Ifrs 9-Financial Instruments (Recognition & Measurement)
Ifrs 9-Financial Instruments (Recognition & Measurement)
Ifrs 9-Financial Instruments (Recognition & Measurement)
OBJECTIVE
The objective of this Standard is to establish principles for the financial reporting of financial
assets and financial liabilities that will present relevant and useful information to users of
financial statements for their assessment of the amounts, timing and uncertainty of an entity’s
future cash flows.
SCOPE
This Standard shall be applied by all entities to all types of financial instruments except:
(a) those interests in subsidiaries, associates and joint ventures that are accounted for in
accordance with IFRS 10 Consolidated Financial Statements, IAS 27 Separate Financial
Statements or IAS 28 Investments in Associates and Joint Ventures. However, entities shall apply
this Standard to derivatives on an interest in a subsidiary, associate or joint venture unless the
derivative meets the definition of an equity instrument of the entity in IAS 32 Financial
Instruments: Presentation.
(b) rights and obligations under leases to which IFRS 16 Leases applies. However: (i) finance
lease receivables (i.e. net investments in finance leases) and operating lease receivables
recognised by a lessor are subject to the derecognition and impairment requirements of this
Standard;
(ii) lease liabilities recognised by a lessee are subject to the derecognition requirements of this
Standard and derivatives that are embedded in leases are subject to the embedded derivatives
requirements of this Standard.
(c) employers’ rights and obligations under employee benefit plans, to which IAS 19 Employee
Benefits applies.
(d) financial instruments issued by the entity that meet the definition of an equity instrument in
IAS 32 (including options and warrants) or that are required to be classified as an equity
instrument. However, the holder of such equity instruments shall apply this Standard to those
instruments, unless they meet the exception in (a).
(i) an insurance contract as defined in IFRS 4 Insurance Contracts, other than an issuer’s rights
and obligations arising under an insurance contract that meets the definition of a financial
guarantee contract, or
(ii) a contract that is within the scope of IFRS 4 because it contains a discretionary participation
feature. However, this Standard applies to a derivative that is embedded in a contract within the
scope of IFRS 4 if the derivative is not itself a contract within the scope of IFRS 4. Moreover, if
an issuer of financial guarantee contracts has previously asserted explicitly that it regards such
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contracts as insurance contracts and has used accounting that is applicable to insurance contracts,
the issuer may elect to apply either this Standard or IFRS 4 to such financial guarantee contracts.
The issuer may make that election contract by contract, but the election for each contract is
irrevocable.
(f) any forward contract between an acquirer and a selling shareholder to buy or sell an acquiree
that will result in a business combination within the scope of IFRS 3 Business Combinations at a
future acquisition date. The term of the forward contract should not exceed a reasonable period
normally necessary to obtain any required approvals and to complete the transaction.
(g) loan commitments other than those loan commitments described in this Standard. However,
an issuer of loan commitments shall apply the impairment requirements of this Standard to loan
commitments that are not otherwise within the scope of this Standard. Also, all loan
commitments are subject to the derecognition requirements of this Standard. The following loan
commitments are within the scope of this standard:
(i) loan commitments that the entity designates as financial liabilities at fair value through profit
or loss. An entity that has a past practice of selling the assets resulting from its loan
commitments shortly after origination shall apply this Standard to all its loan commitments in the
same class;
(ii) loan commitments that can be settled net in cash or by delivering or issuing another financial
instrument. These loan commitments are derivatives. A loan commitment is not regarded as
settled net merely because the loan is paid out in instalments (for example, a mortgage
construction loan that is paid out in instalments in line with the progress of construction); and
(h) financial instruments, contracts and obligations under share-based payment transactions to
which IFRS 2 Share-based Payment applies, except for those contracts to buy or sell a non-
financial item that can be settled net in cash or another financial instrument, or by exchanging
financial instruments, as if the contracts were financial instruments:
(i) and are not entered into and continue to be held for the purpose of the receipt or delivery of a
non-financial item in accordance with the entity’s expected purchase, sale or usage requirements;
(ii) may be irrevocably designated as measured at fair value through profit or loss. This
designation is available only at inception of the contract and only if it eliminates or significantly
reduces a recognition inconsistency (sometimes referred to as an ‘accounting mismatch’) that
would otherwise arise from not recognising that contract. This Standard shall be applied to those
contracts that an entity designates as measured at fair value through profit or loss.
