Finance Cost and Liability Calculation

Financial Instruments - IFRS 9 & IFRS 7

Definitions

• A financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.
• A financial asset is a contractual right to receive cash or an equity instrument of another entity.
• A financial liability is a contractual obligation to deliver cash or other financial assets to another entity.
• Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

Examples of Financial Instruments

• Financial Assets: Financial Investments, Cash, Trade Receivables
• Financial Liabilities and Financial Equity: Equity shares, Loans, Bonds, Convertible debentures, Preference shares

Classifying Finance Raised as Equity / Liability

• Long-term finance raised needs to be reported in the Balance Sheet, classified as Liabilities or Equity.
• An instrument is reported as a liability if its substance meets the definition of a liability.
• Repayable preference shares are classified as a Liability, while non-repayable preference shares are classified as Equity.
• A convertible debenture is deemed to be partly a Liability and partly Equity.

Initial Recording of Financial Assets and Liabilities

• Recognition occurs when an entity enters into contractual provisions of the instrument.
• Initially, recognize financial assets and liabilities at fair value, which is normally the amount of consideration paid to buy a financial asset or received for a financial liability.
• If the proceeds/cost of an instrument do not represent their fair value, then the present value of future cash flows related to the item is taken to be its fair value.

Recording of Financial Instruments in Subsequent Years

• If the main aim is to make a capital gain from a financial instrument, it should be revalued.
• If the main aim is not to make a capital gain, but to receive interest and get the principal back, it should not be revalued.

Financial Assets

• Debt Instruments:
  • Reported at amortised cost if they meet both the business model test and the cash flow characteristic test.
  • Reported at FVTPL if they do not meet both tests.
  • A fair value option exists to designate any debt instrument as FVTPL.
• Equity Instruments:
  • Held for trading items are measured at FVTPL.
  • If not held for trading, then either report at FVTPL or irrevocably designate the instrument as an item to be revalued annually with the gain/loss reported in OCI.

Financial Liabilities

• Held for trading liabilities are reported at FVTPL.
• Other financial liabilities are reported at amortised cost.
• A fair value option exists to designate any debt instrument as FVTPL.

Amortised Cost

• A useful figure if a financial instrument is not revalued.
• Report a fair finance cost in the Income Statement for finance raised.
• Add any unpaid finance costs at the end of the year to the figure reported for the piece of finance in the Balance Sheet.

Impairments

• An assessment should be made at each balance sheet date as to whether there is any objective evidence that a financial asset is impaired.
• The new 'expected loss' model takes into account future expected losses when quantifying impairment.
• Financial assets which have had their credit risk rise significantly since initial recognition should report any credit losses expected over the lifetime of the asset.
• Financial assets which have not had an increase in credit risk since initial recognition should only report expected credit losses for the next 12 months.

Financial Instruments - IFRS 9 & IFRS 7

Definitions

• A financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.
• A financial asset is a contractual right to receive cash or an equity instrument of another entity.
• A financial liability is a contractual obligation to deliver cash or other financial assets to another entity.
• Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

Examples of Financial Instruments

• Financial Assets: Financial Investments, Cash, Trade Receivables
• Financial Liabilities and Financial Equity: Equity shares, Loans, Bonds, Convertible debentures, Preference shares

Classifying Finance Raised as Equity / Liability

• Long-term finance raised needs to be reported in the Balance Sheet, classified as Liabilities or Equity.
• An instrument is reported as a liability if its substance meets the definition of a liability.
• Repayable preference shares are classified as a Liability, while non-repayable preference shares are classified as Equity.
• A convertible debenture is deemed to be partly a Liability and partly Equity.

Initial Recording of Financial Assets and Liabilities

• Recognition occurs when an entity enters into contractual provisions of the instrument.
• Initially, recognize financial assets and liabilities at fair value, which is normally the amount of consideration paid to buy a financial asset or received for a financial liability.
• If the proceeds/cost of an instrument do not represent their fair value, then the present value of future cash flows related to the item is taken to be its fair value.

Recording of Financial Instruments in Subsequent Years

• If the main aim is to make a capital gain from a financial instrument, it should be revalued.
• If the main aim is not to make a capital gain, but to receive interest and get the principal back, it should not be revalued.

Financial Assets

• Debt Instruments:
  • Reported at amortised cost if they meet both the business model test and the cash flow characteristic test.
  • Reported at FVTPL if they do not meet both tests.
  • A fair value option exists to designate any debt instrument as FVTPL.
• Equity Instruments:
  • Held for trading items are measured at FVTPL.
  • If not held for trading, then either report at FVTPL or irrevocably designate the instrument as an item to be revalued annually with the gain/loss reported in OCI.

Financial Liabilities

• Held for trading liabilities are reported at FVTPL.
• Other financial liabilities are reported at amortised cost.
• A fair value option exists to designate any debt instrument as FVTPL.

Amortised Cost

• A useful figure if a financial instrument is not revalued.
• Report a fair finance cost in the Income Statement for finance raised.
• Add any unpaid finance costs at the end of the year to the figure reported for the piece of finance in the Balance Sheet.

Impairments

• An assessment should be made at each balance sheet date as to whether there is any objective evidence that a financial asset is impaired.
• The new 'expected loss' model takes into account future expected losses when quantifying impairment.
• Financial assets which have had their credit risk rise significantly since initial recognition should report any credit losses expected over the lifetime of the asset.
• Financial assets which have not had an increase in credit risk since initial recognition should only report expected credit losses for the next 12 months.