Financial Instruments - IFRS 9 & IFRS 7

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 of another entity.
• A financial asset is a contractual right to receive cash.
• A financial liability is a contractual obligation to deliver cash.
• 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 assets: financial investments, cash, trade receivables.
• Examples of 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.
• The liability component is the obligation to make future payments, and the remainder is equity.

Initial Recording of Financial Assets and Liabilities - Day 1 Rules

• For items that will be reported at fair value through profit and loss (FVTPL) in the future, do not include transaction costs.
• For other assets, transaction costs should be added.
• For other liabilities, transaction costs should be deducted (i.e., report at the net proceeds).

Recording of Financial Instruments in Subsequent Years

• If the main aim is to make a capital gain from a financial instrument, revalue it.
• If not, do not revalue the instrument, and report at amortized cost.

Financial Assets

• Debt instruments:
  • Reported at amortized cost if they meet the business model test and the cash flow characteristic test.
  • Otherwise, reported at FVTPL.
• Equity instruments:
  • Held for trading items are measured at FVTPL.
  • If not held for trading, 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 amortized cost.
• A fair value option also exists to designate any debt instrument as FVTPL if it significantly reduces a measurement or recognition inconsistency.

Amortized Cost

• Amortized cost for financial instruments means two things:
  • Report a fair finance cost in the Income Statement for finance raised.
  • Add any unpaid finance costs at the year-end to the figure reported for the piece of finance in the year-end Balance Sheet.

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.

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 of another entity.
• A financial asset is a contractual right to receive cash or another financial asset.
• A financial liability is a contractual obligation to deliver cash or another financial asset.

Classification of Financial Instruments

• Financial assets include financial investments, cash, and trade receivables.
• Financial liabilities and financial equity include equity shares, loans, bonds, convertible debentures, and preference shares.

Classifying Finance Raised as Equity or Liability

• Long-term finance raised should be reported in the Balance Sheet and classified as liabilities or equity.
• An instrument is reported as a liability if its substance meets the definition of a liability.
• Examples:
  • Repayable preference shares are classified as liabilities.
  • Non-repayable preference shares are classified as equity.
  • A convertible debenture is partly a liability and partly equity.

Initial Recording of Financial Assets and Liabilities

• For items reported at fair value through profit and loss (FVTPL), do not include transaction costs.
• For other assets, add transaction costs.
• For other liabilities, deduct transaction costs.

Recording of Financial Instruments in Subsequent Years

• If the main aim is to make a capital gain, revalue the financial instrument.
• If the main aim is not to make a capital gain, do not revalue the financial instrument.
• Examples:
  • Buying shares in another company: revalue.
  • Giving a loan to someone: do not revalue.

Financial Assets

• Debt instruments:
  • Reported at amortised cost if they meet business model and cash flow characteristic tests.
  • Otherwise, reported at FVTPL.
• Equity instruments:
  • Held for trading items: measured at FVTPL.
  • If not held for trading, report at FVTPL or designate as an item to be revalued annually.

Financial Liabilities

• Held for trading liabilities: reported at FVTPL.
• Other financial liabilities: reported at amortised cost.

Amortised Cost

• Means reporting a fair finance cost in the income statement.
• Adding any unpaid finance costs to the figure reported for the piece of finance in the year-end balance sheet.

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.

Financial Instruments

• For other assets, transaction costs should be added, while for other liabilities, transaction costs should be deducted (i.e., report at net proceeds).
• When recording arrangement fees, if the financial instrument is revalued in future, the blue route is used, and if not, the green route is used.

Revaluing Financial Instruments

• A financial instrument should be revalued if its main aim is to make a capital gain from it.
• Examples of revalued financial instruments include shares bought for capital gain.
• Examples of non-revalued financial instruments include loans given or received for interest and capital repayment.

