Chapter 2

Financial instruments = IFRS 9

The €18,000 is the change in fair value of the financial assets from the date of
acquisition to the balance sheet date. Here's how it is derived:
1. On 1 June, N, 2,000 shares of a money market fund were acquired for €100
per share, totaling €200,000 (2,000 shares * €100/share).
2. The transaction costs amounted to €3,000.
3. On the balance sheet date, the fair value of the shares was €109 per share,
totaling €218,000 (2,000 shares * €109/share).
4. The increase in fair value is the difference between the fair value at the
balance sheet date and the acquisition cost, excluding transaction costs, which
is €218,000 - €200,000 = €18,000.

Thus, the €18,000 is recognized as financial income in the income statement,

reflecting the increase in fair value of the financial assets. The transaction costs
of €3,000 are recognized as an expense at initial recognition because the
financial asset is classified as FVTPL (Fair Value Through Profit or Loss),
according to IFRS 9.

IAS 32
IAS 32, titled "Financial Instruments: Presentation," provides guidance on the
classification and presentation of financial instruments, ensuring that entities
present them clearly and consistently in their financial statements. Here's an
overview of what it covers:

- Scope: IAS 32 applies to the classification of financial instruments, from

the perspective of the issuer, into financial assets, financial liabilities, and
equity instruments. It also addresses the presentation of financial
instruments and how to present related gains, losses, and interests.
- Classification: One of the key aspects of IAS 32 is distinguishing between
financial liability and equity. A financial instrument an entity issues is
classified as a financial liability if it is a contractual obligation to deliver
cash or another financial asset to another entity or to exchange financial
instruments under conditions that are potentially unfavorable to the
issuer. If it represents a residual interest in the assets of the entity after
deducting all of its liabilities, it is classified as equity.
- Compound Instruments: IAS 32 also addresses compound financial
instruments which have both liability and equity components, such as
convertible bonds. The standard requires entities to separate the
components and account for them separately according to their
substance.
- Disclosure: It requires disclosures that enable users of financial
statements to evaluate the significance of financial instruments for an
entity's financial position and performance, as well as the nature and
extent of risks arising from those financial instruments.
- Offsetting: The standard outlines the criteria for offsetting financial
assets and financial liabilities. It stipulates that a financial asset and a
financial liability should only be offset and the net amount presented in
the statement of financial position when an entity currently has a legally
enforceable right to set off the recognized amounts and intends either to
settle on a net basis or to realize the asset and settle the liability
simultaneously.
- Treasury Shares: It also deals with treasury shares (the entity's own
shares that have been reacquired) and states that such shares should be
deducted from equity. No gain or loss is recognized in the income
 statement on the purchase, sale, issuance, or cancellation of treasury
shares.
- Interest, Dividends, Losses, and Gains: The standard provides guidance
on how an entity should recognize interest, dividends, losses, and gains
related to financial instruments. Interest, dividends, losses, and gains
relating to a financial instrument classified as a liability, are reported as
expense or income. Distributions to holders of an equity instrument are
debited directly to equity, not as an expense.

IAS 32 works closely with IAS 39 "Financial Instruments: Recognition and

Measurement" (which has been largely replaced by IFRS 9 "Financial
Instruments") and IFRS 7 "Financial Instruments: Disclosures" to provide a
comprehensive framework for the treatment of financial instruments in IFRS.

Measurement of financial assets - Summary

The slide provides a summary of the measurement and recognition of financial
assets according to IFRS 9, broken down into four categories:

1. Financial asset FVTPL (DEBT or EQUITY instruments):

- These are measured at fair value.
- Gains and losses from fair value remeasurement are recognized in the
income statement (IS).
- Interest (for debt instruments) and dividends (for equity instruments)
are recognized in the IS.
- There is no impairment consideration for equity instruments, while debt
instruments would follow the impairment guidance in IFRS 9.
- Foreign exchange gains/losses and gains/losses from derecognition are
recognized in the IS.

2. Financial asset FVTOCI (DEBT instruments):

- Measured at fair value with changes recognized in Other
Comprehensive Income (OCI).
- Interest income calculated using the Effective Interest Rate method is
recognized in the IS.
- Dividends are not applicable to debt instruments.
- Impairment losses and reversals are recognized in the IS.
- Gains/losses from derecognition are recycled from OCI to IS.

