T S

EN
UM
T R
N S
L I
I A
NC
N A
F I
FINANCIAL INSTRUMENTS RELATED IFRS

IAS 32, Financial Instruments: Presentation

IAS 39, Financial Instruments: Recognition and measurement
IFRS 7, Financial Instruments: Disclosures
IFRS 9, Financial Instruments
IFRS 9 is the outcome of phase 1 of the IASB project to replace IAS 39

Phase 1: Classification and measurement of financial assets

Future phases:
Phase 2: Measurement at amortised cost and impairment issues
Phase 3: Hedge accounting
STRUCTURE OF IFRS 9
Recognition and derecognition
Classification
Measurement
 IFRS 9 PROVIDES
November 2009 version
--> provides financial reporting principles of financial assets
 
October 2010 revision
--> added classification and measurement of financial liabilities
FINANCIAL INSTRUMENTS
The term “financial instrument” encompasses a
financial asset, a financial liability an equity
instrument.
The characteristics of a financial instrument are:
• There must be a contract
• There are at least two parties to the contract.
• The contract shall give rise to a financial asset of one
party and financial liability or equity instrument of
another party.
FINANCIAL ASSET
• Cash
• A contractual right to receive cash or another financial
asset from another entity.
• A contractual right to exchange financial instruments
with another entity under conditions that are potentially
favorable. An example is an option to purchase shares of
another entity at less than market price.
• An equity instrument of another entity.
EXAMPLES OF FINANCIAL ASSETS

• Cash or currency
• deposit of cash
• contractual right to receive cash
FINANCIAL LIABILITY

A financial liability is any liability that is a

contractual obligation:
• To deliver cash or other financial asset to
another entity. (TNLB)
• To exchange financial instruments with another
entity under conditions that are potentially
unfavorable.
 EQUITY INSTRUMENT
An equity instrument is any contract that evidences a residual
interest in the assets of an entity after deducting all of its
liabilities.
 Examples:
• Ordinary share capital
• Preference share capital
• Warrants or written call options that allow the holder to
subscribe for or purchase a fixed number of ordinary share of
the issuing entity in exchange for a fixed amount of cash or
another financial asset.
• A preference share that provides for mandatory redemption by
the issuer for a fixed or determinable amount at a future date.
This is a financial liability of the issuer because the issuer has
a contractual obligation to pay cash at some future time.
• A preference share that gives the holder the right to require the
issuer to redeem the instrument at a particular date for a fixed
or determinable amount. This is also a financial liability
because the issuer has a contractual obligation to pay cash at
some future time.
EXPLAIN THE TREATMENT OF A CONTRACT
THAT WILL OR MAY BE SETTLED BY THE
ENTITY’S OWN SHARES
PAS 32, paragraph 22, provides that the contract is an
equity if it will be settles by the issuance of a fixed
number of shares in exchange for a fixed amount of
cash.
On the other hand, PAS 32, paragraph 24, provides that
the contract is a financial liability when:

• It is settled by the issuance of a variable number of

shares in exchange for a fixed amount of cash.
• It is settled by the issuance of a fixed number of shares
in exchange for a variable amount of cash.
 
CASES
• A contract that requires the entity to issue as many of the
entity’s own shares to equal a fixed amount of P500,000
at a future date.
 
• A contract that requires the entity to issue a fixed
number of the entity’s own shares in exchange for an
amount of cash to equal 100 ounces of gold at a future
date.
RECOGNITION OF FINANCIAL ASSETS

Financial assets are recognised when and only

when
--> the entity becomes a party to the contract
CLASSIFICATION OF FINANCIAL ASSETS
Financial assets are classified as one of the following:
(1) Financial assets subsequently measured at amortised
cost
(2) Financial assets subsequently measured at fair value
FAIR VALUE OPTION
Entity has an option to designate financial assets
--> as financial assets measured at fair value through profit
or loss (FVPL)
Such a designation can be made
--> only at initial recognition, and
--> only if it eliminates accounting mismatch
 EMBEDDED DERIVATIVES
Hybrid contracts have the following components
(1) non-derivative host
(2) embedded derivative

If the non-derivative host of a hybrid contract is a financial asset

--> the embedded derivative is not separated from the host
--> the entire hybrid contract is treated as one instrument

If the non-derivative host of a hybrid contract is not a financial asset

--> the embedded derivative is separated from the host
--> host and embedded derivative are treated as separate instruments
FINANCIAL ASSETS ARE RECLASSIFIED

