FAC2601

LEARNING UNIT 8

FINANCIAL INSTRUMENTS
– IFRS 7, 9 & IAS 32

Financial Accounting
for Companies
CONTENTS
Page

LEARNING UNIT 8: FINANCIAL INSTRUMENTS ................................................................................. 1

8.1 IFRS and IFRS for small and medium enterprises ..................................................... 4
8.2 BACKGROUND AND CURRENT ACCOUNTING POSITION .......................................... 8
8.3 DEFINITIONS.................................................................................................................... 9
8.3.1 Terminology.................................................................................................................... 9
8.3.2 Financial asset ................................................................................................................. 9
8.3.3 Financial liability ........................................................................................................ 10
8.3.4 Equity instrument ........................................................................................................... 10
8.3.5 Financial instrument ....................................................................................................... 11
8.3.6 Derivative instrument (Not part of this module) ........................................................... -
8.4 RECOGNITION ........................................................................................................... 14
8.4.1 Initial recognition ...................................................................................................... 14
8.5 MEASUREMENT .............................................................................................................. 15
8.5.1 Definitions ....................................................................................................................... 15
8.5.2 Classification of financial assets and financial liabilities ................................................. 16
8.5.2.1 Financial assets at fair value through profit or loss ........................................................ 16
8.5.2.2 Financial assets at fair value through other comprehensive income ............................. 17
8.5.2.3 Financial assets at amortised cost (Not part of this module) ........................................ 17
8.5.2.4 Financial liabilities at amortised cost (Not part of this module) .................................... 17
8.5.2.5 Financial liabilities at fair value through profit or loss .................................................... 17
8.5.3 Initial measurement of financial assets and financial liabilities ..................................... 18
8.5.4 Subsequent measurement of financial assets ................................................................ 18
8.5.5 Subsequent measurement of financial liabilities............................................................ 23
8.6 DERECOGNITION ....................................................................................................... 24
8.6.1 Derecognition of a financial asset ................................................................................... 24
8.6.2 Derecognition of a financial liability ............................................................................... 25
8.7 PRESENTATION ............................................................................................................... 25
8.7.1 Liabilities and equity ................................................................................................. 25
8.7.2 Classification of preference shares ................................................................................. 26
8.7.3 Interest, dividends, losses and gains......................................................................... 28
8.7.4 Transaction cost on equity instruments and offsetting ............................................ 28
8.8 DISCLOSURE .............................................................................................................. 28
8.9 SUMMARY ................................................................................................................. 30

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Learning outcomes
Once you have studied this learning unit, you should be able to:
• describe financial instruments and indicate how they should be accounted
for in the annual financial statements of an entity in accordance with the
requirements of Inter- national Financial Reporting Standards (IFRS)
• apply the theory in practical examples to illustrate the principles of
recognition, measurement and disclosure

Assessment criteria
After having studied this learning unit, you should be able to
 state the definitions contained in IFRS 7, IFRS 9, IAS 32 and IAS39 and apply
them to problems posed
 describe the classifications of financial instruments
 describe the principles for the recognition, measurement and
derecognition of financial instruments
 disclose the information relating to financial instruments in the annual
financial statements of an entity in accordance with the requirements of
International Financial Reporting Standards (IFRS)

Overview
This learning unit will be discussed under the following sections:
8.1 IFRS and IFRS for small and medium enterprises
8.2 Background and current accounting position
8.3 Definitions
8.3.1 Terminology
8.3.2 Financial asset
8.3.3 Financial liability
8.3.4 Equity instrument
8.3.5 Financial instrument
8.3.6 Derivative instrument (Not part of this module)
8.4 Recognition
8.4.1 Initial recognition
8.5 Measurement
8.5.1 Definitions
8.5.2 Classification of financial assets and financial liabilities
8.5.2.1 Financial assets at fair value through profit or loss
8.5.2.2 Financial assets at fair value through other comprehensive income
8.5.2.3 Financial assets at amortised cost (Not part of this module)
8.5.2.4 Financial liabilities at amortised cost (Not part of this module)
8.5.2.5 Financial liabilities at fair value through profit or loss
8.5.3 Initial measurement of financial assets and financial liabilities
8.5.4 Subsequent measurement of financial assets
8.5.5 Subsequent measurement of financial liabilities
8.6 Derecognition
8.6.1 Derecognition of a financial asset
8.6.2 Derecognition of a financial liability
8.7 Presentation
8.7.1 Liabilities and equity
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 8.7.2 Classification of preference shares
8.7.3 Interest, dividends, losses and gains
8.7.4 Transaction cost on equity instruments and offsetting
8.8 Disclosure
8.9 Summary

8.1 REPORTING FRAMEWORK

(IFRS AND IFRS for Small and medium size enterprises)
IFRS for SMEs Section 11 and 12 prescribes the accounting treatment (recognition and
measurement) for financial instruments and related disclosure requirements.
Here are the main differences between IFRS 7 and 9 and IAS32 and Section 11 and 12
regarding the accounting treatment for financial instruments. See below Table 1
Table 1: Main differences between IFRS 7 and 9 and IAS 32 / Section 11 and 12 –
Financial instruments
Main difference IFRS 7 & 9 and IAS32 Section 11 and 12
(IFRS for SMEs)
Scope IFRS 7, 9 and IAS32 applies to Applies to all financial
all financial instruments other instruments, except the
than: following:
• Interest in subsidiaries, • Interests in subsidiaries,
associates and joint associates and joint
ventures that are ventures.
consolidated or equity
• Financial instruments that
accounted;
meet the definition of an
• Rights and obligations
entity’s own equity.
under leases in terms of
IFRS 16, except, with regard • Leases.
to:
• Finance lease receivables • Employee benefits.
and operating lease • Insurance contracts.
receivables that are subject
to the derecognition and • Contracts for contingent
impairment provisions for consideration in a business
IFRS 9; combination (applies to
acquirer only)
• Lease liabilities that are
subject to derecognition [IFRS for SMEs 11.7, 12]
provisions of IFRS 9;
• Employers’ rights and
obligations under employee
benefit plans in terms of IAS
19;

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 • Equity instruments that are
classified as shareholders’
equity by the issuer in
terms of IAS 32;
• Rights and obligations
arising under a contract
within the scope of IFRS 17,
insurance contracts;
• Forward contracts between
an acquirer and selling
shareholder in terms of
IFRS 3, Business
Combinations; and
• Contracts and obligations
under share-based payment
transactions in terms of
IFRS 2 except for contracts
that fall with in the scope of
IAS 32;
• Rights and obligations
within the scope of IFRS 15
that are financial
instruments
• In the scope of IAS 32 and
IFRS 7 but excluded from
IFRS 9

Examples of basic This definition is not applicable ‘Basic’ financial instrument

and more to IFRS 7 and IFRS 9 examples:
complex financial
• Cash.
instruments
• Trade accounts and notes
receivable and payable.
• Loans from banks or other
third parties.
• Commercial paper and
commercial bills held.
• Bonds and similar debt
instruments.

