IAS 32 and

IFRS 7 & 9
Financial Instruments
08
INTRODUCTION |1

RELEVANT DOCUMENTS
IAS 32 Financial Instruments: Presentation (Definition and Compound FI)
IFRS 7 Financial Instruments: Disclosures
IFRS 9 Financial Instruments (Classification, Recognition and Measurement)
DEFINITIONS
is any contract that gives rise to
Financial
 a financial asset of one entity; and
instruments
 a financial liability or equity instrument of another entity.
is any asset that is:
 cash e.g. cash in hand or at bank
 an equity instrument of another entity e.g. investment in shares or share
options
 a contractual right to receive cash (or another financial asset) e.g.
receivables, investment in loan
Financial
 a contractual right to exchange financial instruments under conditions
asset
that are potentially favourable e.g. favourable forward contract entered
into by a bank
 a non-derivative contract for which the entity is or may be obliged to
receive a variable number of the entity’s own equity instruments e.g. a
contract with customer to receive our own shares/options (variable
number) worth Rs. 50,000 (amount fixed)
is any liability that is:
 a contractual obligation to deliver cash (or another financial asset) e.g.
payables
 a contractual obligation to exchange financial instruments under
Financial conditions that are potentially unfavourable e.g. unfavourable forward
liability contract entered into by a bank
 a non-derivative contract for which the entity is or may be obliged to
deliver a variable number of the entity’s own equity instruments e.g. a
contract with supplier to deliver our own shares/options (variable
number) worth Rs. 50,000 (amount fixed)
is any contract that evidences a residual interest in the assets of an entity
Equity
after deducting all of its liabilities e.g. equity shares & share options issued by
instruments
an entity.
is a financial instrument with all three of the following characteristics:
(a) its value changes in response to the change in a specified interest
rate, financial instrument price, commodity price, foreign exchange
rate, index of prices or rates, credit rating or credit index, or similar
variable (called the ‘underlying’);
Derivative
(b) it requires no or little initial net investment relative to other types of
contracts that would be expected to have a similar response to
changes in market factors; and
(c) it is settled at a future date.
e.g. options, forward contracts, future contracts, swap contracts etc.
 ICMAP S1 AFA&CR

SUBSTANCE
Some financial instruments have the legal form of equity but are, in substance, liabilities. For
example an issuer has a contractual obligation to either deliver cash or another financial
asset e.g. redeemable preference shares
RELATED GAIN OR LOSS
2| Related to Interest, dividends, relating to a financial instrument or a component that is
financial a financial liability shall be recognised as income or expense in profit or
liability loss.
Related to Distributions to holders of an equity instrument shall be debited by the
equity entity directly to equity, net of any related income tax benefit.
Example For example, dividends paid on redeemable preference shares are
recognised in profit or loss as finance costs while dividend paid on ordinary
shares are reported in statement of changes in equity
QUESTION 01
Identify the following items as a financial asset, a non-financial asset, a financial liability, a
non-financial liability or an equity instrument.
ITEMS ANSWER
Creditors
Investment in loan notes of another entity
Bank loan obtained
Ordinary shares issued
Irredeemable preference shares issued
Unfavourable forward currency contract
Share options issued
Redeemable preference shares issued
Investment in redeemable preference shares
Current tax payable
Inventory

COMPOUND FINANCIAL INSTRUMENTS

Compound Some financial instruments, called compound instruments, have both a
instruments liability and an equity element.
In this case, IAS 32 requires the component parts to be separated from
Requirement each other, with each part accounted for and presented separately
according to its substance.
For example, a convertible debenture has two components:
 one is the financial liability, the issuer’s (entity’s) contractual
Example obligation to pay cash (principal and interest);
 the other is an equity instrument, a call option to convert the debt
security into equity shares.
The separation of components is made at the time the instrument is
issued and is not subsequently revised as a result of a change in interest
Timing
rates, share price, or other event that changes the likelihood that the
conversion option will be exercised.
Transaction Transaction costs on compound financial instrument will be allocated on
costs pro-rata basis of initially recognized amounts.

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 Class Notes

QUESTION 02
On 1 January 2011 David Limited issued a Rs.50m three-year convertible bond at par.
There were no issue costs. The coupon rate is 10%, payable annually in arrears on 31
December. The bond is redeemable at par on 1 January 2014. Bondholders may opt for
conversion. The terms of conversion are two 25-cents equity shares for every Rs.1 owed to
each bondholder on 1 January 2014.
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Bonds issued by similar entities without any conversion rights currently bear interest at 15%.

Split the proceeds of bond at inception into liability and equity component.

QUESTION 03
ABC Limited issues a Rs. 10 million 4% three year convertible debenture on 1 January
2011. The market rate of interest for a similar loan without conversion rights is 8%. The
conversion terms are one equity share of Rs. 1 for every Rs. 2 of debenture. Conversion or
redemption at par shall take place on 31 December 2013.

Required:
(a) Split the proceeds as debt and equity elements separately.
(b) Extracts of financial statements for all three years before conversion or redemption
(c) How should this be accounted for on 31 December 2013, if all holders elect for the
conversion?
(d) How should this be accounted for on 31 December 2013, if no holders elect for the
conversion?

CLASSIFICATION
FINANCIAL Investment in equity
Investment in debt instruments
ASSETS instruments
It should pass the following two tests:
 Business Model Test (the intention
is to hold the financial asset to
collect the contractual cash flows i.e.
principal and interest, rather than
At amortised gain or loss from fluctuation in fair
cost value)
 Cash Flow Characteristics Model
Test (cash flows consist of solely
interest and principal and timing and
amount of cash flows is reliably
measureable.)
1. It must not be held It should pass the following two tests:
for trading.  Business Model Test (the intention
Fair value 2. There must be an is both collecting contractual cash
through other irrevocable choice flows and selling financial asset)
comprehensive for this  Cash Flow Characteristics Model
income classification upon Test (cash flows consist of solely
(FVTOCI) initial recognition. interest and principal and timing and
amount of cash flows is reliably
measureable.)
Fair value 1. It can be debt or/and equity instrument of another entity
through profit 2. Usually held for trading items are classified here including stand-
or loss alone derivatives.
(FVTPL) 3. Default residual category.

