LKAS 32/SLFRS 9/SLFRS 7

Financial Instruments

 Introduction and classification of financial instruments

 Recognition and measurement of financial instruments
 Impairment of financial assets
 Derivatives

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 Hedge Accounting
 Disclosures of financial instrument

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REPORTING STANDARDS

G
There are three reporting standards within the syllabus that deal with financial
instruments:

IN
 LKAS 32 Financial Instruments: Presentation
 SLFRS 7 Financial Instruments: Disclosures


T
SLFRS 9 Financial Instruments

N
LKAS 32 deals with the classification of financial instruments and their financial
statement presentation. SLFRS 7 deals with the disclosure of financial instruments in
financial statements. SLFRS 9 is concerned with the initial and subsequent
U
measurement of financial instruments.
O

GAP ASSESSMENT (LKAS 39 VS SLFRS 9)

C

Impacted LKAS 39 SLFRS 9

Area
Classification Four classifications and Three classifications and selection of
C

of financial every instrument classification is based on considering

assets categorise accordingly whether it is a debt and equity instruments.
A

based on respective Business model and contractual cash flows

management objective tests.
E

Impairment Incurred Loss Expected Credit Loss (ECL)

of financial
N

assets
Hedge 80-120 Rule This requires the Group to ensure that hedge
LI

accounting accounting relationships are aligned with its

risk management objectives and strategy
and to apply a more qualitative and forward‑
N

looking approach to assessing hedge

effectiveness. (Go beyond 80-120 rule)
Require extensive new disclosures in
O

particular about hedge accounting.

 INTRODUCTION AND CLASSIFICATION OF FINANCIAL INSTRUMENTS

KEY DEFINTIONS

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.

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Financial asset. Any asset that is:

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a) Cash
b) An equity instrument of another entity
c) A contractual right to receive cash or another financial asset from another entity;

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or to exchange financial instruments with another entity under conditions that
are potentially favourable to the entity, or

IN
d) A contract that will or may be settled in the entity's own equity instruments and
is:
o A non-derivative for which the entity is or may be obliged to receive a
variable number of the entity's own equity instruments; or

T
o 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
entity's own equity instruments. N
U
Financial liability. Any liability that is:

a) A contractual obligation:
O

 To deliver cash or another financial asset to another entity, or

 To exchange financial instruments with another entity under conditions
C

that are potentially unfavourable; or

C

b) A contract that will or may be settled in the entity's own equity instruments and
is:
A

 A non-derivative for which the entity is or may be obliged to deliver a

variable number of the entity's own equity instruments; or
E

 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
N

entity's own equity instruments.

Equity instrument. Any contract that evidences a residual interest in the assets of an
LI

entity after deducting all of its liabilities

A financial instrument is only an equity instrument if both of the following conditions

N

are met:
O

a) The instrument includes no contractual obligation to deliver cash or another

financial asset to another entity, or to exchange financial assets or liabilities with
another entity under conditions that are potentially unfavourable to the issuer.

b) If the instrument will or may be settled in the issuer’s own equity instruments, it
is either:
  a nonderivative that includes no contractual obligation for the issuer to
deliver a variable number of its own equity instruments
 a derivative that will be settled only by the issuer exchanging a fixed
amount of cash or another financial asset for a fixed number of its own
equity shares

Derivative. A financial instrument or other contract with all three of the following

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characteristics:

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 Its value changes in response to the change in a specified interest rate, financial
instrument price, commodity price, foreign exchange rate, index of prices or
rates, credit rating or credit index, or other variable (sometimes called the

G
'underlying');
 It requires no initial net investment or an initial net investment that is smaller

IN
than would be required for other types of contracts that would be expected to
have a similar response to changes in market factors; and
 It is settled at a future date.