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Initial recognition No difference
Initial On initial recognition, financial
measurement instruments are measured at
fair value plus transaction
costs, in the case of financial
instruments other than fair
value through profit or loss.
The fair value upon initial
recognition is normally the
transaction price, unless part
of the consideration is for
something other than a
financial instrument or the
instrument bears an off-
market interest rate.
[IFRS 39.43, IAS 39 AG64-65]
Subsequent • Financial instruments
measurement classified as held for trading
and designated as at fair
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‘Complex’ financial
instruments are:
• Asset-backed securities and
repurchase agreements.
• Options, rights, warrants,
futures, forward contracts
and interest swaps that can
be settled in cash or by
exchanging another
financial instrument.
• Hedging instruments.
• Commitments to make a
loan to another entity.
• Investments in another
entity’s equity instruments
and other non-convertible
and non-puttable ordinary
shares and preference
shares.
• Investments in convertible
debt.
[IFRS for SMEs 11.5-11.6]
No difference
On initial recognition, basic
financial instruments are
measured at the transaction
price (including transaction
costs unless the instrument is
measured at fair value through
profit or loss). The asset or
liability is measured at the fair
value of future payments if
payment is deferred or is
financed at an interest rate
that is not a market rate. [IFRS
for SMEs 11.13]
No difference
 value through profit or loss
are measured at fair value
through profit or loss.
• Held-to-maturity
investments and loans and
receivables are measured at
amortised cost.
• Financial liabilities other
than those at fair value
through profit or loss are
measured at amortised
cost.
• Available for sale
investments measured at
fair value with changes in
fair value recorded in
equity.
• Investments in equity
securities whose fair value
cannot be measured
reliably are measured at
cost less impairment.
[IAS 39.46-39.47, IAS 39.66]

Disclosure The carrying amount of each of No difference except for basic

the categories of financial and more complex criteria
assets or liabilities as identified
by IFRS 9. The categories are:
• Financial assets at fair
value through profit or loss,
– Showing separately those
mandatorily measured at
fair value;
– Those designated to this
category at initial
recognition
• Financial assets at fair
value through other
comprehensive income,

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 – Showing separately those
mandatorily measured at
fair value;
– Those designated to this
category at initial
recognition
• Financial assets at
amortised cost
• Financial liabilities at
amortised cost
• Financial liabilities at fair
value through profit or loss,
– Those that meet the
definition of held for
trading in terms of IFRS 9;
– Those to this category at
initial recognition

This learning unit is based on IFRS as the accounting framework and use IFRS 7 and
IFRS 9 accounting principles.

LECTURER’S COMMENT
Note: Foreign exchange contracts and derivative instruments do not form part
of this syllabus.

8.2 BACKGROUND AND CURRENT ACCOUNTING POSITION

With the changes in the global financial markets worldwide, a larger range of financial instruments
exist. It is no longer just banks and financial institutions that are the participants in the active trading
of financial instruments, but businesses too. Businesses are forced to use financial instruments due
to competition in the market place. Not only are financial instruments used in their operating
activities, but also in their capital financing activities, investment and risk management activities.
Thus, many corporations have treasury divisions that manage these activities. Continuous
monitoring of financial risk in a global environment is a dynamic activity, as an entity can change its
risk profile instantly by entering into certain financial arrangements.

Large losses from the use of financial instruments have been demonstrated in prominent
organisations thus resulting in highly published disasters. Due to these disasters the need for
accounting and disclosure has heightened.

Financial markets use a variety of financial instruments, ranging from traditional primary instruments
(i.e. debtors, creditors, equity) to derivative instruments (i.e. financial options, futures and forwards,
interest rate swaps and currency swaps).
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The standards IFRS 9, IAS 32, IAS 39 (relevant sections) and IFRS 7 deal with the disclosure, presentation,
recognition and measurement of financial instruments. IFRS 9 was issued in November 2009 and
replaces certain sections of IAS 39. IFRS 9 also addresses impairment of financial assets and hedge
accounting; however, this falls outside the scope of this module.
The objective of IAS 32 Financial instruments: presentation, is to establish principles for presenting
financial instruments as liabilities or equity and for offsetting financial assets and financial liabilities.
IAS 32 prescribes requirements for:
• presentation of financial instruments as assets, liabilities or equity
• offsetting financial assets and liabilities
• classification of financial instruments into financial assets, financial liabilities and equity
instruments
• classification of related interest, dividends, losses and gains
• circumstances in which financial assets and financial liabilities should be offset he objective of
IFRS 7 is to require entities to provide disclosures in their annual financial statements that enable
users to evaluate:
• the significance of financial instruments for the entity’s financial position and performance
• the nature and extent of risks arising from financial instruments to which the entity is exposed
during the period and at the reporting date, and how the entity manages those risks

The objective of IFRS 9 is to address the classification, measurement and impairment of financial
instruments that will present relevant and useful information to users of annual financial statements
for their assessment of the amounts, timing and uncertainty of the entity’s future cash flows

8.3 DEFINITIONS

8.3.1 Terminology

A financial instrument is:

A contract that gives rise to both a financial asset of one entity and a financial liability or equity
instrument of another entity.
Primary instruments or equity instruments such as swaps, futures, options, receivables and
payables form part of financial instruments.
Take note: cum div and ex div transactions do not form part of this module.

Example 1

A creditor being the buyer in one entity and the seller in another entity gives rise to a contract
between the buyer and seller. This results in a financial liability in the books of the buyer’s entity
and a financial asset in the books of the seller’s entity.

8.3.2 Financial asset

A financial asset is any asset that is:

(a) cash;
(b) an equity instrument of another entity (example: investments);

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(c) a contractual right:
– to receive cash or another financial asset from another entity (e.g. accounts receivables); or
– to exchange financial assets or financial liabilities with another entity under conditions that are
potentially favourable to the entity (e.g. purchased options); or
(d) a contract that will or may be settled in the entity’s own equity instruments (not part of this
module)

Example 2

Entity X buys shares in Entity Y for cash. The contract gives rise to a financial asset in Entity X and an
equity instrument in Entity Y.

8.3.3 Financial liability

A financial liability is any liability that is:

(a) a contractual obligation:
– to deliver cash or another financial asset to another entity (e.g. creditors); or
– to exchange financial assets or financial liabilities with another entity under conditions that are
potentially unfavourable to the entity (e.g. written options); or
(b) a contract that will or may be settled in the entity’s own equity instruments (not part of this
module)

Example 3

Company X borrows R300 000 from Bank Y. Interest is payable annually and the capital amount is
repayable after 3 years. Since Company X has a contractual obligation to pay the amount borrowed
as well as interest (principal and interest), this will give rise to a financial liability in the statement
of financial position of Company X.

LECTURER’S COMMENT
Note: No complex financial liability transactions will be dealt with in this
module. The most important will be the recognition, measurement and
disclosure of long-term loans.

8.3.4 Equity instrument

An equity instrument is any contract that evidences a residual interest in the assets of an entity after
deducting all its liabilities. An equity instrument is presented as part of total equity on the face of the
statement of financial position. Thus when an entity receives a fixed amount of cash for issuing a fixed
amount of shares into the market those shares are classified as equity instruments for the issuing
entity.

Example 4

Company X issues 200 000 ordinary shares for cash. These ordinary shares are classified as an equity
instrument in the books of Company X.

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8.3.5 Types of financial instruments

A financial instrument is any contract that gives rise to a financial asset of one entity and a financial
liability or equity instrument of another entity. Below follows a list of the different type of financial
instruments and a brief description thereof:

Bond/Debenture:

A certificate of debt issued by the government which carries a fixed interest rate. These bonds could be
listed. In this manner funds are raised by the government repayable without any security at a specified
date.

Clearing house:

A clearance house provides facilities for settlement or clearing to those trading on the exchange. The
clearing house levies fees to the participants in exchange for a low default risk.

Loan:

This is an amount of money borrowed with repayment of principal at a later date. It contains as interest
component with or without a security.

Ordinary share:

These are equity instruments entitled to a dividend after the preference dividends are paid. These
provide ordinary shareholders voting rights in the entity. The highest risk is carried by such shareholders
as well as the highest return.

Share/equity:

These refer to those who hold shares in the company in exchange for dividends. These shares may also
be listed on the JSE.

Preference share:

The holders of preference shares have a preferential right to dividends when compared to ordinary
shareholders. Preference shareholders also have preference to dividends on liquidation of the company
once the creditors have been paid. They are in different forms such as cumulative, non-cumulative,
participating etc.

Related terms:

Corporate actions:

These are events initiated by a public company such as dividend declarations, mergers, acquisitions,
share splits etc.

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Cum dividend (or cum div)/ex dividend (ex div):

This is when a share is offered for sale with an entitlement to the next dividend payment. If shares are
held on the last day to register (LDR) then the holder is entitled to receive a dividend (cum dividend),
but if shares are sold after the declaration date then the new holder will be entitled to the dividend
(ex-dividend).

