22 Questions
What should be done with transaction costs for other liabilities?
Deducted from the liability
What is the main purpose of revaluing a financial instrument?
To report a capital gain
How are arrangement fees recorded if a loan is not revalued?
As part of the loan liability at net proceeds
Which of the following financial instruments would likely be revalued?
Shares in another company
What is the correct treatment for arrangement fees if a financial instrument is revalued?
Expensed immediately
What is amortised cost?
The cost of a financial instrument adjusted for amortisation
Which test must a debt instrument meet to be reported at amortised cost?
Both business model test and cash flow characteristic test
What is FVTPL?
Fair Value Through Profit or Loss
What is the primary objective of an entity's business model that holds a financial asset?
To collect its contractual cash flows
What is the condition for a financial asset to be classified as held for trading?
If it is designated as FVTPL
What is the treatment of financial liabilities that are not held for trading?
Reported at amortised cost
What does 'amortised cost' mean in the context of financial instruments?
Reporting a fair finance cost in the income statement
What is the benefit of designating a debt instrument as FVTPL?
It significantly reduces a measurement or recognition inconsistency
What happens when the business model of an entity changes?
Instruments may be moved from one category to another
What is the treatment of gains/losses on financial instruments that are not held for trading?
Reported in OCI
What is the purpose of revaluing financial instruments?
To reflect the current market value
What is the purpose of the method shown in the example above for calculating the annual finance cost and closing balance?
To prevent companies from hiding costs until later years
What is the effective rate of interest in the example above?
10.68%
How is the loan liability at the end of year 1 calculated in the example above?
£990,000 + £105,730 - £100,000
What is the fair cost expense for the year ended 30 September 2016 in the Dun plc example?
£1.95m
What should be included in the loan liability at the end of the year?
The unpaid fair finance cost and any accrued interest
When should allowances be created for non-significant balances?
When indicators of non-payment have occurred before the year end
Study Notes
Arrangement Fees
- For other assets, transaction costs should be added
- For other liabilities, transaction costs should be deducted (report at net proceeds)
- Example: Smith Ltd receives a loan of £80 with an arrangement fee of £5, so the loan liability would be £75 (£80 - £5)
Recording of Financial Instruments
- Revalue financial instruments if the main aim is to make a capital gain from it
- Do not revalue if the main aim is to receive interest and get the principal back
- Examples:
- Buying shares in Next plc: revalue to make a capital gain
- Giving a £10m loan: do not revalue, just receive interest and get the principal back
- Receiving a £30m loan: do not revalue, just receive interest and get the principal back
Financial Assets
- Debt Instruments:
- Reported at amortised cost if they meet the business model test and cash flow characteristic test
- Otherwise, reported at Fair Value through Profit or Loss (FVTPL)
- Business model test: hold the financial asset to collect contractual cash flows
- Cash flow characteristic test: solely give rise to receipts of principal and interest
- Fair value option: designate any debt instrument as FVTPL to reduce measurement or recognition inconsistency
Financial Liabilities
- Held for trading liabilities: reported at FVTPL
- Other financial liabilities: reported at amortised cost
- Fair value option: designate any debt instrument as FVTPL to reduce measurement or recognition inconsistency or to achieve fair value growth
Amortised Cost
- Not related to amortisation (wearing out of an intangible asset)
- For financial instruments, amortised cost means:
- Report a fair finance cost in the Income Statement
- Add any unpaid finance costs at year-end to the Balance Sheet figure
- Examples:
- Smith Ltd receives a £10m loan with a 4-year repayment period
- A company issues £1m of 10% loan stock repayable after five years at a premium of £20,000
Impairments
- Non-significant balances can be tested on a group basis with allowances created only when indicators of non-payment have occurred before the year-end
Learn how to account for arrangement fees when receiving a loan, including how to record transaction costs and revalue the loan in the future.
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