(i) rights to payments to reimburse the entity for expenditure that it is required to make to settle a
liability that it recognises as a provision in accordance with IAS 37 Provisions, Contingent
Liabilities and Contingent Assets, or for which, in an earlier period, it recognised a provision in
accordance with IAS 37.
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(j) rights and obligations within the scope of IFRS 15 Revenue from Contracts with Customers
that are financial instruments, except for those that IFRS 15 specifies are accounted for in
accordance with this Standard
Accounts receivable
Are amounts due from customers for goods or services which have been provided in the normal
course of business operations
Carrying amount
Is the amount at which an asset is presented in the statement of financial position
Cash
Refers to cash on hand and demand deposits with banks or other financial institutions
Cash equivalents
Are short-term, highly liquid investments that are readily convertible to known amounts of cash
which are subject to an insignificant risk of changes in value
Compound instrument
Is an issued single financial instrument that contains both liability and equity (e.g. a convertible
loan). Under IAS 32 principles, such instruments are split accounted.
Control
Is the ability to direct the strategic and financial and operating policies of an entity so as to obtain
benefits from its activities.
Credit risk
Is the risk that a loss may occur from the failure of one party to a financial instrument to
discharge an obligation according to the terms of a contract.
Derecognition
Is the removal of a previously recognised financial asset or liability from an entity’s statement of
financial position.
Derivative
Is a financial instrument or other contract with all three of the following features:
Its value changes in response to changes in a specified interest rate, security price,
commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit
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index, or other variable, provided in the case of a non-financial variable that the variable
is not specific to a party to the contract.
It requires little or no initial net investment relative to the other types of contracts that
have a similar response to changes in market conditions.
It is settled at a future date.
Equity instrument
Is any contract that evidences a residual interest in the assets of an entity after deducting all its
liabilities
Fair value
Is the price that would be received to sell an asset, or be paid to transfer a liability, in an orderly
transaction between market participants
Financial instrument
Is any contract which gives rise to both a financial asset of one entity and a financial liability or
equity instrument of another entity
Liquidity risk
Is the risk that an entity may encounter difficulty in meeting obligations associated with financial
liabilities.
Market risk
Is the risk that the fair value or future cash flows of a financial instrument will fluctuate because
of changes in market prices. There are three types of market risk:
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currency risk;
interest rate risk; and
other price risk.
Market value
Is the amount obtainable from a sale, or payable on acquisition, of a financial instrument in an
active market
Transaction costs
Are the incremental costs directly attributable to the acquisition or disposal of a financial asset or
liability
IFRS 9 responds to criticisms that IAS 39 is too complex, inconsistent with the way entities
manage businesses and risks, and defers the recognition of credit losses on loans and receivables
until too late in the credit cycle.
IFRS 9 is built on a logical, single classification and measurement approach for financial assets
that reflects the business model in which they are managed and their cash flow characteristics.
Following from the above is a forward-looking expected credit loss model that will result in
more timely recognition of loan losses and is a single model that is applicable to all financial
instruments subject to impairment accounting.
In addition, IFRS 9 addresses the so-called ‘own credit’ issue, whereby banks and others book
gains through profit or loss as a result of the value of their own debt falling due to a decrease in
credit worthiness when they have elected to measure that debt at fair value.
The Standard also includes an improved hedge accounting model to better link the economics of
risk management with its accounting treatment.
The new Standard is based on the concept that financial assets should be classified and measured
at fair value, with changes in fair value recognised in profit and loss as they arise (‘FVPL’),
unless restrictive criteria are met for classifying and measuring the asset at either Amortised Cost
or Fair Value Through Other Comprehensive Income(‘FVOCI’)
INITIAL RECOGNITION
An entity only recognises a financial asset or financial liability when it becomes party to the
contractual provisions of the instrument.
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Planned future transactions, no matter how likely, are not financial assets or financial liabilities,
as the entity has not become a party to the contract.
Initial measurement
The initial measurement of a financial instrument is driven by its classification in terms of IFRS
9, and for trade receivables, the requirements of IFRS 15 Revenue from Contracts with
Customers (IFRS 15).
Subsequent measurement of financial instruments is determined with reference to its
classification in terms of IFRS 9 only.
Classification determines how financial assets are accounted for in financial statements and, in
particular, how they are measured on an ongoing basis.
Requirements for classification and measurement are the foundation of the accounting for
financial instruments.
The requirements for impairment and hedge accounting are based on that classification.