T
The following are points to note in relation to the definition of a financial instrument
above:
N
 The contract giving rise to a financial asset and liability need not be in writing,
but it must comprise an agreement that has 'clear economic consequences' and
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which the parties to it cannot avoid, usually because the agreement is
enforceable in law
O

 An 'entity' involved in the contract could be an individual, partnership, company

or government agency.
C

Financial assets  Trade receivables

 Options
C

 Shares (when used as an investment)

Financial  Trade payables
A

Liabilities  Debenture & loans payable

 Redeemable preference (non-equity) shares
E

 Forward contracts standing at a loss

N

LKAS 32 makes it clear that the following items are not financial instruments.
LI

1. Physical assets, eg inventories, property, plant and equipment, leased assets and
intangible assets (patents, trademarks etc)
2. Prepaid expenses, deferred revenue and most warranty obligations
N

3. Liabilities or assets that are not contractual in nature

4. Contractual rights/obligations that do not involve transfer of a financial asset, eg
O

commodity futures contracts, operating leases for lessors

 Question 1 – Financial Liabilities or Equity

Coasters wishes to purchase a new ride for their ‘Animation Galaxy’ theme park. In
order to fund this, they have had to obtain extra funding. On 30 September 2020,
Coasters issued the following preference shares and share options:

 1 million preference shares for Rs. 3 each. No dividends are payable. Coasters

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will redeem the preference shares in three years' time by issuing ordinary shares
worth Rs. 3 million. The exact number of ordinary shares issuable will be based

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on their fair value on 30 September 2023.
 2 million preference shares for Rs. 2.80 each. No dividends are payable. The
preference shares will be redeemed in two years' time by issuing 3 million

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ordinary shares.
 4 million preference shares for Rs. 2.50 each. They are not mandatorily

IN
redeemable. A dividend is payable if, and only if, dividends are paid on ordinary
shares.
 Share options to issue 1 million ordinary shares at Rs. 3 each in two years’ time

T
 Share options to issue 2 million ordinary shares in two years’ time based on their
fair value of the shares as of that particular date.

Required: N
Discuss whether these financial instruments should be classified as financial liabilities
U
or equity in the financial statements of Coasters for the year ended 30 September 2020.
O

Interest, dividends, losses and gains

C

The accounting treatment of interest, dividends, losses and gains relating to a financial
instrument follows the treatment of the instrument itself.
C

 Dividends paid in respect of preference shares classified as a liability will be

A

charged as a finance expense through profit or loss

E

 Dividends paid on shares classified as equity will be reported in the statement of

changes in equity.
N

Offsetting
LI

LKAS 32 states that a financial asset and a financial liability may only be offset in very
limited circumstances. The net amount may only be reported when the entity:
N

 'has a legally enforceable right to set off the amounts

O

 intends either to settle on a net basis, or to realise the asset and settle the
liability simultaneously' (IAS 32, para 42).
 The impact of classification

The classification of a financial instrument as either a liability or as equity will have a

major impact on the financial statements.

 If an entity issues an instrument and classifies it as a liability, then gearing will

rise and the entity will appear more risky to potential investors. The servicing of

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the finance will be charged to profit or loss reducing profits.

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 If an entity issues an instrument and classifies it as equity then gearing will fall.
The servicing of the finance will be charged directly to retained earnings and so
will not impact profit.

G
OTHER DEFINITIONS

IN
Primary instruments and derivatives

As the definitions of a financial asset and liability indicate, financial instruments include

T
both of the following.

N
a) Primary instruments: eg receivables, payables and equity securities
b) Derivative instruments (Forward, Futures, Options, Swaps)
U
Settlement options
O

When a derivative financial instrument gives one party a choice over how it is settled
(eg, the issuer can choose whether to settle in cash or by issuing shares) the instrument
C

is a financial asset or a financial liability unless all the alternative choices would result
in it being an equity instrument.
C

Contingent settlement provisions

A

An entity may issue a financial instrument where the way in which it is settled depends
E

on:
a) The occurrence or non-occurrence of uncertain future events, or
N

b) The outcome of uncertain circumstances, that are beyond the control of both the
holder and the issuer of the instrument.
LI

For example, an entity might have to deliver cash instead of issuing equity shares. In
this situation it is not immediately clear whether the entity has an equity instrument or
a financial liability. Such financial instruments should be classified as financial liabilities
N

unless the possibility of settlement is remote.