3. Financial asset FVTOCI (EQUITY instruments):

- Measured at fair value with changes recognized in OCI.
- Dividends are recognized in the IS.
- No impairment losses are recognized.
- Gains/losses from derecognition are not recycled to IS but maintained
within equity (OCI is not transferred to IS upon sale).

4. Financial asset AC (Amortized Cost - DEBT instruments only):

- Measured at amortized cost using the Effective Interest Rate method.
- Gains/losses from remeasurement are not applicable.
- Impairment losses and reversals are recognized in the IS.
- Foreign currency gains/losses and gains/losses from derecognition are
recognized in the IS.
This slide essentially maps out how various types of financial assets are treated
in terms of measurement and recognition of income, expenses, and changes in
fair value according to IFRS 9.

IFRS 9 PT.2
The slide you've provided summarizes the measurement categories for financial
assets, specifically equity instruments, under IFRS 9. Here’s an explanation of
the IFRS 9 categories for equity instruments:

FVTPL (Fair Value Through Profit or Loss):

This category is the default for all financial assets under IFRS 9 unless the
entity makes a different irrevocable election on initial recognition. Equity
instruments in this category are measured at fair value with all gains and losses
recognized in the profit or loss.

FVTOCI (Fair Value Through Other Comprehensive Income):

Equity instruments not held for trading can be designated at initial recognition
to this category. Gains and losses on these instruments are recognized in other
comprehensive income and are never reclassified to profit or loss. However,
dividends from such investments can still be recognized in the profit and loss
account, provided they do not represent a return on investment.

The choice between FVTPL and FVTOCI depends on the entity's business model
and the purpose for which the investments are held. For strategic investments,
it may be more appropriate to select FVTOCI to avoid profit and loss volatility.

Under IFRS 9, there is no amortized cost option for equity instruments because
they do not have fixed or determinable payments. It's important to note that
IFRS 9 has significantly changed the accounting for financial instruments,
particularly in terms of classification and measurement, impairment of financial
assets, and hedge accounting.

IAS 40 – Investment Property

Real estate and buildings held to obtain rental income (investment property) are
carried at amortized cost; the useful lives applied to depreciation generally
correspond to those of the property, plant, and equipment used by the Company
itself. The fair value of investment property is disclosed in the notes. Fair value
is generally estimated using an investment method based on internal
calculations. This involves determining the income value for a specific building
based on gross income, taking into account additional factors such as land
value, remaining useful life, and a multiplier specific to the property.

IAS 40, "Investment Property," is an accounting standard that guides the

recognition, measurement, and disclosure of investment properties. Investment
property is property (land or a building — or part of a building — or both) held
to earn rentals or for capital appreciation or both, rather than for use in the
production or supply of goods or services or for administrative purposes, or sale
in the ordinary course of business.

Key aspects of IAS 40 include:

 1. Initial Recognition: Investment properties are initially measured at cost,
including transaction costs.
2. Subsequent Measurement: After initial recognition, entities can choose
either the cost model or the fair value model for measuring investment
property.
- Under the cost model, the investment property is carried at cost less
any accumulated depreciation and any accumulated impairment losses,
similar to the accounting for property, plant, and equipment under IAS
16.
- Under the fair value model, investment property is re-measured at fair
value at the end of every reporting period. Changes in fair value are
recognized in profit or loss for the period in which they arise.
3. Disclosure: Entities must disclose the determination of fair value, the
methods and significant assumptions applied in determining fair values,
and the extent to which fair values are determined based on a valuation
by an independent valuer who holds a recognized and relevant
professional qualification.
4. Transfers: Transfers to or from investment property are only made when
there is a change in use, evidenced by the end of owner-occupation, the
commencement of an operating lease to another party, or the completion
of development for sale.
5. Disposals: Disposal of an investment property may be through sale or by
entering into a finance lease, and gains or losses arising from the disposal
are included in profit or loss.
6. The change in value are found in the Income Statement

IAS 40 applies to the owners of investment property and to lessees holding

property under a finance lease and treating it as an investment property. It does
not apply to biological assets related to agricultural activity or to mineral rights
and mineral reserves such as oil, natural gas, and similar non-regenerative
resources.

