Corporate Reporting

Financial Instruments
(Chapter 10 - F7)

BS AF
2k18
 Financial Instruments

Example:: Any Contract that

When Goods are Sold to
gives rise to:
Customers on Credit so,
Asset if one entity (Trade
Receivables) & Liability of
other entity (Trade Payables)
are recorded. Financial Liability
As per Standard as this
Financial Asset of or Equity
Trade Receivable & Trade one entity Instrument of
Payables are as a result of & another entity
agreement (for sale of
goods) hence, Trade
Receivables & Trade Payable
will be Financial Asset or
Financial Liability
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Financial Assets- Definition
A financial asset is any asset that is:
1) cash
2) a contractual right to receive cash or another financial asset from another entity
3) a contractual right to exchange financial assets/liabilities with another entity under
conditions that are potentially favourable
4) an equity instrument of another entity. (Shares of other entity)

Examples of financial assets include:

• trade receivables
• options
• investment in equity shares.

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Financial Liabilities- Definition
A financial liability is any liability that is a contractual obligation:
1. to deliver cash or another financial asset to another entity, or
2. to exchange financial instruments with another entity under conditions that are
potentially unfavourable, or
3. that will or may be settled in the entity’s own equity instruments (Shares issue)

Examples of financial liabilities include:

• trade payables
• debenture loans / loan notes
• redeemable preference shares.

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Example 1- Identify financial instruments
Identify which of the following are financial instruments:
a) inventories
b) investment in ordinary shares
c) prepayments for goods or services
d) liability for income taxes
e) a share option (an entity’s obligation to issue its own shares).

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Example 1- Identify financial instruments
Identify which of the following are financial instruments:
a) inventories
b) investment in ordinary shares
c) prepayments for goods or services
d) liability for income taxes
e) a share option (an entity’s obligation to issue its own shares).
Solution
a) Inventory (or any other physical asset such as noncurrent assets) is not a financial instrument
since there is no present contractual right to receive cash or other financial instruments.
b) An investment in ordinary shares is a financial asset since it is an equity instrument of another
entity.
c) Prepayments for goods or services are not financial instruments since the future economic benefit
will be the receipt of goods or services rather than a financial asset.
d) A liability for income taxes is not a financial instrument since the obligation is statutory rather
than contractual.
e) A share option is a financial instrument since a contractual obligation does exist to deliver an
equity instrument. 6
Financial Liabilities
Initial Recognition of Financial Subsequent Measurement of
Liabilities Financial Liabilities

Fair Value = Amortized Cost

Net proceeds of Cash Received less
Issuing Cost
Rs.100,000 –Rs.500= Rs.95,000

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Example 2 – Financial Liabilities

Solution
a) What amount will be recorded as a financial liability when the loan notes are issued?

Initial recognition
Bank (Dr.) $20,000
Loan Notes (Cr.) $20,000
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Example 2
b) What amounts will be shown in the statement of profit or loss and statement of
financial position for years 1–4?

Working:
Years Opening Finance Cost Cash Paid Closing
(opening*5%) 5% (Coupon)
(20,000*5%) (St. of
(St. of P&L) Financial
Position)
1 20,000 1,000 (1,000) 20,000 Non-CL

2 20,000 1,000 (1,000) 20,000 N-CL

3 20,000 1,000 (1,000) 20,000 CL
4 20,000 1,000 (1,000) -
(20,000)
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Example 2
b) What amounts will be shown in the statement of profit or loss and statement of
financial position for years 1–4?

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Subsequent Measurement - Financial Liabilities
Initial Value + Effective Interest
Amortized Cost
Rate – Interest Paid

Effective Interest Rate (Finance Cost – St. of P&L)

Effective Interest may be different from Interest Paid, IF there are
• Additional cost of borrowings e.g. redemption premium, issue cost or discounts on issue. (Deep Discount
bonds)
 (Discount on issue – e.g. nominal value of loan is $ 20,000 but we received a cash of $ 19,000
 Redemption premium- means at the time of repayment of loan excess amount than the nominal value will be
paid- e.g Co received $1,000 but paid back $1,200)
 The full cost of borrowing will include:
1) Issue costs
2) Discount on issue
3) Annual interest payment
4) Premium on redemption 11
Example3 – Deep Discount Bond
A loan note (debt) is issued for $1,000. The debt is redeemable at $ 1,250. The term of debt is
five years and interest is paid at 5.9% p.a. The effective interest rate is 10%. So, this is deep
discount bond/debt
i.e. Loan issued at
Required: Par/Face Value and
Show how the value of debt changes over its life. redeemable(payback
) at premium