O

Treasury shares

If an entity reacquires its own equity instruments, those instruments ('treasury shares')
must be deducted from equity. No gain or loss may be recognised in profit or loss on the
purchase, sale, issue or cancellation of an entity's own equity instruments.
Consideration paid or received shall be recognised directly in equity
 Puttable financial instruments and obligations arising on liquidation

LKAS 32 requires that if the holder of a financial instrument can require the issuer to
redeem it for cash it should be classified as a liability. Some ordinary shares and
partnership interests allow the holder to 'put' the instrument (that is to require the
issuer to redeem it in cash).

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The standard further requires that instruments imposing an obligation on an entity to

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deliver to another party a pro rata share of the net assets only on liquidation should be
classified as equity.

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RECOGNITION AND MEASUREMENT OF FINANCIAL INSTRUMENTS

IN
RECOGNITION AND MEASUREMENT OF FINANCIAL LIABILITIES

Initial recognition of financial liabilities

T
At initial recognition, financial liabilities are measured at fair value.

 N
If the financial liability will be held at fair value through profit or loss,
transaction costs should be expensed to the statement of profit or loss
U
 If the financial liability will not be held at fair value through profit or loss,
transaction costs should be deducted from its carrying amount.
O

Subsequent measurement of financial liabilities

C

The subsequent treatment of a financial liability is that they can be measured at either:
C

 amortised cost
 fair value through profit or loss.
A

FINANCIAL LIABILITIES AT AMORTISED COST

E

Most financial liabilities, such as borrowings, are subsequently measured at amortised

N

cost using the effective interest method. This is considered in more detail below:

Calculating amortised cost

LI

The initial carrying amount of a financial liability measured at amortised cost is its fair
value less any transaction costs (the 'net proceeds' from issue).
N

A finance cost is charged on the liability using the effective rate of interest. This will
O

increase the carrying amount of the liability:

Dr Finance cost (P/L)

Cr Liability

The liability is reduced by any cash payments made during the year:
 Dr Liability
Cr Cash

Amortised cost table

In the exam, assuming interest is paid in arrears, you might find the following working

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useful:

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Opening Finance cost Cash payments Closing
Liability (op. liability × effective %) (nom. value × coupon liability
%)

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XX XX (XX) XX

IN
 The finance cost is charged to the statement of profit or loss.
 The cash payment will be part of 'interest paid' in the statement of cash flows.
 The closing liability will appear on the statement of financial position.

T
Question 2 – Other Financial Liabilities

N
On 1 January 2020 James issued a loan note with a Rs. 50,000 nominal value. It was
issued at a discount of 16% of nominal value. The costs of issue were Rs. 2,000. Interest
U
of 5% of the nominal value is payable annually in arrears. The bond must be redeemed
on 1 January 2025 (after 5 years) at a premium of Rs. 4,611.
O

The effective rate of interest is 12% p.a.

C

Required:
How will this be reported in the financial statements of James over the period to
C

redemption?
A

Question 3 – Other Financial Liabilities

E

Hoy raised finance on 1 January 2020 by the issue of a two year 2% bond with a
nominal value of Rs. 10,000. It was issued at a discount of 5% and is redeemable at a
N

premium of Rs. 1,075. Issue costs can be ignored. The bond has an effective rate of
interest of 10%.
LI

Wiggins raised finance by issuing Rs. 20,000 6% four year loan notes on 1 January 2020.
The loan notes were issued at a discount of 10%, and will be redeemed after four years
N

at a premium of Rs. 1,015. The effective rate of interest is 12%. The issue costs were Rs.
1,000.
O

Cavendish raised finance by issuing zero coupon bonds at par on 1 January 2020 with a
nominal value of Rs. 10,000. The bonds will be redeemed after two years at a premium
of Rs. 1,449. Issue costs can be ignored. The effective rate of interest is 7%.

The reporting date for each entity is 31 December.

 Required:
Illustrate and explain how these financial instruments should be accounted for by each
company.

FINANCIAL LIABILITIES AT FAIR VALUE THROUGH PROFIT OR LOSS

K
Out of the money derivatives and liabilities held for trading are measured at fair value
through profit or loss.

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Irrevocable designation

G
A company is allowed to designate a financial liability as measured at fair value through
profit or loss. This designation is irrevocable and can only be made if:

IN
 it eliminates or significantly reduces a measurement or recognition
inconsistency; or
 this would allow the company to reflect a documented risk management

T
strategy.