Cum interest/ex interest:

“Cum interest” if the trade settlement date occurs before the LDR and before the next coupon payment
date (i.e. the buyer will receive the next coupon payment). It means that the price paid by the buyer for
the bond will equal the clean price (without interest) plus the accrued interest between the previous
coupon payment date and trade settlement date.
“Ex interest” will trade if the trade settlement date occurs after the LDR but before next payment date.

Dividends:

A portion of profit that is paid out to shareholders, proposed by the board of directors and authorised
by shareholders.

Holder:

The party that holds an instrument.

Interest:

It is the amount of money paid over and above the principal amount borrowed over a period of time. As
such a compensation for the principal amount borrowed.

Issuer:

The party that gave or issued an instrument.

Principal/capital/nominal/face value:

The principal amount is the amount borrowed without the interest as such is the face value.

Last date to register (LDR):

The date on which the holder of a share is to receive a dividend (in case of shares) or coupon payment
(in case of bonds).

Interest, dividends, gains and losses

Interest, dividends, gains and losses relating to a financial instrument must be provided as income or
expense through profit or loss if they relate to a financial asset or financial liability. Distributions due to
holders of equity instruments must be recognized directly in equity.
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Offsetting:

A financial asset and a financial liability can be offset against each other in the statement of financial
position of an entity as long as:

• There is a legally enforceable right to do so; and

• Intends to settle the amounts on a net basis (the financial asset and financial liability are settled
simultaneously).
Thus, only the net amount of the liability or asset is disclosed in the financial statements.

LECTURER’S COMMENT
Note: Foreign exchange contracts and derivative instruments do not form part
of this syllabus.

Example 5

Examples of financial assets and financial liabilities

Financial asset/financial liability
• Currency (cash) is a financial asset.
Reason
It represents the medium of exchange and is
therefore the basis on which all transactions are
measured and recognised in annual financial
statements.

• A deposit of cash with a bank or similar
financial institution is a financial asset.
It represents the contractual right of the
depositor to obtain cash from the institution or
to draw a cheque or similar instrument against
the balance in favour of a creditor in payment of
a financial liability.

• Common financial assets and financial In each case, one party’s contractual right to
liabilities receive (or obligation to pay) cash is matched by
- trade accounts receivable and payable the other party’s corresponding obligation to pay
- loans receivable and payable (or right to receive).

• A financial guarantee It is a contractual right of the lender to receive

cash from the guarantor, and a contractual
obligation of the guarantor to the lender, if the
borrower defaults. The contractual right and
obligation exist because of a past transaction
or event (assumption of the guarantee), even
though the lender’s liability to exercise its right
and the requirement for the guarantor to perform
under its obligation are both contingent on a
future act of default by borrower. A contingent
right and obligation meet the definition of a
financial asset and a financial liability, even
though such assets and liabilities are not always
recognised in the annual financial statements.
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Example 6

The following are NOT financial assets and financial liabilities – IAS32
Item Reason
• Physical assets such as: Control of such physical and intangible assets
- Inventories create an opportunity to generate an inflow of
- Property, plant and equipment cash or another financial asset, but it does not
give rise to a present right to receive cash or
another financial asset.

• Leased assets (operating lease): An operating lease is an uncompleted contract

committing the lessor to provide the use of an
asset in future periods in exchange for
consideration similar to a fee for a service. The
lessor continues to account for the leased asset
itself (rather than any amount receivable in the
future under the contract, i.e. a finance lease).

• Prepaid expenses: The future economic benefit is the receipt of

goods or services, rather than the right to receive
cash or another financial asset.

8.4 RECOGNITION

8.4.1 Initial recognition

This refers to how financial assets or financial liabilities are initially accounted for in the records
of an entity.

An entity shall recognise a financial asset or a financial liability on its statement of financial position
when, and only when, the entity becomes a party to the contractual provisions of the instrument.

Example 7

At what stage shall an entity recognise the following items on its statement of financial position?

1. Unconditional receivables and payables

Recognised as assets or liabilities when the entity becomes a party to the contract and,
consequently, has a legal right to receive or a legal obligation to pay cash.

2. Assets to be acquired and liabilities to be incurred as a result of a firm commitment to

purchase or sell goods or services
It is generally not recognised until at least one of the parties has performed under the
agreement.

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 For example:
• An entity that receives a firm order does not generally recognise an asset (and the entity that
places the order does not recognise a liability) at the time of the commitment but, rather,
delays recognition until the ordered goods or services have been shipped, delivered or
rendered.
• If a firm commitment to buy or sell non-financial items is within the scope of this standard,
its net fair value is recognised as an asset or liability on the commitment date.

3. Planned future transactions

No matter how likely they are, they are neither assets nor liabilities because the entity has not
become a party to a contract.

8.5 MEASUREMENT OF FINANCIAL INSTRUMENTS

8.5.1 Definitions

Fair value

The fair value of an instrument would be the price/amount at which the asset (or liability) could be
bought or sold in a current transaction between willing parties or transferred to an equivalent party
between market participants on transaction date.
The measurement of fair value makes reference to:
• Transaction price;
• Quoted market prices in an active market;
• Estimated discounted values of all payments and receipts; or
• Recent prices of similar instruments where there is no active market.
Quoted prices may be used by using discounted cash flow or any other common valuation technique
where market prices are not available, provided that the valuation technique provides reliable
estimates.

Transaction costs

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 not have been
incurred if the entity had not acquired, issued or disposed of the financial instrument. These may
include commission paid, brokerage fees as well as duties and transfer tax or other levies paid to
regulatory bodies. Transaction costs will not include internal costs, discounts, premiums and finance
costs.

The classification of the financial assets or financial liabilities will determine whether the transaction
costs are included in the cost of the financial asset or financial liability.

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8.5.2 Classification of financial assets and financial liabilities

Financial assets

An entity shall classify financial assets as subsequently measured at either amortised cost or fair
value (two subcategories) on the basis of both:

(a) An entity’s business model for managing financial assets

(b) The contractual cash flow characteristics of the financial asset

A financial asset shall be measured at fair value unless it is measured at amortised cost.

Take note: For the purpose of this module, only the following financial asset categories will be dealt
with:
– At fair value through profit or loss
– At fair value through other comprehensive income

8.5.2.1 Financial assets at fair value through profit or loss

This is the default category for purposes of classifying financial assets. Financial assets will be
classified in this category if:

• it is mandatorily measured at fair value

• upon initial recognition, it is designated by the entity as “at fair value through profit or loss”. A
financial asset can only be designated upon initial recognition if it will eliminate or reduce a
measurement or recognition inconsistency.

Financial assets that are classified as held for trading automatically fall into this sub-category. Held
for trading means it is a short-term investment and is intended to sell or repurchase in the near
future.

Example 8

The following are examples of instruments held for trading:

Case 1
Company X buys shares in Company Y (listed company) for speculation purposes. Since Company X
will actively buy and sell shares in Company Y for realizing short term profits.

Case 2
Company X holds the following speculative share portfolios of three shares for the year ended
31 December 20.20:

Name Number of shares Fair value Last date of selling

R
Coke Ltd 5 000 50 000 20 November 20.20
Pepsi Ltd 2 000 24 000 Never
Kingsley Ltd 4 000 48 000 22 March 20.20

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Since Company X has traded On Coke Ltd and Kingsley Ltd for the current financial year, they will be
classified at fair value through profit or loss. Although, no trade has occurred on Pepsi Ltd it is part
of the speculative portfolio and may still be classified at fair value through profit or loss.

Case 3
Company X holds call options not designated as hedging instruments. They will therefore be
classified at fair value through profit or loss.

8.5.2.2 Financial assets at fair value through other comprehensive income

This category is only available for equity instruments not held for trading (e.g. investment in another
company with the intention not to sell the shares in the near future).

