Advance Accounting

Financial Instruments
Elizabeth Gutirrez

Overview of Financial Instruments

Standards
2009

1995
IAS 32

1999
IAS 39

Financial Instrument:
Presentation and Disclosure

Financial Instrument:
Recognition and Measurement

2005
IAS 32
Financial Instrument:
Presentation
Equity and financial
liabilities
Offsetting a financial
asset and a financial
liability

2014
IAS 39
Financial Instrument:
Hedge. IFRS 9 permits to
choose, as an accounting
policy choice, to continue to
apply hedge accounting
requirements of IAS 39
instead of requirements of
IFRS 9

2005
IFRS 7
Financial Instrument:
Disclosures

2011
IFRS 13
Fair Valuation

2014
IFRS 9
Financial Instrument:
Derivatives and embedded
derivatives
Classification of financial
assets and financial liabilities
Recognition and
derecognition
Measurement
Impairment
Hedge Accounting
Transition

Overview of Financial Instruments

Standards
November 1990: approval of Draft
Statement of Principle (DSOP) advocating fair value
measurement for financial assets and liabilities held
for trading but not for others
June 1991: ED 40 consisting of fair value for trading
items and cost for others and an allowed alternative
of fair value for all items
1994; Revised exposure draft
1995: IAS 32
1999: IAS 39
2000: Revision of IAS 39

Overview of Financial Instruments

Standards
2003 2005: Improvement project of IAS 32 and IAS
39: fair value is an option under IAS 39
2004: Carve-out version of IAS 39 adopted by EU:
the use of fair value option for financial liabilities is
prohibited
2005: IFRS 7 on Disclosures
2008: Discussion Paper: Reducing the complexity in
Reporting Financial Instruments

Overview of Financial Instruments

Standards
2009: IFRS 9 phase 1 of revision to IAS 39
Classification and Measurement (with several
amendments)
2009 - 2013: EDs Phase 2 Impairment
2010 2012: EDs Phase 3 Hedge Accounting
2014: Fourth and final Version IFRS 9

Overview of Financial Instruments

Standards
IAS 32
Establish principles for presenting financial
instruments as financial liabilities or equity and for
offsetting financial assets and financial liabilities.
It applies to the classification of financial
instruments from the perspective of the issuer
(asset, liability or equity).
It deals with the classification of related interests,
dividends, losses and gains.

Overview of Financial Instruments

Standards
IFRS 7
Requires entities to provide disclosures that
enables users to evaluate:
The significance of financial instruments for the entitys
financial position and performance
The nature and extent of risks arising from financial
instruments to which the entity is exposed during the
period at the reporting date and how the entity
manages these risks.

Overview of Financial Instruments

Standards
IFRS 9
Recognition and measurement requirements for financial
assets and financial liabilities
The standard applies to annual periods on or after January
1, 2018, although early application is permitted.
Retrospective application is required however, transition
relief is provided (including no restatement of comparative
period information)
Entities will only be permitted to early adopt a previous
version of IFRS 9 if their date of initial application is before
February 1, 2015
However, if an entity has early adopted a previous version
of IFRS 9 before February 1, 2015, the entity is permitted
to continue to apply that version until IFRS 9 becomes
mandatorily effective on January 1, 2018.

Overview of Financial Instruments

Standards
IFRS 9
Main differences with IAS 39
Financial asset classification: Amortised Cost, FVOCI
and FVTPL
Removes the requirement to separate embedded
derivatives from financial asset host
Specific guidance for instruments that creates
concentrations of credit risks

Overview of Financial Instruments

Standards
Scope not identical for the three standards and are
subject to different exclusions.
Generally speaking:
IAS 32 applies to all financial instruments,
including equity issued.
IFRS 9 applies to only financial assets and financial
liabilities.
IFRS 7 applies to all financial instruments,
although most of its disclosure requirement relate
to financial assets and financial liabilities.

Definitions
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

Definitions
A financial asset, per IAS 32, paragraph 11) is 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.

Definitions
d) A contract that will or may be settled in the entitys own
equity instruments and is
i. a non-derivative for which the entity is or may be obliged to
receive a variable number of the entitys own equity
instruments; or
ii.a derivative that will or may be settled other than by the
exchange of a fixed amount of cash or another financial
asset for a fixed number of the entitys own equity
instruments. For this purpose, the entitys own equity
instruments do not include puttable financial instruments
classified as equity instruments, instruments that impose on
the entity an obligation to deliver to another party a pro-rata
share of the net assets of the entity on liquidation and are
classified as equity instrument, or instruments that are
contracts for the future receipt or delivery of the entitys
own equity instruments.