IFRS 9 applies one classification approach for all types of financial assets, including those that
contain embedded derivative features. Financial assets are therefore classified in their entirety
rather than being subject to complex bifurcation requirements
Two tests/criteria are used to determine how financial assets should be classified and measured:
The entity’s business model for managing the financial assets[BM Test]; and
The contractual cash flow characteristics of the financial asset[SPPI Test]
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The business model should be determined on a level that reflects how financial assets are
managed to achieve a particular business objective.
However, the determination is not dependent on management’s intentions for an individual
instrument, and should be made on a higher level of aggregation.
It is also critical to note that the objective of the business model refers to the intentions in the
ordinary course of business, and NOT what the entity may do under severe stress.
A business model can typically be observed through the activities that an entity undertakes to
achieve its business objective. As such, a business model is a matter of fact rather than an
assertion. Objective information, such as:
Business plans;
How managers of the business are compensated; and
The amount and frequency of sales activity etc, should be considered.
Judgement needs to be used when assessing a business model and that assessment should
consider all relevant available evidence.
Financial assets at amortised cost are held in a business model whose objective is to hold
assets in order to collect contractual cash flows.
The objective of this business model is to hold financial assets to collect contractual cash flows
when the sole focus of the entity is collecting the contractual payments over the life of the asset .
This also means that the entity does not consider the potential gains or losses, which could arise
if the financial asset were to be sold.
Sales information in isolation doesn’t determine the business model; however, it does
provide evidence about how the business objective is achieved and how cash flows are realised.
When determining whether this business model is applicable, an entity should consider past sales
information and expectations about future sales activity.
Having some sales activity is not necessarily inconsistent with this business model.
For example, sales that are infrequent or insignificant in value may be consistent with this
business model, as are sales that occur as a result of an increase in credit risk. However, if more
than an infrequent number of sales occur and those sales are more than insignificant in value, an
entity needs to assess whether and how such sales are consistent with an objective of collecting
contractual cash flows
Financial assets classified and measured at fair value through other comprehensive income are
held in a business model whose objective is achieved by both collecting contractual cash flows
and selling financial assets.
In order to achieve the objective of this business model the contractual cash flows are collected,
but sales of financial assets also occur. (i.e, a mixed objective)
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Compared to a business model whose objective is to hold financial assets to collect contractual
cash flows, this business model will typically involve greater frequency and volume of sales.
NOTE: IFRS 9 does not specify a threshold for frequency or significance of sales of financial
assets.
Various objectives may be consistent with this business model, for example to manage liquidity,
maintain a particular interest yield profile or to match the duration of financial liabilities to the
duration of the assets they are funding.
This measurement category results in amortised cost information being provided in profit or loss
and fair value information in the balance sheet.
Any financial assets that are not held in one of the two business models mentioned above are
measured at fair value through profit or loss. As such, fair value through profit or loss
represents a ‘residual’ category.
Financial assets that are held for trading and those managed on a fair value basis are also
included in this category.
Here the focus is to gain from changes in market prices (fair values) of the financial assets.
In this category the collection of contractual cash flows are merely incidental to achieving the
objective. This means that the contractual cash flows received was never the reason why the
entity invested in the financial asset.
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CONTRACTUAL CASH FLOW CHARACTERISTICS [SPPI TEST]
One of the criteria for determining the classification of a financial asset is whether the
contractual cash flows are solely payments of principal and interest (SPPI). Only financial assets
with such cash flows are eligible for amortised cost or fair value through other comprehensive
income measurement dependent on the business model in which the asset is held.
Contractual cash flows can consist of only payments of principal and interest on the principal
amount outstanding, or they can be defined with reference to other factors. These differences are
important in assessing the classification of financial assets.
To classify financial assets as financial assets at amortised cost or fair value through other
comprehensive income the contractual terms should give rise to cash flows:
On specified dates;
That are solely payments of principal and interest on the principal outstanding
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The dates of the cash flows need to be predetermined in the contract. This implies that an
investment in equity shares, where your cash flow is dividend distributions, would not meet this
requirement. The lack of predetermined dates for the contractual cash flows, making the accurate
discounting of the cash flows impossible, would preclude it from being classified as financial
assets at amortised cost or fair value through other comprehensive income.
According to IFRS 9, two assessments (Tests) are required to be carried out in order to classify
financial assets.