IAS 41 – Agriculture
IAS 41, titled "Agriculture," is a standard that prescribes the accounting
treatment, financial statement presentation, and disclosures related to
agricultural activity. Here’s a summary of what IAS 41 includes:

I. Scope: IAS 41 applies to entities engaged in agricultural activity, which is

the management by an entity of the biological transformation of
biological assets (living plants and animals) into agricultural produce
(harvested product of the entity's biological assets).

II. Initial Measurement: Biological assets are initially measured at fair value
less estimated point-of-sale costs, except where fair value cannot be
measured reliably. This is often the case at the point of harvest.

III. Subsequent Measurement: Biological assets should be measured at fair

value less estimated point-of-sale costs at the end of each reporting
period. The change in fair value less estimated point-of-sale costs is
included in profit or loss for the period.
 IV. Agricultural Produce: Upon harvest, agricultural produce is measured at
its fair value less estimated point-of-sale costs, which becomes the basis
for accounting for the produce after that point (often using IAS 2,
Inventories).

V. Bearer Plants: While bearer plants are within the scope of IAS 41, they
are accounted for under IAS 16, Property, Plant, and Equipment, once
they reach maturity. Before maturity, they are treated like other biological
assets.

VI. Government Grants: An entity may receive government grants related to

biological assets. IAS 41 intersects with IAS 20, Accounting for
Government Grants and Disclosure of Government Assistance, in this
area.

VII. Disclosure: IAS 41 requires entities to disclose the aggregate gain or loss
recognized in profit or loss on initial recognition of biological assets and
agricultural produce and from the change in fair value less costs to sell
during the period, among other disclosures related to biological assets.

IAS 41 was the first international accounting standard that required the use of
fair value for the measurement of assets on an ongoing basis. It represents a
significant departure from the historical cost principle, particularly for the
agriculture industry.

• Agricultural activity is the management by an entity of the biological

transformation of biological assets for sale, into agricultural produce, or
into additional biological assets.
• Agricultural produce is the harvested product of the entity’s biological
assets.
• A biological asset is a living animal or plant (ex: sheep, trees in timber
plantation)
• "Bearer plants” are out of the scope of IAS 41 (ex: apple trees are
within the scope of IAS 16, but the apples are within IAS 41)
• Biological transformation comprises the processes of growth,
degeneration, production, and procreation that cause qualitative or
quantitative changes in a biological asset.
• A group of biological assets is an aggregation of similar living animals
or plants.
• Harvest is the detachment of produce from a biological asset or the
cessation of a biological asset’s life processes.

• A biological asset shall be measured on initial recognition and at the

end of each reporting period at its fair value less estimated point-of-sale
costs, except […] where the fair value cannot be measured reliably.
• Changes in fair value to be included in P&L
• Agricultural produce harvested from an entity’s biological assets shall
be measured at its fair value less estimated point-of-sale costs at the
point of harvest. Such measurement is the cost at that date when
applying IAS 2 Inventories or another applicable Standard.
• There is a presumption that fair value can be measured reliably for a
biological asset. However, that presumption can be rebutted only on
 initial recognition of a biological asset for which quoted market prices
are not available and for which alternative fair value measurements are
determined to be unreliable. In such a case, that biological asset shall be
measured at its cost less any accumulated depreciation and any
accumulated impairment losses.
IAS 16 – Property, Plant, and Equipment |Revaluation model
IAS 16, "Property, Plant and Equipment," is an accounting standard that
provides guidelines for the recognition, measurement, and disclosure of
property, plant, and equipment (PPE). It outlines the accounting treatment for
tangible assets that are held for use in the production or supply of goods or
services, for rental to others, or administrative purposes, and specifies how
these assets should be initially recognized, measured, depreciated, and
derecognized.

There are two models available for the subsequent measurement of property,
plant, and equipment (PPE) as per IAS 16:
1. Cost Model: Under this model, PPE is carried at its cost minus any
accumulated depreciation and any accumulated impairment losses. The cost is
the amount of cash or cash equivalents paid or the fair value of the
consideration given to acquire an asset at the time of its acquisition or
construction.
2. Revaluation Model: In this model, PPE is carried at a revalued amount,
which is its fair value at the date of the revaluation less any subsequent
accumulated depreciation and accumulated impairment losses. Revaluations
should be made with "sufficient regularity" to ensure that the carrying amount
does not differ materially from that which would be determined using fair value
at the reporting date.

