FINANCIAL INSTRUMENTS

It is any contract that gives rise to both a financial asset of one entity and a financial liability or equity
instrument of another entity.

Financial asset – any asset that is

a) Cash
b) An equity instrument of another entity
c) A contractual right to receive cash or another financial asset or to exchange financial instrument
with another entity under conditions that are potentially favourable
d) A contract that will or may be settled in the entity’ s own equity instruments and is
I. A non-derivate for which the entity is or may be obliged to receive a variable
number of the entity’ s own equity instruments
II. A derivative that will or may be settled other than by the exchange of the fixed
amount of cash or another financial asset for a fixed number of the entity’ s own
equity instrument .

Examples are trade receivables, investment in equity shares, options

Financial liability – is any liability that is

 A contractual obligation
I. To deliver cash or another financial asset to another entity or
II. To exchange financial instruments with another entity under conditions that are
potentially unfavourable or
 A contract that will or may be settled in the entity’ s own equity instruments and is
I. Non-derivative for which the entity is or may be obliged to deliver a variable number of
the entity’ s own equity instrument or
II. A derivative that will or may be settled other than by exchange of a fixed amount of
cash or another financial asset for a fixed number of the entity’ s own equity
instruments.

Examples are trade payables, debenture loan payables, and redeemable preference shares.

Equity instruments
Any contract that evidences a residual interest in the assets of the entity after deducting all of its
liabilities

Derivative
A financial instrument or any other contract with all 2 of the following characteristics

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 a) Its value changes in response to the change in a specified interest rate, financial instrument
price, commodity price, foreign exchange rate or other variables.
b) It is settled at a future date
c) It requires no initial investment or an initial investment that is smaller than would be required
for other types of contract that would be expected to have a similar response to changes in
market factors.

Derivatives
A derivative is a financial instrument that derives its value from the price or rate of an underlying item.
Examples include:
 Forward contracts- agreements to buy or sell an asset at a fixed price at a fixed future date
 Futures contracts- similar to forward contracts except that contracts are standardized and
traded on an exchange
 Options- rights (but not obligations) for the option holder to exercise at a pre-determined price
 Swaps- agreements to swap one set of cash flows for another (interest rate or currency swaps)

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 IAS 32 FINANCIAL INSTRUMENTS -
PRESENTATION
This standard should be applied in the presentation of all types of Financial Instruments. Certain items
are excluded:

1. Interest in subsidiaries (IAS 27)

2. Interest in associates and joint ventures (IAS 28)
3. Employee benefits (IAS 19)
4. Insurance contracts (IFRS 4)

IAS 32 makes it clear that the following items are not financial instruments:
 Physical assets such as inventories, PPE, leased assets and intangible assets such as patents and
trademarks.
 Prepaid expenses, liabilities or assets that are not contractual in nature.
 Contractual rights or obligations that do not involve transfer of a financial asset, for example, an
operating lease and statutory obligations to remit cash to the tax authorities.

IAS 32 requires the classification of a financial liability or its component parts as a liability or as equity
according to the substance of the contractual arrangement.

Compound instruments / Hybrid Financial Instruments

It is one that has both the liability and an equity component, for example convertible bonds. The value
of a convertible bond consist of a liability component, that is, the bond and an equity component, that
is, the value of the right to convert in due course to equity. The two elements must be separately
recognised in the statement of financial position.

Question 1
Rockbridge Ltd issues 2 000 convertible bonds at the start of 2020. The bonds have a 3 year term and
are issued at par with a face value of $1000 per bond. Interest is payable annually in arrears at a nominal
annual interest rate of 6%. Each bond is convertible at any time up to maturity into 250 common shares.
When the bonds are issued, the prevailing market interest rate for similar debt without conversion
options is 9%. At the issue date, the market price of 1 common share is $3.

Requirement: Split the bond between debt and equity at inception and calculate the finance charge for
each year until conversion or redemption. [6 marks]

Question 2
On 1 October 2020, Bertrand issued $10 million convertible loan notes which carry a nominal interest
(coupon) rate of 5% per annum. The loan notes are redeemable on 30 September 2023 at par for cash or

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can be exchanged for equity shares. A similar loan note, without the conversion option, would have
required Bertrand to pay an interest rate of 8%.

