Basic Financial Instrument

OVERVIEW OF IFRS 11
• Scope of Sections 11
• Accounting policy choice
• Introduction to Section 11
• Basic financial instruments
• Initial recognition of financial assets and liabilities
• Initial measurement
• Subsequent measurement
• Amortized cost and effective interest method
• De-recognition of a financial asset
• De-recognition of a financial liability
• Disclosures of this Standard
• Compare and contrast Financial Instrument of Full IFRS and IFRS for
SME
 SCOPE OF SECTIONS 11
• Section 11 Basic Financial Instruments and Section 12 Other Financial
Instruments Issues together deal with recognizing, derecognizing, measuring
and disclosing financial instruments (financial assets and financial
liabilities). Section 11 applies to basic financial instruments and is relevant to
all entities. Section 12 applies to other, more complex financial instruments
and transactions. If an entity enters into only basic financial instrument
transactions then Section 12 is not applicable. However, even entities with
only basic financial instruments shall consider the scope of Section 12 to
ensure they are exempt.
 ACCOUNTING POLICY CHOICE
• An entity shall choose to apply either:
(a) the provisions of both Section 11 and Section 12 in full, or
(b) the recognition and measurement provisions of IFRS 9
Financial Instruments: Recognition and Measurement and the
disclosure requirements of Sections 11 and 12 to account for all
of its financial instruments.
 INTRODUCTION TO SECTION 11
• A financial instrument is a contract that gives rise to a financial asset of one entity and a
financial liability or equity instrument of another entity.
• Equity Instrument is the residual interest in the assets of the entity after deducting all its
liabilities.
• For the purposes of Section 11, a financial asset could be described as any asset that is
(a) cash;
(b) an equity instrument of another entity;
(c) a contractual right:
(i) to receive cash or another financial asset from another entity; or
(ii) to exchange financial assets or financial liabilities with another entity under
conditions that are potentially favorable to the entity; or
(d) a contract that will or may be settled in the entity’s own equity instruments and under
which the entity is or may be obliged to receive a variable number of the entity’s own
 Cont…

• For the purposes of Section 11, a financial liability could be described as

any liability that is:
(a) a contractual obligation:
(i) to deliver cash or another financial asset to another entity; or
(ii) to exchange financial assets or financial liabilities with another entity
under conditions that are potentially unfavorable to the entity; or
(b) a contract that will or may be settled in the entity’s own equity
instruments and under which the entity is or may be obliged to deliver a
variable number of the entity’s own equity instruments.
 Cont…

• Examples of financial instruments that normally satisfy those conditions

include:
(a) cash.
(b) demand and fixed-term deposits when the entity is the depositor, e.g. bank
accounts.
(c) commercial paper and commercial bills held.
(d) accounts, notes and loans receivable and payable.
(e) bonds and similar debt instruments.
(f) investments in non-convertible preference shares and non-puttable ordinary
and preference shares.
 EXAMPLES

1. Entity A owns preference shares in entity B. The preference shares entitle

entity A to dividends, but not to any voting rights.
2. An entity (the purchaser) buys goods from a supplier on 60 days’ credit.
3. Entity A purchases a subsidiary from entity B. Under the agreement, entity A
pays the purchase price in two instalments—CU5 million(1) upfront and a
further payment (which is not a contingent payment) of CU5 million two
years later.
4. An entity has a present obligation in respect of income tax due for the prior
year.
 EXAMPLE
1. In a lawsuit brought against an entity, a group of people are collectively
seeking compensation for damages to their health as a result of
contamination to the nearby land believed to be caused by waste from that
entity’s production process. It is doubtful whether the entity is the source of
the contamination since many entities operate in the same area producing
similar waste and it is unclear who is the source of the contamination.

2. At the end of the reporting period an entity has an asset for the prepayment
of three months of rent on its office building.
 RECOGNITION OF FINANCIAL ASSETS AND
LIABILITIES

• An entity shall recognize a financial asset or a financial

liability only when the entity becomes a party to the
contractual provisions of the instrument.
 INITIAL MEASUREMENT

• When a financial asset or financial liability is recognized initially, an entity shall measure it
at the transaction price (including transaction costs except in the initial measurement of
financial assets and liabilities that are measured at fair value through profit or loss) unless
the arrangement constitutes, in effect, a financing transaction. A financing transaction may
take place in connection with the sale of goods or services, for example, if payment is
deferred beyond normal business terms or is financed at a rate of interest that is not a
market rate. If the arrangement constitutes a financing transaction, the entity shall measure
the financial asset or financial liability at the present value of the future payments
discounted at a market rate of interest for a similar debt instrument.
 Cont…

