IFRS9 Financial instruments

Basic concept
 Overall review

If you read the financial press you will probably be aware of

rapid international expansion in the use of financial
instruments. These vary from straightforward, traditional
instruments, eg bonds, through to various forms of so-called
'derivative instruments'.
There have been recent high-profile disasters involving
derivatives which, while not caused by accounting failures,
have raised questions about accounting and disclosure
practices
IAS 32 Financial instruments: presentation, which deals with:
I. The classification of financial instruments between liabilities and
equity
II. Presentation of certain compound instruments (instruments
combining debt and equity)
IFRS 7 Financial instruments: disclosure
IFRS 9 Financial instruments. IFRS 9 deals with recognition,
derecognition and measurement of financial assets and liabilities
 Definitions

Financial instrument. Any contract that gives rise to

both a financial asset of one entity and a financial liability
or equity instrument of another entity.
Financial asset. Any asset that is:
(a) Cash
(b) An equity instrument of another entity
(c) A contractual right to receive cash or another financial
asset from another entity; or to exchange financial instruments
with another entity under conditions that are potentially
favourable to the entity
Examples of financial assets include:
(a) Trade receivables
(b) Options
(c) Shares (when held as an investment)
Financial liability. Any liability that is:
(a) A contractual obligation:
I. To deliver cash or another financial asset to another entity, or
II. To exchange financial instruments with another entity under
conditions that are potentially unfavourable.
Examples of financial liabilities include:
(a) Trade payables
(b) Debenture loans payable
(c) Redeemable preference (non-equity) shares
Equity instrument. Any contract that evidences a residual
interest in the assets of an entity after deducting all of its
liabilities.
Recognition of financial
instruments
 Initial recognition
A financial asset or financial liability should be recognised
in the statement of financial position when the reporting
entity becomes a party to the contractual provisions of the
instrument.
Notice that this is different from the recognition criteria
in the Conceptual Framework and in most other standards.
Items are normally recognised when there is a probable
inflow or outflow of resources and the item has a cost or
value that can be measured reliably.
 Classification of financial assets

On recognition, IFRS 9 requires that financial assets are classified as

measured at either:
Amortised cost, or
Fair value.
 Classification basis
A financial asset is classified as measured at amortised cost
where:
a) The objective of the business model within which the
asset is held is to hold assets in order to collect
contractual cash flows
b) The contractual terms of the financial asset give rise on
specified dates to cash flows that are solely payments of
principal and interest on the principal outstanding
 Example: amortised cost
On 1 January 20X1 Abacus Co purchases a debt instrument for
its fair value of $1,000. The debt instrument is due to mature on
31 December 20X5. The instrument has a principal amount of
$1,250 and the instrument carries fixed interest at 4.72% that is
paid annually. The effective rate of interest is 10%.
How should Abacus Co account for the debt instrument over its
five year term?
 Solution

Profit or loss: Interest received Amortised cost

Amortised cost at Interest income for during year (cash at end of year
Year beginning of year year (@10%) inflow)
$ $ $ $
20X1 1,000 100 (59) 1,041
20X2 1,041 104 (59) 1,086
20X3 1,086 109 (59) 1,136
20X4 1,136 113 (59) 1,190
20X5 1,190 119 (1,250+59) –
 债券发行的原理（折价/平价/溢价）

Abacus Co will receive interest of $59 (1,250 × 4.72%)

each year and $1,250 when the instrument matures.
 Ex1
Viking issues $100,000 5% loan notes on 1 January 20X4,
incurring issue costs of $3,000. These loan notes are redeemable at
a premium, meaning that the effective rate of interest is 8% per
annum.
What is the finance cost to be shown in the statement of profit
or loss for the year ended 31 December 20X5?
A. $8,240
B. $7,981
C. $7,760
D. $8,000
 Ex1
Answer B
The loan notes should initially be recorded at their net proceeds, being the
$100,000 raised less the $3,000 issue costs, giving $97,000. This should then be
held at amortised cost, taking the effective rate of interest to the statement of
profit or loss. The annual payment will be the coupon rate, which will be 5% x
$l00,000 = $5,000 a year.
Applying this to an amortised cost table gives $7,981, as shown below.
B/f Interest 8% Payment c/f
$ $ $ $
20X4 97,000 7,760 (5,000) 99,760
20X5 99,760 7,981
If you chose C, you have done the calculation you 20X4. If you chose D, you
have used 8% of the full $100,000 and done the calculation for 20X4. If you
chose A, you have used 8% of the full $100,000
Subsequent measurement of
equity instruments
 Subsequent measurement of equity instruments