Financial assets will be classified in this category if:

• it is mandatorily measured at fair value through other comprehensive income
• upon initial recognition, it is designated by the entity as “at fair value through other
comprehensive income”.

For example:
A Ltd purchased 7 000 ordinary shares in B Ltd. These shares were held as part of a long- term
investment portfolio. These shares will then be classified as a financial asset at fair value through other
comprehensive income.

Example 9

TopStar Ltd purchased a bond with a nominal value of R2 000 000 and a coupon rate of 12% on
1 January 20.17 with a premium of 5% and a nominal value of 13.489%. The bond was purchased at a
fair value of R2 000 000. The bond will be redeemed on 31 December 20.20. TopStar Ltd holds the bond
to collect contractual cash flows and to sell the bond to re-invest in an investment with a higher return.

Both contractual cash flows as well as selling the bonds are an integral part of TopStar Ltd’s business
model, the bond will be classified as a financial asset at fair value through other comprehensive income.

8.5.2.3 Financial assets at amortised cost

This category financial asset does not form part of this module.

8.5.2.4 Financial liabilities at amortised cost

This category financial liability does not form part of this module.

8.5.2.5 Financial liabilities at fair value through profit or loss

A financial liability is classified as held for trading if:

• it is acquired or incurred principally for the purpose of selling or repurchasing it in the near term;
or
• on initial recognition, it is part of a portfolio of identified/designated financial instruments that
are managed together and for which there is evidence of a recent actual pattern of short-term
profit-taking.
If the instrument forms part of a hedging relationship, hedge accounting principles will apply and
this falls outside the scope for this module.
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8.5.3 Initial measurement of financial assets and financial liabilities

Initial measurement can be summarised as follows:

Financial asset category Initial measurement

• Financial assets/liability at fair value through At fair value, excluding transaction costs
profit or loss

• Financial assets at fair value through other At fair value + transaction costs
comprehensive income (Investments in equity –
not held for trading)

The fair value of a financial instrument on initial recognition is normally the transaction price (i.e.
the fair value of the consideration given or received). If the fair value is not equal to the transaction
price a gain or loss is recognized at initial recognition. This gain or loss is recognized through profit
or loss.

Example 10

A Ltd bought 1 000 ordinary shares in B Ltd at R5,00 per share. Transaction costs amounted to R500.

REQUIRED

Journal entries at initial recognition in the financial records of A Ltd when the
financial asset is recognised:
• at fair value through other comprehensive income
• at fair value through profit or loss

Solution 10

• At fair value through other comprehensive income: R R

Dr Financial asset (SFP) [(1 000 x R5,00) + R500] 5 500
Cr Bank (SFP) 5 500

• At fair value through profit or loss: R R

Dr Financial asset (SFP) (1 000 x R5,00) 5 000
Dr Transaction cost (P/L) 500
Cr Bank (SFP) 5 500

8.5.4 Subsequent measurement of financial assets

Financial assets at fair value through profit or loss:

After initial recognition, any subsequent gains or losses must be measured directly through profit
or loss.
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Financial assets at fair value through other comprehensive income:

After initial recognition, any subsequent gains or losses must be measured directly through other
comprehensive income.

A financial asset is measured at fair value through other comprehensive income when:
• The financial asset being is held within the business model to obtain cash flows and sell the
financial asset (In this case it is a debt instrument)
• The entity has made an irrevocable election on initial recognition to classify it as equity.

Below follows a summary of the initial and subsequent measurements of the two different classes
of financial assets:

Initial Subsequent Gains and losses on

Financial asset category measurement measurement remeasurement
1. Financial assets at fair Cost (being fair value but Fair value Recognised in profit or
value through profit or excluding transaction loss
loss costs)

2. Financial assets at fair Cost (being fair value, Fair value Recognised in other
value through other including transaction comprehensive income
comprehensive income costs) and accumulated in
(Investments in equity – equity (mark-to-
not held for trading) market reserve)

Example 11

(Initial and subsequent measurement of financial assets at fair value through profit or loss)
A financial asset at fair value through profit or loss is purchased at R2 000 and a commission of R50.
At initial measurement the financial asset is recorded at R2 000 and the R50 is expensed (as per
IFRS 9). The quoted market price at the next reporting date is R2 225. This will result in an
adjustment R225 (R2 225 – R2 000) recognized in profit or loss.

Example 12

(Initial and subsequent measurement of financial assets at fair value through profit or loss)
Viva-Voo Ltd acquired 1 000 shares in Waterloo Ltd at a price of R15,00 per share. The shares were
acquired on 1 July 20.10 and are held for trading. Transaction costs amounted to R1 000. At year-end
(31 December), the market value of one Waterloo Ltd share was R17,00.

REQUIRED
Journal entries to account for the investment in the financial records of
Viva-Voo Ltd for the year ended 31 December 20.10 in accordance with the
requirements of International Financial Reporting Standards (IFRS).

19
Solution 12
Dr Cr
R R
Initial measurement – 1 July 20.10
Investment in shares (1 000 x R15) (SFP) 15 000
Transaction costs (Profit / Loss) 1 000
Bank (SFP) 16 000
Subsequent measurement – 31 December 20.10
Investment in shares [(1 000 x R17) – 15 000] (SFP) 2 000
Fair value adjustment (Profit/Loss) 2 000

Example 13

(Initial and subsequent measurement of financial assets at fair value through other
comprehensive income)
Viva-Voo Ltd acquired 1 000 shares in Waterloo Ltd at a price of R15,00 per share. The shares were
acquired on 1 July 20.10 and are NOT held for trading. Transaction costs amounted to R1 000. At
year-end (31 December), the market value of one Waterloo Ltd share was R17,00.

REQUIRED
Journal entries to account for the investment in the financial records of
Viva-Voo Ltd for the year ended 31 December 20.10 in accordance with the
requirements of International Financial Reporting Standards (IFRS).

Solution 13
Dr Cr
R R
Initial measurement – 1 July 20.10
Investment in shares [(1 000 x R15) + 1000] (SFP) 16 000
Bank (SFP) 16 000

Subsequent measurement 31 December 20.10

Investment in shares [(1 000 x R17) – 16 000] (SFP) 1 000
Mark-to-market reserve (OCI) 1 000

Example 14

(Initial and subsequent measurement of financial assets at fair value through other comprehensive
income – debt instruments.)

On 2 January 20.19, Company X bought R 2 000 000 SA Post Office 8% Bonds at fair value of
R1 848 368 (when the market interest rate was 10%). Transaction costs amounted to R15 000. The
bonds mature at a nominal value 2 January 20.24. On 31 December 20.19 the bonds had a fair value
of R1 993 866. On 2 January 20.20 the bonds were sold at a fair value of R1 993 866. The bonds were
classified at financial assets at fair value through other comprehensive income.

20
 Dr Cr
R R
Initial measurement – 2 January 20.19
Bonds (SFP) (fair value + transaction costs) 1 863 368
Bank (SFP) (price paid for bonds) 1 848 368
Bank (SFP) (transaction costs) 15 000
Purchase of bonds

Subsequent measurement – 31 December 20.19

Bank (SFP) 160 000
Bonds 119 505
Finance income 279 505

Subsequent measurement at amortised cost

Bonds 10 993
Market -to-market reserve on debt instruments (OCI) 10 993

Subsequent measurement at amortised cost

Sale of bonds – 2 January 2020
Bank 1 993 866
Bonds 1 993 866
Investment sold for cash
Market to market reserve on debt instrument (OCI) 10 993
Gain on investment in bonds (P/L) 10 993
Reclassify other comprehensive income to profit and loss

Solution 14

Step 1
Using a financial calculator calculate the effective interest rate:
PV = – (R1 848 368 + R15 000); n = 5; Payment = 160 000 (8% x R2 000 000);
FV = 2 000 000; Comp i = 9.79%

Step 2
Determine the carrying amount on 31 December 2019
Carrying amount on 31 December 2019 before fair value adjustment: 1 863 368 + 279 505
[(1 848 368 + 15 000) x 9.79%] – 160 000 = R1 982 873

Step 3
Determine the fair value gain by subtracting the fair value from the carrying amount calculated
R1 993 866 – R1 982 873 = R10 993

Example 15

(Initial and subsequent measurement of financial assets at fair value through other comprehensive
income – equity instruments.)