Example of Financial Assets

Example of c):
Trade accounts receivable
Note receivables
Loan receivables
Bonds receivables
Example of d.ii): Written option to buy gold that, if
exercised, is settled net in the entitys own
instrument by the entity delivering as many of those
instruments as are equal to the value of the option
contract.

Definitions
A financial liability, per IAS 32, paragraph 11, is 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 unfavourable to the entity; or

Definitions
(b) A contract that will or may be settled in the entitys own equity

instruments and is
(i) a non-derivative for which the entity is or may be obliged to
deliver a variable number of the entitys own instruments; or
(ii) a derivative that will or may be settled other than by the
exchange of a fixed amount of cash or another financial asset for a
fixed number of the entitys own equity instruments. For this
purpose, the entitys own equity instruments do not include
puttable financial instruments that are classified as equity
instruments, instruments that impose on the entity an obligation to
deliver to another party a pro rata share of the net assets of the
entity only on liquidation and are classified as equity instruments,
or instruments that are themselves contracts for the future receipt
or delivery of the entitys own equity instruments.

Example of Financial Liabilities

Example of a.i):
Trade accounts payables
Note payables
Loan payables
Bonds payables

Definitions
Financial instrument is the contract, NOT the asset or
liability
Contract or contractual refer to an agreement
between two or more parties that has clear
economic consequences that the parties have little, if
any chance of avoiding, because generally the
agreement is enforceable in law .

Activity
Assets and Liabilities
Cash
Gold bullion (gold bars or ingots)

Debtors
Creditors
Loans
Bank deposits
Debentures (deb security medium or long
term)
A promissory note payable in government
bonds
Ordinary shares
Preference shares
Plant and equipment previously bought
Pre-payments of goods or services

Financial Instruments?

Example of Financial Instruments

Derivatives such as :
financial options
futures
forwards
interest rate swaps
currency swaps

Example of Financial Instruments

Derivatives as defined in the standards are
financial instruments:
whose value changes in response to the
change in a specified interest rate, security
price, commodity price, foreign exchange
rate, index of prices or rates, a credit rating
or credit index or similar variable (underlying)
that requires no initial net investment or little
initial net investment relative to other types
of contracts that have a similar response to
changes in market conditions
that is settled at a future date

Specific exemptions from Financial

Instruments Standards
Applicable
Standard

IAS 32

IFRS9

IFRS7

NA

NA

NA

IFRS 10
IAS 27

NA

NA

NA

IAS 28
IAS 27

Interests in subsidiaries.
However, in some cases IFRS 10 or IAS 27 require or permit
an entity to account for an interests in a subsidiary in
accordance with some or all of the requirements of IFRS 9 (in
which case IAS 32 and IFRS 7 also apply). An entity applies
IAS 32 to derivatives linked to interests in subsidiaries. An
entity also applies IFRS 9 and IFRS 7 to such derivatives,
unless the derivative meet the definition of an equity
instrument in IAS 32.

Interest in associated and joint ventures.

However, in some cases IAS 27 or IAS 28 require or permit an
entity to account for an interests in associate or joint venture
in accordance with some or all of the requirements of IFRS 9
(in which case IAS 32 and IFRS 7 also apply). An entity applies
IAS 32 to derivatives linked to interests in associates or joint
ventures. An entity also applies IFRS 9 and IFRS 7 to such
derivatives, unless the derivative meet the definition of an
equity instrument in IAS 32.

Specific exemptions from Financial

Instruments Standards
Applicable
Standard

IAS 32

IFRS9

IFRS7

Employers rights and obligations under

employee benefit plans

NA

NA

NA

IAS 19

Financial instruments, contracts and obligations

under share-based payment transactions

NA

NA

NA

IFRS 2

NA

NA

NA

IFRS 4

NA

NA

Rights and obligations under insurance

contracts (except embedded derivatives and
certain financial guarantees).
IFRS 9 applies to an insurance contract that is a financial
guarantee entered into, or retained, on transferring to
another party financial assets or financial liabilities in the
scope of IFRS 9 and to issued financial guarantees contracts
not accounted for under IFRS 4. Financial guarantee held are
not in the scope of IFRS 9.

Financial Instruments with a discretionary

participation feature (except embedded
derivatives)

IFRS 4

Specific exemptions from Financial

Instruments Standards
IAS 32

IFRS9

IFRS7

Applicable
Standard

Rights and obligations under lease.