The present value of $1 receivable at the end of each year, based on discount rates of 5% and 8%, can
be taken as:
5% 8%
End of year 1 0·95 0·93
2 0·91 0·86
3 0·86 0·79

Required
How would the convertible loan appear in Bertrand’s statement of financial position on initial
recognition (1 October 2020)?

Preference shares
If preference shares are irredeemable they are classified as equity. If preference shares are redeemable
they are classified as a financial liability.

Interest and Dividends

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

a) Equity dividends declared are reported directly in equity

b) Dividends on redeemable preference shares classified as a liability are an expense in the income
statement.

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 IAS 39 FINANCIAL INSTRUMENTS –
RECOGNITION & MEASUREMENT
Measurement of financial instruments

Initial recognition
An entity should recognise a financial asset or liability in its SFP

1) When and only when it becomes a party to the contractual provisions of the instruments.
2) At cost, that is, the fair value of the consideration given or received for each plus transaction
costs.

De-recognition of financial instruments

Financial instruments should be de-recognised as follows

 Financial assets – when the contractual rights provided by the asset expire or the entity loses
control of the contractual rights that comprise the financial asset.
 Financial liability – 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 the liability and the
amount received or paid for it should be included in the profit and loss for the period.

Subsequent measurement
Under both IAS 39 and IFRS 9 financial assets and financial liabilities are measured either at amortised
cost using the effective interest method or at fair value.

Financial assets
IFRS 9 classifies financial assets into 3 categories

1. Financial assets at fair value through profit and loss (FVTPL).

It meets either the following conditions

 It is classified as held for trading. A financial asset is classified as held for trading if it is one
acquired principally for the purposes of selling it in the near future.
 Part of a portfolio of identified financial assets that are managed together and for that there is
evidence of a recent actual pattern of short-term profit making.

This also includes derivatives unless they are part of a properly designated hedging
arrangement. Debt instruments will be classified to be measured and accounted for
@FVTPL unless they have been correctly designated to be measured at amortised cost.

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 Initial recognition at fair value is normally cost incurred and this will exclude transaction
costs, which are charged to profit or loss as incurred. Re-measurement to fair value
takes place at each reporting date, with any movement in fair value taken to profit or
loss for the year, which effectively incorporates an annual impairment review.

Question 3
Gresham Ltd bought a ten-year bond on 1 August 2020 at a cost of $45 million. The bond carries an
interest coupon of $4 million paid annually in arrears, and its effective yield to maturity was 12% at the
date of purchase.

Gresham Ltd is holding the bond as a speculative investment, expecting its value to increase, and hopes
to sell the bond at a profit in the short to medium term. On 31 July 2021, its reporting date, the fair
value of the bond had declined to $43 million. The interest payment was received as scheduled.
Required
How much should be recognised in profit or loss as a result of the above, and what should be the
carrying value of the bond at the reporting date of 31 July 2021 under IFRS 9 - Financial Instruments?

2. Financial assets at fair value through other comprehensive income (FVTOCI)

This classification applies to equity instruments only and must be designated upon initial recognition. It
will typically apply to equity interests that an entity intends to retain ownership of on a continuing basis.
Initial recognition at fair value would normally include the associated transaction costs of purchase.
The accounting treatment automatically incorporates an impairment review, with any change in fair
value taken to other comprehensive income in the year.

Question 4
Oracle Ltd purchased a loan on 1 January 2020 and classified it as measured at fair value through OCI.

Terms:
Nominal value $50 million
Coupon rate 10%
Term to maturity 3 years
Purchase price $48 million
Effective rate 11.67%

Fair values at each year end to maturity are as follows

31 December 2020 $49.2 million
31 December 2021 $49.5 million
31 December 2022 $50.0 million
Required
Show the double entry for each year to maturity of the bond

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3. Financial assets measured at amortised cost

This classification can apply only to debt instruments and must be designated upon initial recognition.
For the designation to be effective, the financial asset must pass two tests as follows:
 The business model test – to pass this test, the entity must be holding the financial asset to collect
the contractual cash flows associated with that financial asset. If this is not the case, such as the
financial asset being held and then traded to take advantage of changes in fair value, then the test is
failed and the financial asset reverts to FVTPL.
 The cash flow characteristics test – to pass this test, the contractual cash flows collected must
consist solely of payment of interest and capital. If this is not the case, the test is failed and the
financial asset reverts to the classification to be measured at FVTPL.
NB; Convertible bonds would fail this test. While there is a receipt of the interest payable by the bond
issuer, and the bond will be converted into shares or cash at a later date, the cash flows are affected by
the fact that the bond holder has a choice either to receive shares or cash at the time the bond is
redeemed.