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FINANCIAL LIABILITIES
Fair value through profit Liabilities held for trading (usually by banks and finance
or loss companies)
At amortised cost All other liabilities
QUESTION 04
4| Identify the most likely classification of following items:
ITEMS ANSWER
FINANCIAL ASSETS
Investments held for trading purposes.
Investment in interest bearing debt instruments. The
instrument is redeemable in five years. The intention is to
collect cash flows (which are interest and principal amounts
only)
Investment in interest bearing debt instruments. The
instrument is redeemable in five years. The intention is to
collect cash flows (which are interest and principal amounts
only). However, the entity may sell the loan notes earlier if any
good offer is received.
A trade receivable
Derivatives held for speculation purpose
Investment in equity shares. The entity has no intention of
selling these shares in foreseeable future.
Investment in loan notes. The objective is to collect contractual
cash flows which consist of interest, changes in oil prices in
next five years and principal amount at the end of year 5.
Investment in loan notes. The objective is to collect contractual
cash flows which consist of interest, changes in oil prices in
next five years and principal amount at the end of year 5.
However, the entity may sell the loan notes earlier if any good
offer is received.
Investment in convertible debentures
FINANCIAL LIBILITIES
A 12% bank loan obtained by A Limited payable in 5 years’
time.
8% loan notes issued by C Limited
A short term currency swaps agreement entered into by B4-
Bank Limited which is currently unfavourable. These types of
transactions are usual feature of B4-Bank Limited’s business.
Trade payable

RECLASSIFICATION
IFRS 9 requires that when an entity changes its business model for managing
financial assets, it should reclassify all affected financial assets. This
reclassification applies only to debt instruments.
When?
For example, a bank decides to shut down its retail mortgage business. That
business no longer accepts new business and the bank is actively marketing its
mortgage loan portfolio for sale.
Reclassification is not permitted in the following circumstances, because
change in the business model has not taken place:
Not  A change in intention related to particular financial assets
permitted  A temporary disappearance of particular market for financial assets
 A transfer to financial assets between parts of the entity with different
business models.
Reclassification of financial liabilities is not allowed in any situation.

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 Class Notes

MEASUREMENT
FINANCIAL ASSETS
Initial Subsequent Disposal
Category Changes
measurement measurement gain/ loss
FVTPL Fair value Fair value Change in FV  PL Profit or loss
FVTOCI Fair value + |5
Fair value Change in FV  OCI Profit or loss
(Equity) transaction costs
First, include effective
FVTOCI Fair value + Effective Interest  PL
interest Profit or loss
(Debt) transaction costs Change in FV  OCI
Secondly, Change to FV
Amortised Fair value +
Amortised cost Effective Interest  PL Profit or loss
cost transaction costs

FINANCIAL LIABILITIES
Initial Subsequent Disposal
Category Changes
measurement measurement gain/ loss
FVTPL Fair value Fair value Profit or loss Profit or loss
Amortised Fair value -
Amortised cost Profit or loss Profit or loss
cost transaction costs

ADDITIONAL POINTS
Amortised Amortised cost is present value of future cash flows using effective interest
cost rate.
FVTOCI The dividends received are recognised in profit or loss. On disposal, the
amount in equity may be transferred to retained earnings.
Transaction Transaction costs are incremental costs that are directly attributable to the
costs acquisition, issue or disposal of a financial asset or financial liability.
Transaction costs are expensed in case of FVTPL.
Interest Cash = par value x coupon rate
PL = Outstanding balance x effective rate
QUESTION 05
Goal plc invested in a debt instrument with a nominal value of Rs.10,000. The instrument is
redeemable in two years at a premium of Rs.2,100 and has been classified as ‘at amortised
cost’. The coupon rate is 0% while the effective interest rate is 10%.

Required:
How will this be reported in the financial statements of Goal plc over the period to
redemption?

QUESTION 06
Ball plc invested in a debt instrument with a nominal value of Rs.10,000. The instrument is
redeemable in two years at a premium of Rs.1,680 and has been classified as ‘at amortised
cost’. The coupon rate is 2% while the effective interest rate is 10%.

Required:
How will this be reported in the financial statements of Ball plc over the period to
redemption?

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QUESTION 07
On 1 January 2011, Jack plc issued a deep discount bond with a Rs.50,000 nominal value.
The discount rate was 16% of nominal value, and the costs of issue were Rs.2,000.

Interest of 5% nominal value is payable annually in arrears.

6| The bond must be redeemed on 1 January 2016 (after 5 years) at a premium of Rs.4,611.

The effective rate of interest is 12% p.a.

Required:
How will this be reported in the financial statements of Jack plc over the period to
redemption?

QUESTION 08
On January 01, 2011, XYZ Limited invested Rs. 100 (fair value at that date) in equity shares
of another company. XYZ Limited also incurred transaction costs of Rs. 2.

On June 30, 2011 (year end) the fair value of the investments is Rs. 120.

On August 31, 2011 XYZ Limited disposed off the investment for Rs. 150.

Required:
(a) Pass the journal entries if the investment is classified as FVTPL.
(b) Pass the journal entries if the investment is classified as FVTOCI.

QUESTION 09 SBR
On 1st January 20X1, Tokyo bought a Rs.100,000, 5% bond for Rs.95,000, incurring issue
costs of Rs.2,000. Interest is received in arrears. The bond will be redeemed at a premium of
Rs.5,960 over nominal value on 31 December 20X3. The effective rate of interest is 8%.

The fair value of the bond was as follows:

31/12/X1 Rs.110,000
31/12/X2 Rs.104,000

Required:
Explain, with calculation, how the bond will have been accounted for over all relevant years
if:
(a) Tokyo’s business model is to hold bonds until the redemption date
(b) Tokyo’s business model is to hold bonds until redemption but also to sell them if
investments with higher returns become available.
(c) Tokyo’s business model is to trade bonds in the short term. Assume that Tokyo sold
this bond for its fair value on 1 January 20X2

QUESTION 10 PE 501 Nov 2009 4a

The details of investment extracted from the books of Finance Limited for the year ended
June 30, 2009 show the following:
Date of Qty Cost Market Date of
Purchase Price Maturity
(Rs.000) (Rs.000)
Shares in Alpha Limited 1-Oct-08 18,000 441 576 N/A
Shares in Beta Limited 1-Nov-08 24,500 1,960 1,911 N/A
14% Debentures in Gamma Ltd
1-Jul-08 1,800 9,090 9,360 30-Jun-11
(face value - Rs.5,000)
16% Debentures in Theta Ltd
1-Jan-09 650 3,185 N/A 31-Dec-11
(face value - Rs.5,000)

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The company is aware of the fact that it needs to apply IFRSs on the above investments.
However, due to inadequate knowledge of the requirements of the Standard, the accountant
has approached you for an advice.

He informs you that the investment made in the shares of Alpha Limited was with the
intention of making short-term gain in expectation of upward momentum in stock market |7
activity, whereas the shares in Beta Limited are high dividend-yielding and the company
intends to hold it for the long-term.

The debentures in Gamma Limited were also acquired with the intention of short-term profit
making. However, the company later changed its intention and now wishes to hold it till
maturity. The debentures in Theta Limited are acquired with a firm intention to hold these till
maturity. Both these debentures are to be redeemed at their face values. The coupon
payments are made on yearly basis on June 30 and December 31. The original effective rate
of interest on debentures of Gamma Limited is 13.58% while on debentures of Theta Limited
is 16.91%.

Required:
(i) Advise the accountant about the classification of above investments in the books of
the company in accordance with the IFRSs along with reasons. (04)
(ii) State the amount at which each of the above investments will be carried in the
statement of financial position as at June 30, 2009 (definitions of various categories
of financial assets as per IFRSs are not required). Also calculate the impact to be
reflected in the 'statement of profit or loss' or 'other comprehensive income' for the
year ended June 30, 2009. (06)

QUESTION 11 PE 501 Dec 2010 4c

Mr. Investor has a portfolio of diversified investments. In 2008, he made investments in two
financial assets:
(i) Rs.550,000 were invested in .fair-value-through profit and loss. investment that also
incurred a transaction cost of Rs.5,000. At the end of 2008, value of the investment
increased to Rs.600,000. In 2009, he sold the investment for Rs.625,000.
(ii) Second investment was bought for Rs.775,000 and was classified as fair value
through other comprehensive income. Transaction cost was Rs.6,000. Its value
increased to Rs.790,000 at the end of 2008. It was also sold for Rs.915,000 in 2009.