EXAMPLES OF FINANCIAL ASSET

1. For a long-term loan made to another entity, a receivable is recognized at the present
value of cash receivable (including interest payments and repayment of principal) from
that entity.
2. For goods sold to a customer on short-term credit, a receivable is recognized at the
undiscounted amount of cash receivable from that entity, which is normally the invoice
price.
3. For an item sold to a customer on two-year interest-free credit, a receivable is recognized
at the current cash sale price for that item. If the current cash sale price is not known, it
may be estimated as the present value of the cash receivable discounted using the
prevailing market rate(s) of interest for a similar receivable.
4. For a cash purchase of another entity’s ordinary shares, the investment is recognized at the
amount of cash paid to acquire the shares.
 Cont…
EXAMPLES OF FINANCIAL LIABILITIES

1. For a loan received from a bank, a payable is recognized initially at the

present value of cash payable to the bank (e.g. including interest payments
and repayment of principal).

2. For goods purchased from a supplier on short-term credit, a payable is

recognized at the undiscounted amount owed to the supplier, which is
normally the invoice price.
 Cont…

• Transaction costs are incremental costs that are directly attributable to the
acquisition, issue or disposal of a financial asset or financial liability. An
incremental cost is one that would have been avoided if the entity had not
acquired, issued or disposed of the financial instrument.
• Transaction costs include:
 fees and commissions paid to agents (including employees acting as selling
agents, if such costs are incremental), advisers, brokers and dealers;
 levies by regulatory agencies and securities exchanges; and transfer taxes and
duties
 Cont…
• Transaction costs will therefore be included in the calculation of amortized cost
using the effective interest method and consequently are recognized in profit or
loss over the life of the instrument. The journal entry for transaction costs that are
paid in cash and relate to financial instruments to be measured at amortized cost is:
Dr Financial asset/financial liability xx
Cr Cash xx
• For financial instruments that are measured at fair value through profit or loss after
initial recognition (see paragraph 11.14(c)(i)), transaction costs are recognized as
expenses when they are incurred
Dr Profit or loss xx
Cr Cash xx
 Cont…

1. An entity incurred CU10 broker transaction fees to buy 50 non puttable

ordinary shares in a listed company on the market for cash of CU500.

2. An entity incurred CU10 broker transaction fees to buy 50 non-puttable

ordinary shares in an unlisted company for cash of CU500. The fair value of
the shares cannot be measured reliably on an ongoing basis and therefore the
investment is measured at cost less impairment.
 SUBSEQUENT MEASUREMENT

1. Amortized cost and effective interest method: This method used when:

A debt instrument that satisfies all of the following conditions:

 returns to the holder (the lender/creditor) assessed in the currency in which the debt

instrument is denominated are either:

(i) a fixed amount;

(ii) a fixed rate of return over the life of the instrument;

(iii) a variable return that, throughout the life of the instrument, is equal to a single

referenced quoted or observable interest rate.

 Cont…
 The amortized cost of a financial asset or financial liability at each reporting date is the net of
the following amounts:
(a) The amount at which the financial asset or financial liability is measured at initial
recognition,
(b) Minus any repayments of the principal,
(c) Plus or minus the cumulative amortization using the effective interest method of any
difference between the amount at initial recognition and the maturity amount,
(d) Minus, in the case of a financial asset, any reduction (directly or through the use of an
allowance account) for impairment or uncollectibility.
 The effective interest method is a method of calculating the amortized cost of a financial asset
or a financial liability (or a group of financial assets or financial liabilities) and of allocating
the interest income or interest expense over the relevant period. The effective interest rate is
the rate that exactly discounts estimated future cash payments or receipts through the expected
life of the financial instrument.
Cont…
 Cont…

2. Commitments to receive a loan shall be measured at cost (which sometimes is

nil) less impairment.

3. Investments in non-convertible preference shares and non-puttable ordinary or

preference shall be measured as follows:
(i) if the shares are publicly traded or their fair value can otherwise be
measured reliably, the investment shall be measured at fair value with
changes in fair value recognized in profit or loss.
(ii) all other such investments shall be measured at cost less impairment.
 Impairment or uncollectibility must be assessed for financial instruments in
(1), (2) and (3)(ii) above.
 Cont…
Impairment of financial instruments measured at cost or
amortized cost

At the end of each reporting period, an entity shall assess whether

there is objective evidence of impairment of any financial assets
that are measured at cost or amortized cost. If there is objective
evidence of impairment, the entity shall recognize an impairment
loss in profit or loss immediately.
 significant financial difficulty of the issuer or obligor.

