There are 3 Accounting Standard on Financial Instruments:
1. IAS 32 Financial Instruments: Presentation which deals with:
a. The classification of Financial Instrument between Equity and Liability
b. Presentation of certain compound instruments.
1. IAS 32 Financial Instruments: Presentation which deals with:
a. The classification of Financial Instrument between Equity and Liability
b. Presentation of certain compound instruments.
2. IFRS 7 Financial
Instruments: Disclosures, which revised, simplified and incorporated
disclosure requirements previously in IAS 32
3. IFRS 9 Financial
Instruments replaces IAS 39 Financial Instrument: Recognition and
measurement. This standard covers:
a. Recognition and Derecognition
b. The measurement of Financial Instrument
c. Impairment
d. General Hedge Accounting
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WHAT ARE KEY DEFINATIONS IN IAS 32?
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Financial
liability: any liability that is:
· a contractual obligation:
· to deliver cash or another financial asset to another entity
· to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity; or
· a contract that will or may be settled in the entity's own equity instruments and is a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity's own equity instruments or
· a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity's own equity instruments.
· For this purpose the entity's own equity instruments do not include: instruments that are themselves contracts for the future receipt or delivery of the entity's own equity instruments;
· puttable instruments classified as equity or certain liabilities arising on liquidation
IAS 32 clearly states that the following items are not Financial Instruments.
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WHAT ARE DERIVATIVES?
A derivative is a financial instrument that derives its value from the price or rate of underlying item.
a) Forward Contracts : agreement to buy or sell an asset at a fixed price at a fixed future date
b) Future Contracts: similar to forward contract except that contracts are standardized and traded on an exchange.
c) Options: rights for option holder to exercise at pre-determined price, the option writer losses out if option is not exercised
d) Swap: agreements to swap one set of cash flow for another
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HOW TO CLASSIFY FINANCIAL ASSET AND LIABILITY?
The Classification of financial Instrument into equity or liability depends on following:
o The substance of Contractual arrangement on initial recognition
o The definations of Financial Liability and equity instrument.
The critical feature of liability is obligation to transfer economic benefit. The Financial Liability exists regardless of the way in which obligation shall be settled. If this feature is not met then it is Equity Instrument.
Ø HOW TO CLASSIFY COMPOUND FINANCIAL INSTRUMENT INTO EQUITY AND LIABILITY?
Some Financial Instruments contain both an equity and liability element. In such cases the component parts of instrument to be classified separately. One of the most common type od compound instrument is convertible debt.
Although there are possible ways of calculating the split, the following method is used
a) Calculate the value for liability component.
b) Deduct this from the instrument as a whole to leave equity component.
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WHAT IS THE TREATMENT OF TREASURY SHARES?
If an entity reacquires its own equity instrument, those instrument i.e treasury shares shall be deducted from equity. No Gain/Loss shall be recognised.
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HOW INTEREST, DIVIDEND, LOSSES AND GAINS SHOULD BE PRESENTED?
a) Interest, Dividend, Losses and Gains relating to Financial Instrument shall be classified as Financial Liability should be recognised as income or expense in P&L.
b) Distributions to the holder of financial instrument classified as an equity instrument should be debited directly to equity by issuer.
c) Transaction Cost of an equity transaction shall be accounted for as deduction in equity.
COMPILED BY
a. Recognition and Derecognition
b. The measurement of Financial Instrument
c. Impairment
d. General Hedge Accounting
Financial asset: any asset that is:
· cash ,
· an equity instrument of another entity,
· a contractual right to receive cash or another financial asset from another entity,
· to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or
· a contract that will or may be settled in the entity's own equity instruments and is:
a non-derivative for which the entity is or may be obliged to receive a variable number of the entity's own equity instruments
· a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity's own equity instruments. For this purpose the entity's own equity instruments do not include instruments that are themselves contracts for the future receipt or delivery of the entity's own equity instruments
· puttable instruments classified as equity or certain liabilities arising on liquidation classified by IAS 32 as equity instruments
· cash ,
· an equity instrument of another entity,
· a contractual right to receive cash or another financial asset from another entity,
· to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or
· a contract that will or may be settled in the entity's own equity instruments and is:
a non-derivative for which the entity is or may be obliged to receive a variable number of the entity's own equity instruments
· a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity's own equity instruments. For this purpose the entity's own equity instruments do not include instruments that are themselves contracts for the future receipt or delivery of the entity's own equity instruments
· puttable instruments classified as equity or certain liabilities arising on liquidation classified by IAS 32 as equity instruments
· a contractual obligation:
· to deliver cash or another financial asset to another entity
· to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity; or
· a contract that will or may be settled in the entity's own equity instruments and is a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity's own equity instruments or
· a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity's own equity instruments.
· For this purpose the entity's own equity instruments do not include: instruments that are themselves contracts for the future receipt or delivery of the entity's own equity instruments;
· puttable instruments classified as equity or certain liabilities arising on liquidation
IAS 32 clearly states that the following items are not Financial Instruments.
a) Physical Assets eg: Inventories, property
,plant and equipment, leased assets and intangible Assets.
b) Prepaid expenses
c) Liabilities or Assets that are not contractual in nature
d) Contractual rights/obligation that do not involve transfer of Financial Assets
b) Prepaid expenses
c) Liabilities or Assets that are not contractual in nature
d) Contractual rights/obligation that do not involve transfer of Financial Assets
A derivative is a financial instrument that derives its value from the price or rate of underlying item.
a) Forward Contracts : agreement to buy or sell an asset at a fixed price at a fixed future date
b) Future Contracts: similar to forward contract except that contracts are standardized and traded on an exchange.
c) Options: rights for option holder to exercise at pre-determined price, the option writer losses out if option is not exercised
d) Swap: agreements to swap one set of cash flow for another
The Classification of financial Instrument into equity or liability depends on following:
o The substance of Contractual arrangement on initial recognition
o The definations of Financial Liability and equity instrument.
The critical feature of liability is obligation to transfer economic benefit. The Financial Liability exists regardless of the way in which obligation shall be settled. If this feature is not met then it is Equity Instrument.
Ø HOW TO CLASSIFY COMPOUND FINANCIAL INSTRUMENT INTO EQUITY AND LIABILITY?
Some Financial Instruments contain both an equity and liability element. In such cases the component parts of instrument to be classified separately. One of the most common type od compound instrument is convertible debt.
Although there are possible ways of calculating the split, the following method is used
a) Calculate the value for liability component.
b) Deduct this from the instrument as a whole to leave equity component.
If an entity reacquires its own equity instrument, those instrument i.e treasury shares shall be deducted from equity. No Gain/Loss shall be recognised.
a) Interest, Dividend, Losses and Gains relating to Financial Instrument shall be classified as Financial Liability should be recognised as income or expense in P&L.
b) Distributions to the holder of financial instrument classified as an equity instrument should be debited directly to equity by issuer.
c) Transaction Cost of an equity transaction shall be accounted for as deduction in equity.
COMPILED BY
CA.HARSIMRAN KAUR
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