Required:
How above financial assets would have been accounted for in the financial statements of
2008 and 2009. (11)

QUESTION 12 PE 501 Jun 2011 3c

On January 01, 2011 .A. Company issued 5% loan notes with a nominal value of
Rs.1,000,000. Loan notes were issued at a discount of 22.5% and are payable after three
years at par on December 31, 2013. Effective rate of interest is 16.16%. Issue costs were
Rs.25,000.

Required:
(i) What amount will be recorded in the Statement of Financial Position as financial
liability at the time of issue of the notes? (02)
(ii) Calculate finance costs to be charged to income statement for the year ended
December 31, 2011 to 2013. (03)
(iii) What would be the amounts of financial liability, which will be shown in the Statement
of Financial Position as at December 31, 2011 to 2013? (03)

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QUESTION 13 PE 501 Nov 2011 4c

Ammar Company issued two debt instruments on January 01, 2011 with nominal value of
Rs.25,000 each and redeemable in three years on January 01, 2014. Effective rate of
interest is 15%.
 Debt 1 has coupon rate of 1%. It was issued at par and is to be redeemed at a
premium of Rs.12,154.
8|  Debt 2 has also a coupon rate of 1%. It was issued at discount of Rs.7,991 and is to
be redeemed at par.

Required:
(i) At what amounts will they be recorded initially? (02)
(ii) What amounts of interest will be charged to the income statement for the three years
in respect of each financial liability? (03)
(iii) What amount will be recognised in the statement of financial position at the end of
year 2011 to 2013 in respect of each financial liability? (03)

QUESTION 14 IFRS 9 PE Mod 2013 Q4a

In July 2010 DNA investment issued 3-year 10% TFCs for Rs.25 million. At the date of
issuance of loan effective rate of interest was also 10%. The loan notes were redeemable at
par and the liability is held for trading purposes and classified at fair value through profit and
loss. DNA investment incurred transaction cost of Rs 500,000 to issue loan notes. Market
interest rates at year end were as follows:
Year end Rate
At June 30, 2011 11%
At June 30, 2012 12%

Required:
As per IFRS 9, calculate the amount:
(i) initially measured in the statement of financial position. (02)
(ii) to be presented in the statement of financial position and statement of profit or loss
for the year ended June 30, 2011 and 2012. (08)

RECOGNITION
An entity shall recognise a financial asset or a financial liability in its statement of financial
position when, and only when, the entity becomes party to the contractual provisions of
the instrument.
Unconditional
receivables or These are recognised when the entity becomes a party to the contract.
payables
Commitments These are not recognised until one party has fulfilled its part of the contract
to sell goods e.g. a sales order will not be recognised as revenue and a receivable until
etc. the goods have been delivered.
Forward Forward contracts are recognised on the commitment date, not on the date
contracts when the item under contract is transferred from seller to buyer.

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DERECOGNITION
A financial asset should be derecognized if one of the following criteria
occurs:
 the contractual rights to the cash flows have expired, e.g. when an
option held by the entity has expired worthless
 the financial asset has been sold in substance (i.e. risk and rewards |9
Financial
transferred), for example if an entity sells an investment in shares and
assets
enters into a total return swap with the buyer, the buyer will return any
increases in value to the entity or the entity will pay the buyer for any
decrease in value. In this case the entity has retained substantially all of
the risks and rewards of the investment, which therefore should not be
derecognized.
A financial liability should be derecognized when, and only when, the obligation
specified in the contract is:
Financial
 Discharged e.g. paid in cash or other consideration
liabilities
 Cancelled e.g. by operation of law
 Expired e.g. by passage of time
On derecognition, the difference between the carrying amount of the asset or
Gain or
liability and the amount received or paid for it should be recognised in the profit
loss
or loss for the period.
QUESTION 15
MES Solutions has entered into the following transactions involving the sale of several of its
financial assets during the last year.
(a) Sale of a financial asset for Rs.20,000. There are no conditions attached to the sale
and no other rights and obligations are retained by MES.
(b) Sale of an investment in shares for Rs.20,000. However, MES retains a call option to
repurchase the shares at any time at the current fair value on the date of the
repurchase of the shares.
(c) Sale of a part of its short term receivables for Rs.200,000. According to the terms of
the sale, it promises to pay Rs.6,000 to compensate the buyer, CCE, for any
defaults on payment. The expected credit losses on this transaction are significantly
lower than Rs.6,000 and there are no significant risks.
(d) MES enters into a total return swap with EMW, the essence of which will return any
increases in the fair value of the shares worth Rs.20,000 sold to MES and
compensate EMW for any decreases in the fair value of the shares.

Required:
State, to what extent derecognition of these assets is appropriate in the financial statements
in each of the above cases.

QUESTION 16
Consider the following cases:
(a) B Limited owes S Limited Rs.25,000. B Limited has set this amount aside in a special
trust that it will not use for any other purpose but to pay S Limited.
(b) AIM Limited pays Object Limited Rs.25,000 in discharge of an earlier obligation.
(c) A put option written by J&J Limited expires.

Required:
In which cases would you, as an accountant, derecognize the above financial liabilities

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DERIVATIVE
is a financial instrument with all three of the following characteristics:
(a) its value changes in response to the change in a specified interest rate, financial
instrument price, commodity price, foreign exchange rate, index of prices or rates,
credit rating or credit index, or similar variable (called the ‘underlying’);
10| (b) it requires no or little initial net investment relative to other types of contracts that
would be expected to have a similar response to changes in market factors; and
(c) it is settled at a future date.

e.g. options, forward contracts, future contracts, swap contracts etc.

The holder of a forward contract is obliged to buy or sell a defined
Forward
amount of a specific underlying asset, at a specified price at a specified
contract
future date.
They give the holder the right but not the obligation, to buy or sell a
Option contract
specific underlying asset on or before a specified future date.
Future contracts oblige the holder to buy or sell a standard quantity of a
Future contract
specific underlying item at a specified future date.
Two parties agree to exchange periodic payments at specified intervals
Swap contract
over a specified time period e.g. interest swap or currency swap.

ACCOUNTING TREATMENT
The gain or loss on derivatives can be far greater than the amount initially invested in
derivatives. In most cases, entering into a derivative is at low or no cost; therefore, traditional
accounting does not recognise any amount. Although it is very important that derivatives are
recognised and disclosed in financial statements as derivatives may expose the entity to
significant gains or losses.
Initial
At FV (transaction costs are not included)
measurement
Subsequent If stand alone derivative, same as FVTPL
measurement If hedging instrument, the hedge accounting applies (see later)
QUESTION 17
Z Limited entered into a call option (not for hedging purposes) on 1 January to purchase
10,000 shares in another entity on 1 November at a price of Rs.10 per share. The cost of
each option is Rs.1. By June 30 (year-end) the fair value of each option has increased to
Rs.1.30
On 1 November the options were exercised and the share price was Rs. 12.5. The
investment in shares is to be classified as FVTPL.
Required:
Show the accounting treatment through journal entries.