Solution
On issuance (Initial Recognition) FV (Net proceeds – Issue Cost)
Bank (Dr.) $1,000
Loan Notes (Cr.) $1,000

1- Discount on issue – Instead of receiving nominal value / received less

2- Redemption premium
3- Effective interest rate is higher than interest payment rate when there is additional cost of
borrowing 12
Example3 – Deep Discount Bond
Subsequent Measurement (Amortized Cost)- (Movement)

Years Opening Finance Cost Interest Paid Closing

10% of (5.9% *1,000)
Opening value (St. of
Financial
(St. of P&L) Position)
$ $ $ $
1 1,000 (1,000*10%) (59) 1,041
100
2 1,041 (1,041*10%) (59) 1,086
104
3 1,086 109 (59) 1,136
4 1,136 113 (59) 1,190
5 1,190 119 (59) -
(1,250)
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Example3 – Deep Discount Bond
Entries for Subsequent Measurement

At the end of EACH Year These two entries will

Finance Cost (Dr.) St. of P&L $100 remain same for the whole
period of loan (only Finance
Loan Notes (Cr.) $100 Cost figure will change as
given in Amortization cost
At the end of Each Year – Payment of Interest table)
Loan Notes (Dr.) $59
Bank (Cr.) $59

At the end of 5th Year – After passing above two entries also pass entry for repayment of
loan
At the end of Loan Period i.e. 5th Year
Loan Notes(Dr.) $1,250
Bank (Cr.) $1,250 14
Example 4

Solution
On issuance (Initial Recognition)
Bank (Dr.) $40,000
Loan Notes (Cr.) $40,000

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Example 4
Subsequent Measurement (Amortized Cost)- (Movement)

Years Opening Finance Cost Interest Paid Closing

9% of Opening (0% *40,000)
value (St. of
Financial
(St. of P&L) Position)
$ $ $ $
1 40,000 3,600 (0) 43,600
(40,000*9%)
2 43,600 3,924 (0) 47,524
3 47,524 4,276 (0) -
(51,800)
This $ 51,800
repayment is
combination of
$40,000 Loan notes &
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$ 11,800 premium
Example 4

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Example 5

Solution
On issuance (Initial Recognition) (Fv)
Nominal Value $20,000
Bank (Dr.) $18,966 Discount (2.5%) $ (500)
Loan Notes (Cr.) $18,966 Issue Cost $ (534)
Amount received $ 18,966

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Example 5
Subsequent Measurement (Amortized Cost)- (Movement)

Years Opening Finance Cost Interest Paid Closing

7% of Opening (4% *20,000)
value (St. of
Financial
(St. of P&L) Position)
$ $ $ $
1 18,966 1,328 (800) 19,494
2 19,494 1,365 (800) 20,059
3 20,059 1,404 (800) 20,663
4 20,663 1,446 (800) 21,309
5 21,309 1,491 (800) -
(22,000)

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Example 5

Statement of P&L and Statement for Financial Position for Year 1

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Share Capital - Equity
1. Ordinary Share capital – Equity
• Dividend payment is discretion of company / not binding
• Share issued are irredeemable
• In event of Company’s liquidation Ordinary Share holders have last right on Company ‘s assets

2. Preference Share Capital

a) Irredeemable preference Shares – Equity
• Dividend payment is discretion of company if not agreed at the time of issuance
• Share issued are irredeemable
• Like Ordinary Share Capital
• If carry dividend payment then not like equity (ordinary share capital) (In this case Financial Liability)

b) Redeemable Preference Shares

• Dividend payment are considered as Interest and compulsory (as per the terms agreed)
• Shares issued are redeemable
• Is considered as Financial Liability
Share Capital - Equity
Type of Share Capital Dividend Payment Consider as Treatment

Ordinary Share Capital - Equity NOT Compulsory Equity No Treatment Under Financial
Instruments
Irredeemable preference Shares NOT Compulsory Equity No Treatment Under Financial
Instruments
Irredeemable preference Shares Yes Financial Liability Treat Under Financial Instruments
Redeemable preference Shares Yes Financial Liability Treat Under Financial Instruments

Treatment of Interest & Dividend

The accounting treatment of interest and dividends depends upon the accounting treatment
of the underlying instrument itself:

• equity dividends declared are reported directly in equity

• dividends on redeemable preference shares classified as a liability are an expense in the statement of
profit or loss.
Compound Instrument
A financial instrument that has characteristics of both
• equity and
• liabilities, such as a convertible loan.

