FINANCIAL INSTRUMENTS (IFRS – 9)

Objective:

The objective of IFRS 9 Financial Instruments is to establish principles for the financial reporting
of financial assets and financial liabilities that will present relevant and useful information to
users of financial statements for their assessment of the amounts, timing and uncertainty of an
entity’s future cash flows.

Scope:

The standard covers the following key areas;

• Classification and measurement of financial assets and financial liabilities
• Expected credit loss impairment model
• Hedge accounting

Definitions:

Financial Instruments: Financial Instruments are the contracts that give rise to financial
asset (one entity) and financial liability (another entity)
Financial Asset:
example:

• Cash in hand or cash at bank

• Equity Instrument of another entity (e.g., investment in
shares)
• Contractual rights to receive cash or another financial asset
(e.g., receivables or investment in loan)
• A contractual right to exchange financial instrument under
conditions that are potentially favorable (e.g., a favorable
forward contract entered into the bank)

Financial Liability: These are usually bonds or loan notes, or other instruments which
are likely to carry interest and a capital element of repayment.
example:

• Any contractual obligation to deliver cash or another

financial asset (e.g., loan payable)
 • A contractual right to exchange financial instrument under
conditions that are potentially unfavorable (e.g., an
unfavorable forward contract entered into the bank)

Equity Instrument: Equity instruments are likely to be shares that have been purchased
in a company, but not enough to give the investee significant
influence (associate), control (subsidiary) or joint control (joint
venture).

Substance over form: Recognition is made considering economic reality instead of legal
reality.
Some financial instruments have the legal form of equity but are in
substance, liability.
For instance, redeemable preference shares
The issuer has a contractual obligation to either deliver cash or
another financial asset. Therefore, dividend on redeemable
preference shares is treated as finance cost in P&L account. While
dividend on ordinary shares is presented in Statement of change in
equity.
Example 1: Identify the following items as a Financial Asset, a Non-financial Asset, a Financial
Liability, a Non-financial Liability or an equity instrument.

S# Items Recognized as
1 Trade Payable
2 Investment in Loan Notes of Another Entity
3 Bank Loan Obtained
4 Ordinary Shares Issued
5 Irredeemable Preference Shares Issued
6 Unfavorable Forward Currency Contract

Example 2
Identify the following items as a Financial Asset, a Non-financial Asset, a Financial
Liability, a Non-financial Liability or an equity instrument.

S# Items Recognized as
1 Share option purchased
2 Redeemable Preference Shares Issued
3 Investment in Redeemable Preference Shares
4 Prepaid Rent
 5 Current Tax Payable
6 Inventory

Recognition of Financial Instrument:

In accordance with IFRS 9, Financial Instruments, a company recognizes a financial asset or a
financial liability when the company becomes party to the contractual provisions of the
instrument. For example, if a company receives a firm order for goods from a customer, it should
delay recognition of the trade receivable until at least one of the parties has performed under the
agreement. This would normally be when the goods are shipped or delivered. In contrast, however,
a forward contract or option is recognized on the commitment date if it falls within the scope of
IFRS 9.
 Classification & Measurement of Financial Instruments:
Classification:
a. Financial Asset (Equity)
b. Financial Asset (Debt)
c. Financial Liability

a. Financial Asset (Equity)

Financial Assets- Investment in Equity Instrument

Category Conditions
Amortized Cost Not Applicable

Fair Value through OCI (FVTOCI) Instrument is NOT held for Trading.
Irrevocable Choice is made.
Fair Value through P&L (FVTPL) Default Residual Category
i.e., Instrument is held for Trading

Example 3:
Identify the classification of the following assets.
i. Investment in shares held for trading Purpose.
Answer: _____________
ii. The investment in equity shares. The entity has no intention of selling the shares in
foreseeable future.
Answer: _____________

b. Financial Asset (Debt)

Financial Assets - Investment in Debt Instrument

Category *Business Model **Cash Flows
Amortized Cost Hold to collect contractual cashflows Receipt of Principal and
Interest on specific dates.
Fair Value through OCI Hold to collect contractual cashflows Receipt of Principal and
(FVTOCI) and/or sell if beneficial Interest on specific dates.
Fair Value through P&L Default Residual Category
(FVTPL) Allowed even of the conditions of other classifications are met. If
doing so eliminates accounting mismatch.
*Intention behind the investment (collect cashflows/sell/)
**Nature of Cash flows
Example 4:
XYZ Limited makes a large bond issue to the market. Three companies i.e., A Limited, B Limited
& C Limited, each buy Rs. 1000000 bonds. How they should classify these financial assets based
on their business model?
A Limited holds bonds for the purpose of collecting contractual cash flows to the maturity.
B Limited holds bonds for the purpose of collecting contractual cash but intends to sell them on
the market when prices are favorable.
C Limited buys bonds to trade in them.
Answer: A Limited: _______
B Limited: _______
C Limited: _______