These are;
Business model for managing the financial assets
Contractual cash flows give rise to solely payments of principal and interest (also
colloquially referred to as the ‘SPPI Test’)
The outcome of these assessments, determine whether the investment is accounted for:
At fair value through profit or loss
At fair value through other comprehensive income (OCI) (with or without recycling)
At amortised cost
A financial asset shall be measured at fair value through profit or loss unless it is measured at
amortised cost or at fair value through other comprehensive income.
Classification requirements are applied to a financial asset in its entirety without separating
embedded derivatives
Except for trade receivables which do not contain a significant financing component, at initial
recognition, an entity shall measure a financial asset or financial liability at its fair value plus or
minus, in the case of a financial asset or financial liability not at fair value through profit or loss,
transaction costs that are directly attributable to the acquisition or issue of the financial asset or
financial liability.
Transaction costs are those incremental costs that are directly incurred in the acquisition of a
financial instrument and that would not have been incurred otherwise.
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Transaction costs are expensed where the financial instrument is classified as fair value through
profit or loss.
Example 1
An entity, Suarez, purchased a five-year bond on 1 January 2010 at a cost of $5m with annual
interest of 5%, which is also the effective rate, payable on 31 December annually. At the
reporting date of 31 December 2010 interest has been received as expected and the market rate of
interest is now 6%.
Required:
Account for the financial asset at 31 December 2010 on the basis that:
(i) It is classified as FVTPL, and
(ii) It is classified to be measured at amortised cost, on the assumption it passes the necessary
tests and has been properly designated at initial recognition.
Solution
(i) If classified as FVTPL
This requires that the fair value of the bond is measured based upon expected future cash flows
discounted at the current market rate of interest of 6% as follows:
Therefore, at the reporting date of 31 December 2010, the financial asset will be stated at a fair
value of $4.8267m, with the fall in fair value amounting to $0.1733m taken to profit or loss in
the year. Interest received will be taken to profit or loss for the year amounting to $0.25m.
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In addition, interest received during the year of $0.25m will be taken to profit or loss for the
year.
IFRS 9 requires financial assets to be reclassified between measurement categories when, and
only when, the entity’s business model for managing them changes. This is a significant event
and thus is expected to be uncommon. This ensures that users of financial statements are always
provided with information reflecting how the cash flows on financial assets are expected to be
realised.
Financial liability is prohibited from being reclassified between fair value and amortised cost.
Changes in the objective of an entity’s business model are expected to be very infrequent.
Changes in the objective of an entity’s business model must be determined by the entity’s senior
management.
The change must be a result of external or internal changes, and must be significant to the
entity’s operations and demonstrable to external parties [IFRS 9.B4.4.1].
A change in the objective of the entity’s business model must be effected before the
reclassification date [IFRS 9.B4.4.2].
The reclassification date is the first day of the first reporting period following the change in
business model that results in an entity reclassifying financial assets
If an entity reclassifies financial assets, it shall apply the reclassification prospectively from the
reclassification date. The entity shall not restate any previously recognised gains, losses or
interest [IFRS 9.5.6.1].
In essence, if a financial asset is a simple debt instrument and the objective of the entity’s
business model within which it is held is to collect its contractual cash flows, the financial asset
is measured at amortised cost.
In contrast, if that asset is held in a business model the objective of which is achieved by both
collecting contractual cash flows and selling financial assets, then the financial asset is measured
at fair value on the statement of financial position, and amortised cost information is provided
through profit or loss.
If the business model is neither of these, then fair value information is increasingly important so
it is provided both in profit or loss and on the statement of financial position
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reclassification date.
FVTPL Difference with carrying
amount should be
recognised in P & L
FVTPL Amortised Cost FV at the
reclassification date
becomes its new gross
carrying amount*
Amortised Cost FVOCI FV is measured at
reclassification date.
Difference with amortised cost
should be recognised in OCI.
Effective interest rate is not
adjusted as a result of there
reclassification
IFRS 9 effectively incorporates an impairment review for financial assets that are measured at
fair value, as any fall in fair value is taken to profit or loss or other comprehensive income for the
year, depending upon the classification of the financial asset.
IFRS 9 sets out a new forward looking ‘expected loss’ impairment model which replaces the
incurred loss model in IAS 39.