Split Accounting – A Compound Instrument can be split into 2 parts:

1. Calculate liability component first
2. Equity = remainder (Amount will remain same over the years)
Compound Instrument- Example
Compound Instrument - Example
At Inception:
Year Cash flow Discount Factor Present Value
($ 000) 9.1% ($ 000)
1 720 0.92 662.4
(2%*36,000)
2 720 0.84 604.8
3 36,720 0.77 28,274.4
(36,000+720)
29,541.6
Splitting Equity & Debt Part ($ 000)

Total cash inflow 36,000

Debt – Financial Liability 29,541.6
Equity (Remaining Part) 6,458
Compound Instrument - Example
Entries: $ 000

Bank (Dr.) 36,000

Financial Liabilities (Cr.) 29,542
Equity (Cr.) 6,458

Subsequent Measurement (Amortized Cost)- (Movement of Liability Part)

Years Opening Finance Cost Interest Paid Closing
9.1% of (2% *36,000) (St. of
Opening value Financial
$ (St. of P&L) Position)
$ $ $
1 29,542 2,688 (720) 31,510
2 31,510 2,867 (720) 33,658
3 33,658 3,062 (720) 36,000
Compound Instrument - Example
Financial Statements- Extracts
 Financial Assets

Financial Assets
Initial
Recognition

At fair value –
1)- Equity 2)- Debt
amount paid to
Instruments Instruments
acquire the
Assets (Purchase of (Purchase of Bonds
Shares of other / redeemable
Entities) preference Shares)

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 Financial Assets

Initial
Recognition
1)- Equity Instruments
At fair value –
amount paid to
acquire the (Purchase of Shares of
Assets other Entities)

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1)- Equity Instruments (Financial Assets)

Fair Value through Profit & loss

Two Alternative
Treatments
Fair Value through
OCI

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 Equity Instruments are the
1)- Equity Instruments (Financial Assets) Purchases of Shares of Other
Entity

Equity Instruments are measured at either:

1) Fair value through profit & loss (treatment 1)
Intention is TRADING of Shares

1) Fair Value through other comprehensive income (treatment 2)

Intention is to HOLD the Shares

1)- Fair value through profit & loss 2)- F.V through Other Comprehensive Income

Transaction Cost Expense (St. of Profit & loss) Transaction Cost Capitalized (Added to the Cost of
Asset)

Investment (Asset) Revalued to fair value at the end Investment (Asset) Revalued to fair value at the end of
(Purchases of Shares) of each year (Purchases of Shares) each year

Revaluation Gain / Taken to St. of Profit & loss Revaluation Gain / Loss Taken to St. of Other
Loss Comprehensive Income 31
Example- 1
Norman bought 100,000 shares in a listed company on 1 November 2015. Each share cost $5 to
purchase and a fee of $0.25 per share was paid as commission to a broker. The fair value of each share
at 31 December 2015 was $3.50.
Required:
Explain how this will be accounted for in the financial statements.

Solution - Fair value through profit & loss (treatment 1) (Intention is Trading of Shares)

Initial Recognition (Shares/ Asset) Transaction Cost

Investment in Shares (Dr.) $ 500,000 Transaction Cost (St. of P&L) (Dr.) $ 25,000

Bank (Cr.) $ 500,000 Bank (Cr.) $ 25,000

(Purchase of 100,000 Shares @ $5 each) (Paid Commission 100,000 Shares @ $0.25 each)
100,000*5= $500,000 100,000*0.25= $25,000 32
Example- 1
Subsequent Measurement- Revaluation of Shares to Fair Value (FV)
Revaluation to FV
Shares purchased at 100,000 @ $ 5 each = $ 500,000
Fair Value (Share price) at 31 Dec 2015 (100,000 @ $
Loss on investment in Shares (Dr.) (St. P&L) $ 150,000
3.5 each) = $ 350,000
Investment in Shares (Cr.) $ 150,000 Loss on investment in Shares $ 150,000

Statement of Profit or loss for the year 31 Dec 2015

Transaction Cost ($25,000)
Loss on Investment ($150,000)

Statement of Financial Position at 31 Dec 2015

Current Assets
Investment in Shares ( $3.5 * 100,000) $350,000
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Example- 2