Example 5:
Identify the classification of the following financial assets?
Investment in interest bearing debt instrument. The instrument is redeemable is five years. The
intention is to collect cash flows (which are interest and principal amount only)
Answer: _______
Investment in interest bearing debt instruments. The instrument is redeemable in five years. The
intention is to collect cash flows (which are interest and principal only). However, the entity may
sell the loan notes earlier if any good offer is received.
Answer: _______
Investment in loan notes. The objective is to collect contractual cash flows which consist of
interest, changes in oil prices in next five years and principal amount at the end of year 5.
Answer: _______
Investment in loan notes. The objective is to collect contractual cash flows which consist of
interest, changes in oil prices in next five years and principal amount at the end of year 5. However,
the entity may sell the loan earlier if any offer is received.

c. Financial Liabilities

Financial Liabilities
Category Conditions
Amortized Cost All financial liabilities other than those measured at
FV
Fair Value Instrument is held for Trading OR to eliminate the
accounting mismatch OR held for hedging purpose
Example 6:
A 12% bank loan obtained by A Limited payable in 5 years’ time.
Answer: ______
8 % loan Notes issued by C limited
Answer: ______
A short-term currency swaps agreement entered into bank by Alpha bank which is currently
unfavorable. These types of transactions are usual feature of Alpha bank’s business.
Answer: ______
Trade Payable
Answer: ______
Derivatives held for speculation purpose (currently unfavorable)
 Measurement of Financial Instruments: Basics

Transaction Cost

Incremental costs that are directly attributable to the acquisition,

issue and disposal of financial asset or financial liability.
Examples;
Fees and commission paid to agents
Levies by regulatory agencies
Transfer taxes and duties
Credit assessment fee
Registration charges and similar costs
Note:
i. Transaction Costs are expensed in case of FVTPL
ii. Non Transaction Costs are always charged to P&L (Expense) i.e., Borrowing cost/
Internal administration cost, insurance of asset or security arrangements.

Amortized Cost

Present Value of future cashflows using effective

interest rates.

Effective interest rate

True cost of borrowing (Outstanding Balance x Effective Interest)

Nominal Interest rate

Stated (Par Value x coupon rate)

Example 7:

Jalal Limited invested in a debt instrument with a nominal value of Rs. 10000. The
instrument is redeemable in two years at premium amounting to Rs 2100 and has
been classified as at amortized cost. The coupon rate is 0% while the effective
interest rate is 10%.

Required:

How will this be reported in the financial statements of Jalal Limited over the
period to redemption?

Solution:

Effective
Cash @ 0% Closing
Opening Interest 10%
Year Rs. Balance Rs.
Balance Rs. Rs.
PL Cash Flow SCI

Example 8:

Bilal Limited Invested in a debt instrument with a nominal value of Rs. 10000. The
instrument is redeemable in two years at a premium of Rs. 1680 and has been
classified as at amortized cost. The coupon rate in 2% while the effective interest
rate is 10%.

Required:
How will this be reported in the financial statements of Bilal Limited over the
period to redemption?

Year Opening Effective Cash @ 2% Closing

Balance Rs. Interest 10% Rs. Balance Rs.
Rs.
PL Cash Flow SCP

Key points

i. Measurement of Financial Assets: (Equity Investment)

ii. Measurement of Financial Assets: (Debt Investment)
iii. Measurement of Financial Liabilities

i. Measurement of Financial Assets: (Equity Investment)

Category Initial Subsequent Changes

Measurement Measurement
Amortized Cost Not applicable
FVTOCI FV + Fair Value Dividend in PL
Transaction Change in FV in
Cost OCI**
FVTPL Fair Value* Fair Value Dividend in PL***
Change in FV in PL
*Transaction Cost in FVTPL model is taken as expense.
** Change in FV in OCI is shown in Fair Value reserve just like Revaluation Surplus.
*** Dividends are treated through PL, hence direct impact on Retained Earning.