Under the IFRS 9 ‘expected loss’ model, a credit event (or impairment ‘trigger’) no longer has
to occur before credit losses are recognised. An entity must always recognise (at a minimum) 12-
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month expected credit losses in profit or loss. Lifetime expected losses will be recognised on
assets for which there is a significant increase in credit risk after initial recognition
For financial assets designated to be measured at amortised cost, an entity must make an
assessment at each reporting date whether there is evidence of possible impairment; if there is,
then an impairment review should be performed. If impairment is identified, it is charged to
profit or loss immediately.
Quantification of the recoverable amount would normally be based upon the present value of the
expected future cash flows estimated at the date of the impairment review and discounted to their
present value based on the original effective rate of return at the date the financial asset was
issued.
Improvement Deterioration
Expected credit losses are calculated by: (a) identifying scenarios in which a loan or receivable
defaults; (b) estimating the cash shortfall that would be incurred in each scenario if a default
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were to happen; (c) multiplying that loss by the probability of the default happening; and (d)
summing the results of all such possible default events.
Credit loss:
The difference between all contractual cash flows that are due to an entity in accordance with the
contract and all the cash flow that the entity expects to receive (i.e. all cash shortfalls),
discounted at the original effective interest rate
Question:
On 1 January 2022 Entity A purchased a debenture at its fair value of R1 000 000. No
transaction costs were paid. The debenture pays coupon interest of 5% (R50 000) on 31
December each year and will be redeemed at R900 000 on 31 December 2024.
On 1 January 2022 the debenture was not credit impaired, and the credit risk was
considered low. Entity A has assessed the classification of the debenture in terms of IFRS 9
and has classified it as a financial asset at amortised cost.
Entity A will firstly have to determine the effective interest rate of the instrument. This is
calculated as 1,7235% (FV = 900 000, PMT = 50 000, N = 3, PV = -1 000 000, I = ?). This
effective interest rate is then used when recognising the effective interest for the year ended
31 December 2022.
Dr Bank 50 000
Cr Financial asset 32 765
Cr Interest income (R1 000 000 x 1,7235%) 17 235
Interest for the 2022 year recognised in December 2022
The journal entry to create the allowance for credit losses is therefore the following:
Dr Expected credit losses (P/L) 116 135
Cr Allowance for expected credit losses 116 135
Allowance for expected credit losses December 2022
After recognising the allowance for expected credit losses, Entity A will continue to
recognise the effective interest using the original effective interest rate. It will apply this
rate to the gross carrying amount of the financial asset, as it is not credit impaired.
The journal will therefore be the same as the interest journal above, except that the
calculation would take into account the financial asset value of R967 235 (1 000 000 – 32
765).
On 31 December 2023 Entity A will adjust the expected credit losses on the debenture to
reflect the current credit risk exposure. Entity A still deems the credit risk to have increased
significantly since initial recognition, and hence will still recognise lifetime expected credit
losses.
The probability-weighted (i.e. expected) contractual cash flows of the debenture,
considering the possible default events, are as follows: annual coupon payments of R40 000
and a capital redemption on 31 December 2024 of R850 000. The allowance for expected
credit losses is calculated based on the original effective interest rate:
On redemption, any difference between the redemption amount received and the value of
the financial asset as per the accounting records will be accounted for as a credit loss in
profit or loss, and the expected credit loss and related allowance accounts will be reversed
out.
If we take the exact scenario as above, except when it comes to assessing the expected credit
loss, we change the following:
On 31 December 2022 Entity A will have to recognise an allowance for expected credit
losses on the debenture. This allowance will depend on the assessment of whether the credit
risk of the debenture has increased significantly since initial recognition.
Entity A determines that the credit risk has increased significantly since the debenture was
initially recognised. Entity A will therefore have to recognise lifetime expected credit losses
on the debenture.
Assume that entity A received the first coupon payment that was due 31 December 2022.
The possible default events indicates that no further annual coupon payments will be
received when they are contractually due, but rather that all outstanding coupon payments
will be received together with the capital redemption amount on 31 December 2024.
The probability-weighted (i.e. expected) contractual cash flows of the debenture are
therefore as follows: no annual coupon payments and a capital redemption on 31 December
2024 of R900 000 plus the two outstanding coupon payments of R50 000. The allowance for
expected credit losses is calculated based on the original effective interest rate:
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I = 1,7235%, PV = ?)
Lifetime expected credit losses 833
Allowance for credit losses December 2022
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Current 1-30 31-60 61-90 90
or
more
Initial recognition
Financial liabilities that will be accounted at amortised cost are initially recognised at the fair
value less issue costs i.e. at the net proceeds of issue less the issue costs.