Question 5
Berger Plc invested in a bond on 1 April 2020, at a cost of $40 million. The costs of purchase were $2
million. The nominal and maturity value of the bond was $50 million, and the coupon interest rate was
2% annually in arrears. The maturity date was 31 March 2025, giving an effective yield to maturity of
5.775%.
Required
What should be the carrying value of the bond at the reporting date of 31 March 2021 under the
amortised cost method of IFRS 9 Financial Instruments, assuming the interest was paid as scheduled?

Question 6
Carrot Ltd purchased a 6% $50 million bond on 1 August 2020 at a 10% discount to par value. Expenses
of purchase were $500,000. The bond is due for redemption on 31 July 2030 at par. The effective annual
interest rate to maturity is 7.3%. Carrot Ltd intends to hold the bond until its maturity date. At 31 July
2021, the fair market value of the bond was $48 million.
Required
How much should be recognised in Carrot Ltd profit or loss in respect of the above transaction for year
ended 31 July 2021 (to two decimal places)?

Question 7
IFRS 9 - Financial Instruments sets out the principles and rules for the appropriate accounting treatment
of most financial instruments. In particular, it deals with loans between entities, both from the
perspective of the lender and the borrower.

Tamsin Plc invests in bonds. Sometimes, it trades these bonds by flipping them quickly for profit. Others
are held for the long term.

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Details of two particular bonds purchased on 1 August 2018 are as follows:
‘Athy’ ‘Rathangan’
Nominal value of bond $45 million $30 million
Coupon interest rate 4% 5%
Purchase price of bond $38.5 million $28 million
Effective yield to maturity 6.75% 7.8%

The ‘Athy’ bond was purchased with a view to holding it for the long term, drawing the interest and
principal as it becomes payable.

The ’Rathangan’ bond was bought at a deep discount, and the aim is to wait until the market value
increases, and then sell it on at a profit. At 31 July 2019, the ‘Rathangan’ bond had a fair value of $27.5
million.

In both cases, the coupon is payable on 31 July each year, and has been paid as promised.
Requirement:
(a) Discuss the accounting treatment required by IFRS 9 for recognition and measurement of financial
assets such as bonds, paying particular attention to the tests required to decide between alternative
treatments. (10 marks)
(b) In the case of each bond above, outline the accounting treatment required by IFRS 9 for year ended
31 July 2019. Show all workings clearly. (10 marks)

Question 8
On 2 January 2012, a company bought $1 million par value municipal 8% bonds for $924 184 (when the
market interest rate was 10%). The related transaction cost was $10 000. The bonds mature at par on 31
December 2016, and interest is paid annually in arrears. The bonds were initially classified as held to
maturity investments. The effective interest rate is 9,724% per annum throughout the life of the
financial asset.
Requirement

a) Draw up an amortisation table to record the movement of the municipal bonds to redemption
starting with the opening balance of $934 184 (i.e. $924 184 + $10 000). Round up to the nearest
dollar.

(Use formula opening balance + interest – coupon receipt)

b) Draw up the yearly journal entries from the purchase of the bond to the redemption

Credit impairment of financial assets

For financial assets designated to be measured at amortised cost, an entity must make an assessment at
each reporting date whether there is evidence of possible impairment. The recoverable amount would
normally be based upon the present value of the expected future cash flows estimated at the date of

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the impairment review and discounted to their present value based on the original effective rate of
return at the date the financial asset was issued.
IFRS 9 gives the following examples of indications that a financial asset may be impaired:
 Significant financial difficulty of the issuer
 A breach of contract, such as a default in interest or principal payments
 The lender granting a concession to the borrower that the lender would not otherwise consider, for
reasons relating to the borrower’s financial difficulty
 It becomes probable that the borrower will enter bankruptcy
 The disappearance of an active market for that financial asset or financial difficulties

Financial Liabilities
They can be classified into 2 categories, that is:
1) Financial liabilities at fair value through profit and loss

These are financial liabilities held for trading purposes and also derivatives that are not part of a hedging
arrangement. These are carried at fair value with gains and losses to the profit and loss.