N
Where this designation is used, the part of the change in fair value due to a change in the
entity’s own credit risk must be recognised in other comprehensive income. This is a
U
little difficult to understand but the rule exists to prevent an undesired effect.
O

Question 4 – FVTPL Financial Liabilities

On 1 January 2020, McGrath issued a financial liability for its nominal value of Rs. 10
C

million. Interest is payable at a rate of 5% in arrears. The liability is repayable on 31

December 2022. McGrath trades financial liabilities in the short term.
C

At 31 December 2020, market rates of interest have risen to 10%.

A

Required:
E

Discuss the accounting treatment of the liability at 31 December 2020.

N

Question 5 –Financial Liabilities designated at FVTPL

LI

Bean regularly invests in assets that are measured at fair value through profit or loss.
These asset purchases are funded by issuing bonds. If the bonds were not remeasured
to fair value, an accounting mismatch would arise. Therefore, Bean designates the bonds
N

to be measured at fair value through profit or loss.

The fair value of the bonds fell by Rs. 30 Mn during the reporting period, of which Rs.
O

10mn related to Bean's credit worthiness.

Required:
How should the bonds be accounted for?
 FAIR VALUE

Definition

Fair value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date
(i.e. it is an exit price).

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Fair value measurement looks at the asset (liability) from the point of view of a market

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participant. The fair value must take into account all factors that a market participant
would consider relevant to the value. These factors might include:

G
 the condition and location of the asset; and
 restrictions (if any) on the sale or use of the asset.

IN
SLFRS 13 defines an active market as a market in which transactions for the asset
(liability) take place with sufficient frequency and volume to provide pricing
information on an on-going basis.

T
A quoted price in an active market provides the most reliable evidence of fair value and
N
must be used to measure fair value whenever available.
U
Bid /Offer prices

For some assets (liabilities) markets quote prices that differ depending on whether the
O

asset is being sold to or bought from the market.

C

The price at which an asset can be sold to the market is called the bid price (it is the
amount the market bids for the asset).
C

The price at which an asset can be bought from the market is called he ask or offer price
A

(it is the amount the market asks for the asset or offers to sell it for).
E

The price within the bid-ask spread that is most representative of fair value in the
circumstances must be used to measure fair value. Previously, LKAS 39 required that
N

bid price had to be used for financial assets and ask price for financial liabilities but this
is no longer the case.
LI

COMPOUND INSTRUMENTS

A compound instrument is a financial instrument that has characteristics of both equity

N

and liabilities. An example would be debt that can be redeemed either in cash or in a
fixed number of equity shares.
O

Presentation of compound instruments

LKAS 32 requires compound financial instruments be split into two components:

 a financial liability (the liability to repay the debt holder in cash)
 an equity instrument (the option to convert into shares).
 These two elements must be shown separately in the financial statements.

The initial recognition of compound instruments

On initial recognition, a compound instrument must be split into a liability component

and an equity component:

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 The liability component is calculated as the present value of the repayments,

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discounted at a market rate of interest for a similar instrument without
conversion rights.
 The equity component is calculated as the difference between the cash proceeds

G
from the issue of the instrument and the value of the liability component.

IN
Question 6 – Compound instruments

On 1 January 2020 Daniels issued a Rs. 50 Mn three-year convertible bond at par.

T
 There were no issue costs.
 The coupon rate is 10%, payable annually in arrears on 31 December.


N
The bond is redeemable at par on 1 January 2023.
Bondholders may opt for conversion in the form of shares. The terms of
U
conversion are two 25cent equity shares for every Rs. 1 owed to each
bondholder on 1 January 2023.
O

 Bonds issued by similar entities without any conversion rights currently bear
interest at 15%.
C

 Assume that all bondholders opt for conversion in shares.

Required:
C

How will this be accounted for by Daniels?

A

Question 7 – Compound instruments with conversion

E

Craig issues a Rs. 100,000 4% three-year convertible loan on 1 January 2020. The
market rate of interest for a similar loan without conversion rights is 8%. The
N

conversion terms are one equity share (Rs. 1 nominal value) for every Rs. 2 of debt.
Conversion or redemption at par takes place on 31 December 2022.
LI

Required:
How should this be accounted for:
N

a) if all holders elect for the conversion?

b) no holders elect for the conversion?
O
 RECOGNITION AND MEASUREMENT OF FINANCIAL ASSETS

Initial recognition of financial assets

SLFRS 9 deals with recognition and measurement of financial assets. An entity should
recognise a financial asset on its statement of financial position when, and only when,
the entity becomes party to the contractual provisions of the instrument.