Financial Assets

• Debt instruments are reported at amortised cost if they meet both the business model test and the cash flow characteristic test, otherwise they are reported at FVTPL (Fair Value Through Profit or Loss).
• Business model test: The objective is to hold the financial asset to collect its contractual cash flows.
• Cash flow characteristic test: The terms of the financial asset solely give rise to receipts of principal and interest on the principal.
• A fair value option exists to designate any debt instrument as FVTPL if it significantly reduces a measurement or recognition inconsistency.

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 (Other Comprehensive Income).

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 if it significantly reduces a measurement or recognition inconsistency.

Amortised Cost

• Amortised cost means reporting a fair finance cost in the Income Statement for finance raised.
• It also means adding any unpaid finance costs at a Year-End to the figure reported for the piece of finance in the Year-End Balance Sheet.

Financial Instruments - IFRS 9 & IFRS 7

• A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability.
• A financial asset is a contractual right to receive cash.
• A financial liability is a contractual obligation to deliver cash.
• 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.

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.
• Examples of liabilities include repayable preference shares, convertible debentures, and loans.
• Examples of equity include non-repayable preference shares and ordinary shares.

Ariu plc Annual Report 2016

• Investments at fair value through profit and loss as at 30 Sep 2015: £12,000,000
• Investments at fair value through OCI as at 30 Sep 2015: £5,000,000
• Income from both investments: £2,000,000
• Value of fair value through profit and loss investment as at 30 Sep 2016: £15,000,000
• Value of fair value through OCI investment as at 30 Sep 2016: £9,000,000

Zap Ltd Convertible Bonds

• Issuance of convertible bonds: 1st January 2020, £50,000,000 at par
• Repayment terms: 3 years, at par, or convertible to 75,000,000 equity shares
• Interest rate: 6% per annum, payable annually in arrears
• Market interest rate for similar non-convertible bonds: 9% per annum

Price plc Annual Report 2016

• 6% redeemable preference shares as at 30 Sep 2015: £41,600,000
• Preference dividend paid: £2,400,000
• Effective finance cost of preference shares: 10% per annum
• Issuance of preference shares: 1 October 2014, £40,000,000 premium payable on redemption

Dun plc Annual Report 2016

• 5% loan note as at 30 Sep 2016: £20,000,000
• Interest paid (6 months): £500,000
• Administrative expenses: £34,200,000
• Direct costs of loan note issuance: £500,000, charged to administrative expenses
• Effective finance cost of loan note: 10% per annum
• Redemption terms: 30 Sep 2018, at a large premium

Tide plc Annual Report 2016

• Loan interest paid: £1,000,000
• 2% loan note as at 30 Sep 2016: £50,000,000
• Effective rate of interest on loan: 5.5% per annum
• Issuance of loan note: 1 October 2015, redeemable on 30 Sep 2020 at a large premium

Lam plc Annual Report 2016

• Loan interest paid: £800,000
• 2% loan note as at 30 Sep 2016: £80,000,000
• Effective rate of interest on loan: 6% per annum
• Issuance of loan note: 1 April 2016, redeemable in 2018 at a large premium

Loan and Preference Shares Extracts

• Price plc's 6% redeemable preference shares were issued on 1 October 2014 for £40 million with an effective finance cost of 10% per annum due to a premium payable on redemption.
• As at 30 September 2016, the preference shares have a carrying value of £41,600,000.
• The finance cost for the year ending 30 September 2016 is £4,160,000 (10% of £41,600,000).
• The carrying value of the preference shares as at 30 September 2016 includes a liability of £1,760,000 in addition to the initial £41,600,000.

Price plc Trial Balance Extract

• Preference dividend paid during the year is £2,400,000.

Lam plc Loan Extract

• The 2% loan note was issued on 1 April 2016 with a large premium on redemption in 2018.
• The effective rate of interest on the loan is 6% per annum.
• The cost paid in cash during the year is £800,000 (2% x 80,000,000 x 6/12).
• A liability of £1,600,000 is outstanding at the year-end (not yet paid).

Tide plc Loan Extract

• The 2% loan note was issued on 1 October 2015 with a large premium on redemption on 30 September 2020.
• The effective rate of interest on the loan is 5.5% per annum.
• Loan interest paid during the year is £1,000,000.