2) Financial liability at amortised cost

These are financial liabilities which are not for trading and are carried at amortised cost using the
effective interest method.

Question 9
The effective interest rate method is a way of allocating the finance costs associated with a financial
liability to appropriate accounting periods. It seeks to charge each accounting period with an
appropriate portion of these costs based on applying a constant percentage rate to the outstanding
balance at any given time. This method is required by IFRS 9 Financial Instruments to account for
financial instruments held at amortised cost. It is believed that this method results in a fairer distribution
of finance cost than alternative methods such as straight line and sum of the digits.

On 1 April 2020, Robby plc issued a bond with the following terms:
 The bond had a par value of $100 million.
 The bond has a coupon interest rate of 5% and is payable annually in arrears.
 The term of the bond is 4 years.
 The bond is redeemable on 31 March 2024 at a premium of 6%.
 The issue price of the bond was $96 million.
 Costs associated with issuing the bond were $2 million.

The effective interest rate has been calculated at 8.146%. Present value interest factors at 8.146% are as
follows:
 1 year 0.9247
 2 years 0.8550

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 3 years 0.7906
 4 years 0.7311

REQUIREMENT:
In the case of the bond referred to above, calculate the finance costs over its lifetime. Show the amount
of this cost that would be allocated to each accounting period under the effective interest rate method.
Assume the accounting period ends on 31 March each year. (10 marks)

Question 10
Dell Ltd issued a bond with a nominal value of $1 000 000 at a coupon rate of 10% on 1 January 2012.
The bond interest payments at the coupon rate are paid annually in arrears. The bond was issued at fair
value of $1 000 000 but transaction costs associated with the bond amounted to $15 000. The bond will
be redeemed on 31 December 2014 at 105% of par value. The effective interest rate is 12, 1059%.
Requirement
In accordance with IFRS 9, Financial Instruments, Recognition & Measurement
a) Starting with the net proceeds of the bond issue as the opening balance, prepare an amortization
table to record the movement of the bond liability from the issue date to the date of redemption.
Ignore cents. [5]
b) Prepare journal entries with brief narrations to record the bond issue on 1 January 2012 [2]
c) Prepare the journal entry with a brief narration to record the interest cost, the capital portion and
the instalment paid as at 31 December 2012 [1 ½ ]
d) Prepare the journal entry with a brief narration to record the interest cost, the capital portion and
the instalment paid as at 31 December 2013 [1 ½ ]
e) Prepare the journal entry with a brief narration to record the interest cost, the capital portion and
the instalment paid as at 31 December 2014 [1 ½ ]
f) Prepare the journal entry with a brief narration to record the bond pay back to the holders at the
premium at 31 December 2012 [1 ]

NB: If the interest rate is not given then it can be calculated as follows:
a) Calculate the interest rate using the formula:
n
Interest rate = Redemption value
Issue value

Question 11
Galaxy Ltd issues a bond for $503 778 on 1 January 2013. No interest is payable on the bond but it will
be held for maturity and redeemed on 31 December 2015 for $600 000. The bond has not been
designated as at fair value through profit and loss.
Requirement
Calculate the charge to the profit and loss of Galaxy Ltd for the year ended 31 December 2013 and the
balance outstanding at 31 December 2013

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Hedging
Hedging is taking action to minimise risk and is allowed in certain strictly defined circumstances.
IAS 39 requires hedge accounting where there is a designated hedging relationship between a hedging
instrument and a hedged item. It is prohibited otherwise.
Entities hedge to reduce their exposure to risk and uncertainty, such as changes in prices, interest rates
or foreign exchange rates. Hedge accounting recognises hedging relationships by allowing (for example)
losses on a hedged item to be offset against gains on a hedging instrument.