EMBEDDED DERIVATIVES
An embedded derivative is a derivative instrument that is combined with a
Definition
non-derivative 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.
Examples include:
Situations (a) investment in convertible debentures (the debentures are host
contract and the conversion option is an embedded derivative)
(b) a construction contract priced in foreign currency (the construction
contract is host contract and effect of change in exchange rates is an
embedded derivative)

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 Class Notes

The host contract (non-financial) and embedded derivatives are separately

treated. The host contract is measured in accordance with relevant IFRS and
Accounting the embedded derivative is measured in the same way as FVTPL.
treatment
However, where the host contract itself is a financial asset, there is no need to
separate and the whole contract is measured as FVTPL.
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HEDGE ACCOUNTING
is a method of managing risk by designating one or more hedging
Hedge
instruments so that their change in fair value is offset, in whole or in part, by
accounting
the change in fair value or cash flows of a hedged item.
A hedged item is an asset or liability that exposes the entity to risks of
changes in fair value or future cash flows (and is designated as being
hedged). There are 3 types of hedged item:
 A recognised asset or liability
Hedged item  An unrecognised firm commitment – a binding agreement for the
exchange of a specified quantity of resources at a specified price on
a specified future date
 A highly probable forecast transaction – an uncommitted but
anticipated future transaction.
A hedging instrument is a designated derivative, or a non-derivative
Hedging financial asset or financial liability, whose fair value or cash flows are
instrument expected to offset changes in fair value or future cash flows of the hedged
item.
'Fair value hedge: a hedge of the exposure to changes in fair value of a
recognised asset or liability or an unrecognised firm commitment that is
attributable to a particular risk and could affect profit or loss (or other
comprehensive income for equity investments measured at fair value
Classification
through other comprehensive income).
of hedging
relationships
Cash flow hedge: a hedge of the exposure to variability in cash flows that
is attributable to a particular risk associated with a recognised asset or
liability or a highly probable forecast transaction and that could affect profit
or loss'
Under IFRS 9, hedge accounting rules can only be applied if the hedging
relationship meets the following criteria:
 The hedging relationship consists only of eligible hedging
Conditions instruments and hedged items.
 At the inception of the hedge there must be formal documentation
identifying the hedged item and the hedging instrument.
 The hedging relationship meets all effectiveness requirements
QUESTION 18
ABC Co has entered into a hedging relationship. The entity assesses the fair value of the
hedged item and hedging instrument at the year end and the gain and losses arise as
follows:
Hedged item – loss of Rs.1,800
Hedging instrument – gain of Rs.1,500

Required:
Calculate the effectiveness of the hedge

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FAIR VALUE HEDGE – ACCOUNTING TREATMENT

At the reporting date:
 The hedging instrument will be remeasured to fair value.
 The carrying amount of the hedged item will be adjusted for the change in fair value
since the inception of the hedge.

12| The gain (or loss) on the hedging instrument and the loss (or gain) on the hedged item will
be recorded:
 in profit or loss in most cases, but
 in other comprehensive income if the hedged item is an investment in equity that is
measured at fair value through other comprehensive income.

QUESTION 19 SBR
An entity has inventories of gold that cost $8m but whose value has increased to $10m. The
entity is worried that the fair value of this inventory will fall, so it enters into a futures contract
on 1 October 20X1 to sell the inventory for $10m in 6 months' time. This was designated as
a fair value hedge.

By the reporting date of 31 December 20X1, the fair value of the inventory had fallen from
$10m to $9m. There was a $1m increase in the fair value of the derivative.

The entity believes that all effectiveness criteria have been met.

Required:
Discuss the accounting treatment.

QUESTION 20 SBR
On 1 January 20X8 an entity purchased equity instruments for their fair value of $900,000.
They were designated upon initial recognition to be classified as fair value through other
comprehensive income.

At 30 September 20X8, the equity instrument was still worth $900,000 but the entity became
worried about the risk of a decline in value. It therefore entered into a futures contract to sell
the shares for $900,000 in six months' time. It identified the futures contract as a hedging
instrument as part of a fair value hedging arrangement. The fair value hedge was correctly
documented and designated upon initial recognition. All effectiveness criteria have been
complied with.

By the reporting date of 31 December 20X8, the fair value of the equity instrument had fallen
to $800,000, and the fair value of the futures contract had risen by $90,000.

Required:
Explain the accounting treatment of the fair value hedge arrangement based upon the
available information.

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QUESTION 21 SBR
Chive has a firm commitment to buy an item of machinery for CU2m on 31 March 20X2. The
Directors are worried about the risk of exchange rate fluctuations.

On 1 October 20X1, when the exchange rate is CU2:$1, Chive enters into a futures contract
to buy CU2m for $1m on 31 March 20X2.
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At 31 December 20X1, CU2m would cost $1,100,000. The fair value of the futures contract
has risen to $95,000. All effectiveness criteria have been complied with.

Required:
Explain the accounting treatment of the above in the financial statements for the year ended
31 December 20X1 if:
(a) Hedge accounting was not used.
(b) On 1 October 20X1, the futures contract was designated as a fair value hedge of the
movements in the fair value of the firm commitment to purchase the machine.

CASH FLOW HEDGE – ACCOUNTING TREATMENT

For cash flow hedges, the hedging instrument will be remeasured to fair
value at the reporting date. The gain or loss is recognised in other
comprehensive income.
Main
treatment
However, if the gain or loss on the hedging instrument since the inception of
the hedge is greater than the loss or gain on the hedged item then the
excess gain or loss on the instrument must be recognised in profit or loss.
If the hedged item eventually results in the recognition of a financial asset
Eventually or a financial liability, the gains or losses that were recognised in equity
resulting in shall be reclassified to profit or loss as a reclassification adjustment in the
financial item same period during which the hedged forecast cash flows affect profit or
loss (e.g. in the period when the hedged forecast sale occurs).
If the hedged item eventually results in the recognition of a non-financial
Eventually
asset or liability, the gain or loss held in equity must be adjusted against the
resulting in
carrying amount of the non-financial asset/liability. This is not a
non-financial
reclassification adjustment and therefore it does not affect other
item
comprehensive income.
QUESTION 22 SBR
A company enters into a derivative contract in order to protect its future cash inflows relating
to a recognised financial asset. At inception, when the fair value of the hedging instrument
was nil, the relationship was documented as a cash flow hedge.

By the reporting date, the loss in respect of the future cash flows amounted to $9,100 in fair
value terms. It has been determined that the hedging relationship meets all effectiveness
criteria.

Required:
Explain the accounting treatment of the cash flow hedge if the fair value of the hedging
instrument at the reporting date is:
(a) $8,500
(b) $10,000.

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 ICMAP S1 AFA&CR

QUESTION 23 SBR
On 31 October 20X1, Bling had inventories of gold which cost $6.4m to buy and which could
be sold for $7.7m. The management of Bling are concerned about the risk of fluctuations in
future cash inflows from the sale of this gold.