Solution - Fair value through Other Comprehensive Income(treatment 2)

(If Company plans to hold Shares)
Initial Recognition (Shares/ Asset)
Shares purchased at 20,000 @ $ 3.8 each = $ 76,000
Investment in Shares (Dr.) $ 76,000
If there was any Transaction Cost – will add that to
the Value of Asset
Bank (Cr.) $ 76,000
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Example- 2
Subsequent Measurement- Revaluation of Shares to Fair Value (FV)
Revaluation to FV
Shares purchased at 20,000 @ $ 3.8 each = $ 76,000
Fair Value (Share price) at 31 Dec 20x7 (20,000 @ $ 3.4
Loss on investment in Shares (Dr.) (St. OCI) $ 8,000
each) = $ 68,000
Investment in Shares (Cr.) $ 8,000 Loss on investment in Shares $ 8,000

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 Financial Assets

Initial
Recognition 2)- Debt Instruments
At fair value –
amount paid to (Purchase of Bonds /
acquire the redeemable preference
Assets
Shares/ Giving loan/ debt)

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2)- Debt Instruments (Financial Assets)

Fair Value through profit or

Loss

Three Alternative Amortized Cost

Treatments

Fair Value through OCI

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Example - 3
Example - 3

Solution (FV through P&L)

Plan to hold bonds in the short term means company has intention to trade (sale
bonds to earn gain through increase in Fair Value)

Initial Recognition (Bonds/ Asset) Transaction Cost

Investment in Bonds (Dr.) $ 95,000 Transaction Cost (St. of P&L) (Dr.) $ 2,000
Bank (Cr.) $ 2,000
Bank (Cr.) $ 95,000
Transaction Cost or issue cost
Face value of Bonds = $ 100,000
Fair value / consideration paid - $ 95,000
(Recording on Fair value)
Example- 3
Subsequent Measurement- Bank (Dr.) $ 5,000
Interest on Bonds Received
Interest Income (Cr.) (St. P&L) $ 5,000

5% bonds of $100,000
(Interest received / interest income is on interest rate given
along with bonds and is calculated on Face value / Par value
/ nominal value
$100,000 *5% = $ 5,000

Revaluation of Bonds to Fair Value (FV)

Revaluation to FV On 31/12/20x1
Bonds purchased at FV- $ 95,000
Investment in Bonds (Dr.) $ 15,000 FV at 31/12/20x1 - $ 110,000

Gain on investment in Bonds (Cr.) (St. $ 15,000 Gain on investment in Bonds $ 15,000
P&L)
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Example- 3
On 01/01/ 20x2 selling of Bonds
Bank (Dr.) $ 110,000

Investment in Bonds (Cr.) $ 110,000

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Example - 3

Solution (Amortized Cost)

Plan to hold bonds Until redemption date means
• has intention to hold till maturity (will not sale bonds at any time)
Initial Recognition (Bonds/ Asset)

Investment in Bonds (Dr.) $ 97,000

In Case of Amortized Cost (Financial Assets Debt)
Bank (Cr.) $ 97,000 If there was any Transaction Cost – will add that to
the Value of Bonds on Initial Recognition
Face value of Bonds = $ 100,000
Fair value / consideration paid - $ 95,000 + $ 2,000

(Recording on Fair value + Transaction Cost)

Example- 3
Subsequent Measurement- Amortized Cost

Years Opening Finance Income Cash Received Closing

(opening*8%) 5%
($100,000*5%)
(St. of Financial
(Effective Interest rate) (Face value * Interest Position)
(St. of P&L) rate)
31/12/20x1 97,000 7,760 (5,000) 99,760
31/12/20x2 99,760 7,981 (5,000) 102,741
31/12/20x3 102,741 8,219 (5,000) -
(105,960)

Redeem (at payment time)

Receive premium along with Face value/ Par value
($100,000 + $ 5,960)
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Example3
Entries for Subsequent Measurement

At the end of EACH Year (Effective interest rate) These two entries will
remain same for the whole
Investment in Bond (Dr.) $7,760
period of Bonds (only
Finance Income (Cr.) (St. of P&L) $7,760 Finance Income figure will
change as given in
At the end of Each Year – Receipt of Interest Amortization cost table)
Bank (Dr.) $5,000
Investment in Bond (Cr.) $5,000