After initial recognition equity instruments are measured at

either fair value through profit or loss (FVTPL) or fair
value through other comprehensive income (FVTOCI).
If equity instruments are held at FVTPL no transaction costs
are included in the carrying amount.
 Ex2
What is the default classification for an equity investment?
A. Fair value through profit or loss
B. Fair value through other comprehensive income
C. Amortised cost
D. Net proceeds
 Ex3
DEF Co has purchased an investment of 15,000 shares on 1 August
20X6 at a cost of $6.50 each. Transaction costs on the purchase
amounted to $1,500.
As at the year end 30 September 20X6, these shares are now worth
$7.75 each.
Select the correct gain and the place it will be recorded

Gain Where recorded

17,250 Other Comprehensive Income

18,750 Statement of profit or loss

 Ex3
Answer
Where recorded
Gain

18,750 Statement of profit or loss

Financial Assets held for trading will be valued at Fair Value
through Profit or Loss. These are therefore valued excluding any
transaction costs (which will be expensed to profit or loss).
The initial value of the investment is therefore 15,000 x $6.50 =
$97,500
The shares will be revalued to fair value as at year end, and the
gain will be taken to profit or loss. The year-end value of the shares
is 15,000 x $7.75 = $116,250, giving a gain of $18,750. This is
recognised within profit or loss.
Equity instruments can be held at FVTOCI if:
a) They are not held for trading (ie the intention is to hold
them for the long term to collect dividend income)
b) An irrevocable election is made at initial recognition to
measure the investment at FVTOCI If the investment is
held at FVTOCI, all changes in fair value go through
other comprehensive income. Only dividend income will
appear in profit or loss.
 Ex4
ABC Co purchased 10,000 shares on 1 September 20X4, making
the election to use the alternative treatment under IFRS 9. The
shares cost $3.50 each. Transaction costs associated with the
purchase were $500.
At 31 December 20X4, the shares are trading at $4.50 each.
What is the gain to be recognised on these shares for the year
ended 31 December 20X4?
$ .
 Ex4
Answer $9,500
The investment should be classified as Fair Value through other
comprehensive income.
As such, they will initially be valued inclusive of transaction costs.
Therefore, the initial value is 10,000 x $3.50 = $35,000 + $500 =
$35,500.
At year-end, these will be revalued to fair value of $4.50 each,
therefore 10,000*$4.50 =$45,000.
The gain is therefore $45,000 - $35,500 = $9,500.
 Ex5
For which category of financial instruments are transaction costs
excluded from the initial value, and instead expensed to profit or
loss?
A. Financial Liabilities at amortised cost
B. Financial Assets at fair value through profit or loss
C. Financial Assets at fair value through other comprehensive
income
D. Financial Assets at amortised cost
Compound financial
instruments
Some financial instruments contain both a liability and an equity
element. In such cases, IAS 32 requires the component parts of
the instrument to be classified separately, according to the
substance of the contractual arrangement and the definitions of a
financial liability and an equity instrument.
One of the most common types of compound instrument is
convertible debt. This creates a primary financial liability of the
issuer and grants an option to the holder of the instrument to
convert it into an equity instrument (usually ordinary shares) of the
issuer. This is the economic equivalent of the issue of conventional
debt plus a warrant to acquire shares in the future.
Although in theory there are several possible ways of calculating
the split, IAS 32 requires the following method.
a) Calculate the value for the liability component.
b) Deduct this from the instrument as a whole to leave a residual
value for the equity component.
 Example
Rathbone Co issues 2,000 convertible bonds at the start of 20X2.
The bonds have a three year term, and are issued at par with a
face value of $1,000 per bond, giving total proceeds of
$2,000,000. Interest is payable annually in arrears at a nominal
annual interest rate of 6%. Each bond is convertible at any time
up to maturity into 250 ordinary shares.
When the bonds are issued, the prevailing market interest rate for
similar debt without conversion options is 9%.
Required
What is the value of the equity component in the bond?
 Solution

