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FFAS 2012
Session structure
On completion of this session students should be able to explain: How the effective yield for a financial asset is calculated The accounting treatment for a vanilla fixed-rate term loan How impairment charges are used to create impairment allowances for identified credit losses The accounting treatment for variable-rate time deposits The accounting treatment of trading securities and trading liabilities The accounting treatment for financial assets/liabilities classified at fair value The accounting treatment for securities classified as available for sale The major changes due to be introduced in the move from IFRS 7 treatment of financial assets and liabilities to IFRS 9
FFAS 2012
Interest calculated and paid on quarterly basis at 2% of principal outstanding at end of previous quarter.
1. 2. 3. 4. Calculation of Quarterly payment. Calculation of annual effective yield for loan. Accounting treatment of interest income and principal repayments in 1Q14. Introduction to accounting treatment of impaired loans.
The IFRS 7 IAS 39 standard will be revised in IFRS 9 for planned implementation in January 2015 will cover the key proposed changes
PMT PV
(1 ri )n ri (1 ri )n 1
Where r is the interest rate per period and n is the total number of periods
PMT 100,000
Cash 31-Dec-13 31-Mar-14 30-Jun-14 30-Sep-14 31-Dec-14 31-Mar-15 30-Jun-15 30-Sep-15 31-Dec-15 +100,000 13,651.0 13,651.0 13,651.0 13,651.0 13,651.0 13,651.0 13,651.0 13,651.0
Interest Expense 2,000.0 1,767.0 1,529.3 1,286.9 1,039.6 787.4 530.1 267.7 9,207.8
Principal repaid 11,651.0 11,884.0 12,121.7 12,364.1 12,611.4 12,863.6 13,120.9 13,383.3 100,000.0
Contractual balance 100,000 88,349.0 76,465.0 64,343.3 51,979.2 39,367.8 26,504.2 13,383.3 0
= (1 + 0.02)4 1 = 8.243%
Effective yield calculated based on expected (contractual) cashflows. Effective yield equivalent to Internal Rate of Return. IAS 39 revenue recognition.
90 31-Mar-14
91 30-Jun-14 92 30-Sep-14 92 31-Dec-14 90 31-Mar-15 91 30-Jun-15 92 30-Sep-15 92 31-Dec-15
13,651.0
13,651.0 13,651.0 13,651.0 13,651.0 13,651.0 13,651.0 13,651.0
Fewer days in first half of year than second half receives money sooner than approximate method assumes
This has an impact of value for loan on banks balance sheet and the contractual balance
Using Excel to calculate effective yield depends on version May have to make sure Analysis Toolpak Add-in installed.
Tools then Add-ins then check (select) Analysis Toolpak and Analysis Toolpak for VBA. Press OK.
Use XIRR rather than IRR far more flexible and powerful. Form in Excel given by =XIRR(range of values, range of dates, guess) Gives Effective Yield of 8.262% for the loan.
Effective yield
8.262%
1,976.7
1,765.6 1,544.9 1,300.3
1,027.6
786.8 535.5
39,367.8
26,504.2 13,383.3 0
270.4 9,207.8
100,000.0
Using Excel to calculate values for accounting entries Formula for Interest Income in each period = Value at end of previous period ((1 + Effective Yield)^(Number of days in period/365)-1) Principal repaid = Quarterly Payment less Interest Income Carried forward Value on Balance Sheet = Brought forward Value less Principal
Repaid
(3) Accounting for loans (cont.) Balance Sheet and Income Statement 1Q 2014
From previous slide for quarter Cash received = 13,651.0
Payment
End of 1Q
-11,674.2
88,325.8
13,651.0
-86,349.0
1,976.7
1,976.7
1,976.7
1,976.7
Loans
I/S
Retained profit
101,975.7
101,976.7 101,976.7 -26,616.0 -26,616.0 75,360.7 75,360.7 -26,616.0 -26,616.0 -26,616.0 -26,616.0
Will look at treatment of credit losses in more detail in Week 4; controversial area
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Treatment of deposits
Effective yield calculated based on expected (contractual) cashflows i.e. same as for loans, at amortised cost.
Bank has 100,000 in 1-month floating-rate time deposits. Interest is calculated and paid on a full month basis at 0.25%. Interest is capitalised at end of each month. Interest rate for month of March increased to 0.3%. Interest expense ( ) 31-Dec-13 31-Jan-14 28-Feb-14 31-Mar-14 250.0 250.6 301.5 802.1 Accounting entries for deposits in 1Q14 Cash Deposits I/S -802.1 -802.1 Retained profit -802.1 -802.1
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Deposit made
Interest paid End of 1Q
100,000.0
100,000.0
100,000.0
802.1 100,802.1
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Cash
Buy stocks Price falls to 900 End of 1Q -1,000 -1,000
Equities
1,000 -100 900
I/S
-100 -100
I/S 0 0
Retained profit
-100
1 April
-100
-100
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-100
900
-100
-100
0
0
1 April
-100
900
-100
-100
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Cash
-90,702.95
I/S
-1,703.30 -1,703.30 5,339.98 3,636.67
AFS reserve
Retained profit
-1,703.30 -1,703.30
3,636.67 3,636.67
Interest income at 6%
Payment Retain profit for the year End of Y2
5,660.38
-100,000.00 0.00 100,000.00
5,660.38
5,660.38 9,297.05 5,660.38 9,297.05 9,297.05 9,297.05 9,297.05
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Buy
Increase in rate Interim balance Interest income at 6% Amortisation of loss* Retain profit for the year End of Y1 Interest income at 6% Amortisation of loss Payment Retain profit for the year End of Y2
90,702.95
-1,703.30 88,999.64 5,339.98
-90,702.95
804.83
94,339.62
5,660.38 -100,000.00 0.00
-90,702.95
-898.47
898.47
4,535.15 4,535.15
4,761.90 4,761.90
9,297.05
0.00 0
4,761.90 9,297.05
9,297.05
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Coupon Bonds
Semi-annual and annual Accounting treatment same as for zero coupon bonds Complicated by regular coupon payments As bond approaches coupon payment date price increases After coupon paid price falls Need to maintain record of price schedule at yield when bond was bought Unrealised gains and losses calculated by comparing current market price with that of original schedule Computational overhead but not difficult to do with automated bank accounting systems
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Demand deposits are explicitly prohibited from being held at fair value
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FV with changes in value reflected in Other Comprehensive Income (an equity reserve)
Restricted to investments in equities not held for trading (e.g. Associates) but very few financial assets will fall in this category also means that cant hold unquoted equities at cost less any impairment
Accounting treatment of bonds issued and accounted for at fair value under IAS39 was controversial
Deterioration of banks financial position will result in credit spread on its bonds widening Result will be fall in market value of these liabilities and an unrealised gain This unrealised gain was taken through the income statement and P&L account introducing un-wanted volatility to net income Any gains were reversed in calculating regulatory capital (Basel Accord)
Under IFRS 9 any unrealised gain (or loss) on own-credit will be reflected in Other Comprehensive Income (an equity reserve account)
Will still be reversed in calculating regulatory capital
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Session Objectives
On completion of this session students should be able to explain: How the effective yield for a financial asset is calculated The accounting treatment for a vanilla fixed-rate term loan How impairment charges are used to create impairment allowances for identified credit losses The accounting treatment for variable-rate time deposits The accounting treatment of trading securities and trading liabilities The accounting treatment for financial assets/liabilities classified at fair value The accounting treatment for securities classified as available for sale The major changes due to be introduced in the move from IFRS 7 treatment of financial assets and liabilities to IFRS 9
FFAS 2012
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