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Financial Instruments Initial recognition Classification and subsequent…
Financial Instruments
Initial recognition
Classification and subsequent measurement
An entity should recognize a FA or FL in its BS only when it becomes party to contractual provisions
Examples
• Unconditional receivables and payables are recognized as FA/L when the entity becomes a party to the contract and has a legal right to receive or pay cash
• Issued debt Is recognized as FL when the issuing entity becomes a party to contractual obligations and hence has a legal obligation to pay cash
• A derivative is recognized on commitment date rather than on date of settlement. At inception FV of right and obligation created maybe equal in which case FV of derivative is zero.
Arrangements not recognized
• Planned future transactions no matter how likely are not assets or liabs because entity is not a party to a contract
• Derivatives contract to buy or sell non-financial items that are scoped out of IAS 109 are not recognized as FA/L because they are executory
• Assets to be acquired and liabs to be incurred as a firm commitment to purchase or sell goods or services are generally not recognized until at least one party has performed under contract.
A FA (
except certain trade receivables)
or FL should at initial recognition should be measure at FV +/-,
for FA or FL not subsequently measured at FVTPL
,transaction costs that are not directly attributable to acquisition or issue of FA or FL.
Trade receivables that do not contain a significant financing component
(determined as per IAS Revenue)
are initially measured at transaction price and not fair value
Day 1 profit or loss
If FV at initial recognition differs from transaction price and part of consideration is for something other than the FI
(eg. goods or service or capital contribution or deemed distribution)
and if FV is evidenced by a quoted price in an active market for an identical asset or liab OR based on a valuation technique that uses data only from observable markets , then the difference is reconsecrated as gain or loss on initial recongnition
In all other cases day 1 profit or loss is included in carrying amount of FI and after initial recognition, is recognized as gain or loss to the extent that it arises from a change in a factor (including time) that market participants would take into account when pricing asset or liabiltiy
Under IAS 109 a 'regular way' purchase or sale of FA can be de/recognized using either 'trade date accounting' or 'settlement date accounting'
Transaction costs are defined as incremental costs that are directly attributable to the acquisition or issue or disposal of FI. An incremental cost is one that would not have been incurred if the entity had not acquired/issued/disposed the FI
Includes fees and commission paid to agents, advisers, brokers and dealers, levies by regulatory agencies and exchanges. However it does
NOT INCLUDE
debt premiums or discounts, financing costs, internal admin costs and holding costs.
In practice this requires significant judgement
The consequences of treatment of Transaction costs on initial measurement are:
• For debt instruments subsequently measured at amortized cost or FVOCI, transaction costs are included in calculation of EIR – in effect they are amortized through P&L and over term of instrument.
• For investments in equity instruments designated at FVOCI, the transaction costs remain in equity and are not subsequently reclassified to P&L. An entity may equity the cumulative gain or loss (which includes transaction costs) for example when investment in equity instrument is derecognized
• For FI classified at FVPL transaction costs are recognized in PL immediately on initial recognition
FL Classification and subsequent measurement
All FL are classified and subsequently measure at amortized cost, except for:
• FL at FVPL
• FL that arise when a transfer of FA does not qualify for derecognition or when the continuing involvement approach applies
• Financial guarantee contracts not designated as at FVPL that are not accounted for under IAS Insurance Contracts
• Commitments to provide a loan at below-market interest rate
Business Combination
When FL are assumed in a BC those should be classified in CFS of the acquirer into one of the permitted categories mentioned above. It is entirely possible that the classification of a FL for these purposes may differ from its classification int eh FS of the acquiree.
IAS 103 provides clear evidence that at the acquisition date the acquirer should make any classifications, designations concerning FL or FA assumed in a BC in accordance with pertinent conditions at that date.
FV at FVPL
This category can be further sub-divided as follows:
• FL classified as HFT
• FL designated by entity as FVPL. This is a onetime option and such FL cannot be reclassified into another category during its lifetime
FL may upon initial recognition be designated as FVPL only in following circumstances
• It eliminates or significantly reduces a measurement or recognition (‘an accounting mismatch’) that would otherwise arise from measuring assets or liabs or recognizing gains or losses thereon on different bases
• A group of FL or FA is managed and its performance is evaluated on a FV basis, in accordance with a documented risk management or investment strategy and information about the group is provided internally on that basis to KMPs
• In the case of a hybrid FL containing one or more EDs an entity may choose FVPL unless:
o The ED does not significantly modify cash flows that
otherwise would be required by the contract
OR
o It is clear with little to no analysis when a similar hybrid
instrument is first considered that separation of ED is
prohibited
Reclassification of FL into and out of FVPL category is prohibited. Following circumstances are not reclassification:
a. a derivative that was previously a designated and effective hedging instrument in a cash flow hedge or net investment hedge no longer qualifies as such
b. a derivative that becomes a designated and effective hedging instrument in a cash flow hedge or net investment hedge
FL classified as HFT if it falls into one of following
• FL incurred principally for purpose of repurchasing in near future
• FL that on recognition forms part of a portfolio of identified FIs that are managed together and for which there is evidence of recent actual pattern of short-term profit-taking
• Derivative liabs, unless the derivative is a financial guarantee contract or it forms part of a designated and effective hedging relationship
Following are examples of liabs that would be classified as HFL and thus included in trading category
• An interest rate swap that has negative FV that is not accounted for as hedging instrument
• A derivative liab incurred upon writing a foreign exchange option that is not accounted for as a hedging instrument
• An obligation to deliver FA borrowed by a short-seller (i.e. an entity that sells FA it has borrowed and does not yet own)
• A quoted debt instrument that the issuer plans to buy back in the near term depending on movements in the debt instrument’s FV i.e. FL incurred with intention of repurchase in near term
IAS 109 provides specific guidelines for accounting Hedged Instruments
Amortized cost of FL is determined using EIR method.
In case of FL measured at FVPL, FV gains and losses are recognized in PL except that in the case of FL (other than loan commitments of financial guarantee contracts) that are designated at FVPL, the gains or losses are required to be presented as follows:
• The amount of the change in FV of the FL that is attributable to changes in credit risk of that liab should be presented in OCI; AND
• The reminder of the change in the FV of the liab should be presented in PL unless the treatment of the effects of changes in the liab’s credit risk described above would create or enlarge an accounting mismatch in PL (in which case all gains or losses are recognized in PL)
In making the determination of whether a change due to credit risk of FL recognized in OCI would create an accounting mismatch in PL, entity should consider whether it expects that effect of changes in credit risk will be offset in Pl by a change in FV of another FI measured FVPL. Economic relation between characteristics of FL and FI must be examined. Determination is only at time of initial recognition and not reassessed.