Principal
$2,000,000 discounted at 9% over 3 years:
2,000,000 ÷ 1.09 ÷ 1.09 ÷ 1.09 (or 2,000,000 × 1 / 1.093) 1,544,367
Interest
Year 1 120,000 ÷ 1.09 110,091
Year 2 110,091 ÷ 1.09 101,002
Year 3 101,002 ÷ 1.09 92,662
303,755
Value of liability component 1,848,122
Equity component (balancing figure) 151,878
Proceeds of bond issue 2,000,000
 Solution
$
Present value of the principal: $2,000,000 payable at the end of three years
($2m × 0.772183)* 1,544,367
Present value of the interest: $120,000 payable annually in arrears for three years
($120,000 × 2.5313)* 303,755
Total liability component 1,848,122
Equity component (balancing figure) 151,878
Proceeds of the bond issue 2,000,000
Practice:
convertible loan notes
 Question
A company issues $20m of 4% convertible loan notes at par on 1 January
2009. The loan notes are redeemable for cash or convertible into equity
shares on the basis of 20 shares per $100 of debt at the option of the loan
note holder on 31 December 2011. Similar but non-convertible loan notes
carry an interest rate of 9%.
The present value of $1 receivable at the end of the year based on
discount rates of 4% and 9% can be taken as:
Required
Show how these loan notes should be accounted for in the financial
statements at 31 December 2009.
Question

4% 9%
$ $
End of year 1 0.96 0.92
2 0.93 0.84
3 0.89 0.77
Cumulative 2.78 2.53
 Answer

$
Statement of profit or loss
Finance costs (W2) 1,568
Statement of financial position
Equity – option to convert (W1) 2,576
Non-current liabilities
4% convertible loan notes (W2) 18,192
 Working 1

Equity and liability elements

$'000
3 years interest (20,000 × 4% × 2.53) 2,024
Redemption (20,000 × 0.77) 15,400
Liability element 17,424
Equity element (β) 2,576
Proceeds of loan notes 20,000
Working 2