At the end of 3rd Year – After passing above two entries also pass entry for redemption of
bonds
At the end of Bond Term i.e. 3 Years
Bank (Dr.) $105, 960
Investment in Bond (Cr.) $105, 960 44
Example3
Statement of Profit or loss for the year 31-12-20x1 31-12-20x2 31-12-20x3
Finance Income $7,760 $7,981 $8,219

Statement of Financial Position at 31-12- 20x1 31-12-20x2 31-12-20x3

Non - Current Assets
Investments In Bonds $99,760

Current Assets
Investments In Bonds 102,741
-

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Example - 3

Solution (FV through OCI)

Plan to sell the bonds if gets Higher Return means
• May hold bonds till maturity (will not sale bonds at any time) or
• May Sale Bonds if gets good return (value)

Initial Recognition (Bonds/ Asset) If there was any Transaction Cost – will add that to
the Value of Bonds on Initial Recognition
Investment in Bonds (Dr.) $ 97,000
$95,000(Cash Paid) + $ 2,000 (Transaction cost) =
Bank (Cr.) $ 97,000 $97,000
Example- 3
Subsequent Measurement- FV through OCI

Years Opening Finance Income Cash Received Sub Total Gain / (Loss) Fair value
(opening *8%) 5% (St. of
(as in amortized (100,000*5%) Financial
cost) (A) (St. of OCI) Position)
(B-A)
(St. of P&L) (B)
31/12/20x1 97,000 7,760 (5,000) 99,760 10,240 110,000

31/12/20x2 110,000 7,981 (5,000) 112,981 (8,981) 104,000

(99,760*8%)
31/12/20x3 104,000 8,219 (5,000) 1,259 (1,259) -
(102,741*8%) (105,960)
Finance Income
will be taken from
amortization Cost
Table 47
Example3
Entries for Subsequent Measurement

At the end of EACH Year (Effective interest rate) First two entries will remain
Investment in Bond (Dr.) $7,760 same for the whole period
of Bonds (only Finance
Finance Income (Cr.) (St. of P&L) $7,760
Income figure will change as
given in table)
At the end of Each Year – Receipt of Interest
Bank (Dr.) $5,000
Investment in Bond (Cr.) $5,000

At Year end- Investment in

Difference B/W Sub total & FV (Taken to OCI) Bonds will be revalued to FV
Investment in Bond (Dr.) $10,240 and difference in Sub total &
FV (Gain / loss) will be taken
Gain on Investment in Bonds (Cr.) $10, 240 to OCI
(OCI)
48
Example3
At the end of 3rd Year – After passing above entries also pass entry for redemption of bonds

At the end of Bonds Term i.e. 3rd Year

Bank (Dr.) $105, 960
Investment in Bond (Cr.) $105, 960

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Example3
Statement of Profit or loss for the year 31-12-20x1 31-12-20x2 31-12-20x3
Finance Income $7,760 $7,981 $8,219

Statement of Other Comprehensive Income 31-12-20x1 31-12-20x2 31-12-20x3

Gain / (loss) on Investment in Bonds $10,240 ($8,981) ($1,259)

Statement of Financial Position at 31-12- 20x1 31-12-20x2 31-12-20x3

Non - Current Assets
Investments In Bonds $110,000

Current Assets
Investments In Bonds 104,000
-
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Summary – Financial Instruments
*In Case of Company’s
own Equity (No Further
Financial Instruments
treatment)

Financial Liabilities* Financial Assets

Equity Instruments Debt Instruments

Amortized Cost

FV Through
Transaction Cost FV Through OCI FV Through Amortized
P&L FV Through OCI
(TC) – Deduct P&L Cost
from Amount
Received TC – P&L, TC – Add to
TC – Add to value TC – Add to
TC – P&L, value of Asset,
FV Gain/ of Asset, value of Asset,
** For Compound Amortized cost
Loss- P&L FV Gain/ Loss- FV Gain/ Amortized cost table + FV –
instruments- Split Financial OCI Loss- P&L table Gain/ loss to OCI
Liability & equity part and
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then treat respectively
De-recognition– Financial Instruments
Financial Instruments should be de-recognized:
• financial asset – when, and only when, the contractual rights to the cash flows of
the financial asset have expired.

• financial liability – when, and only when, the obligation specified in the contract is
discharged, cancelled or expires.

On de-recognition:
• the difference between the carrying amount of the asset or liability, and the amount
received or paid for it,
• should be included in the profit or loss for the period. (any balancing figure)

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Thank You!!

Best Wishes….