Conditions for hedge accounting

Before a hedging relationship qualifies for hedge accounting, all of the following conditions must be
met.
1. The hedging relationship must be designated at its inception as a hedge based on the entity's risk
management objective and strategy. There must be formal documentation (including identification
of the hedged item, the hedging instrument, the nature of the risk that is to be hedged and how the
entity will assess the hedging instrument's effectiveness in offsetting the exposure to changes in the
hedged item's fair value or cash flows attributable to the hedged risk).
2. The hedge is expected to be highly effective in achieving offsetting changes in fair value or cash
flows attributable to the hedged risk. This means that the ratio of the gain or loss on the hedging
instrument compared to the loss or gain on item being hedged is within the ratio 80% to 125%.
(Note. The hedge need not necessarily be fully effective.)
3. For cash flow hedges, a forecast transaction that is the subject of the hedge must be highly
probable and must present an exposure to variations in cash flows that could ultimately affect profit
or loss.
4. The effectiveness of the hedge can be measured reliably.
5. The hedge is assessed on an ongoing basis (annually) and has been effective during the reporting
period.

Accounting treatment for fair value hedges

The gain or loss resulting from re-measuring the hedging instrument at fair value is recognised in profit
or loss.
The gain or loss on the hedged item attributable to the hedged risk should adjust the carrying amount
of the hedged item and be recognised in profit or loss.

Question 12
On 1 July 2016 Jungle acquired 10,000 ounces of a material which it held in its inventory. This cost $200
per ounce, so a total of $2 million. Jungle was concerned that the price of this inventory would fall, so on
1 July 2016 he sold 10,000 ounces in the futures market for $210 per ounce for delivery on 30 June
2017.
On 1 July 2016 the conditions for hedge accounting were all met.
At 31 December 2016, the end of Jungle’s reporting period, the fair value of the inventory was $220 per
ounce while the futures price for 30 June 2017 delivery was $227 per ounce. On 30 June 2017 the trader
sold the inventory and closed out the futures position at the then spot price of $230 per ounce.

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Required
Set out the accounting entries in respect of the above transactions.

Question 13
A company owns 100,000 barrels of crude oil which were purchased on 1 July 2012 at a cost of $26.00
per barrel.
In order to hedge the fluctuation in the market value of the oil the company signs a futures contract on
the same date to deliver 100,000 barrels of oil on 31 March 2013 at a futures price of $27.50 per barrel.
Due to unexpected increased production by OPEC, the market price of oil on 31 December 2012
slumped to $22.50 per barrel and the futures price for delivery on 31 March 2013 was $23.25 per barrel
at that date.
Required
Explain the impact of the transactions on the financial statements of the company for the year ended
31 December 2012.

Question 14
A company owns inventories of 20,000 gallons of oil which cost $400,000 on 1 December 2013.
In order to hedge the fluctuation in the market value of the oil the company signs a futures contract to
deliver 20,000 gallons of oil on 31 March 2014 at the futures price of $22 per gallon.
The market price of oil on 31 December 2013 is $23 per gallon and the futures price for delivery on
31 March 2014 is $24 per gallon.
Required
Explain the impact of the transactions on the financial statements of the company:
(a) Without hedge accounting
(b) With hedge accounting

Accounting treatment for cash flow hedges

The portion of the gain or loss on the hedging instrument that is determined to be an effective hedge
shall be recognised directly in equity through the statement of changes in equity.
The ineffective portion of the gain or loss on the hedging instrument should be recognised in profit or
loss.
When a hedging transaction results in the recognition of an asset or liability, changes in the value of the
hedging instrument recognised in equity either:
a) Are adjusted against the carrying value of the asset or liability, or
b) Affect the profit or loss at the same time as the hedged item (for example, through depreciation or
sale).

Question 15
Bets Co signs a contract on 1 November 2011 to purchase an asset on 1 November 2012 for
€60,000,000. Bets reports in US$ and hedges this transaction by entering into a forward contract to buy
€60,000,000 on 1 November 2012 at US$1: €1.5.
Spot and forward exchange rates at the following dates are:

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 Spot Forward (for delivery on 1.11.2012)
1.11.2011 US$1: €1.45 US$1: €1.5
31.12.2011 US$1: €1.20 US$1: €1.24
1.11.2012 US$1: €1.0 U S$1: €1.0 (actual)
Required
Show the double entries relating to these transactions at 1 November 2011, 31 December 2011 and
1 November 2012.

Question 16
Arundel Limited manufactures television components. Due to a surge in demand for its components
Arundel decided to acquire a new manufacturing plant. On 1 November 2011 an order was placed to the
plant from America for an amount of $250 000. The plant was shipped free on board (FOB) on 1
February 2012. The purchase consideration was settled on 1 March 2012. The functional currency of
Arundel is Tambala (Tmla).