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Examples of this principle are as follows:

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 A trading commitment to buy or sell goods is not recognised until one party has
fulfilled its part of the contract. For example, a sales order will not be recognised

G
as revenue and a receivable until the goods have been delivered.

 Forward contracts are accounted for as derivative financial assets and are

IN
recognised on the commitment date, not on the date when the item under
contract is transferred from seller to buyer.

T
 Option contracts are accounted for as derivative financial assets and are
recognised on the date the contract is entered into, not on the date when the
item subject to the option is acquired. N
U
ACCOUNTING FOR INVESTMENTS IN EQUITY INSTRUMENTS

CLASSIFICATION
O

Investments in equity instruments (such as an investment in the ordinary shares of

C

another entity) are measured at either:

C

 fair value either through profit or loss, or

 fair value through other comprehensive income.
A

Fair value through profit or loss

E

The normal expectation is that equity instruments will have the designation of fair value
through profit or loss.
N

Fair value through other comprehensive income

LI

It is possible to designate an equity instrument as fair value through other

comprehensive income, provided that the following conditions are complied with:
N

 the equity instrument must not be held for trading, and

O

 there must have been an irrevocable choice (Designation) for this designation
upon initial recognition of the asset.
 MEASUREMENT

Fair value through profit or loss

Investments in equity instruments that are classified as fair value through profit or loss
are initially recognised at fair value. Transaction costs are expensed to profit or loss.

K
At the reporting date, the asset is revalued to fair value with the gain or loss recorded in
the statement of profit or loss.

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Fair value through other comprehensive income

G
Investments in equity instruments that are classified as fair value through other
comprehensive income are initially recognised at fair value plus transaction costs.

IN
At the reporting date, the asset is revalued to fair value with the gain or loss recorded in
other comprehensive income. This gain or loss will not be reclassified to profit or loss in
future periods.

T
Question 8 – Classification of Equity Instruments

Ashes' holds the following financial assets:

N
U
 Investments in ordinary shares that are held for short term speculation.
 Investments in ordinary shares that, from the purchase date, are intended to be
O

held for the long term.

C

Required:
How should Ashes classify and account for its financial assets?
C

Question 9 – Measurement of Equity Instruments

A

Jones bought an investment in equity shares for Rs. 40 million plus associated
E

transaction costs of Rs. 1 million. At the reporting date the fair value of the financial
asset had risen to Rs. 60 million. Dividend Received during the year Rs. 2 million.
N

Shortly after the reporting date the financial asset was sold for Rs. 70 million.
LI

How should the investment be accounted for?

a) The asset was designated upon initial recognition as fair value through other
N

comprehensive income.
b) How would the answer have been different if the investment had been classified
O

to be measured at fair value through profit and loss?

 ACCOUNTING FOR INVESTMENTS IN DEBT INSTRUMENTS

CLASSIFICATION

Financial assets that are debt instruments can be measured in one of three ways:

 Amortised cost

K
 Fair value through other comprehensive income
 Fair value through profit or loss.

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Amortised cost

G
An investment in a debt instrument is measured at amortised cost if:

IN
 The financial asset is held within a business model whose aim is to collect the
contractual cash flows
o This means that the entity does not plan on selling the asset prior to
maturity but rather intends to hold it until redemption.

T
 The contractual terms of the financial asset give rise on specified dates to cash
N
flows that are solely payments of principal and interest on the principal amount
outstanding
U
o For example, the interest rate on convertible bonds is lower than market
rate because the holder of the bond gets the benefit of choosing to take
O

redemption in the form of cash or shares. The contractual cash flows are
therefore not solely payments of principal and interest on the principal
amount outstanding.
C

Fair value through other comprehensive income

C

An investment in a debt instrument is measured at fair value through other

A

comprehensive income if:

 The financial asset is held within a business model whose objective is achieved
E

by both collecting contractual cash flows and selling financial assets

o This means that sales will be more frequent than for debt instruments
N

held at amortised cost. For instance, an entity may sell investments if the
possibility of buying another investment with a higher return arises.
LI

 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.
N

Fair value through profit or loss

O

An investment in a debt instrument that is not measured at amortised cost or fair value
through other comprehensive income will be measured at fair value through profit or
loss.
 Irrevocable designations

On initial recognition of a financial asset that would otherwise be measured at

amortised cost or at fair value through OCI a company can make an irrevocable decision
to designate them as at fair value through P&L. This is only allowed where it eliminates
or significantly reduces a measurement or recognition inconsistency.

