FINANCIAL INSTRUMENTS

Financial instruments (IAS32 & 39)

IAS32 Presentation Definitions fin assets, liability and equity Classification between fin liability and equity IAS 39 Recognition and measurement Definition derivatives 4 categories fin instruments Initial recognition and de-recognition Reclassification Impairment Hedging fair value hedges, cash flow hedges, investment in foreign operation IFRS 7 - Disclosure

Financial instruments (IAS32 & 39)

IAS 39 applies to all entities and all financial instruments, except: Certain interest in subs, jvs and associates Rights and obligations under leases Employers rights and obligations employee benefit plans Equity instruments issued by the reporting entity Insurance contracts Contracts involving business combination Certain loan commitments Contracts and obligations IFRS 2 Reimbursement rights

Financial instruments (IAS32 & 39)

Weather derivatives either insurance policy or derivative Contracts over non-financial items IAS39 where contract to buy or sell non-financial item (e.g. wheat) may be settled in cash or another financial instrument. IAS2 where held for actual receipt or delivery of physical item

Financial instruments (IAS32 & 39)

A financial instrument is Any contract that gives rise to: A financial asset And a financial liability or equity instrument on the other side

Financial instruments (IAS32 & 39)

Financial asset Cash Contractual right to Contractual obligation Contract evidences receive cash or fin asset to deliver cash or fin residual interest in asset to another entity assets less liabilities Contractual right to exchange favourably e.g FEC asset, derivative Equity instrument of another entity Contractual obligation to exchange unfavourably e.g. Unfavourable call Financial liability Equity instrument

Financial instruments (IAS32 & 39)

Financial asset Financial liability Equity instrument A contract that will or A contract that will or may be settled in the may be settled in the entitys own equity and entitys own equity and is: is: A non-derivative for A non-derivative for which an entity is or which an entity is or may be obliged to may be obliged to receive a variable deliver a variable number of its own number of its own equity instruments equity instruments A derivative that will or A derivative that will or may be settled other may be settled other than for the exchange than for the exchange of a fixed amount of of a fixed amount of cash/fin asset for a cash/fin asset for a fixed number of entitys fixed number of entitys own equity own equity

Financial instruments (IAS32 & 39)

Recognition When it becomes a party to the contractual provisions of the financial instrument Trade date accounting recognise asset receivable and liability payable on commitment date Settlement date accounting recognise on date asset is received Consistent for specific class of asset

Financial instruments (IAS32 & 39)

Derecognition Removal of a previously recognised financial asset/liability from an entitys statement of financial position Derecognised when: o rights to cash flows expire; or o financial asset is transferred and the transfer qualifies for recognition Transfer if: o Transfers right to receive cash flows; or o Retains cash flow rights but assumes obligation to pay them over This transfer qualifies for derecognition, if: o Risks and rewards ownership passed; or o Entity relinguished control

Financial instruments (IAS32 & 39)

Financial instruments (IAS32 & 39)

Derecognition If qualify derecognise; and account for any rights or obligations if not qualify then continue to recognise and consideration for transfer is a financial liability Difference between carrying amount and [consideration received + cumulative gains/losses in OCI and accumulated in equity] go to profit/loss If continuing involvement then portion derecognised and portion continues to be recognised Derecognition of Financial liabilities Remove from F/P only if Fin liability is extinguished CA of Fin Liability - Consideration

Financial instruments (IAS32 & 39)

Example: an entity has a strategic investment in the shares of B Ltd which has been classified as available-for-sale: Cost of shares on 30 Sept 2004 500 000 Fair value adj: 2004 20 000 2005 40 000 2006 10 000 570 000 Sold 1 Jan 2007 for 580 000

Financial instruments (IAS32 & 39)

Solution
Statement of comprehensive income Other income Profit for the period Other comprehensive income Available for sale investments -Gains arising during current year -Reclassification adjustments for gains included in P/L 10 000 (80 000) (70 000) Taxation (70 000 x 14%) (tax rate 28%) Total comprehensive income 9 800 Xx R 80 000 Xx

Financial instruments (IAS32 & 39)

Example: on 30.9.2007, XYZ Ltd sold trade receivables with a carrying amount of R300 000 to a banks factoring department for R280 000. The bank has full right of recourse in respect of the transferred receivables. The receivables are due on 31.12.2007. Required: journal entries Assume no debtors defaulted.