21
On 2 November 20.19, Company X bought 20 000 ordinary shares in a listed company Gold Ltd at
R3 per share. The shares are not held for speculative purposes but were acquired with a long-term
view. The directors irrevocably elected at initial recognition to classify this investment as at fair value
through other comprehensive income. Transaction costs amounted to R3 000 and paid by
Company X. The market value of the shares on 31 December 20.19 was R6 per share. The shares
were sold at R6,20 per share on 2 January 20.20 which was their fair value at the date. It is the
accounting policy of the company to transfer the cumulative balance on the market to market
reserve on equity instruments to retained earnings when the asset or part of the asset is
derecognized.

Solution 15

Dr Cr
R R
Initial measurement – 1 November 20.19
Investment in shares (SFP) [(20 000 x R3) + R 3 000) 63 000
Bank (SFP) 63 000
Purchase of investment

Subsequent measurement – 31 December 20.19

Investment in shares (SFP) [(20 000 x R6) – R63 000] 57 000
Market-to-market reserve on equity instruments (OCI) 57 000
Investment remeasured to fair value and adjustment recognized through other
comprehensive income

Subsequent measurement at amortised cost

Derecognition of shares – 2 January 2020
Investment in shares [R124 000 (20 000 x R6,20) – R120 000 (R63 000 + R57 000)] 4 000
Market of market reserve on equity instruments (OCI) 4 000
Remeasure investment on date of derecognition to fair value and recognize
adjustment in other comprehensive income

Sale of shares – 2 January 2020

Bank (SFP) 124 000
Investment in shares (SFP) 124 000

Market to market reserve on equity instruments (Equity) (R57 000 + R4 000) 61 000
Retained earnings (Equity) 61 000
Transfer the accumulated profit in the market-to-market reserve directly to
retained earnings

• The gains in the market to market reserve on equity instruments is transferred to retained
earnings upon disposal. (in equity instruments in statement of changes in equity)
• Market to market reserves can have a debit balance if there was a loss (decrease in fair value)

22
8.5.5 Subsequent measurement of financial liabilities

Financial liabilities at fair value through profit or loss

All financial liabilities at fair value through profit or loss are initially measured at cost. The cost is
therefore the fair value. Transaction costs are excluded from the cost of the liability. All gains and
losses upon subsequent measurement are also recognized through profit or loss.

If the financial liability was designated into the category of profit or loss, the subsequent changes in
fair value have to be separated between changes in credit risk of the issuer and other changes.

Changes in credit risk must be recognized in other comprehensive income and accumulate in equity.
Upon derecognition they will be recognized in retain earnings directly in equity. If however, the
separation of credit risk and other changes results in an accounting mismatch all changes can be
shown through profit or loss.

Impairment of financial assets

IFRS 9 requires a loss allowance be recognized for the following financial assets:

• Financial assets at amortised cost;

• Investment in debt instruments measured at fair value through other comprehensive income;
• Lease receivables (IFRS 16);
• Contract assets (IFRS 15)

Credit losses

A recognition of a loss allowance is based on an expected loss to be incurred and not on a loss
actually incurred.

A credit loss is a cash shortfall that arises due to the difference in contractual cash flows expected
to be received in terms of the contract and all the cash flows that the entity expects to receive. This
shortfall is discounted at an effective interest rate.

Credit risks

When a failure to discharge an obligation by any of the parties occurs, this results in a credit risk. An
example would be when a borrower’s inability to repay a debt increased due to adverse economic
conditions. The entity should then assess the risk of default with the information available, to
determine if the risk is significant.

The entity may however assume that the credit risk on a financial asset has not increased
significantly, if it had a low credit risk on the reporting date.

23
 Financial liability Subsequent Gains and losses on
category Initial measurement measurement remeasurement
1. Financial At cost (being fair Fair value Recognised in profit or
liability at fair value but excluding loss (unless the FV changes
value through transaction costs) are due to credit risk, then
profit or loss in other comprehensive
income)
2. Amortised At cost (being fair Amortised cost Not applicable, but an
cost value including interest component will
transaction costs) be recognised in profit or
loss.
The accounting treatment of financial liabilities can be summarised as follows:

Take note: Financial liabilities at amoritised cost do not form part of this module.

8.6 DERECOGNITION

8.6.1 Derecognition of a financial asset

STUDY
Study paragraph 6.1 of the prescribed textbook.

Derecognition is the removal of a previously recognised financial asset from an

entity’s statement of financial position.

An entity shall derecognise a financial asset when, and only when:

(a) the contractual rights to the cash flows from the financial asset expire; or
(b) the financial asset is transferred, and the transfer qualifies for derecognition.

Financial assets recognised as “at fair value through profit or loss” must first be restated to fair value
through profit or loss before derecognition. This will result in no additional profit or loss on
derecognition, provided that the asset was sold at fair value.

Financial assets recognised as “at fair value through other comprehensive income” must first be
restated to fair value through other comprehensive income upon derecognition. This will result in no
additional profit or loss on derecognition, provided that the asset was sold at fair value.

The entity may decide to reclassify the resultant balance in the mark-to-market reserve (relating to
the asset derecognised), directly to retained earnings.

Example 16

Trade receivables that have a carrying amount R80 000 (at date of sale) are sold for R100 000. The
trade receivables have to be derecognized since the right to cash flows has expired. In this instance,
a profit of R20 000 will have to be recognized.

24
8.6.2 Derecognition of a financial liability

An entity shall remove a financial liability (or a part of a financial liability) from its statement of financial
position when, and only when, it is extinguished, that is, when the obligation specified in the contract:
(a) is settled/discharged
(b) is cancelled
(c) expires

A financial liability (or a part of it) is extinguished when:

(a) the debtor discharges the liability (or part of it) by paying the creditor, normally with cash, other
financial assets, goods or services
(b) the debtor is legally released from primary responsibility for the liability (or part of it), either by
process of law or by the creditor (If the debtor has given a guarantee, this condition may still be
met).
(c) an exchange occurs between an existing borrower and lender of debt instruments with
substantially different terms
(d) a change occurs to the conditions of an existing debts instrument

Example 17

(Derecognition of financial liability)

X Ltd owes R400 000 (carrying amount) in terms of a long loan from Y Ltd. Y Ltd would like to obtain
an investment that is held by X Ltd (classified at fair value through profit or loss with a fair value of
R360 000) and is prepared to accept this as a settlement of a debt. The journal entry to effect this
in the books of X Ltd is as follows:

DR CR
R R
Long-term loan (SFP) 400 000
Investment at fair value through profit or loss (SFP) 360 000
Profit on settlement of long-term loan (P/L) 40 000
Settlement of long-term loan by investment taken over

8.7 PRESENTATION

IAS32 deals with the presentation of financial instruments and deal with the following:
• Classification of financial instruments between assets, liabilities and equity
• Classification of interest, dividends, losses and gains driven by their financial instrument
classification
• The circumstances when financial assets and liabilities could be set off

8.7.1 Liabilities and equity

The issuer of a financial instrument shall classify the instrument, or its component parts, on initial
recognition as a financial liability, a financial asset or an equity instrument in accordance with:
• the substance of the contractual arrangement
• the definitions of a financial liability, a financial asset and an equity instrument

25
A critical feature in differentiating a financial liability from an equity instrument is the existence of a
contractual obligation of one party to the financial instrument (the issuer), either to:
• deliver cash or another financial asset to the other party (the holder), or
• exchange financial assets or financial liabilities with the holder under conditions that are
potentially unfavourable to the issuer

Although the holder of an equity instrument may be entitled to receive a pro-rata share of any
dividends or other distributions of equity, the issuer does not have a contractual obligation to make
such distributions because it cannot be required to deliver cash or another financial asset to another
party.