 a breach of contract, such as a default or delinquency in interest or

principal payments.
 Impairment of financial instruments
measured at cost or amortized cost

 the creditor, for economic or legal reasons relating to the debtor’s

financial difficulty, granting to the debtor a concession that the
creditor would not otherwise consider.
 it has become probable that the debtor will enter bankruptcy or
other financial reorganization.
 observable data indicating that there has been a measurable decrease
in the estimated future cash flows from a group of financial assets
since the initial recognition of those assets.
 EXAMPLE
• Entity A lends CU100 to an employee for one year with interest payable
at 8 percent. The entity rarely makes loans to employees and therefore
this is considered a one-off transaction. There is no reason to believe that
the employee will not pay the interest and principal on the loan when it
falls due. The market rate of interest for similar loans is 8 per cent per
year (i.e. the market rate of interest for a similar loan to this individual).
Entity A wishes to recognize an impairment loss of CU10 on the loan
because in the past entity A has found that, on average, 10 per cent of its
trade receivable balances (ie amounts due from customers) are not repaid.
 Example
At the end of a financial reporting period an
entity has an outstanding balance of CU1,000
due from a customer. This balance was not
discounted as the transaction took place on
normal business terms (short-term credit) with
no hidden financing transaction. Because of
financial difficulties being experienced by the
customer, the entity does not expect the
customer to repay any of the CU1,000.
 Cont…
Reversal
If, in a subsequent period, the amount of an impairment loss decreases and the decrease
can be related objectively to an event occurring after the impairment was recognized
(such as an improvement in the debtor’s credit rating), the entity shall reverse the
previously recognized impairment loss either directly or by adjusting an allowance
account. The reversal shall not result in a carrying amount of the financial asset (net of
any allowance account) that exceeds what the carrying amount would have been had the
impairment not previously been recognized. The entity shall recognize the amount of the
reversal in profit or loss immediately.
Example
• The facts are the same as the above example. However, in this example, after the prior
year financial statements were authorized for issue the entity received CU200 from the
customer. The entity does not expect to receive the remaining CU800.
•
 DE-RECOGNITION OF A
FINANCIAL ASSET
An entity shall derecognize a financial asset only when:
(a) The contractual rights to the cash flows from the financial asset expire or are settled, or
(b) The entity transfers to another party substantially all of the risks and rewards of
ownership of the financial asset, or
(c) The entity, despite having retained some significant risks and rewards of ownership, has
transferred control of the asset to another party and the other party has the practical ability
to sell the asset in its entirety to an unrelated third party and is able to exercise that ability
unilaterally and without needing to impose additional restrictions on the transfer. In this
case, the entity shall:
(i) Derecognize the asset, and
(ii) Recognize separately any rights and obligations retained or created in the
transfer.
 DERECOGNITION OF A FINANCIAL
LIABILITY

 An entity shall derecognize a financial liability (or a part of a financial

liability) only when it is extinguished—i.e. when the obligation
specified in the contract is discharged, is cancelled or expires.

 The entity shall recognize in profit or loss any difference between the
carrying amount of the financial liability (or part of a financial liability)
extinguished or transferred to another party and the consideration paid,
including any non-cash assets transferred or liabilities assumed.
 DISCLOSURES OF THIS STANDARD
• An entity shall disclose the carrying amounts of each of the following categories of
financial assets and financial liabilities at the reporting date, in total, either in the
statement of financial position or in the notes:
(a) Financial assets and financial liabilities measured at fair value through profit or
loss
(b) Financial assets and financial liabilities that are debt instruments measured at
amortized cost
(c) Financial assets that are equity instruments measured at cost less impairment
(d) Loan commitments measured at cost less impairment
(e) If a reliable measure of fair value is no longer available for an equity instrument
measured at fair value through profit or loss, the entity shall disclose that fact.
(f) The fact related to Derecognition of Financial asset and financial liabilities.
 COMPARE AND CONTRAST
FINANCIAL INSTRUMENT OF FULL
IFRS AND IFRS FOR SME
• Section 11 requires instruments to be measured at transaction price unless the arrangement
constitutes a financing transaction, in which case the cash flows from the instrument are
discounted. Under IFRS 9, financial instruments are initially measured at fair value. In
practice, the different terminology is unlikely to result in any significant difference in value
on initial recognition.
• Section 11 establishes a simple principle for derecognition. That principle does not rely on
the ‘pass-through’ and ‘continuing involvement’ provisions that apply to derecognition
under IFRS 9. The derecognition provisions of the IFRS for SMEs would not result in
derecognition for some factoring transactions that a small or medium-sized entity may enter
into, whereas IFRS 9 would result in derecognition.
• many of the IFRS 7 disclosures are designed for financial institutions (which are not
eligible to use the IFRS for SMEs);
prepared by Redwan , Hassen and Kib
ruysfaw