Question:
Klopp raises finance by issuing $20,000 6% four-year loan notes on the first day of the current
accounting period. The loan notes are issued at a discount of 10%, and will be redeemed at a
premium of $1,015. The effective rate of interest is 12%. The issue costs were $1,000.
Required:
Explain and illustrate how the loan is accounted for in the financial statements of Klopp
Solution:
Initial recognition of Liability:
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With both a discount on issue and transaction costs the first step is to calculate the initial
measurement of the liability.
Cash received - the nominal value less the discount on issue ($20,000 x 90%) $18,000 Less the
transaction costs ($1,000)
In then applying amortised cost, the finance cost to be charged to the statement of profit or loss is
calculated by applying the effective rate of interest (in this example 12%) to the opening balance
of the liability each year. The finance cost will increase the liability.
The actual cash is paid at the end of the reporting period and is calculated by applying the
coupon rate (in this example 6%) to the nominal value of the liability (in this example $20,000).
The annual cash payment of $1,200 (6% x $20,000 = $1,200) will reduce the liability.
In the final year there is an additional cash payment of $21,015 (the nominal value of $20,000
plus the premium of $1,015) which extinguishes the remaining balance of the liability
The workings for the liability being accounted for at amortised cost can be summarised and
presented as follows.
Opening Plus profit or loss Less cash paid Closing Balance, being
Balance finance charge (6% of 20 000) the liability on the statement
@12 on the of financial position
opening balance
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charged to income over the period of the loan comprise not only the interest paid, but also the
discount on the issue, the premium on redemption and the transaction costs.
IFRS 9 includes the same option as IAS 39 that permits entities to elect to measure financial
liabilities at fair value through profit or loss if particular criteria are met.
the disappearance of an active market for the financial asset because of financial
difficulties
DISCLOSURES
The disclosure requirements for IFRS 9 are contained within IFRS 7 Financial Instruments:
Disclosures.
PRACTICE QUESTIONS
Question 1
(a) One of the matters addressed in IFRS 9 – Financial Instruments is the initial and subsequent
measurement of Financial Assets. IFRS 9 requires that financial assets are initially measured at
their fair values at the date of initial recognition. However, subsequent measurement of financial
assets depends on their classification for which IFRS 9 identifies three possible alternatives.
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Required:
Explain the three classifications which IFRS 9 identifies for financial assets and the bases of
measurement which is appropriate for each classification.
You should identify any exceptions to the normal classifications which may apply in specific
circumstances.
(b) Ginat Ltd prepares its financial statements to 30 September each year. During the year ended
30 September 2021, Ginat entered into the following transactions;
(i) On I October 2020, Ginat made an interest free loan to an employee of $800 000. The loan is
due for repayment on 30 September 2022 and Ginat is confident that the employee will repay the
loan. Ginat would normally require an annual rate of return of 10% on business loans.
(ii) On 1 October 2020, Ginat made a three-year loan of $10 million to entity X. The rate of
interest payable on the loan was 8% per annum, payable in arrears. On 30 September2023, Ginat
will receive a fixed number of shares in entity X in full settlement of the loan.
Entity X paid the interest due of $800 000 on September 2021 and entity X has no liquidity
problems.
Following payment of this interest, the fair value of this loan asset at 30 September 2021 was
estimated to be $10,5 million.
(iii) On 1 October 2020, Ginat purchased an equity investment in entity Y for $12 million. The
investment did not give Ginat control or significant influence over entity Y but the investment is
seen as a long term one. On 30 September 2021, the fair value of Ginat’s investment in entity Y
was estimated to be $10,5 million.
Solution:
The business model for managing the asset – specifically whether or not the objective is
to hold the financial asset in order to collect the contractual cash flows.
Whether or not the contractual cash flows are solely payments of principal and interest on
the principal amount outstanding.
Where the business model for managing the asset is to hold the financial asset in order to collect
the contractual cash flows and the contractual cash flows are solely payments of principal and
interest on the principal amount outstanding, then the financial asset is normally measured at
amortised cost.
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Where the business model for managing the asset is to both hold the financial asset in order to
collect the contractual cash flows and to sell the financial asset and the contractual cash flows are
solely payments of principal and interest on the principal amount outstanding, and then the
financial asset is normally measured at fair value through other comprehensive income. Interest
income on such assets is recognised in the same way as if the asset were measured at amortised
cost.