Financial instruments (IAS32 & 39)

Solution: Condition for derecognition has not been met as the bank has full right of recourse (the risks of ownership have remained with XYZ). The substance of the transaction is a borrowing arrangement 30.9 and the debtors are held as security by the Bank 280 000 bank.
Liability Interest expense (recognise over security period) Liability Liability Trade receivables 300 000 300 000 20 000 20 000 280 000

Financial instruments (IAS32 & 39)

Initial measurement All financial assets and liabilities, except for at fair value through profit or loss:
FAIR VALUE + TRANSACTION COSTS Once included, transaction costs form part of

the cost of the financial instrument At fair value through profit or loss: FAIR VALUE Transaction costs are expensed Fair value = amount for which asset could be exchanged or liability settled between knowledgeable willing parties in arms length transaction

Financial instruments (IAS32 & 39)

Financial asset categories (5 categories): At fair value through profit or loss Held-to-maturity investments Loans and receivables Available for sale Special rule investments

Financial instruments (IAS32 & 39)

Financial liability categories (5 3 shown here): At fair value through profit or loss Loan commitments at below market rates All other financial liabilities

Financial instruments (IAS32 & 39)

Financial instrument categories (5 categories): At fair value through profit or loss Meet one of two conditions: 1. Held for trading Profit taking in the short term Part of a portfolio where pattern short-term profit taking Derivative (except for hedging instrument) 2. Designated at initial recognition For more relevant information (to reduce mismatch or group of assets/liabs) Except for equity instrument with no quoted price or fair value that cannot be reliably measured (special rule)

Financial instruments (IAS32 & 39)

Held-to-maturity investments Non-derivative financial assets with fixed or determinable payments and fixed maturity Positive intent and ability to hold to maturity Other than designated at fair value through profit or loss or available-for-sale or loans and receivables Only quoted instruments e.g. government or corporate bonds If the entity does not have the financial resources or has constraints that limit the intention to hold then cannot be classified at HTM

Financial instruments (IAS32 & 39)

Bond a financial asset that represents the

right to receive fixed amounts of cash from the issuer on fixed future dates. The principal amount is repaid at a future fixed date. Therefore, a discount rate is needed. The coupon rate is the fixed rate to determine interest received The bond is a financial liability from the issuers point of view

Financial instruments (IAS32 & 39)

Loans and receivables Non-derivative fin assets with fixed or determinable payments (no mention of fixed maturity) Other than designated at fair value through profit or loss or available-for-sale or to be sold in the near term Not quoted on active market Investment in unquoted preference shares E.g. Staff loans, accounts receivable, investments in unlisted bonds

Financial instruments (IAS32 & 39)

Available for sale Non-derivative financial assets that are: Designated as available for sale (free choice) Not classified as 1, 2 or 3 above (catch all)

Financial instruments (IAS32 & 39)

Special rule investments All financial assets that are: Equity instruments Not quoted in an active market Fair value cannot be reliably measured

Financial instruments (IAS32 & 39)

Subsequent measurement At fair value through profit/loss At fair value with changes to profit/loss Held-to-maturity Amortised cost, with gains/losses to profit/loss Fair value movements not relevant Discount and account for interest at effective interest rate

Financial instruments (IAS32 & 39)

The effective interest rate method: Calculate amortised cost using effective i; and Allocate interest over the relevant period Rate that exactly discounts the stream of future

cash flows (in or out) over the life of the financial instrument to the net carrying amount Includes all cash flows e.g. Fees, transaction costs, premiums and discounts that are an integral part of the effective interest rate Amortised cost is the amount at which the financial asset/liability was measured at initial recognition less principal repayments, plus or minus the cumulative amortisation of any difference between that initial amount and the maturity amount, and minus any write-downs for impairment or uncollectibility

Financial instruments (IAS32 & 39)

Bond a financial asset that represents the

right to receive fixed amounts of cash from the issuer on fixed future dates. The principal amount is repaid at a future fixed date. Therefore, a discount rate is needed. The coupon rate is the fixed rate to determine interest received The effective interest rate method: Calculate amortised cost; and Allocate interest over the relevant period (income or expense) The bond is a financial liability from the issuers point of view

Financial instruments (IAS32 & 39)

Available-for-sale o At fair value, with fair value changes

through other comprehensive income to equity (mark-to-market reserve) o Items directly to P/L interest using effective interest, forex gains/losses, dividends, impairment losses o Derecognition: cumulative gains/losses in equity reclassified through other comprehensive income to p/l

Financial instruments (IAS32 & 39)

Example: fair value through profit/loss ABC Ltd purchased a financial asset, classified as HFT, hence, FVTP, on 1.1.2017. The cost of the financial asset, including transaction costs of R5 000, was R232 000. The fair value of the asset on 31.12.2017 was R278 000. if the asset was sold on that date, transaction costs of R6 000 would result. A dividend of R10 000 was received in respect of this asset on 1.12.2017. Required: Journal entries

Financial instruments (IAS32 & 39)

Journals FVTP financial asset Operating expenses Bank Bank Dividend income or gain to financial assets FVTP financial asset (278 000 227 000) Gain on financial assets (P/L) (Ignore R6 000 transaction costs if sale) 51 000 51 000 10 000 10 000 Dr 227 000 5 000 232 000 Cr

Financial instruments (IAS32 & 39)

Example: held-to-maturity Lizt Ltd purchase an Exom bond on 1 April 20.2. The bond is classified as held-tomaturity investment. Details of bond: maturity date = 31 March 20.5, market rate = 14%, instalment = R200 000 pa (consisting of annual interest at 10%), future value = R2 000 000, period = 3 yrs, coupon rate = 10% and PV (or price) = R1 814 269 NOTE: Use initial market rate (effective i) even if this rate changes over the period of the instrument