--> when and only when the business model for managing
financial assets changes
INITIAL MEASUREMENT

Financial assets are initially measured at

--> fair value + transaction costs

Transaction costs are not added

--> for financial assets at fair value through profit or
loss (FVPL)
Example 11
Entity E lends €100 million for five years to one
of its group companies at 2% interest when the
benchmark yield is 4%. What should be the fair
value of the loan for initial recognition?
Solution
• The fair value of a long-term loan or receivable
that carries no interest can be estimated as the
present value of all future cash receipts discounted
using the prevailing market rate(s) of interest for a
similar instrument (similar as to currency, term,
type of interest rate and other factors) with a
similar credit rating.
Example

Entity E lends €100 million for five years to one

of its group companies at 2% interest when the
benchmark yield is 4%. It receives upfront fees
of €10 million. Should the fees be adjusted while
determining fair value of the loan?
Solution

Fair value the loan on the basis of discounted

cash flows using benchmark yield as the
discount factor. The cash flows shall include the
upfront fees collected.
 FINANCIAL ASSETS CLASSIFICATION

• Group 1 financial assets at amortised cost (AC)

• Group 2 financial assets at fair value through profit or loss
(FVPL)
• Group 2A financial assets at fair value through other
comprehensive income (FVOCI)
MEASUREMENT SUBSEQUENT TO INITIAL
RECOGNITION
• After initial recognition, an entity shall measure the
financial asset at either fair value or amortized cost in
accordance with the classification followed.
• When the fair value of a financial asset is negative, an
entity shall recognize a financial liability.
• For example, a derivative may have a positive fair value
when it is recognized as an asset, whereas it becomes a
liability when its fair value becomes negative.
Entity E made investments in equity shares during the year
2009. The transaction price of the shares was €100 million and
there was a transaction cost of €0.05 million. It made an
irrevocable election to classify the investment as at fair value
through other comprehensive income. At the year-end, the fair
value of the investment is €102 million. If the investments were
sold at the yearend, it would have incurred a transaction cost of
€0.06 million. Should the fair value at the yearend be €102
million minus transaction cost of €0.06 million? How should
the fair value change be accounted for?
At subsequent measurement, fair value of the financial
asset is not computed net of cost to sell. The fair value is
€102 million. Entity E shall recognize the change in fair
value (year-end fair value €102 million minus initial fair
value €100.05 million = €1.95 million) in the statement
of other comprehensive income and accumulate in a
separate component of equity.
Example

Continue with investments in equity shares

discussed previously. Entity E sold the
investments in 2010 at €103 million net of
transaction cost. How should the entity
recognize gain or loss? Should the entity
reclassify the accumulated fair value gain/loss in
the same way as is required by IAS 39?
Solution

The gain of €1 million (net sale proceeds €103 million

minus year-end fair value €102 million) is recognized in
the statement of income. Detailed discussion on
recognition of gain or loss of financial assets will follow.
IFRS 9 does not require a reclassification adjustment.
The accumulated fair value gain/loss on the particular
financial asset shall be transferred to retained earnings.
FINANCIAL ASSETS ARE SUBSEQUENTLY
MEASURED AT AMORTISED COST
--> if both of the conditions (A) and (B) are satisfied
(A) financial assets are held to collect contractual
cash flows
(B) cash flows are the payments of principal and
interest

Example: INVESTMENT IN BONDS

GROUP 1 FINANCIAL ASSETS

 used for convenience, not a designation by IFRS 9

 measured at amortised cost
 gains and losses are recognised in profit or loss
 financial assets are reviewed for impairment
requirements
BUSINESS MODEL
• The business model followed by an entity is a critical factor
for classification of financial assets.
• In particular, for classifying a financial asset at amortized cost
it is necessary to evaluate whether the asset is held within a
business model whose objective is to hold assets in order to
collect contractual cash flows.
• The business model is decided by the key managerial
personnel
• It is not an instrument-specific model and therefore, intention
of the management as regards a particular financial asset is
not relevant.
BUSINESS MODEL
• It simply requires a higher level of aggregation than
simply evaluating an individual financial asset.
For example, it is possible to aggregate all loans to employees
together to evaluate the business model. An entity need not hold a
financial asset till maturity to satisfy the criteria that the asset is
held within a business model whose objective is to hold assets in
order to collect contractual cash flows. An entity’s business
model can be to hold financial assets to collect contractual cash
flows even when sales of some of the financial assets occur.