To mitigate this risk, Bling entered into a futures contract on 31 October 20X1 to sell the gold
14| for $7.7m. The contracts mature on 31 March 20X2.

The hedging relationship was designated and documented at inception as a cash flow
hedge. All effectiveness criteria are complied with.

On 31 December 20X1, the fair value of the gold was $8.6m. The fair value of the futures
contract had fallen by $0.9m.

There is no change in fair value of the gold and the futures contract between 31 December
20X1 and 31 March 20X2. On 31 March 20X2, the inventory is sold for its fair value and the
futures contract is settled net with the bank.

Required:
(a) Discuss the accounting treatment of the hedge in the year ended 31 December
20X1.
(b) Outline the accounting treatment of the inventory sale and the futures contract
settlement on 31 March 20X2.

QUESTION 24 SBR
In January, Grayton, whose functional currency is the dollar ($), decided that it was highly
probable that it would buy an item of plant in one year’s time for KR 200,000. As a result of
being risk averse, it wished to hedge the risk that the cost of buying KRs would rise and so
entered into a forward rate agreement to buy KR 200,000 in one year’s time for the fixed
sum of $100,000. The fair value of this contract at inception was zero and it was designated
as a hedging instrument.

At Grayton’s reporting date of 31 July, the KR had depreciated and the value of KR 200,000
was $90,000. The fair value of the derivative had declined by $10,000. These values
remained unchanged until the plant was purchased.

Required:
How should this be accounted for?

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 Class Notes

IFRS 7: DISCLOSURE OF FINANCIAL INSTRUMENTS

INTRODUCTION
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. | 15
The extent of disclosure required depends on the extent of the entity's use
of financial instruments and of its exposure to risk. It adds to the
requirements previously in IAS 32 by requiring:
General
 Enhanced statement of financial position and statement of
requirements
comprehensive income disclosures
 Disclosures about an allowance account when one is used to
reduce the carrying amount of impaired financial instruments.
The objective of the IFRS is to require entities to provide disclosures in their
financial statements that enable users to evaluate:
 The significance of financial instruments for the entity's financial
Objective position and performance
 The nature and extent of risks arising from financial instruments to
which the entity is exposed during the period and at the reporting
date, and how the entity manages those risks.

CLASSES OF FINANCIAL INSTRUMENTS AND LEVELS OF DISCLOSURE

The entity must group financial instruments into classes appropriate to the nature of the
information disclosed. An entity must decide in the light of its circumstances how much detail
it provides. Sufficient information must be provided to permit reconciliation to the line items
presented in SFP.
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 to risk where the entity has
made a transfer such that part or all of the financial assets do not
qualify for derecognition.
(d) The carrying amount of financial assets the entity has pledged as
Statement of collateral for liabilities or contingent liabilities and the associated
financial terms and conditions.
position (e) When financial assets are impaired by credit losses and the entity
records the impairment in a separate account (eg an allowance
account used to record individual impairments or a similar account
used to record a collective impairment of assets) rather than
directly reducing 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
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.
Statement of
(a) Net gains/losses by IAS 39 category (broken down as appropriate:
comprehensive
eg interest, fair value changes, dividend income)
income
(b) Interest income/expense
(c) Impairments losses by class of financial asset
Other Entities must disclose in the summary of significant accounting policies
disclosures the measurement basis used in preparing the financial statements and

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 ICMAP S1 AFA&CR

the other accounting policies that are relevant to an understanding of the

financial statements.
Disclosures must be made relating to 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
16| (c) The nature of the risks being hedged
Hedge
(d) For cash flow hedges, periods when the cash flows will occur and
accounting
when will affect profit or loss
(e) For fair value hedges, gains or losses on the hedging instrument
and the hedged item.
(f) The ineffectiveness recognised in profit or loss arising from cash
flow hedges and net investments in foreign operations.
Disclosures must be made relating to fair value:
(a) By class in a way that allows comparison to statement of financial
position value in the statement of financial position. (Financial
assets and liabilities may only be offset to the extent that their
carrying amounts are offset in the statement of financial position.)
(b) The methods and assumptions used, for example by reference to
an active market, and any change in these assumptions. If the
Fair value market for a financial instrument is not active, a valuation
technique, as per IAS 39, must be used. There could be a
difference between the fair value at initial recognition and the
amount that would be determined using the valuation technique.
The accounting policy for recognising that difference in profit or
loss, the aggregate difference yet to be recognised in profit or loss
at the beginning and end of the period and a reconciliation of the
changes in the balance of this difference should be disclosed

NATURE AND EXTENT OF RISKS ARISING FROM FINANCIAL INSTRUMENTS

In undertaking transactions in financial instruments, an entity may assume or transfer to
another party one or more of different types of financial risk as defined below. The
disclosures required by the standard show the extent to which an entity is exposed to these
different types of risk, relating to both recognised and unrecognised financial instruments.
The risk that one party to a financial instrument will cause a financial loss
Credit risk
for the other party by failing to discharge an obligation.
The risk that the fair value or future cash flows of a financial instrument will
Currency risk
fluctuate because of changes in foreign exchange rates.
Interest rate The risk that the fair value or future cash flows of a financial instrument will
risk fluctuate because of changes in market interest rates.
The risk that an entity will encounter difficulty in meeting obligations
Liquidity risk
associated witfi financial liabilities.
Loans Loans payable are financial liabilities, other than short-term trade payables
payable on normal credit terms.
The risk that the fair value or future cash flows of a financial instrument will
Market risk fluctuate because of changes in market prices. Market risk comprises three
types of risk: currency risk, interest rate risk and other price risk.
The risk that the fair value or future cash flows of a financial instrument will
fluctuate because of changes in market prices (other than those arising
Other price
from interest rate risk or currency risk), whether those changes are caused
risk
by factors specific to the individual financial instrument or its issuer, or
factors affecting all similar financial instruments traded in the market.
A financial asset is past due when a counterparty has failed to make a
Past due
payment when contractually due.

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 Class Notes

QUALITATIVE AND QUANTITATIVE DISCLOSURES

For each type of risk arising from financial instruments, an entity must
disclose:
Qualitative (a) The exposures to risk and how they arise
disclosures (b) Its objectives, policies and processes for managing the risk and the
methods used to measure the risk
(c) Any changes in (a) or (b) from the previous period. | 17
For each financial instrument risk, summary quantitative data about risk
exposure must be disclosed. This should be based on the information
provided internally to key management personnel. More information should
be provided if this is unrepresentative. Information about credit risk must be
disclosed by class of financial instrument:
(a) Maximum exposure at the year end
(b) Any collateral pledged as security
(c) In respect of the amount disclosed in (b), a description of collateral
held as security and other credit enhancements
(d) Information about the credit quality of financial assets that are
neither past due nor impaired
(e) Financial assets those are past due or impaired, giving an age
analysis and a description of collateral held by the entity as security.
Quantitative
(f) Collateral and other credit enhancements obtained, including the
disclosures
nature and carrying amount of the assets and policy for disposing of
assets not readily convertible into cash.