Financial instruments (IAS32 & 39)

Journals FA held-to-maturity Bank YR1 Bank (200 000x10%) FA held-to-maturity Interest income (1 814 269x14%) YR2 - Bank FA held-to-maturity Interest income [(1 814 269+53 998) x 14%] YR3 Bank FA held-to-maturity Interest income [(1 814 269 +53 998 +61 557) 200 000 70 176 270 176 200 000 61 557 261 557 200 000 53 998 253 998 Dr 1 814 269 1 814 269 Cr

Financial instruments (IAS32 & 39)

Example: Loans and receivables ABC Ltd lent R500 000 to a director at a 5% pa interest rate on 1.1.2017. the loan is repayable in full at 31.12.2018 plus all the accumulated interest. A fair rate of interest is 15% pa. Required: Journal entries

Financial instruments (IAS32 & 39)

Journals 1.1.17 LAR financial asset (Wkgs 1) Expense to company/benefit to director Bank LAR financial asset (416 824 x 15%) Interest revenue Bank (wkgs 2) LAR financial asset Interest revenue 1. (n=2, i=15%, FV=551 250, pv=?) 551 250 479 348 71 902 62 524 62 524 Dr 416 824 83 176 500 000 Cr

Financial instruments (IAS32 & 39)

Example: Available-for-sale On 1 Jan 20.1 A acquired 10 000 shares in B Ltd at cost of R5 per share with R1 000 transaction costs. FV on 31 Dec 20.1 = R5,20ps. Sold on 31 Jan 20.2 at R5,25. Classified as available-for-sale

Financial instruments (IAS32 & 39)

Journals 1 Jan 20.1 FA-available-for-sale Bank [(10 000xR5)+1 000] 31 Dec 20.1 FA-available for sale Equity fair value adjustments (OCI) [(10 000 x 5,20) 51 000] 31 Jan 20.1 FA-available-for-sale Equity fair value adjustments (OCI) [(10 000 x 5,25) 52 000] Bank FA available-for-sale Equity fair value adjustments (OCI) 1 500 52 500 52 500 500 500 1 000 1 000 Dr 51 000 51 000 Cr

Financial instruments (IAS32 & 39)

Example: Available-for-sale debt instrument On 1 Jan 20.1 acquired 200 10% R500 debentures at fair value of R95 000 + R3 500 transaction costs (R98 500). Details of bond: maturity date = 31 Dec 20.5 at R100 000. Fair value on 31 Dec 20.1 = R101 000 and 20.2 = R102 100. Debentures designated as available for sale.

Financial instruments (IAS32 & 39)

Journals (YR1) FA available-for sale Bank (95 000 + 3 500) Bank FA available-for-sale Interest income (98 500 x 10.4%) FA available-for-sale Equity fair value adjustments (OCI) (101 000(98 500+244)) (YR2) Bank FA available-for-sale Interest income [(98 500+244)x10.4%] 10 000 269 10 269 2 256 2 256 10 000 244 10 244 Dr Cr 98 500 98 500

Financial instruments (IAS32 & 39)

Calculation of 10.4% (effective interest rate): PV = -98 500 Pmt = 10 000 FV = 100 000 n =5 Amount of equity = 3 087 (2 256 + 831) Equals 102 100 FV 99 013 amortised cost By the time settle at end term equity = nil as amort cost = R100 000 and fair value = R100 000

Financial instruments (IAS32 & 39)

Subsequent measurement of financial liabilities A fair value through profit/loss financial liability: Held-for-trading (short-term settlement, portfolio, derivative) Designated (reduce mismatch or managed as a group) At fair value through profit/loss At fair value, with fair value changes to profit/loss Also for derivatives measured at fair value Other liabilities

Financial instruments (IAS32 & 39)

Reclassification Recent amendment: Permits limited reclassification from fair value through profit and loss to cost/amortised cost Permits limited reclassification from at fair value through P/L to available for sale Fair value continues but through equity May not reclassify into FVTP after initial recognition

Financial instruments (IAS32 & 39)

Permitted to reclassify out of at fair value through profit or loss (except for loans & receivables) if: Not designated at fair value through profit or loss Not a derivative No longer held for purpose of selling in near term Rare circumstance Permitted to reclassify loans & receivables out of fair value through profit or loss - the above and intend and are able to hold

Financial instruments (IAS32 & 39)

Permitted to reclassify loans and receivables out of available-for-sale if intend and are able to hold for foreseeable future or until maturity Fair value at that date becomes new cost/amortised cost

Effective 1 July 2008. Cannot classify before that date.

Financial instruments (IAS32 & 39)

Example: Accumulated loss in equity R700 000 Objective evidence of impairment: Debit : Imp Loss (P/L) R700 000 Credit: Mark-to-market reserve R700 000 Subsequent improvement in value of R450 000 Debit : Investment in shares R450 000 Credit: Mark-to-market reserve (OCI) R450 000 (not profit/loss)