SITUATION
For example, the entity may sell a financial asset if
• The financial asset no longer meets the entity’s investment policy
(e.g., the credit rating of the asset declines below that required by
the entity’s investment policy);
• An insurer adjusts its investment portfolio to reflect a change in
expected duration (i.e., the expected timing of payouts); or
• An entity needs to fund capital expenditures.
EVALUATE THE FOLLOWING
CASES
Entity D purchased 3% debentures of €20 million, which
form part of a portfolio of financial assets having contractual
cash flows. It has adopted a business model whose objective is
to hold assets in order to collect contractual cash flows. It
evaluates among other information, the financial assets’ fair
values from a liquidity perspective (i.e., the cash amount that
would be realized if the entity needs to sell assets). It also
sold during the year certain items of financial assets having
contractual cash flows out of the portfolio. Can the entity
classify the new purchase as a financial asset at amortized
cost?

CASE I
Infrequent sale out of the portfolio of financial assets having
contractual cash flows does not alter the entity’s business
objective. An entity may sell some of the financial assets that
no longer meet the entity’s investment policy, or for adjusting
the duration of the portfolio or to meet the fund’s capital
expenditure. It can classify the new purchase as a financial asset
at amortized cost. However, it has to reassess the business
model in light of the objective of holding the assets for
collecting contractual cash flows when there are a more
infrequent number of sales. It may be noted that disclosures are
required for these infrequent sales.

SOLUTION – CASE I
Entity E purchased floating-rate debentures of €20 million at
LIBOR + 40 basis points that form part of a portfolio of
financial assets having contractual cash flows. It has adopted
a business model whose objective is to hold assets in order
to collect contractual cash flows. Subsequently, it has
entered into an interest-rate-swap transaction that alters the
pattern of cash flows. Can the entity classify the floating-rate
debentures as a financial asset at amortized cost because it
had changed the pattern of contractual cash flows?

CASE II
Even if an entity alters or modifies the pattern of
contractual cash flows, it can classify the
financial asset having contractual cash flows at
amortized cost. This principle will also apply
when an entity realizes less than the
contractual cash flows because of impairment
loss

SOLUTION – CASE II
Entity F invested €200 million in various types of
debt instruments that have contractual cash
flows. It evaluates performance of that block of
financial assets on the basis of fair value. They are
not held with an objective of collecting
contractual cash flows. It purchased 3%
debentures of €20 million, which form part of that
portfolio. Can the entity classify the new purchase
as a financial asset at amortized cost?

CASE III
No. Similarly, a financial asset having
contractual cash flows that is part of an actively
managed portfolio whose objective is
maximizing return based on change in the
maturity spread or credit spread is not classified
as a financial asset at amortized cost. It is
classified as a financial asset at FVTPL.

SOLUTION – CASE III

 NATURE OF CONTRACTUAL CASH FLOWS
• The contractual cash flows inherent in the financial asset
shall consist solely of the payments of (1) principal and (2)
interest on the principal amount outstanding for the currency
in which the financial asset is denominated.
• Leverages that are part of the contractual cash-flow
characteristic of some financial assets can increase the
variability of such contractual cash flows.
• Stand-alone options, futures/forwards, and swaps on fixed-
income securities include this leverage feature.
 NATURE OF CONTRACTUAL CASH FLOWS
• They are not regarded as contractual cash flows
consisting solely of the payments of principal and
interest on the principal amount outstanding in the
denominated currency.
• Therefore, any leveraged financial assets, like
interest-rate options, futures, or swaps, are not
classified as financial assets at amortized cost.
NATURE OF CONTRACTUAL CASH FLOWS
• Another example of a leveraged financial asset is a
fixed interest- rate bond in which repayment of the
principal is linked to an equity index.
• However, inflation-adjusted Treasury notes or bonds in
which payment of interest is linked to inflation adjusted
principal but repayment of principal is set at the higher
of the nominal principal or inflation-adjusted principal
represent contractual cash flows.
• Inflation adjustments are simply adjustment for time
value of money.
Entity E invested in five-year, 4%, €1,000
debentures. The debentures pay interest over
eight years and repay principal after five years.
Are the debentures having contractual cash
flows consisting solely of principal and interest
on outstanding principal?

CASE IV
• It is just a readjustment of the timing of the cash flows.
• If the payment satisfies the condition of time value of
money, it can be identified as contractual cash flows
consisting solely of the principal and interest on
outstanding principal.
• The entity would satisfy the condition comparing to
the benchmark yield of a five-year maturity debt
instrument.