For example, a preference share that provides for mandatory redemption by the issuer for a fixed or
determinable amount at a fixed or determinable future date, or gives the holder the right to require
the issuer to redeem the instrument at or after a particular date for a fixed or determinable amount, is
a financial liability. (See learning unit 1 par 1.5.3). Substance over form determines the classification of
a financial instrument.
8.7.2
8.7.2 Classification of preference shares

There are two separate cash flow streams when dealing with preference shares:
• The dividend amount of the shares
• The capital amount of the shares

These two streams must be considered separately when determining if the preference shares are
equity or liabilities. Preference shares are compound instruments (with equity and liability
components).
LECTURER’S COMMENT
Note: Only the classification of the preference shares and thus the disclosure
of preference shares is important for this module. The accounting of redeemable
preference shares on redemption date and the conversion of preference shares
to ordinary shares do not form part of this module.

Refer to learning unit 1

Example 18

Lula-Lee Ltd issued 1 000 redeemable preference shares on 1 January 20.10. The shares are
redeemable in cash at the option of the holder. If the options are not exercised, the shares will be
redeemable on 31 December 20.12.

Must the preference shares be presented as a financial liability or equity in the annual financial
statements of Lula-Lee Ltd?

The preference shares redeemable in cash at the option of the holder, or redeemable by the issuer
on 31 December 20.12, creates an obligation on the part of the issuer to deliver cash to the holder.
Therefore, it meets the definition of a financial liability.

26
Example 19

Lula-Lee Ltd issued 1 000 redeemable preference shares on 1 January 20.10. Lula-Lee Ltd has the
option to redeem the shares at any time.

Must the preference shares be presented as a financial liability or equity in the annual financial
statements of Lula-Lee Ltd?

Lula-Lee Ltd does not have a present obligation to transfer cash or financial assets to the holder and
therefore it does not meet the definition of a financial liability. The preference shares will be presented
as equity in the annual financial statements of Lula-Lee Ltd.

Example 20

Lula-Lee Ltd issued 1 000 convertible preference shares on 1 January 20.9. The shares will be converted
to ordinary shares on 31 December 20.12.
Must the preference shares be presented as a financial liability or equity in the annual financial
statements of Lula-Lee Ltd?

If the criteria for classification of an equity instrument are applied:

• the instrument includes no contractual obligation to deliver cash or another financial asset, or to
exchange a financial asset, or to exchange a financial asset or liabilities; and
• the instrument will be settled in the entity’s own equity instruments (ordinary shares) Therefore
this is an equity instrument.

The latter represents a non-derivative that presents no contractual obligation to be settled by the
issuer by issuing a variable number of its ordinary shares (equity instruments).

If any entity does not have an unconditional right to avoid delivering cash or another financial
asset to settle a contractual obligation, the obligation meets the definition of a financial liability
(IAS 32.19).

A financial instrument that does not explicitly establish a contractual obligation to deliver cash or
another financial asset may establish an obligation indirectly through its terms and conditions.

For example:
(a) A financial instrument may contain a non-financial obligation that must be settled if, and only if:
• the entity fails to make distributions, or
• to redeem the instrument.
If the entity can avoid a transfer of cash or another financial obligation only by settling the non-financial
obligation, the financial instrument is a financial liability.

(b) A financial instrument is a financial liability if it provides that, on settlement, the entity will deliver
either:
• cash or another financial asset, or
• its own shares whose value is determined to exceed substantially the value of the cash or other
financial asset (IAS 32.20).

27
8.7.3 Interest, dividends, losses and gains

The classification of the financial instrument in the statement of financial position would determine
where the losses, gains, interest or dividends relating to that instrument will be shown. If the items
relate to a financial liability it will be shown through profit or loss. If they relate to an equity
instrument it should be shown in equity

Example 21

X Ltd issued 1 000 000 compulsory redeemable preference shares at R1 000 000 bearing a
compulsory dividend of 9c per share. From a legal perspective it would give rise to a preference
dividend of R90 000. From an accounting perspective this would be classified as interest using
substance over form. This would therefore be shown in profit or loss in the statement of
comprehensive income.

8.7.4 Transaction cost on equity instruments

The transaction costs of an equity transaction shall be accounted for as a deduction from equity, to
the extent that they are incremental costs directly attributable to the equity transaction that would
otherwise have been avoided. These costs may include registration and other regulatory fees,
amounts paid to legal, accounting and other professional advisers, printing costs and stamp duties.

The amount incurred in respect of transaction costs related to equity transactions (net of any
associated taxation) is presented separately in terms of IAS 1 as a deduction in the statement of
changes in equity.

8.8 DISCLOSURE

The disclosure requirements of IAS 32 have been scrapped and have been replaced by a new standard,
namely IFRS 7. Although the old standard has been scrapped, many of the principles contained in the
new standard are similar to those in the old standard.

The disclosure requirement of IFRS 7 is very specialised and will not be covered in this module. It
will, however, be studied in detail in later accounting studies.

Disclosure in respect of financial assets and liabilities

The carrying amounts of each categories of financial assets or liabilities as identified by IFRS 9.
Shall be presented on face of the statement of financial position or shown in the notes.

Financial assets measured at fair value through profit or loss must show separately:
• Those mandatorily measured at fair value through profit or loss in terms of IFRS 9;
• Those designated to this category at initial recognition

Financial assets measured at fair value through other comprehensive income must show separately:
• Those mandatorily measured at fair value through other comprehensive income in terms of
IFRS 9;
• Those designated to this category at initial recognition

28
Financial liabilities measured at fair value through profit or loss must show separately:
• Those that meet the definition as held for trading in terms of IFRS 9;
• Those designated to this category at initial recognition

Disclosure in respect of gains, losses, income or expenses

The following items of income, expenses, gains or losses must be shown through the statement of
comprehensive income or disclosed in the notes:
• Financial assets and liablities designated at fair value through profit or loss;
• Financial assets and liablities classified at fair value through profit or loss;
• Financial assets designated at fair value through other comprehensive income;
• Financial asset classified at fair value through other comprehensive income;

Total interest income and total interest expense on:

• Financial asset classified at fair value through other comprehensive income;

Example 22

Lions Ltd owns 50 000 ordinary shares in Bulls Ltd. These shares were purchased for R50 000.
Transaction costs amounted to R1 000. These shares trade on the JSE and the market value at year-
end was R3 per share. These shares are held for speculative purposes.

REQUIRED

Solution 22

• Identify category: At fair value through profit or loss

• Measurement: Fair value (Excl. transaction cost)
• Initial recognition: R50 000
• Year-end at fair value:
• 50 000 shares x R3 = R150 000
• Fair value adjustment at year-end: R150 000 – R50 000 = R100 000.

Disclosure:
• Recognise the fair value adjustment in “profit or loss” in SOCI and profit before tax note
• Investments will be disclosed at fair value under “Current assets” in the statement of financial
position

Example 23

Lions Ltd owns 50 000 ordinary shares in Bulls Ltd. These shares were purchased for R50 000. Transaction
costs amounted to R1 000. These shares trade on the JSE and the market value at year-end was R3 per
share. This investment was designated as not-held-for-trading.

29
 REQUIRED

Solution 23

• Identify category: At fair value through other comprehensive income

• Measurement: Fair value (Incl. transaction costs)
• Initial recognition: R50 000 + R1 000 = R51 000
• Measurement at year-end at fair value: 50 000 shares x R3 = R150 000
• Fair value adjustment: R150 000 – R51 000 = R99 000.

Disclosure:
• Recognise the fair value adjustment in “other comprehensive income” in SOCI and mark-to-
market reserve in SOCE
• Investments will be disclosed at fair value under non-current assets in the statement of financial
position

8.9 SUMMARY

These examples illustrate the difference in disclosure and recognition of the different category of
financial assets.