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Question 10 – Business model and SPPI Test

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A Co holds investments to collect their contractual cash flows but would sell an
investment in particular circumstances, perhaps to fund capital expenditure, or because

G
the credit rating of the instrument falls below that required by A Co’s investment policy

IN
Required:
How should company classify and account for its financial assets?

T
Question 11 – Classification of Debt Instruments

N
Paloma purchased a new financial asset on 31 December 2020. The asset is a bond that
will mature in three years. Paloma buys debt investments with the intention of holding
them to maturity although has, on occasion, sold some investments if cash flow
U
deteriorated beyond acceptable levels. The bond pays a market rate of interest. The
Finance Director is unsure as to whether this financial asset can be measured at
O

amortised cost.
C

Required:
Advise the Finance Director on how the bond will be measured.
C

MEASUREMENT
A

Amortised cost
E

For investments in debt that are measured at amortised cost:

N

 The asset is initially recognised at fair value plus transaction costs.

LI

 Interest income is calculated using the effective rate of interest.

Fair value through other comprehensive income

N

For investments in debt that are measured at fair value through other comprehensive
O

income:

 The asset is initially recognised at fair value plus transaction costs.

 Interest income is calculated using the effective rate of interest.

 o This means that the amounts that are recognised in profit or loss are the
same as the amounts that would have been recognised in profit or loss if
the financial asset had been measured at amortised cost.

 At the reporting date, the asset will be revalued to fair value with the gain or loss
recognised in other comprehensive income. This will be reclassified to profit or
loss when the asset is disposed.

K
.L
Fair value through profit or loss

For investments in debt that are measured at fair value through profit or loss:

G
 The asset is initially recognised at fair value, with any transaction costs expensed

IN
to the statement of profit or loss.

 At the reporting date, the asset will be revalued to fair value with the gain or loss
recognised in the statement of profit or loss.

T
Note on loss allowances
N
For debt instruments measured at amortised cost or at fair value through other
U
comprehensive income, a loss allowance must also be recognised. This detail is covered
in the next section.
O

Question 12 – Classification of Debt Instruments

C

On 1 January 2020, Tokyo bought a Rs.100,000 5% bond for Rs. 95,000, incurring issue
costs of Rs. 2,000. Interest is received in arrears. The bond will be redeemed at a
C

premium of Rs. 5,960 over nominal value on 31 December 2022. The effective rate of
interest is 8%.
A

The fair value of the bond was as follows:

E

31/12/2020 Rs.110,000
31/12/2021 Rs.104,000
N

Required:
LI

Explain, with calculations, how the bond will have been accounted for over all relevant
years if:
N

a) Tokyo's business model is to hold bonds until the redemption date.

b) Tokyo's business model is to hold bonds until redemption but also to sell them if
O

investments with higher returns become available.

c) Tokyo's business model is to trade bonds in the short term. Assume that Tokyo
sold this bond for its fair value on 1 January 2021.
 The requirement to recognise a loss allowance on debt instruments held at amortised
cost or fair value through other comprehensive income should be ignored.

Question 12 – Concessionary Rate Lending

On 1 January 2020, Magpie lends Rs. 2 million to an important supplier. The loan, which
is interest free, will be repaid in two years’ time. The asset is classified to be measured

K
at amortised cost. There are no transaction fees.

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Market rates of interest are 8%. The loss allowance is highly immaterial and can be
ignored.

G
Required:
Explain the accounting entries that Magpie needs to post in the year ended 31

IN
December 2020 to account for the above.