SOLUTION – CASE IV
A constant maturity bond with a five-year term
that pays a variable rate, but on which, although
the rate is reset periodically, it always reflects a
five-year maturity. Is this bond having
contractual cash flows consisting solely of the
principal and interest on outstanding principal?

CASE V
• No. The bond does not result in contractual cash
flows that are payments of the principal and
interest on the principal amount outstanding.
• That is because the interest payable in each
period is disconnected from the term of the
instrument (except at origination).

SOLUTION – CASE V
Entity E invested in 1,000, five-year floating-
rate €1,000 debentures. However, the interest
rate cannot be higher than 6.5%. Are the
debentures having contractual cash flows
consisting solely of the principal and interest on
outstanding principal?

CASE VI
• A variable-rate debt instrument in which interest rate is
capped satisfies the test of having contractual cash flows
consisting solely of the principal and interest on
outstanding principal.
• The contractual cash flows of both (1) an instrument that
has a fixed interest rate, and (2) an instrument that has a
variable interest rate are payments of principal and interest
on the principal amount outstanding as long as the interest
reflects consideration for the time value of money and for
the credit risk associated with the instrument during the
term of the instrument.

SOLUTION – CASE VI
Entity E invested in five-year, 4%
€100,000,000 debentures, which is a full-
recourse instrument and is secured by
collateral. Is the loan having contractual
cash flows consisting solely of the
principal and interest on outstanding
principal?

CASE VII
The characteristics of a full-recourse and
collaterized loan does not in itself affect
the analysis of whether the contractual
cash flows are solely payments of the
principal and interest on the principal
amount outstanding.

SOLUTION – CASE VII

FINANCIAL ASSETS ARE SUBSEQUENTLY
MEASURED AT FAIR VALUE

--> if they are not measured at amortised cost

GROUP 2 FINANCIAL ASSETS

--> used for convenience, not a designation by

IFRS 9
--> gains and losses are recognised in profit or loss
--> financial assets are not reviewed for
impairment requirements
--> measured at fair value
GROUP 2A FINANCIAL ASSETS

--> gains and losses are recognised in other

comprehensive income (OCI)
--> financial assets are not reviewed for
impairment requirements
--> measured at fair value
GROUP 2A FINANCIAL ASSETS SATISFY ALL OF
THE FOLLOWING CONDITIONS

(1) investment in equity instruments

(2) investment is not "held for trading"
(3) entity elected to present the changes in fair value
in OCI
(4) this election is allowed only at initial
recognition
(5) this election is "irrevocable"
RECLASSIFICATION

An entity reclassifies a financial asset when and

only when there is a change in the business
model. Reclassification is applied prospectively
from the date of reclassification. No restatement
is required for previously recognized gains or
losses.
RECLASSIFICATION
Financial assets at amortized cost to financial assets
at fair value

• The difference between fair value measured at the

reclassification date and amortized cost is charged to the
statement of income.
RECLASSIFICATION

Financial assets at fair value to financial assets at

amortized cost

• The difference between the amortized cost measured at

the reclassification date and fair value is charged to the
statement of income.
• The fair value at the date of reclassification becomes the
new carrying amount for applying amortized cost method.
 EXAMPLES OF CHANGES IN THE BUSINESS
MODEL:
• The investment objective of a loan portfolio of an entity that has
undergone a change consequent to acquisition of another entity whose
loan portfolio is managed on the basis of collecting the contractual cash
flows. The entity has decided not to manage the loan portfolio with an
objective of collecting the contractual cash flows.
• A financial entity was earlier managing its mortgaged loan portfolio of
investments with an objective of collecting the contractual cash flows.
It has now decided to shut the business and is actively selling the
mortgaged loans.
 GAINS OR LOSSES ON FINANCIAL ASSETS
1. Financial assets at fair value

 That are elected at initial recognition to present in other comprehensive income

subsequent changes in the fair value of an investment in an equity instrument.
Fair value change is accounted for in the statement of other comprehensive
income. The accumulated fair value change is retained in a separate fair value
reserve. On derecognition of the investment, accumulated fair value gain/loss
is reclassified. It is transferred to another component of equity, for example,
retained earnings.
 Other financial assets (1) Equity investments that are held for trading (2) Debt
instruments that are designated as FVTPL
 Fair value change is accounted for in the statement of income.
GAINS OR LOSSES ON FINANCIAL ASSETS

2. Financial assets at amortized cost

• Recognized in profit or loss when the financial asset is

derecognized, impaired or reclassified.