Example 9:

On January 01, 2011, XYZ limited invested Rs. 100 (fair value at that date) in equity
shares of another company. XYZ Limited also incurred transaction costs of Rs. 2.

On April 25, 2011 an interim dividend of Rs 3 was received.

On June 30 2011 (year-end) the fair value of the investments is Rs. 120.

On June 30, 2012 (year-end) the fair value of the investment is Rs. 150.

Required:

Pass the Journal entries based on different classifications of above investment.

ii. Measurement of Financial Assets: (Debt Investment)

Category Initial Subsequent Changes

Measurement Measurement
Amortized Cost FV + Amortized Effective Interest in
(Note 1) Transaction Cost PL
Cost
FVTOCI FV + Fair Value *Effective Interest in
Transaction (after effective PL
Cost interest) Change in FV in OCI
 FVTPL Fair Value** Fair Value Dividend in PL
(after interest) Change in FV in PL
*Usual Mistake
** transaction cost will be taken as expense
Note 1: Trade Receivable are measured according to IFRS-15 not IFRS-9

Example 10:

On January 01, 2011, Multan Limited (ML) invested in Rs. 10 millions, 5% bond
for Rs. 9.5 million, incurring issue cost of Rs. 0.2 million Interest is received in
arrears. The bond will be redeemed at a premium over nominal value on 31
December 2023. The effective rate of interest is 8%.

The fair value of the bond was as follows;

31 December 2021 Rs. 11 million

31 December 2022 Rs. 10.4 million

Required:

How the bond will have been accounted for over all relevant years if ML’s business
model is to hold until the redemption date but also to sell them if investments with
higher returns become available.

Solution:

Effective
Opening Cash @
Interest Total Gain Fair
Year Balance 2%
10% (Loss) Value
Rs.
Rs. Rs.
 Cash
PL Rs. m OCI SFP
Flow

Example 11:

On 1 January 2021, Multan Limited (ML) invested in Rs. 10 million, 5% bond for
Rs. 9.5 million, incurring issue cost of Rs. 0.2 million. Interest is received in arrears.
The bond will be redeemed at a premium of Rs. 0.596 million over nominal value
on 31 December 2023, The effective rate of interest is 8%.

The Fair value of the Bond was as follows;

31 December 2021 Rs. 11 million

31 December 2022 Rs. 10.4 million

Required:

How the bond will have been accounted for over all relevant years if ML’s business
model is to trade bonds in the short term and ML sold the bonds for 10.8 million on
31 January 2022.

Example 12:

Momin Limited (ML) purchased 5000 shares for Rs.100 each on 1st January 2009.
Transaction costs are 2% (in both buying and selling). Fair values at different dates
are as follows;
 1st January 2009 Rs. 100
31 December 2009 Rs. 108
30 June 2010 Rs. 111
31 December 2010 Rs. 110

Dididends amounting to Rs. 4 per share declared on 30 June 2010. ML year-end is

31 December.

Required:

a. Fair Value Through PL

b. Fair value through OCI

iii. Measurement of Financial Liabilities

Category Initial Subsequent Changes Disposal

Measurement Measurement gain/loss
Amortized Fair value – Amortized Effective interest PL
Cost transaction cost in PL
cost
Fair value Fair Value Fair Value Change due to PL
own credit in
OCI
Remaining
Change in PL
Example 13:

On 1 jan 2021, jawad Limited issued a deep discount bond with a Rs. 50000
nominal value. The discount rate was 16% of nominal value and the costs of issue
were Rs. 2000.

Interest of 5 % nominal value is payable annually in arrears. The Bond must be

redeemed on 1 january 2026 (after 5 years)at the premium of Rs. 4611. The
effective interest rate Is 12% p.a.

Required:

How will this be reported in the financial statements of Jawad Limited over the
period of redemption?

Example 14:

Alpha Limited (AL) regularly invests in assets that are measured at fair value
through profit or loss. On jan 1, 2018 AL issued 9% debentures at nominal value of
Rs. 80000 to finance a similar investment in assets. The management has decided to
classify these debentures to be measured at fair value through profit & loss.

The fair value of debentures were 88000 on 31 December 2018, there was no change
in own i.e., credit risk of AL in this time period.

The fair value of debentures were 82000 on 31 December 2019 and AL has estimated
that it includes Rs. 4000 due to change in own credit risk as AL’s credit rating was
dropped during the year.

Required:

Prepare Journal Entries