However, the following are subject to the specified provisions
of IFRS 9 and to the requirements of IFRS 7: (1) lease
receivables recognized by a lessor - derecognition an
impairment provisions; (2) finance lease payable recognized
by a lessee derecognition provisions, and (3) derivatives
embedded in leases embedded derivatives provisions.

NA

IAS 17

Equity instruments issued by the entity,

including warrant and option that meet the
definition of an equity instrument (for the
issuer)

NA

IAS 32

Financial instruments issued by the entity that

are classified as equity instruments in
accordance with paragraph 16A and 16B or
paragraphs 16C and 16D of IAS 32(for the
issuer)

NA

NA

IAS 32

Specific exemptions from Financial

Instruments Standards
IAS 32
Forward contracts between an acquirer and a
selling shareholder for the sale/acquisition of
an acquiree that will result in a business
combination at a future date of acquisition.
Loan commitments that cannot be settled net
in cash or another financial instrument (except
for those loan commitments that are
designated as at FVTPL or are to provide loans
at below-market interest). However:
Impairment requirements of IFRS 9 apply to
such loan commitments issued, and
Loan commitments are subject to the
derecognition provisions of IFRS 9

IFRS9

NA

NA

IFRS7

Applicable
Standard
IFRS 3

Specific exemptions from Financial

Instruments Standards
IAS 32

IFRS9

IFRS7

Applicable
Standard

Rights to reimbursement payments in relation

to provisions

NA

IAS 37

Financial instruments that are right and

obligations within the scope of IFRS 15 Revenue
from Contracts with Customers, except for
those that IFRS 15 specifies are accounted for
in accordance with IFRS 9 e.g receivables

NA

IFRS 15

Financial Assets
IFRS 9 considers three categories of financial assets:
At amortized costs
At fair value through other comprehensive income
(FVOCI)
At fair value through profit or loss (FVTPL)
The classification of an instrument is determined on
initial recognition.
Reclassifications are made only upon a change in an
entitys business model.
No other reclassifications are permitted.

Financial Assets
The classification and measurement depends on two
assessments:
the financial assets contractual cash flows and
the entitys business model for managing financial
assets

Financial Assets
Financial Asset in the scope of IFRS 9
Is the asset and equity
investment?

Are the assets

contractual cash
flows solely
principal and
interest?

No

Yes
Is held for trading?

Yes

Yes

No

No
No

No
Has the entity elected
the OCI option
(irrevocable)?

No

Is the business
models objective
achieved both by
collecting contractual
cash flows and by
selling financial
assets?

Yes

Yes
FVOCI
(Equity
Instruments)

Is the business models

objective to hold to
collect contractual
cash flows?

FVTPL

FVOCI (Debt
Instruments)

Amortized
cost

Yes

Financial Assets
At amortized costs: A financial asset is measured at
amortized cost only if it meets both of the following
conditions:
The asset is held within a business model whose
objective is to hold assets to collect contractual
cash flow (the held-to-collect business model);
and
The contractual terms of the financial asset give
rise on specified dates to cash flows that are solely
payments of principal and interest on the principal
amount outstanding (SPPI criterion).

Financial Assets
At fair value through other comprehensive income
(FVOCI): A debt instrument is measured at FVOCI
only if it meets both the following conditions:
The asset is held within a business model whose
objective is achieved by both collecting
contractual cash flows and selling financial assets;
and
The contractual terms of the financial asset meet
the SPPI criterion.

Financial Assets
At fair value through other comprehensive income
(FVOCI). Investment in equity instruments fail the
SPPI criterion and are therefore measured at FVPL.
However, on initial recognition an entity may make
an irrevocable election to present in OCI the changes
in the fair value of an investment in an equity
instrument that is not held for trading.

Financial Assets
At fair value through profit or loss (FVTPL)
Financial assets that are neither measured at
amortized cost nor at FVOCI.
In addition, an entity has the option on initial
recognition to irrevocably designate a financial
asset as a FVTPL if doing so eliminates or
significantly reduces a measurement or
recognition inconsistency that would otherwise
arise from measuring assets or liabilities, or
recognizing the gains and losses on them, on
different bases.

Financial Assets

Financial Assets

Financial Assets
Financial Asset in the scope of IFRS 9
Is the asset and equity
investment?

Are the assets

contractual cash
flows solely
principal and
interest?

No

Yes
Is held for trading?

Yes

Yes

No

No
No

No
Has the entity elected
the OCI option
(irrevocable)?