For liquidity risk entities must disclose:

(a) A maturity analysis of financial liabilities
(b) A description of the way risk is managed

Disclosures required in connection with market risk are:

(a) Sensitivity analysis, showing the effects on profit or loss of changes
in each market risk
(b) If the sensitivity analysis reflects interdependencies between risk
variables, such as interest rates and exchange rates the method,
assumptions and limitations must be disclosed.

CAPITAL DISCLOSURES
Certain disclosures about capital are required. An entity s capital does not relate solely to
financial instruments, but has more general relevance. Accordingly, those disclosures are
included in IAS 1, rather than in IFRS 7.

QUESTION 25 IFRS 9 PE Extra 2014 Q3a

IFRS-7 Financial Instruments: Disclosures provides the disclosure requirements. One of
which is the information about the nature and extent of risks arising from financial
instruments. You are required to explain the types of financial risk. (07)

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 ICMAP S1 AFA&CR

18|

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 Class Notes

ANSWERS 08
ANSWER 01
Identify the following items as a financial asset, a non-financial asset, a financial liability, a
non-financial liability or an equity instrument. | 19
ITEMS ANSWER
Creditors A financial liability
Investment in loan notes of another entity A financial asset
Bank loan obtained A financial liability
Ordinary shares issued An equity instrument
Irredeemable preference shares issued An equity instrument
Unfavourable forward currency contract A financial liability
Share options issued An equity instrument
Redeemable preference shares issued A financial liability
Investment in redeemable preference shares A financial asset
Current tax payable A non-financial liability (statutory
obligation)
Inventory A non-financial asset
ANSWER 02

Discount factor Present value

Date Description Cash flows Rs.
15% Rs.
31.12.11 Interest 5,000,000 1.15-1 4,347,826
31.12.12 Interest 5,000,000 1.15-2 3,780,718
31.12.13 Interest 5,000,000 1.15-3 3,287,581
01.01.14 Principal 50,000,000 1.15-3 32,875,812
Liability component 44,291,937
Equity component β 5,708,063
Total proceeds 50,000,000

ANSWER 03
Part (a)
Discount factor Present value
Date Description Cash flows Rs.
8% Rs.
31.12.11 Interest 400,000 1.08-1 370,370
31.12.12 Interest 400,000 1.08-2 342,936
31.12.13 Interest 400,000 1.08-3 317,533
31.12.13 Principal 10,000,000 1.08-3 7,938,322
Liability component 8,969,161
Equity component β 1,030,039
Total proceeds 10,000,000

Part (b)
2011 2012 2013
Statement of comprehensive income Rs. Rs. Rs.
Interest expense 717,533 742,936 770,370

Statement of financial position

Equity component of convertible debentures 1,030,039 1,030,039 1,030,039

Liability component of convertible debentures 9,286,694 9,629,630 10,000,000

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 ICMAP S1 AFA&CR

Working
Closing
Opening balance Effective Payments
Year balance
Rs. interest 8% Rs.
Rs.
2011 8,969,161 717,533 (400,000) 9,286,694
20| 2012 9,286,694 742,936 (400,000) 9,629,630
2013 9,629,630 770,370 (400,000) 10,000,000

Part (c)
Date Particulars Dr. Rs. Cr. Rs.
31.12.13 Liability component 10,000,000
Equity component 1,030,039
Share capital 5,000,000
Share premium β 6,030,039

Part (d)
Date Particulars Dr. Rs. Cr. Rs.
31.12.13 Liability 10,000,000
Cash 10,000,000
The equity component will remain in equity (usually it is transferred to some non-
distributable reserve)
ANSWER 04
Identify the most likely classification of following items:
ITEMS ANSWER
FINANCIAL ASSETS
Investments held for trading purposes. FVTPL
Investment in interest bearing debt instruments. The instrument is
redeemable in five years. The intention is to collect cash flows Amortised cost
(which are interest and principal amounts only)
Investment in interest bearing debt instruments. The instrument is
redeemable in five years. The intention is to collect cash flows
FVTOCI
(which are interest and principal amounts only). However, the
entity may sell the loan notes earlier if any good offer is received.
A trade receivable Amortised cost
Derivatives held for speculation purpose FVTPL
Investment in equity shares. The entity has no intention of selling
FVTOCI
these shares in foreseeable future.
Investment in loan notes. The objective is to collect contractual
cash flows which consist of interest, changes in oil prices in next FVTPL
five years and principal amount at the end of year 5.
Investment in loan notes. The objective is to collect contractual
cash flows which consist of interest, changes in oil prices in next
FVTPL
five years and principal amount at the end of year 5. However, the
entity may sell the loan notes earlier if any good offer is received.
Investment in convertible debentures FVTPL
FINANCIAL LIABILITIES
A 12% bank loan obtained by A Limited payable in 5 years time. Amortised cost
8% loan notes issued by C Limited Amortised cost
A short term currency swaps agreement entered into by B4-Bank
Limited which is currently unfavourable. These types of FVTPL
transactions are usual feature of B4-Bank Limited’s business.
Trade payable Amortised cost

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 Class Notes

ANSWER 05

Closing
Opening balance Effective Payments 0%
Year balance
Rs. interest 10% Rs.
Rs.
[profit or loss] [cash flows] [SFP]
1 10,000 1,000 0 11,000 | 21
2 11,000 1,100 (10,000 + 2,100) 0

ANSWER 06

Closing
Opening balance Effective Payments 2%
Year balance
Rs. interest 10% Rs.
Rs.
[profit or loss] [cash flows] [SFP]
1 10,000 1,000 (200) 10,800
2 10,800 1,080 (200+10,000+1,680) 0

ANSWER 07

Initial recognition of liability – net proceeds Rs.

Par value 50,000
Less: Discount 16% (8,000)
Less: Issue costs (2,000)
40,000

Closing
Opening balance Effective Payments 5%
Year balance
Rs. interest 12% Rs.
Rs.
[profit or loss] [cash flows] [SFP]
2011 40,000 4,800 (2,500) 42,300
2012 42,300 5,076 (2,500) 44,876
2013 44,876 5,385 (2,500) 47,761
2014 47,761 5,731 (2,500) 50,992
2015 50,992 6,119 (2,500+50,000+4,611) -

ANSWER 08

Classification FVTPL FVTOCI

Date
01.01.11 Dr. Investment 100 Dr. Investment 102
Cr. Cash 100 Cr. Cash 102
01.01.11 Dr. PL 2
Cr. Cash 2
30.06.11 Dr. Investment 20 Dr. Investment 18
Cr. PL 20 Cr. OCI (other reserves) 18
31.08.11 Dr. Cash 150 Dr. Cash 150
Cr. Investment 120 Cr. Investment 120
Cr. PL 30 Cr. PL 30
31.08.11 Dr. Other reserves 18
Cr. Retained earnings 18

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 ICMAP S1 AFA&CR

ANSWER 09 SBR
Part (a)
FV 95,000 + 2,000 Transaction costs
Closing
Opening balance Effective Payments 5%
Year balance
Rs. interest 8% Rs.
Rs.
22| [profit or loss] [cash flows] [SFP]
20X1 97,000 7,760 (5,000) 99,760
20X2 99,760 7,981 (5,000) 102,741
20X3 102,741 8,219 (5,000 + 100,000 + 5,960) 0

Part (b)
FV 95,000 + 2,000 Transaction costs
Opening Effective Total Gain
Year Payments 5% Rs. Fair value
balance interest 8% Rs. (loss)
Rs. [PL] [cash flows] OCI SFP
20X1 97,000 7,760 (5,000) 99,760 10,240 110,000
20X2 110,000 7,981 (5,000) 112,981 (8,981) 104,000
20X3 104,000 8,219 (5,000 + 100,000 + 1,259 (1,259) 0
5,960)
Part (c)
FV Rs. 95,000
Transaction costs expense of Rs. 2,000
Gain of Rs. 15,000 on first year end
Disposal on very next day, leading to derecognition.