In other circumstances, financial assets are normally measured at fair value through profit or
loss. Notwithstanding the above, where equity investments are not held for trading, an entity may
make an irrevocable election to measure such investments at fair value through other
comprehensive income.
Finally, an entity may, at initial recognition, irrevocably designate a financial asset as measured
at fair value through profit or loss if to do eliminates or significantly reduces an accounting
mismatch.
(b) (i) The loan is a financial asset which would initially be recognised at its fair value on 1
October 2020. Given the fact that Ginat normally requires a return of 10% per annum on
business loans of this type, the loan asset should be initially recognised at $661 157 ($800
000/(1.10)2).
An amount of $138 843 ($800 000 - $661 157) would be charged to profit or loss at 1 October
2020.
Because of the business model and the contractual cash flows, this loan asset will subsequently
be measured at amortised cost.
As such, $66 116 ($661 157*10%) will be recognised as finance income in the year ended 30
September 2021.
The closing loan asset balance is $727 273 ($661 157 + $66 116).
This will be shown as a current asset since repayment is due on 30 September 2022.
(ii) Since the loan is at normal commercial rates, the loan would initially be recognised at $10
million, the amount advanced. The interest received and receivable of $800 000 would be
credited to profit or loss as finance income. In this case, the contractual cash flows are not solely
payments of principal and interest on the principal amount outstanding, therefore the loan asset
would be measured at fair value through profit or loss.
A fair value gain of $500 000 ($10,5 million minus $10 million), would be recognised in profit
or loss. The loan asset of $10.5 million would be shown as a non-current asset in the SOFP.
(iii) The equity investment would initially be recognised at cost of purchase -$12 million.
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The contractual cash flows relating to an equity investment are not solely payments of principal
and interest on the principal amount outstanding, therefore the asset would normally be measured
at fair value through profit or loss.
This would result in a gain on remeasurement to fair value of $1 million ($13 million -$12
million) being recognised in profit or loss.
Since the equity investment is being held for the long term, rather than as part of a trading
portfolio, it is possible to make an irrevocable election on 1October 2020 to classify the asset as
at fair value through other comprehensive income. In such circumstances, the remeasurement
gain of $1 million would be recognised in other comprehensive income rather than profit or loss
Question 2
The following events have occurred which are relevant to the year ended 31 March 2018.
(i) On 1 April 2017, Demma loaned $30 million to another entity. Interest of $1,5 million is
payable annually in arrears. Additional financial payment of $35,3 million is due on 31 March
2020. Demma incurred direct costs of $250 000 in arranging this loan.
The annual rate of interest implicit in this arrangement is approximately 10%. Demma has no
intention of assigning this loan to a third party at any time.
(ii) On 1 April 2017, Demma purchased 500 000 shares in a key supplier –entity X.
These shares were purchased in order to protect Demma’s source of supply and Demma has no
intention of trading in these shares. The shares cost $2 per share and the direct costs of
purchasing the shares were $100 000. On 1 January 2018, entity X paid a dividend of 30 cents
per share.
(iii) On 1 January 2018, Demma purchased call options in entity Y – an unconnected third party.
Each option allowed Demma to purchase shares in entity on 31 December 2018 at $6 per share.
Demma paid $1, 25 per option on 1 January 2018. On 31 March 2018, the fair value of a share
option purchased was $8 and the fair value of a share option purchased by Demma was $1,60.
This purchase of call options is not part of a hedging arrangement.
Required:
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Explain and show how the three events should be reported in the financial statements of Demma
for the year ended 31 March 2018.
In (b) you should assume that Demma only measures financial assets at fair value through profit
or loss when required to do so by IFRS 9.
Solution:
(i) Since the business model is to collect the contractual cash flows and the cash flows consist
solely of the repayment of principal and interest, this asset is measured at amortised cost.
The initial carrying amount of the financial asset will be $30, 25 million ($30 million fair value
plus $250 000 transaction costs).
The finance income recorded under investment income category in the statement of profit or loss
for the year ended 31 March 2018 will be $3, 025 million ($30,25 million *10%).
The carrying amount of the financial asset in the SOFP at 31 March 2018 will be 31, 775 ($30,25
million ($30,25 million plus $3,025 million minus $1,5 million).
(ii) Since this is an equity investment which Demma has no intention of selling, Demma can
measure the investment at fair value through other comprehensive income (provided irrevocable
election on initial recognition has been made.