Loan note balance

$'000
Liability element (W1) 17,424
Interest for the year at 9% 1,568
Less interest paid (20,000 × 4%) (800)
Carrying value at 31 December 2009 18,192
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OT1
Financial instruments
 B139
An 8% $30 million convertible loan note was issued on 1 April 20X5 at par.
Interest is payable in arrears on 31 March each year. The loan note is
redeemable at par on 31 March 20X8 or convertible into equity shares at the
option of the loan note holders on the basis of 30 shares for each $100 of loan.
A similar instrument without the conversion option would have an interest rate
of 10% per annum.
The present values of $1 receivable at the end of each year based on discount
rates of 8% and 10% are:
8% 10%
End of year 1 0.93 0.91
2 0.86 0.83
3 0.79 0.75
Cumulative 2.58 2.49
 B139
What amount will be credited to equity on 1 April 20X5 in respect of this
financial instrument?
A.$5,976,000
B.$1,524,000
C.$324,000
D.$9,000,000 (2 marks)
 B139
Answer B
$'000
Interest years 1–3 (30m × 8% × 2.49) 5,976
Repayment year 3 (30m × 0.75) 22,500
Debt component 28,476
Equity option (β) 1,524
30,000
 B140
A 5% loan note was issued on 1 April 20X0 at its face value of $20
million. Direct costs of the issue were $500,000. The loan note will be
redeemed on 31 March 20X3 at a substantial premium. The effective
interest rate applicable is 10% per annum.
At what amount will the loan note appear in the statement of financial
position as at 31 March 20X2?
A.$21,000,000
B.$20,450,000
C.$22,100,000
D.$21,495,000 (2 marks)
 B140
Answer D
$'000
Proceeds (20m – 0.5m) 19,500
Interest 10% 1,950
Interest paid (20m × 5%) (1,000)
Balance 30 March 20X1 20,450
Interest 10% 2,045
Interest paid (20m × 5%) (1,000)
21,495
 B141
How does IFRS 9 Financial Instruments require investments in equity
instruments to be measured and accounted for (in the absence of any
election at initial recognition)?
A.Fair value with changes going through profit or loss
B.Fair value with changes going through other comprehensive income
C.Amortised cost with changes going through profit or loss
D.Amortised cost with changes going through other comprehensive income
(2 marks)
 B141
Answer A
Fair value with changes going through profit or loss. Fair value through
OCI would be correct if an election had been made to recognise changes in
value through other comprehensive income.
Amortised cost is used for debt instruments, not equity instruments.
 B142
On 1 January 20X1 Penfold purchased a debt instrument for its fair value
of $500,000. It had a principal amount of $550,000 and was due to mature
in five years. The debt instrument carries fixed interest of 6% paid
annually in arrears and has an effective interest rate of 8%. It is held at
amortised cost.
At what amount will the debt instrument be shown in the statement of
financial position of Penfold as at 31 December 20X2?
A.$514,560
B.$566,000
C.$564,560
•$520,800 (2 marks)
 B142
Answer A
$
1 January 20X1 500,000
Interest 8% 40,000
Interest received (550,000 6%) (33,000)
31 December 20X1 507,000
Interest 8% 40,560
Interest received (33,000)
31 December 20X2 514,560
 B143
Which of the following are not classified as financial instruments
under IAS 32 Financial instruments: presentation?
Share options
Intangible assets
Trade receivables
Redeemable preference shares (2 marks)
 B143
Answer
The correct answer is:
Intangible assets.
These do not give rise to a present right to receive cash or other financial
assets. The other options are financial instruments.
 B144
Dexon's draft statement of financial position as at 31 March 20X8
shows financial assets at fair value through profit or loss with a
carrying amount of $12.5 million as at 1 April 20X7.
These financial assets are held in a fund whose value changes
directly in proportion to a specified market index. At 1 April 20X7
the relevant index was 1,200 and at 31 March 20X8 it was 1,296.
What amount of gain or loss should be recognised at 31 March
20X8 in respect of these assets?
$ (2 marks)
 B144
Answer $1,000,000 gain
$'000
$12,500 1,296 / 1,200 13,500
Carrying amount (12,500)
Gain 1,000
OT2
Section B
 Information relevant to questions B146-B150
Bertrand issued $10 million convertible loan notes on 1 October
20X0 that carry a nominal interest (coupon) rate of 5% per annum.
They are redeemable on 30 September 20X3 at par for cash or can be
exchanged for equity shares in Bertrand on the basis of 20 shares for
each $100 of loan. A similar loan note, without the conversion
option, would have required Bertrand to pay an interest rate of 8%.
The present value of $1 receivable at the end of each year, based on
discount rates of 5% and 8%, can be taken as:
5% 8%
End of year 1 0.95 0.93
2 0.91 0.86
3 0.86 0.79
cumulative 2.72 2.58
 B146
How should the convertible loan notes be accounted for?
A.As debt
B.As debt and equity
C.As equity
D.As debt until conversion, then as equity
 B146
Answer B
As debt and equity
 B147
What is the amount that will be recognised as finance costs for
the year ended 30 September 20X1?
A.$500,000
B.$800,000
C.$735,000
D.Nil
 B147
Answer C
$'000
Interest payable ($10m × 5% × 2.58*) 1,290
Capital repayable ($10m × 0.79) 7,900
Debt element 9,190
Finance costs for year = 9,190 × 8% 735
 B148
What is the amount that should be shown under liabilities at 30
September 20X1?
A.$9,425,000
B.$9,925,000
C.$9,690,000
D.Nil
 B148
Answer A
$'000
1 October 20X0 9,190
Finance charge 8% 735
Interest paid (10,000 × 5%) (500)
Balance 30 September 20X1 9,425
 B149
If Bertrand had incurred transaction costs in issuing these loan
notes, how should these have been accounted for?
A.Added to the proceeds of the loan notes
B.Deducted from the proceeds of the loan notes
C.Amortised over the life of the loan notes
D.Charged to finance costs
 B149
Answer B
Deducted from the proceeds of the loan notes. The effective interest
rate is then applied to the netamount.
 B150
Later that year Bertrand purchased a debt instrument which will
mature in five years' time. Bertrand intends to hold the debt
instrument to maturity to collect interest payments.
How should this debt instrument be measured in the financial
statements of Bertrand?
A.As a financial liability at fair value through profit or loss
B.As a financial liability at amortised cost
C.As a financial asset at fair value through profit or loss
D.As a financial asset at amortised cost
 B150
Answer D
As a financial asset at amortised cost
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