No

Is the business
models objective
achieved both by
collecting contractual
cash flows and by
selling financial
assets?

Yes

Yes
FVOCI
(Equity
Instruments)

Is the business models

objective to hold to
collect contractual
cash flows?

FVTPL

FVOCI (Debt
Instruments)

Amortized
cost

Yes

Financial Assets
The SPPI criterion:
Are the assets contractual cash flows solely
principal and interest on specified dates?
Principal is the fair value of the financial asset at initial
recognition (from the view of the current holder).
Interest is consideration for the time value of money
and for the credit risk associated with the principal
amount outstanding during a particular period of time.
This may include considerations for other basic lending
risks and costs and profit margin.

Financial Assets
The SPPI criterion:
Some considerations:
Basic lending arrangement time value money and
credit risk
Currency in which the financial asset is denominated
An equity investment does not give rise to cash flow
that are solely principal and interest
An entity does not separate embedded derivatives
from host contracts that are financial assets in the
scope of IFRS 9.

Financial Assets
The SPPI criterion:
Some considerations:
Basic lending arrangement time value money and
credit risk
Currency in which the financial asset is denominated
An equity investment does not give rise to cash flow
that are solely principal and interest
An entity does not separate embedded derivatives
from host contracts that are financial assets in the
scope of IFRS 9.

Financial Assets
The SPPI criterion:
Modify time value of money
The relationship between the interest rate and the
period for which the rate is set is imperfect between
the passage of time and the interest rate my be
imperfect.

Financial Assets
The SPPI criterion:
Modify time value of money
Perfect benchmark: the cash flows that would arise if
the time value of money element was not modified.
Qualitatively or Quantitative
Quantitative:

Comparison of undiscounted cash flows

Same credit quality and contract terms
Actual or hypothetical
More than one scenario needs to be evaluated

Financial Assets
The SPPI criterion:
Modify time value of money - Example
Bond matures in ten years containing a constant
maturity reset feature where the interest rate resets
annually to a ten-year rate of interest. The interest is
linked to the bonds original maturity.
Comparison of undiscounted cash flows on this bond to
those on a bond that resets annually to a one-year rate.
The test should consider a number of different interest
rates scenarios and how the relation between the oneyear rate and a ten-year rate could change over the life
of the instrument.

Financial Assets
The SPPI criterion:
Examples of contractual terms that change the
timing or amount of contractual cash flows and
MEET the SPPI criterion:
Variable Interest Rate

Time value of money

Credit risk
Other basic lending risk and cost
Profit Margin

Financial Assets
The SPPI criterion:
Examples of contractual terms that change the
timing or amount of contractual cash flows and
MEET the SPPI criterion:
Prepayment feature
To put the debt instrument back to the issuer before maturity;
and
Prepayment represent unpaid amount outstanding, which
may include reasonable additional compensation for the early
termination of the contract.

Term extension feature

To extend the contractual term of a debt instrument; and
Result in contractual cash flow that are solely payment of
principal and interest.

Financial Assets - Activity

The SPPI criterion:
1. Company B has an investment in a convertible
bond. Under the terms of the bond, the holder
has the option to convert it into fixed number of
equity shares of the issuer.
2. Company X holds an asset with a variable
interest rate that resets every month to a oneyear rate.
3. Investor X places a deposits on special saving
accounts. The interest rate is determined by the
central bank and the government according to a
formula that reflects protection against inflation.

Financial Assets - Activity

The SPPI criterion:
4. Company X issues a bond to company Y. It is
mandatory for X to redeem the bond at par if a
specified default event occurs. The default events
relate to a credit downgrade or loan covenant
violations. If a default event occurs, then the
prepayment amount substantially represents
unpaid amounts of principal and interest on the
principal amount outstanding.

Financial Assets
Financial Asset in the scope of IFRS 9
Is the asset and equity
investment?

Are the assets

contractual cash
flows solely
principal and
interest?

No

Yes
Is held for trading?

Yes

Yes

No

No
No

No
Has the entity elected
the OCI option
(irrevocable)?

No

Is the business
models objective
achieved both by
collecting contractual
cash flows and by
selling financial
assets?

Yes

Yes
FVOCI
(Equity
Instruments)

Is the business models

objective to hold to
collect contractual
cash flows?