Arundel Limited decided to hedge the transaction from 1 December 2011 to 1 March 2012. The hedging
is against changes in future cash flows of the highly probable forecast transaction as well as the changes
in the fair value of the resulting foreign creditor.

The hedge complies with all the hedging criteria.

The following information is applicable to the foreign exchange transactions.
Date Spot rate $=Tmla FEC rate $1=Tamla FEC period
1 November 2011 7.20 7.50 4 months
1 December 2011 7.27 7.60 3 months
31 December 2011 7.30 7.70 2 months 1 day
1 February 2012 7.32 7.75 1 month
1 March 7.98

Additional information
i. The year-end of Arundel Limited id 31 December.
ii. You can accept the hedge was effective during the financial period during which the hedge was
designated.
iii. It is company policy to remove all associated gain and losses that were accumulated in equity
and include them in the cost price or carrying amount of the non-financial asset resulting from
the hedge of a highly probable forecast transaction.
iv. There are no other items than those mentioned above, that must be taken into account.

Required
Journalise the foreign exchange transaction. Your answer must comply with the requirement of the
internal Financial reporting Standards.
Show the date of each journal, your calculation and these calculations should be rounded off to the
nearest Tmla. Journal narrations are not required. [20]

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Question 17
Mega Ltd entered into a contract on 1 July 2011 to purchase 10,000 shares in Wax Ltd on 31 October
2011 at an agreed price of $200 per share. On 1 July 2011, the market value of the shares in Wax Ltd
amounted to $200 per share. On 31 October 2011, it amounted to $250 per share.
If Mega Ltd were to settle the contract on a gross basis, the entity would buy the actual shares at $200
per share. If the contract were to be settled on a net basis, only the difference between the market price
($250) and the agreed contract price ($200) would be settled in cash or with another financial
instrument, without purchasing the actual shares.
The above contract will be accounted for as a derivative financial instrument, irrespective of whether
the entity uses the gross or net settlement, as the underlying instrument is a financial asset (equity
share in another entity) and cash is exchanged for a financial asset or liability.
Required
Prepare the journal entries to record the above transactions on a gross and net basis on 1 July 2011 and
31 October 2011 in the books of Mega Ltd [4]

Embedded derivatives
An embedded derivative is a derivative instrument that is combined with a non-derivate host contract
to form a single hybrid instrument.
Certain contracts that are not themselves derivatives (and may not be financial instruments) include
derivative contracts that are 'embedded' within them. These non-derivatives are called host contracts.

Possible examples of embedded derivatives

Possible examples include:
1. A term in a lease of retail premises that provides for contingent rentals based on sales: The host'
contract is the lease and the embedded derivative is the element of contingent rentals
2. Construction contract priced in a foreign currency. The construction contract is a non-derivative
contract, but the changes in foreign exchange rate is the embedded derivative.
3. Convertible debt

Accounting treatment of embedded derivatives

Financial asset host contract
Where the host contract is a financial asset within the scope of the standard, the classification and
measurement rules of the standard are applied to the entire hybrid contract. (i.e. accounted for as one
instrument)

Other host contracts

Where the host contract is not a financial asset within the scope of IFRS 9, the standard requires that an
embedded derivative be separated from its host contract and accounted for as a derivative when the
following conditions are met.
a. The economic characteristics and risks of the embedded derivative are not closely related to the
economic characteristics and risks of the host contract.

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b. A separate instrument with the same terms as the embedded derivative would meet the definition
of a derivative.
c. The hybrid (combined) instrument is not measured at fair value with changes in fair value
recognised in the profit or loss (a derivative embedded in a financial liability need not be separated
out if the entity holds the combined instrument at fair value through profit or loss).