DERECOGNITION OF FINANCIAL INSTRUMENTS

T
A financial asset should be derecognised if one of the following has occurred:

 N
The contractual rights to the cash flows of the financial asset have expired.
o For example, an option held by the entity may have lapsed and become
U
worthless.
O

 The financial asset has been sold and the transfer qualifies for derecognition
because substantially all the risks and rewards of ownership have been
transferred from the seller to the buyer.
C

The analysis of where the risks and rewards of ownership lie after a transaction is
C

critical. If an entity has retained substantially all of the risks and rewards of a financial
asset then it should not be derecognised, even if it has been legally 'sold' to another
A

entity.
E

A financial liability should be derecognised when, and only when, the obligation
specified in the contract is discharged, cancelled or has expired.
N

The accounting treatment of derecognition is as follows:

LI

 The difference between the carrying amount of the asset or liability and the
amount received or paid for it should be recognised in profit or loss for the
N

period.

 For investments in equity instruments held at fair value through other

O

comprehensive income, the cumulative gains and losses recognised in other

comprehensive income are not recycled to profit or loss on disposal.

 For investments in debt instruments held at fair value through other

comprehensive income, the cumulative gains and losses recognised in other
comprehensive income are recycled to profit or loss on disposal.
 Question 13 – Derecognition Financial Investments

Ming has two receivables that it has factored to a bank in return for immediate cash
proceeds. Both receivables are due from long standing customers who are expected to
pay in full and on time. Ming had agreed a three-month credit period with both
customers.

K
The first receivable is for Rs. 200,000. In return for assigning the receivable, Ming has
received Rs. 180,000 from the factor. Under the terms of the factoring arrangement,

.L
Ming will not have to repay this money, even if the customer does not settle the debt
(the factoring arrangement is said to be 'without recourse').

G
The second receivable is for Rs. 100,000. In return for assigning the receivable, Ming has
received Rs. 70,000 from the factor. The terms of this factoring arrangement state that

IN
Ming will receive a further Rs. 5,000 if the customer settles the account on time.

If the customer does not settle the account in accordance with the agreed terms then the
receivable will be reassigned back to Ming who will then be obliged to refund the factor

T
with the original Rs. 70,000 (this factoring arrangement is said to be 'with recourse').

Required: N
Discuss the accounting treatment of the two factoring arrangements.
U
Question 14 – Derecognition Equity Investments
O

Case holds equity investments at fair value through profit or loss. Due to short-term
C

cash flow shortages, Case sold some equity investments for Rs. 5 million when the
carrying amount was Rs. 4 million. The terms of the disposal state that Case has the
right to repurchase the shares at any point over the next two years at their fair value on
C

the repurchase date. Case has not derecognised the investment because its directors
believe that a repurchase is highly likely.
A

Required:
E

Advise the directors of Case as to the acceptability of the above accounting treatment.
N

RECLASSIFICATION OF FINANCIAL ASSETS

LI

SLFRS 9 requires that when an entity changes its business model for managing financial
assets, it should reclassify all affected financial assets. It is not allowed in any other
circumstance. This reclassification applies only to debt instruments, as equity
N

instruments must be classified as measured at fair value through profit or loss. An

election to measure them at fair value through other comprehensive income is only
permitted at initial recognition
O

Financial liabilities cannot be reclassified.

If a financial asset is reclassified from amortised cost to fair value, any gain or loss
arising from a difference between the previous carrying amount and fair value is
recognised in profit or loss.
 If a financial asset is reclassified from fair value to amortised cost, fair value at the date
of reclassification becomes the new carrying amount.

Reclassification Reclassification to Accounting consequences

from
Amortised cost Fair value through Remeasure to FV at the reclassification

K
profit or loss date
Recognise any gain or loss arising in P&L

.L
Amortised cost Fair value through Remeasure to FV at the reclassification
OCI date
Recognise any gain or loss arising in OCI

G
Fair value through Amortised cost FV at reclassification date becomes gross
profit or loss carrying amount

IN
Fair value through Amortised cost FV at reclassification date becomes gross
OCI carrying amount
Fair value through Fair value through Continue to measure the financial asset at
profit or loss OCI fair value

T
Fair value through Fair value through Continue to measure the financial asset at
OCI profit or loss fair value
N
U
O
C
C
A
E
N
LI
N
O