;

• Equity instrument of another entity;

• Contractual right to receive cash or another financial asset or to exchange financial assets or financial
liabilities with another entity under conditions that are potentially favorable to the entity.

Examples: Trade accounts receivable, notes receivable, loans receivable, bonds receivable

Financial liability - any liability that is a contractual obligation:

• to deliver cash or another financial asset to another entity;or

• to exchange financial assets or financial liabilities with another entity under conditions that are
potentially unfavorable to the entity.

Examples: Trade accounts payable, notes payable, loans payable, bonds payable

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Equity instrument - any contract that evidence a residual interest in the assets of an entity after
deducting all of the liabilities.

- include ordinary share capital, preference share capital and warrants or options.

How to present financial instruments?

The fundamental rule in PAS 32, paragraph 15 is to classify the financial instruments on initial
recognition as a financial liability, a financial asset or an equity instrument in accordance with:

•The substance of the contract, and

•The definitions of a financial asset, financial liability and an equity instrument.

It not such a big deal to classify financial assets, but sometimes there are challenges to distinguish
between financial liabilities and equity instruments.

When liability and when equity

Is there a contractual obligation to deliver cash or another financial asset to another entity?

If yes, then the instrument is a financial liability.

If not, then the instrument is an equity instrument.

Compound financial instrument - contains both a liability and an equity element from the perspective
of the issuer.

Examples: bonds payable issued with share warrants, convertible bonds payable

Accounting for compound instrument

PAS 32 mandates that such components shall be accounted for separately. The fair value of the liability
component is first determined, then it will be deducted from the total consideration received from the
issuance of the compound financial instrument. The residual amount is allocated to the equity
component.

Bonds payable issued with share warrants

When the bonds are sold with share warrants, the bondholders are given the right to acquire shares of
the issuer at a specified price at some future time. In this case, two securities are sold- the bonds and
the share warrants. Share warrants have a value and therefore shall be accounted for separately.

Allocation of issue price

The bonds are assigned an amount equal to the "market value of the bonds ex-warants", regardless of
the market value of the warrants. The residual amount of the issue price shall then be allocated to the
warrants.

For example, an entity issued bonds with face amount of 5,000,000 at 105. Each 1,000 bond is
accompanied by one warrant that permits the bondholder to purchase 20 shares, par 50, at 55 per share.

The market value of the bond ex-warrant at the time of issuance is 98.
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Issue price of bonds with warrants (5,000,000x105%) 5,250,000

Market value of bonds ex-warrants-liablity (5,000,000x98%) (4,900,000)
Residual amount allocated to share warrants-equity 350,000
Convertible bonds

It give the holders the right to convert their bondholdings into share capital of the issuing entity within a
specified period of time. The issuance shall be accounted for as partly liability and partly equity. In other
words, the issue price of the convertible bonds shall be allocated between the bonds payable and the
conversion privilege.

Allocation of issue price

The bonds are assigned an amount equal to the maket value of the bobds without the conversion
privilege. The residual amount shall be allocated to the conversion privilege or equity component

For example, an entity issued bonds with face amount of 5,000,000 at 105. The bonds contain a
conversion privilege that provides for an exchange of a 1,000 bond for 20 shares with par value of 50.

It is reliably determined that the bonds would sell only at 95 without the conversion privilege.

Total issue price (5,000,000x105%) 5,250,000

Issue price of bonds without conversion privilege (5,000,000x95%) (4,750,000)
Residual amount allocated to conversion privilege-equity 500,000

Financial asset
Initial measurement

- fair value plus transaction costs that are directly attributable to the acquisition of the financial assets,
in the case of financial asset not at fair value through profit or loss.

- transaction costs are expensed outright, if the financial asset is held for trading of if it is measured at
fair value through profit or loss.

Subsequent measurement

a. Fair value through profit or loss(FVPL)

b. Fair value through other comprehensive income( FVOCI)

c. Amortized cost

Financial assets at FVPL

The following financial assets shall be measured at FVPL:

1. Financial assets held for trading (trading securities)

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• Trading securities are debt and equity securities that are purchased with the intent of selling them
in the near term or very soon.

2. All other investments in quoted equity instruments

3. Debt investments that are irrevocably designated on initial recognition as at FVPL.

4. All debt investments that do not satisfy the requirements for measurement at amortized cost and at
FVOCI.

Note:
- expensed outright
- unrealized gain is classified in the income statement as other income
- unrealized loss is reported in the income statement as other expense
- on disposal of financial asset, the difference between the carrying amount and the consideration
received is recognized as gain or loss on disposal to be reported in the income statement

Financial assets at FVOCI

At initial recognition, PFRS 9, paragraph 5.7.5, provides that an entity may make an irrevocable election
to present in other comprehensive income or OCI subsequent changes in fair value of an investment in
equity instrument that is not held for trading.

Note:

- fair value plus transaction costs directly attributable to the acquisition

- unrealized gain/loss is presented as component of other comprehensive income
-gain or loss on disposal of equity investment measured at FVOCI is recognized in retained earnings
-the cumulative gain or loss recognized in other comprehensive income is also transferred to retained
earnings

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SOURCES:
//
Valix(2018). Conceptual Framework and Reporting Standard
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