Question 18
1. Embedded derivatives synthetic instruments
Entity A issues a five year floating rate debt instrument. At the same time, it enters into a five year
pay-fixed receive-variable interest rate swap with Entity B. Entity A regards the combination of the
debt instrument and swap as a synthetic fixed rate instrument. Entity A contends that separate
accounting for the swap is inappropriate since IAS 39 AG33 (a) requires an embedded derivative to
be classified together with its host instrument if the derivative is linked to an interest rate that can
change the amount of interest that would otherwise be paid or received on the host debt contract.
Decide and comment whether the entity’s analysis is correct? 2 marks

2. Embedded derivatives: purchases and sales contracts in foreign currency instruments

A supply contract provides for payment in a currency other than (a) the functional currency of either
party to the contract (b) the currency in which the product is routinely denominated in commercial
transactions around the world and (c) the currency that is commonly used in contracts to purchase
or sell non-financial items in the economic environment in which the transactions takes place.
Is there an embedded derivative that should be separated under IFRS 9 and illustrate how this this
applied? 3 marks

3. Recognition: cash collateral

Entity B transfers cash to Entity A as collateral for another transaction with Entity A (for example,
securities borrowing transaction). The cash is not legally segregated from Entity A assets.
Should Entity A recognized the cash collateral it has received as an assets?
Should entity A recognize the cash collateral it has received as an asset? 2 marks

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 IFRS 7 FINANCIAL INSTRUMENTS –
DISCLOSURES
IFRS 7 specifies the disclosures required for financial instruments. The standard requires qualitative and
quantitative disclosures about exposure to risks arising from financial instruments and specifies
minimum disclosures about credit risk, liquidity risk and market risk.

The IASB maintains that users of financial instruments need information about an entity’s exposures to
risks and how those risks are managed, as this information can influence a user’s assessment of the
financial position and financial performance of an entity or of the amount, timing and uncertainty of its
future cash flows.

Classes of financial instruments and levels of disclosure

The entity must group financial instruments into classes appropriate to the nature of the information
disclosure. An entity must decide in the light of its circumstance how much detail it provides. Sufficient
information must be provided to permit reconciliation to the line items presented in the statement of
financial position.

Statement of financial position

The following must be disclosed.

a. Carrying amount of financial assets and liabilities by IAS 39 category

b. Reason for any reclassification between fair value and amortised cost (and vice versa)
c. Details of the assets and exposure of risk where the entity has made a transfer such that part or all
of the financial assets do not qualify for de-recognition.
d. The carrying amount of financial assets the entity has pledged as collateral liabilities or contingent
liabilities and the associated terms and conditions.
e. When financial assets are impaired by credit losses and the entity records the impairment in a
separate account (e.g. an allowance account used to record individual impairments or a similar
account used to record a collective impairment of assets) rather than directly reduced the carrying
amount of the asset, it must disclose a reconciliation of changes in that account during the period
for each class of financial assets.
f. The existence of multiple embedded derivatives, where compound instruments contain these.
g. Defaults and breaches

Statement of comprehensive income

The entity must disclose the following items of income, expense, gains or losses, either on the face of
the financial statements or in the notes.

16 Compiled by T T Herbert (0773 038 651 / 0712 560 772)

a. Net gains/losses by IFRS 9 category (broken down as appropriate: e.g. interest, fair value changes,
dividend income)
b. Interest income/expense
c. Impairments losses by class of financial asset

Other disclosures
Entities must disclose in the summary of significant accounting policies the measurement basis used in
preparing the financial statements and other accounting policies that are relevant to an understanding
of the financial statements.

Hedge accounting
Disclosures must be made relating hedge accounting, as follows:

a. Description of hedge
b. Description of financial instruments designated as hedging instruments and their fair value at the
reporting date
c. The nature of the risks being hedges periods when the cash flows will occurs and when will affect
profit or loss
d. For fair value hedges, gains or losses on the hedging instrument and the hedged item.
e. The ineffectiveness recognised in profit or loss arising from cash flow hedge and net investments in
foreign operations.

Fair value
IFRS 7 retains the following general requirements in relation to the disclosure of fair value for these
financial instruments measured at amortised cost:

a. For each class of financial assets and financial liabilities an entity should disclose the fair value of
that class of assets and liabilities in a way that permits it to be compared with its carrying amount.
b. In disclosing fair values, an entity should group financial liabilities into classes, but should offset
them only to the extent that their carrying amounts are offset in the statement of financial
position.
It also states that disclosure of fair value is not required where:

 Carrying amount is a reasonable approximation of fair value

 For investments in equity instruments that do not have a quoted market price in an active market
for an identical instrument, or derivatives linked to such equity instruments.

17 Compiled by T T Herbert (0773 038 651 / 0712 560 772)