ANSWER 10 PE 501 Nov 2009 4a

Part (i)
Shares in Alpha Limited
This shall be classified as ‘fair value through profit or loss’ because it is equity investment in
another entity with intention to hold it for trading.

Shares in Beta Limited

This shall be classified as ‘fair value through other comprehensive income’ because
although it is equity investment in another entity but there is no intention to hold it for trading.

Debentures in Gamma Limited

Although it is a debt instrument of another entity yet business model test is not passed as
entity initially had an intention of short term profit making. Therefore, it shall be classified as
‘fair value through profit or loss’. There shall be no reclassification on subsequent change of
intention.

Debentures in Theta Limited

This is investment in debt instrument of another entity and business model test and cash
flow characteristics model test appear to have passed, therefore, it shall be classified as ‘at
amortised cost’.

Part (ii)
Shares in Alpha Limited Rs. 000
Initial recognition 441
Subsequent recognition SFP as at June 30, 2009 (fair value) 576
Gain on re-measurement in profit or loss [576 – 441] 135

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 Class Notes

Shares in Beta Limited Rs. 000

Initial recognition 1,960
Subsequent recognition SFP as at June 30, 2009 (fair value) 1,911
Loss on re-measurement in other comprehensive income [1,960 – 1,911] (49)

Debentures in Gamma Limited Rs. 000

Initial recognition 9,090 | 23
Subsequent recognition SFP as at June 30, 2009 (fair value) 9,360
Gain on re-measurement in profit or loss [9,360 – 9,090] 270

Debentures in Theta Limited Rs. 000

Initial recognition 3,185
Subsequent recognition SFP as at June 30, 2009
[3,185 + 269 – (16% x 5,000 x 6/12)] 3,054
Interest income in profit or loss [3,185 x 16.91% x 6/12] 269

ANSWER 11 PE 501 Dec 2010 4c

Date Investment 1 (Rs. 000) Investment 2 (Rs. 000)

During 2008 Dr. Investment 550 Dr. Investment 781
Cr. Cash 550 Cr. Cash 781
During 2008 Dr. PL 5
Cr. Cash 5
End 2008 Dr. Investment 50 Dr. Investment 9
Cr. PL 50 Cr. OCI (other reserves) 9
During 2009 Dr. Cash 625 Dr. Cash 915
Cr. Investment 600 Cr. Investment 790
Cr. PL 25 Cr. PL 125
During 2009 Dr. Other reserves 9
Cr. Retained earnings 9

ANSWER 12 PE 501 Jun 2011 3c

Part (i)
Initial recognition of liability – net proceeds Rs.
Par value 1,000,000
Less: Discount 22.5% (225,000)
Less: Issue costs (25,000)
750,000

Part (ii) and (iii)

Closing
Opening balance Effective Payments 5%
Year balance
Rs. interest 16.16% Rs.
Rs.
[profit or loss] [cash flows] [SFP]
2011 750,000 121,200 (50,000) 821,200
2012 821,200 132,706 (50,000) 903,906
2013 903,906 146,094 (50,000 + 1,000,000) -
ANSWER 13 PE 501 Nov 2011 4c
Debt 1
Opening balance Effective Payments 1% Closing
Year
Rs. interest 15% Rs. balance Rs.
[profit or loss] [cash flows] [SFP]
2011 25,000 3,750 (250) 28,500
2012 28,500 4,275 (250) 32,525
2013 32,525 4,879 (250) 37,154

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 ICMAP S1 AFA&CR

Debt 2
Closing
Opening balance Effective Payments 1%
Year balance
Rs. interest 15% Rs.
Rs.
[profit or loss] [cash flows] [SFP]
2011 17,009 2,551 (250) 19,310
24| 2012 19,310 2,897 (250) 21,957
2013 21,957 3,294 (250) 25,000

ANSWER 14 IFRS 9 PE Mod 2013 Q4a

Part (i)
The initial measurement of liability classified as FVTPL will be at fair value i.e., Rs. 25
million. The transaction cost will not be added to the above amount. Instead it is to be
expensed through profit or loss.

Part (ii)
Amount in Rs .million.
June 30 Balance Market Finance Cash Total (Gain) Balance
B/F rate cost Paid / loss B/F
2011 25.00 10% 2.50 2.50 25.00 (0.41) 24.57
2012 24.57 11% 2.70 2.50 24.80 (0.24) 24.55
2013 24.55 12% 2.95 27.50 0 0 0

2011: 2.50 x 0.9009 + (25+2.5) x 0.8116 = 24.57

2012: 2.50 x 0.8929 + 25.00 x 0.8929 = 24.55

ANSWER 15
(a) This financial asset should be derecognized in the financial statements of MES since
all the risks and rewards of ownership have been transferred to the purchaser.
(b) With the sale of the financial asset, all the risks and rewards of ownership have been
transferred to the purchaser of the asset. While MES has retained a call option on the
shares, the exercise price of the asset is the fair value of the asset as on the date of
repurchase. This makes the value of the call option zero and therefore no risks and
rewards of ownership are retained by MES. As a result, this asset should be
derecognized on its sale.
(c) As MES agrees to compensate CCE for any defaults on payment, it retains the risk of
ownership. As a result, it should not derecognize the financial asset in its financial
statements.
(d) Even after the swap, MES should continue to recognise the asset in its accounts as
risk and rewards have not been practically transferred.

ANSWER 16
(a) Although B Limited has set aside the amount in a trust meant only for the purpose of
paying S Limited, it will still have to recognise the liability since it has not completely
discharged the obligation of paying S Limited.
(b) In this case, the obligation has been discharged and there is no further liability.
Therefore, the liability shall be derecognized.
(c) Since the put option has expired, the entity will not be able to pay anything and can
therefore derecognize the put option in its books of accounts.

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 Class Notes

ANSWER 17

Date Particulars Dr. Cr.

Rs. Rs.
01 Jan Investment – Call option 10,000
Cash 10,000
| 25
30 Jun Investment – Call option 3,000
Profit or loss 3,000

01 Nov Investment in shares 125,000

Gain on derecognition of call option 12,000
Cash 100,000
Investment – Call options 13,000

ANSWER 18
This can be calculated in two ways:
Rs.1,500 / Rs.1,800 = 83.33% effective
Rs.1,800 / Rs.1,500 = 120% effective

ANSWER 19 SBR
Under a fair value hedge, the movement in the fair value of the item and instrument since the
inception of the hedge are accounted for. The gains and losses will be recorded in profit or
loss.