FVTPL

FVOCI (Debt
Instruments)

Amortized
cost

Yes

Financial Assets
Business Model Assessment:
Is the business models objective to hold to collect
contractual cash flows?
Business model is determined by the entitys key
management personnel in the way that assets are
managed and their performance is reported to
them.
Not an instrument-by-instrument analysis

Financial Assets
Business Model

Held-to-Collect

Key Features
The objective of the business model is to hold
assets to collect contractual cash flows
Sales are incidental to the objective of the
model.
This model typically involves the lowest level of
sales in comparison with other business models
(in frequency and volume).
The entity NOT hold all of these assets until
maturity.

Both collecting contractual cash flows and sales

are integral to achieving the objective of the
Both held to
business model.
collect and for sale This model typically has more sales (in
frequency and volume) than the held-to-collect
business model

Category

Amortized
Cost

FVOCI

Financial Assets
Business Model
Other business models,
including:
Trading
Managing assets on a
FV basis
Maximizing cash flows
through sales

Key Features
The business model is neither held-tocollect nor held to collect and for sale.
The collection of contractual cash flows
is incidental to the objective of the
model

Category

FVTPL

Financial Assets
Financial Asset in the scope of IFRS 9
Is the asset and equity
investment?

Are the assets

contractual cash
flows solely
principal and
interest?

No

Yes
Is held for trading?

Yes

Yes

No

No
No

No
Has the entity elected
the OCI option
(irrevocable)?

No

Is the business
models objective
achieved both by
collecting contractual
cash flows and by
selling financial
assets?

Yes

Yes
FVOCI
(Equity
Instruments)

Is the business models

objective to hold to
collect contractual
cash flows?

FVTPL

FVOCI (Debt
Instruments)

Amortized
cost

Yes

Financial Assets
At amortized costs:
Interest revenue, credit impairment and foreign
exchange gain or loss recognized in Profit or Loss
On derecognition, gains or losses recognized in
Profit or Loss

Financial Assets
Financial Asset in the scope of IFRS 9
Is the asset and equity
investment?

Are the assets

contractual cash
flows solely
principal and
interest?

No

Yes
Is held for trading?

Yes

Yes

No

No
No

No
Has the entity elected
the OCI option
(irrevocable)?

No

Is the business
models objective
achieved both by
collecting contractual
cash flows and by
selling financial
assets?

Yes

Yes
FVOCI
(Equity
Instruments)

Is the business models

objective to hold to
collect contractual
cash flows?

FVTPL

FVOCI (Debt
Instruments)

Amortized
cost

Yes

Financial Assets
At fair value through other comprehensive income
(FVOCI) Debt Instruments:
Interest revenue, credit impairment and foreign
exchange gain or loss recognized in Profit or Loss.
Other gains and losses recognized in OCI
On derecognition, cumulative gains and losses in
OCI reclassified to Profit or Loss.

Financial Assets
Financial Asset in the scope of IFRS 9
Is the asset and equity
investment?

Are the assets

contractual cash
flows solely
principal and
interest?

No

Yes
Is held for trading?

Yes

Yes

No

No
No

No
Has the entity elected
the OCI option
(irrevocable)?

No

Is the business
models objective
achieved both by
collecting contractual
cash flows and by
selling financial
assets?

Yes

Yes
FVOCI
(Equity
Instruments)

Is the business models

objective to hold to
collect contractual
cash flows?

FVTPL

FVOCI (Debt
Instruments)

Amortized
cost

Yes

Financial Assets
At fair value through other comprehensive income
(FVOCI)- Equity Instruments:
Dividends generally recognized in Profit or Loss
Changes in Fair Value recognized in OCI
No reclassification of gains and losses to Profit or
Loss on derecognition and no impairment
recognized in Profit or Loss

Financial Assets
Financial Asset in the scope of IFRS 9
Is the asset and equity
investment?

Are the assets

contractual cash
flows solely
principal and
interest?

No

Yes
Is held for trading?

Yes

Yes

No

No
No

No
Has the entity elected
the OCI option
(irrevocable)?

No

Is the business
models objective
achieved both by
collecting contractual
cash flows and by
selling financial
assets?

Yes

Yes
FVOCI
(Equity
Instruments)

Is the business models

objective to hold to
collect contractual
cash flows?

FVTPL

FVOCI (Debt
Instruments)

Amortized
cost

Yes

Financial Assets
At fair value through profit or loss (FVTPL)
Change in fair value recognized in Profit or Loss

References

International Financial Reporting and Analysis

David Alexander, Anne Britton, Ann Jorissen, Martin
Hoogendoorn and Carien van Mourik (sixth Edition)
Manual of Accounting IFRS 2015 PWC
Insight into IFRS 2015 KPMG
Ernst&Young Foundation Academic Resource
Center