Since the financial asset is measured at fair value through other comprehensive income, the
transaction cost (agent’s commission) is included in the initial fair value of shares (500 000*$2
plus $100 000). The difference (fair value gain) of $25 000 ($1,115 million minus $1,1 million)
will be recognised in other comprehensive income.
Dividend income of $150 000 (500000*30 cents) will be recognised as other income in the
statement profit and loss.
(iii) The call option cannot be measured at amortised cost or fair value through other
comprehensive income, so it must be measured at fair value through profit or loss.
The initial carrying value of the call option will be $125 000 ($100 000 *$1,25).
At the year end, the call opinion will be re-measured to its fair value of $160 000 (100 000
*$1,60).
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Question 3
(a) Briefly define the financial risks identified by IFRS 7 and provide an example of each (6
marks)
(c) A company purchases a deep discount bond with a par value of $500 000on 1 January 2001
for proceeds of $440 000. Annual coupon payments of 5% are payable on 31 December each
year.
The entity incurred transaction costs of $5 867. The bond will be redeemed on 31 December
2003 at par.
The effective interest rate on the bond has been calculated at 9,3%
Required:
Show the profit or loss impact and carrying value of the bond for each of the 3 years of the bond.
(13 marks)
Solution:
Liquidity risk
Credit risk
Market risk
Liquidity risk concerns the possibility that an entity cannot be able to meet its short-term cash
obligations. This entails having insufficient financial resources to pay off short-term debts as
they fall due. For example, an entity might have a large trade payables balance which requires
immediate settlement but the entity have little cash resources to settle the balance.
Credit risk is the possibility of loss resulting from the uncertainty in counterparty’s ability or
willingness to meet its contractual obligations. An entity that largely sells its products on credit
may suffer large financial losses when some of its credit customers fail to pay up what they owe
in future.
Market risk concerns the possibility that the fair value or future cash flows of a financial
instrument will fluctuate due to market prices. Market risk consists of currency risk, interest rate
risk and other price risks. An entity might have financial assets measured at fair values through
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profit or loss, any decrease in the current market value of such an asset will result in a downward
adjustment on the carrying amount of the asset hence a financial loss for the entity.
(b) According to IFRS 9, credit losses on financial assets are measured and recognised using the
expected credit losses approach. This approach results in the early recognition of credit losses
because it includes not only losses that have already been incurred but also expected future credit
losses hence it is a forward-looking model. The approach is prudent as both the carrying amounts
of financial assets and the reported profits are resultantly reduced.
Credit losses are the difference between the present value of all contractual cash flows and the
present values of expected future cash flows. This approach classifies expected credit losses into
lifetime and 12-month expected credit losses.
Lifetime expected credit losses are those that result from all possible events over the expected
life of a financial asset and 12-month expected credit losses are those that result from default
events that are possible within 12 months after the reporting date.
Under the approach, expected credit losses are recognised in two stages. As soon as a financial
asset is originated or purchased, a 12-month expected credit loss is recognised in the profit or
loss and a loss allowance is established (which may be nil). Interest revenue of the financial asset
is calculated on the gross carrying amount.
At each reporting date, the expected credit losses are re-measured. If at the reporting date, the
credit risk on the financial asset has not increased significantly, then the 12-month expected
credit losses are continued to be recognised. If the credit risk has increased significantly in the
interim and is not considered low, full lifetime expected credit losses are recognised in profit of
loss.
If the credit risk of a financial asset increases to the point that is considered credit-impaired,
interest revenue is calculated based on the amortised cost, which is the gross carrying amount
less the credit allowance. Lifetime expected credit losses are recognised on this financial asset.
Financial assets in this stage are generally assessed individually.
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(c) Bond Amortisation Cost Table
Question 4
Ammar Company issued two debt instruments on January 01, 2011 with nominal value of $25
000 each and redeemable in three years on January 01, 2014. Effective rate of interest is 15%.
Debt 1 has coupon rate of 1%. It was issued at par and is to be redeemed at a premium of
$12 154.
Debt 2 has also a coupon rate of 1%. It was issued at discount of $7 991 and is to be
redeemed at par
Required:
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(ii) What amounts of interest will be charged to the income statement for the three years in
respect of each financial liability?
(iii) What amount will be recognised in the statement of financial position at the end of year
2011 to 2013 in respect of each financial liability?
Debt 1
Debt 2
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