The $1m gain on the future and the $1m loss on the inventory will be accounted for as
follows:
Dr Derivative $1m
Cr Profit or loss $1m

Dr Profit or loss $1m

Cr Inventory $1m

By applying hedge accounting, the profit impact of remeasuring the derivative to fair value
has been offset by the movement in the fair value of the inventory. Volatility in profits and
'earnings per share' has, in this example, been eliminated. This may make the entity look
less risky to current and potential investors.

Note that the inventory will now be held at $7m (cost of $8m – $1m fair value decline). This
is neither cost nor NRV. The normal accounting treatment of inventory has been changed by
applying hedge accounting rules.

ANSWER 20 SBR
The hedged item is an investment in equity that is measured at fair value through other
comprehensive income (OCI). Therefore, the increase in the fair value of the derivative of
$90,000 and the fall in fair value of the equity interest of $100,000 since the inception of the
hedge are taken to OCI.
Dr Derivative $90,000
Cr OCI $90,000
Dr OCI $100,000
Cr Equity investment $100,000
The net result is a small loss of $10,000 in OCI.

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 ICMAP S1 AFA&CR

ANSWER 21 SBR
(a) The futures contract is a derivative and is measured at fair value with all movements
being accounted for through profit or loss. The fair value of the futures contract at 1
October 20X1 was nil. By the year end, it had risen to $95,000. Therefore, at 31
December 20X1, Chive will recognise an asset at $95,000 and a gain of $95,000 will
be recorded in profit or loss.
26|
(b) If the relationship had been designated as a fair value hedge then the movement in
the fair value of the hedging instrument (the future) and the fair value of the hedged
item (the firm commitment) since inception of the hedge are accounted for through
profit or loss. The derivative has increased in fair value from $nil at 1 October 20X1
to $95,000 at 31 December 20X1. Purchasing CU2 million at 31 December 20X1
would cost Chive $100,000 more than it would have done at 1 October 20X1.
Therefore the fair value of the firm commitment has fallen by $100,000.

At year end, the derivative will be held at its fair value of $95,000, and the gain of
$95,000 will be recorded in profit or loss.

The $100,000 fall in the fair value of the commitment will also be accounted for, with
an expense recognised in profit or loss.

Dr Derivative $95,000
Cr Profit or loss $95,000

Dr Profit or loss $100,000

Cr Firm commitment $100,000

The gain on the derivative and the loss on the firm commitment largely net off. There
is a residual $5,000 ($100,000 – $95,000) net expense in profit or loss due to hedge
ineffectiveness. Nonetheless, financial statement volatility is far less than if hedge
accounting had not been used.

ANSWER 22 SBR
Part (a)
The movement on the hedging instrument is less than the movement on the hedged item.
Therefore, the instrument is remeasured to fair value and the gain is recognised in other
comprehensive income.

Dr Derivative $8,500
Cr OCI $8,500

Part (b)
The movement on the hedging instrument is more than the movement on the hedged item.
The excess movement of $900 ($10,000 – $9,100) is recognised in the statement of profit or
loss.

Dr Derivative $10,000
Cr Profit or loss $900
Cr OCI $9,100

ANSWER 23 SBR
Part (a)
Between 1 October 20X1 and 31 December 20X1, the fair value of the futures contract had
fallen by $0.9m. Over the same time period, the hedged item (the estimated cash receipts
from the sale of the inventory) had increased by $0.9m ($8.6m – $7.7m).

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 Class Notes

Under a cash flow hedge, the movement in the fair value of the hedging instrument is
accounted for through other comprehensive income. Therefore, the following entry is
required:

Dr Other comprehensive income $0.9m

Cr Derivative $0.9m
| 27
The loss recorded in other comprehensive income will be held within equity.

Part (b)
The following entries are required:
Dr Cash $8.6m
Cr Revenue $8.6m

Dr Cost of sales $6.4m

Cr Inventory $6.4m

To record the sale of the inventory at fair value

Dr Derivative $0.9m
Cr Cash $0.9m

To record the settlement of the futures contract

Dr Profit or loss $0.9m
Cr OCI $0.9m

To recycle the losses held in equity through profit or loss in the same period as the hedged
item affects profit or loss.

ANSWER 24 SBR
The forward rate agreement has no fair value at its inception so is initially recorded at $nil.

This is a cash flow hedge. The derivative has fallen in value by $10,000 but the cash flows
have increased in value by $10,000 (it is now $10,000 cheaper to buy the asset).

Because it has been designated a cash flow hedge, the movement in the value of the
hedging instrument is recognised in other comprehensive income:

Dr Other comprehensive income $10,000

Cr Derivative $10,000
(Had this not been designated a hedging instrument, the loss would have been recognised
immediately in profit or loss.)

The forward contract will be settled and closed when the asset is purchased.

Property, plant and equipment is a non-financial item. The loss on the hedging instrument
held within equity is adjusted against the carrying amount of the plant.

The following entries would be posted:

Dr Liability – derivative $10,000
Dr Plant $90,000
Cr Cash $100,000

Being the settlement of the derivative and the purchase of the plant.
Dr Plant $10,000
Cr Cash flow hedge reserve $10,000

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 ICMAP S1 AFA&CR

Being the recycling of the losses held within equity against the carrying amount of the plant.
Notice that the plant will be held at $100,000 ($90,000 + $10,000) and the cash spent in total
was $100,000. This was the position that the derivative guaranteed.

ANSWER 25 IFRS 9 PE Extra 2014 Q3a

28| NATURE AND EXTENT OF RISKS ARISING FROM FINANCIAL INSTRUMENTS

In undertaking transactions in financial instruments, an entity may assume or transfer to
another party one or more of different types of financial risk as defined below. The
disclosures required by the standard show the extent to which an entity is exposed to these
different types of risk, relating to both recognised and unrecognized financial instruments.
The risk that one party to a financial instrument will cause a financial loss
Credit risk
for the other party by failing to discharge an obligation.
The risk that the fair value or future cash flows of a financial instrument will
Currency risk
fluctuate because of changes in foreign exchange rates.
Interest rate The risk that the fair value or future cash flows of a financial instrument will
risk fluctuate because of changes in market interest rates.
The risk that an entity will encounter difficulty in meeting obligations
Liquidity risk
associated witfi financial liabilities.
Loans Loans payable are financial liabilities, other than short-term trade payables
payable on normal credit terms.
The risk that the fair value or future cash flows of a financial instrument will
Market risk fluctuate because of changes in market prices. Market risk comprises three
types of risk: currency risk, interest rate risk and other price risk.
The risk that the fair value or future cash flows of a financial instrument will
fluctuate because of changes in market prices (other than those arising
Other price
from interest rate risk or currency risk), whether those changes are caused
risk
by factors specific to the individual financial instrument or its issuer, or
factors affecting all similar financial instruments traded in the market.
A financial asset is past due when a counterparty has failed to make a
Past due
payment when contractually due.

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