FINANCIAL ASSETS:

The three categories of financial assets are as follows:

• At fair value through profit or loss (held for trading/speculative purposes)

Measurement: Fair value, excluding transaction costs

Fair value gain/loss – disclose in SOCI under “profit or loss” (other income/expenses)
• At fair value through other comprehensive income (not held for trading)

Measurement: At fair value + transaction costs

Fair value gain/loss – Disclose in “other comprehensive income” in SOCI and accumulated in mark-to-
market reserve in the statement of changes in equity.
• At amortised cost (not applicable in FAC2601)

Example 24

50 000 shares in Bulls Ltd at R50 000. Transaction costs R1 000. The shares trade on the JSE and
market value at year-end was R3 per share. These shares are held for speculative purposes.
• Identify category: At fair value through profit or loss
• Measurement: Fair value (Excl transaction cost)
• Initial recognition: R50 000
• Year-end at fair value: 50 000 shares x R3 = R150 000

Fair value adjustment at year-end: R150 000 – R50 000 = R100 000.

30
Disclosure:
• Recognise the fair value adjustment in “profit or loss” in SOCI and profit before tax note.
• Investments will be disclosed at fair value under current assets in the statement of financial
position.

Example 25

50 000 shares in Bulls Ltd at R50 000. Transaction costs R1 000. These shares trade on the JSE and
market value at year-end was R3 per share. This investment was designated as not held for trading.
Identify category: At fair value through other comprehensive income Measurement: Fair value (Incl
transaction costs)

Initial recognition: R50 000 + R1000 = R51 000

Measurement at year-end at fair value: 50 000 shares x R3 = R150 000 Fair value adjustment:
R150 000 – R51 000 = R99 000.

Disclosure:
• Recognise the fair value adjustment in “other comprehensive income” in SOCI and mark-to-
market reserve in SOCE.
• Investments will be disclosed at fair value under non-current assets in the statement of financial
position.

Financial assets at fair value through profit or loss

For a clear understanding before looking at further examples on financial assets at fair value through
profit or loss, the concepts following below will be explained:

Capitalisation issue
This is an issue to shareholders in a proportionate amount determined according to the number of
shares held prior to the issue. The issuer does not receive any consideration.

Implications for the investor:

• Additional shares received without any payment by the investor;
• The number of shares held increases, but the rand value of the investment is on constant;
• This implies that the value per share decreases as there are more shares at the same value;

Implications for the issuer:

• Reserves are converted into capital
• No inflow of capital or resources come into the entity
Shares held for speculative purposes /trading

Shares held for speculative purposes or trading fall into the category of financial assets at fair value
through profit or loss and must carried at fair value at year end. Any fair value adjustment increase
or decrease is shown in the statement of profit or loss and other comprehensive income.

31
Example 26

Plato Ltd had the following transactions in Space Ltd during the year ended 31 December 20.20:

1 January Balance : 9 000 ordinary shares at 90c each

12 February Purchase 5 000 ordinary shares at R1 each
31 March A capitalization issue of two shares for every four shares held
15 May Sells 4 000 ordinary shares at fair value of 75c each
30 June The market value of the shares at this date was 80 c each
1 July Space Ltd had a rights issue of one right for every 10 shares held in terms of
the rights issue. The holder has the right to acquire two shares at 62c per
share for each right. The rights expire on 15 January 20.21.
20 August 500 rights purchased at 43c each
5 October Sells 600 rights at a fair value of 45c each
8 November Exercise 400 rights
15 December Sells 5 900 shares at fair value of 72c each

On 31 December 20.20 the closing price on the JSE Ltd was 44c per right to ordinary shares of
Space Ltd and 68c per ordinary share in Space Ltd. It is accounting policy of Plato Ltd to value all
investments in Space Ltd at first-in, first-out method.

Plato Ltd acquired the shares in Space Ltd with the objective of making profits from the short-term
fluctuation of prices. The rights were not acquired as hedging instruments.

Transaction costs of 2c per share were incurred for each purchase transaction. Transaction costs of
1c per share were incurred for each sales transaction. These costs are not included in the prices per
share given above.
Assume the impact of discounting to be immaterial.

NB: If the weighted average method is used, the average price must be calculated after each
purchase transaction. The share group in this manner will not be held separately, but all shares will
be grouped together at an average price.

14 000 shares (9 000 + 5 000) and the price being (R8 100 (9 000 x 90 c) + R5 000 (5 000 x R1)) thus
average price 13 100/14 000 = 94 c.
Shares Per Share R
Prior to rights issue (cum rights value) 17 000 80c 13 600
(9 000 + 5 000 + 7 000 – 4 000)
Rights issue 3 400 60c 2 040
(17 000/10 = 1 700 x 2)
Ex-rights value 20 400 77c 15 640

Cum-rights value 80c

Ex-rights value 77c
3c
Change per existing share (17 000 x 3c) R510
Or
Each ten shares are one right R510
3c x 10 = 30c x 1700

32
 Or
Ex-rights value
Price to acquire one new share in terms of the rights issue 77c
3 400 x 15c 62c
496 (800 X 62c)* + 120 (30c x 400) R510
616/800 = 77c R616

Investment: Ordinary shares in space ltd

Price Number Shares Price Number Shares
1 January R 31 March R
Balance b/f 90c 9 000 8 100 Balance c/f 90c 9 000 8 100
12 Feb
Bank R1 5 000 5 000 Balance c/f R1 5 000 5 000
13 100 13 100
31 March 15 May
Balance b/f 90c 9 000 8 100 Bank 75c 4 000 3 000
Caps issue Balance c/f 60c 9 500 5 700
9 000/4 x 2 4 500 (13 500 – 4 000)
60c 13 500 8 100 Balance c/f 67c 7 500 5 000
Balance b/f R1 5 000 5 000
Caps issue 2 500
5 000/4 x 2
67c 7 500 5 000
Fair value adj. 600
4 000 x (75c – 60c)
13 700 13 700
15 May 30 June
Balance b/f 60c 9 500 5 700 Balance c/f 80c 17 000 13 600
Balance b/f 67c 7 500 5 000 (9 500 + 7 500)
Fair value adj. 2 900
13 600 13 600
Investment: Ordinary shares in space ltd
Price Number Shares Price Number Shares
R R
30 June 1 July
Balance b/f 80c 17 000 13 600 Investment: Rights
(9 500 + 7 500) to ord. shares 510
Balance b/f 77c 17 000 13 090
13 600 13 600
1 July 15 December
Balance b/f 77c 17 000 13 090 Fair value adj. 295
8 November (72c – 77c) x 5 900
Rights 79c 800 632 Bank 72c 5 900 4 248
Balance c/f 77c 11 100 8 547
(17 000 – 5 900)
Balance c/f 79c 800 632
13 722 13 722
15 Dec 31 Dec
Balance b/f 77c 11 100 8 547 Balance c/f 68c 11 900 8 092
(17 000 – 5 900)
Balance b/f 79c 800 632 Fair value adj. 1 087
9 179 9 179
1 January 68c 11 900 8 092

33
Investment: Rights to ordinary shares in space ltd
Price Number Shares Price Number Shares
R R
1 July 5 October
Investment in
Ordinary shares 30c 1 700 510 Bank 45c 600 270
20 August Balance c/f 30c 1 100 330
(1 700 – 600)
Bank 43c 500 215 Balance c/f 43c 500 215
5 October 15c 600 90
[600 x (45c – 30c)]
815 815
5 October 8 November
Balance c/f 30c 1 100 330 Investment in
(1 700 – 600) ordinary shares 79c 800 632
Balance c/f 43c 500 215 Balance c/f 44c 1 200 528
[(1 100 – 400) + 500]
8 November
Bank 62c 800 496
31 December
Fair value adj. 119
1 160 1 160
1 Jan 15 January
Balance b/f 44c 1 200 528 Loss (profit or loss) 44c 1 200 528