Dun plc Loan Extract

• The 5% loan note was issued on 1 October 2015 for £20,000,000 with direct costs of £500,000 charged to administrative expenses.
• The effective finance cost of the loan note is 10% per annum.
• The loan note will be redeemed on 30 September 2018 at a large premium.
• Interest paid during the year is £500,000 (6 months).

Lam plc

• Loan note was issued on 1 April 2016 with a large premium on redemption in 2018.
• Effective rate of interest on the loan is 6% per annum.
• Loan interest paid during the year: £800,000.
• Loan note amount: £80,000,000.
• Cost paid in cash during the year: £0.8 million (2% x 80m x 6/12).
• Liability not yet paid at year-end: £1.6 million.

Price plc

• 6% redeemable preference shares were issued on 1 October 2014 for £40,000,000.
• Effective finance cost of preference shares: 10% per annum.
• Preference dividend paid: £2,400,000.
• Preference shares at 30 September 2015: £41,600,000.
• Finance cost for year end 30 September 2016: £4,160,000 (10% x 41.6m).
• Non-current liability: £43,360,000 (41.6m + 1.76m).

Dun plc

• 5% loan note was issued on 1 October 2015 for £20,000,000.
• Direct costs of issue: £500,000 (charged to administrative expenses).
• Effective finance cost of loan note: 10% per annum.
• Loan note will be redeemed on 30 September 2018 at a large premium.
• Interest paid (6 months): £500,000.

Tide plc

• Loan note was issued on 1 October 2015 with a large premium on redemption.
• Effective rate of interest on the loan: 5.5% per annum.
• Loan interest paid: £1,000,000.
• Loan note amount: £50,000,000.

Lam plc

• Loan note was issued on 1 April 2016 with a large premium on redemption in 2018.
• Effective rate of interest on the loan is 6% per annum.
• Loan interest paid during the year: £800,000.
• Loan note amount: £80,000,000.
• Cost paid in cash during the year: £0.8 million (2% x 80m x 6/12).
• Liability not yet paid at year-end: £1.6 million.

Price plc

• 6% redeemable preference shares were issued on 1 October 2014 for £40,000,000.
• Effective finance cost of preference shares: 10% per annum.
• Preference dividend paid: £2,400,000.
• Preference shares at 30 September 2015: £41,600,000.
• Finance cost for year end 30 September 2016: £4,160,000 (10% x 41.6m).
• Non-current liability: £43,360,000 (41.6m + 1.76m).

Dun plc

• 5% loan note was issued on 1 October 2015 for £20,000,000.
• Direct costs of issue: £500,000 (charged to administrative expenses).
• Effective finance cost of loan note: 10% per annum.
• Loan note will be redeemed on 30 September 2018 at a large premium.
• Interest paid (6 months): £500,000.

Tide plc

• Loan note was issued on 1 October 2015 with a large premium on redemption.
• Effective rate of interest on the loan: 5.5% per annum.
• Loan interest paid: £1,000,000.
• Loan note amount: £50,000,000.

Loan Details

• As at 30 September 2016, the trial balance shows a 2% loan with a balance of £50,000.
• The loan was issued on 1 October 2015.
• The loan is redeemable on 30 September 2020 at a large premium.
• The effective rate of interest on the loan is 5.5% per annum.

Interest Paid

• Loan interest paid during the year ending 30 September 2016 was £1,000.

Loan Terms

• The loan has an annual interest payable that is lower than the effective rate of interest.
• The large premium on redemption is to compensate for the low annual interest payable.

Loan Details

• As at 30 September 2016, the trial balance shows a 2% loan with a balance of £50,000.
• The loan was issued on 1 October 2015.
• The loan is redeemable on 30 September 2020 at a large premium.
• The effective rate of interest on the loan is 5.5% per annum.

Interest Paid

• Loan interest paid during the year ending 30 September 2016 was £1,000.

Loan Terms

• The loan has an annual interest payable that is lower than the effective rate of interest.
• The large premium on redemption is to compensate for the low annual interest payable.