PLATO LTD
EXTRACT FROM STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.20
Notes R
Assets
Current assets
Financial assets at fair value through profit or loss 3 8 620

PLATO LTD
NOTES FOR THE YEAR ENDED 31 DECEMBER 20.20

3. Financial assets at fair value through profit or loss

Current financial assets

Listed
11 900 ordinary shares in Space Ltd – at fair value 8 092
1 200 rights to ordinary shares in Space Ltd – at fair value 528
Financial assets at fair value through profit or loss (mandatorily) 8 620

4. Profit before tax

Income
Listed – dividend income
Expenses
Fair value adjustments on financial assets at fair value through profit or loss 2 427
(600 + 2 900 – 1 087 + 119 – 295 + 190)

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Financial assets at fair value through other comprehensive income

(Debt instrument)

Investment in debt instruments

When debt instruments are held within a business model to collect the contractual cash flows from
it and then sell the investment it will be classified as financial assets at fair value through other
comprehensive income. The initial recognition of the investment is at fair value including the
transaction costs. The investment is subsequently measured at fair value and any changes are shown
in mark to mark reserve in equity and as other income in the statement of profit or loss and other
comprehensive income. This reserve has a separate column namely, mark to mark, in the statement
of changes in equity. It may have a debit balance (losses) or credit balance (gains) as the changes in
fair value increase or decrease. On derecognition any profit or losses are recognized to profit or loss.

Example 27

On 1 January 20.20, Plato Ltd purchases two 12% debentures R5 000 each from QT Ltd, company
listed on the JSE, at their fair value of R9 979. The debentures mature at 108% of the nominal value
in two equal annual instalments on 31 December 20.21 and 31 December 20.22. Interest is payable
on 31 December. The market related interest rate on similar debentures with same terms as these
debentures in 15% per annum. Plato has a 31 December year end. Assume that transaction costs of
R100 in total was paid by Plato Ltd in respect of the debentures. The objective of Plato Ltd’s business
model is to hold debentures in order to collect contractual cash flows (principal amount and interest
on the outstanding principal) and sell the debentures. The fair value of the debentures was as
follows:

31 December 2020: R5 400 per debenture

31 December 2021: R5 600 per debenture

On 1 January 2022 Plato Ltd disposed its debenture at its fair value of R5 600.

Plato Ltd’s profit for the year after any adjustments relating to the investment of debentures was
as follows:

For the year ended 31 December 2020: R60 000

For the year ended 31 December 2021: R80 000
For the year ended 31 December 2022: R93 000

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Step 1

Initial recognition of the debenture

1 January 20.20
Dr Cr
R R
J1 Initial measurement– 1 December 20.20
Investment in debenture (SFP) 9 979
Bank (SFP) 9 979
Debentures recognized at fair value on initial recognition

J2 Investment in debentures (SFP) 100

Bank (SFP) 100
Transactions costs paid and capitalized

Step 2

Capitalise transaction costs (J2). Calculate a new discount rate, since the PV has changed since it
includes transaction costs.

CFj 9 979 +100 = 10 079

CFj 1 200 (5 000 x 2 x 12%)
CFj 6 600 (5 000 x 2 x 12%) + ((5 000 x 2)/2 x 108%)
CFj 6 000 (5 000 x 12%) + (5 000 x 108/100)
IRR =14,5% per annum

Step 3

Recognition of interest on debentures at each year end

Account for the interest on the debentures as though they were carried at amortised cost, fair value
adjustment at year end and the settlement payments.
31 December 20.20.
Dr Cr
R R
J3 Bank (SFP) (R5 000 x 2 x 12%) 1 200
Investment in debenture (balancing) 261
Interest income (P/L) [(9 979 + 100) balance x 14,5% ] 1 461
Recognise interest and amortization adjustment

J4 Investment in debentures (SFP) ((5 400 x 2) – (10 079 + 261)) 460

Market-to-market reserve on debt instruments (OCI) 460
Remeasure debentures to fair value at year end

J5 Bank (SFP) (2 x R5 000/2 x 108%) 5 400

Investment in debentures (SFP) 5 400
Payment of instalment

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Account for the interest on the debentures as though they were carried at amortised cost, fair value
adjustment at year end and the settlement payments.
31 December 20.21
Dr Cr
R R
J6 Bank (SFP) (R5 000 x 2 x 12%) 1 200
Investment in debenture (balancing) 300
Interest income (P/L) [(9 979 + 100 + 261) x 14,5% ] 1 500
Recognise interest and amortization adjustment

J7 Bank (SFP) (2 x R5000/2 x 108%) 5 400

Investment in debentures 5 400
Investment installment paid

J8 Investment in debentures (SFP) Market-to-market reserve on debt

instruments (OCI) (700 + 460) 700
Market to market reserve 700
Remeasure debentures to fair value at year end

Step 4

Account for derecognition of debentures and reclassification of market to market reserve to profit
or loss .

1 January 20.22
Dr Cr
R R
J9 Mark-to-market reserve on debt instruments (OCI) 1 160
Gain on disposal of investment in debentures (P/L) 1 160
Recognise in profit or loss

Financial assets at fair value through other comprehensive income

(Equity instrument)

Investment in equity instruments

Company X acquired 10 000 listed ordinary shares in a listed company Y Ltd on 1 November 20.20.
The shares were not acquired for trading but as a long-term investment. The directors elected to
irrevocably recognize these shares as financial assets at fair value through other comprehensive
income on initial recognition. These shares were purchased at a fair value of R3,50 per share.
Transaction costs amounted to R500 and was paid by the purchaser. The market value of the shares
at the following year ends were:

• 31 December 20.20 was R3,58 per share

• 31 December 20.21 was R3,62 per share
• 31 December 20.22 was R3,60 per share

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On 31 December 20.22 Y Ltd declared and paid a dividend of 60c per share to shareholders. On
31 March 20.23 sold its shares at a fair value R3,65 per share.

X Ltd’s profit for year ends before taking the investment in Y Ltd’s shares is as follows:
• For the year ended 31 December 20.20, R40 000;
• For the year ended 31 December 20.21, R50 000;
• For the year ended 31 December 20.22, R45 000;
• For the year ended 31 December 20.23, R55 000

Dr Cr
R R
J1 Initial measurement – 30 June 20.20
Investment in shares in Y Ltd (SFP) [(10 000 x R3,50) + 500] 35 500
Bank (SFP) 35 500
Purchase of investment and transaction costs capitalized

J2 Year end – 31 December 20.20

Investment in shares in Y Ltd [(10 000 x 3,58) – R35 500] (SFP) 300
Mark to market reserve on equity instruments (OCI) 300
Investment at fair value at year end adjustment

J3 Year end – 31 December 20.21

Investment in shares in Y Ltd [(10 000 x 3,62) – R35 800] (SFP) 400
Mark to market reserve on equity instruments (OCI) 400
Investment at fair value at year end adjustment

J4 Year end – 31 December 20.22

Mark to market reserve on equity instruments (OCI) 200
Investment in shares in Y Ltd [(R36 200 – (10 000 x R3,60)] (SFP) 200
Investment at fair value at year end adjustment

J5 Bank 6 000
Dividend income (P/L) 6 000
Dividend received on investment (10 000 x 60c)

J6 Investment in shares in Y Ltd [(10 000 x 3,65) – R36 000] (SFP) 500
Mark to market reserve on equity instruments (OCI) 500
Subsequent measurement at fair value upon derecognition

J7 Bank (SFP) 36 500

Investment in shares in Y Ltd (SFP) 36 500
Subsequent measurement at fair value upon derecognition

J8 Mark to market reserve on equity instruments (Equity) 1 000

(R400 + R300 – R200 + R500)
Retained earnings (Equity) 1 000
Transfer of cumulative balances of fair value adjustments to retained earnings
upon derecognition

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