The slide also includes a note indicating that whichever model is chosen, it must
be applied to the entire class of PPE. This means that all assets of similar nature
and use within an entity’s operations should be measured using the same model
to ensure consistency. The phrase "subject to interpretation" suggests that what
constitutes "sufficient regularity" for revaluations can depend on the
circumstances and might require judgment by the entity's management.

• The revalued amount of an asset is its fair value at the date of the
revaluation less accumulated depreciation and less accumulated
impairment losses.
• Revaluations shall be made with sufficient regularity
• Unrealized gains (so-called “revaluation surplus”) are recorded as Other
Comprehensive Income (equity; which will never be recycled in net
income)
• Unrealized losses are expensed (after an eventual surplus in OCI has
been reduced to 0)
• Most companies in continental Europe do not use revaluation accounting;
some use in the UK, for example

Key aspects of IAS 16 include:

1. Initial Recognition: Property, plant, and equipment should be recognized
as assets when it is probable that future economic benefits associated
with the asset will flow to the entity, and the cost of the asset can be
 reliably measured. The cost of an item of PPE comprises its purchase
price, including import duties and non-refundable purchase taxes, and
any directly attributable costs of bringing the asset to the location and
condition necessary for it to be capable of operating in the manner
intended by management.
2. Subsequent Measurement: After initial recognition, an entity can choose
between the cost model and the revaluation model for measuring its PPE.
- Under the cost model, assets are carried at cost less accumulated
depreciation and any accumulated impairment losses.
- Under the revaluation model, assets are carried at a revalued amount,
being fair value at the date of revaluation less subsequent depreciation
and impairment, with revaluations reflected in other comprehensive
income.
3. Depreciation: Depreciation is the systematic allocation of the depreciable
amount of an asset over its useful life. The depreciable amount is the cost
of an asset, or other amount substituted for cost, less its residual value.
Depreciation should be recognized as an expense in the profit or loss
unless it is included in the carrying amount of another asset.
4. Derecognition: An item of PPE should be derecognized upon disposal or
when no future economic benefits are expected from its use or disposal.
Any gain or loss arising from the derecognition of an asset should be
included in profit or loss.
5. Disclosure: Entities are required to disclose information about the
measurement bases used for PPE, depreciation methods, useful lives or
depreciation rates, gross carrying amount, accumulated depreciation,
and accumulated impairment losses. If the revaluation model is used,
additional disclosures about fair values, revaluation surplus, and the
effective date of the revaluation should be provided.

Overall, IAS 16 ensures that entities account for property, plant, and equipment
in a manner that reflects their economic substance and provides users of
financial statements with relevant and reliable information about the entity's
investment in tangible assets and the depreciation thereof over time.

Quizzes
1. Different measurement bases such as historical cost, amortized cost, or fair
value may be used depending on the nature of the asset and the specific
IFRS standard that applies.
2. Fair value is the market-based measurement, not the entity-specific value.
3. Fair value for both listed and unlisted assets may be determined using
valuation techniques appropriate to the circumstances.
4. This statement is correct; Level 3 inputs are unobservable and used when
market data is not available.
5. Classification of financial instruments under IFRS 9 depends on the entity's
business model for managing the financial assets and the contractual cash
flow characteristics.
6. Shares can be classified as FVTPL, FVTOCI, or at cost in some cases,
depending on the purpose for which they are held and the business model.
7. Most derivatives fail the SPPI test because their cash flows are not solely
payments of principal and interest.
8. The measurement of tangible assets after initial recognition can be either at
costless depreciation or at a revalued amount.
9. This statement is correct; properties measured at fair value are not
depreciated.
10.Increases in fair value beyond any previous revaluation decrease are
recognized in other comprehensive income and presented in the revaluation
surplus within equity.
11.Trees in a timber plantation can be biological assets; however, bearer plants
are accounted for under IAS 16 once they reach maturity.

Questions and answers

1. What is fair value? Fair value is the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date.

2. How is a fair value measured according to IFRS 13? Fair value is measured
based on the exit price, considering the characteristics of the asset or liability
and using market participant assumptions.

3. What are some assets and liabilities for which fair value measurement is
mandatory? Fair value measurement is mandatory for certain financial
instruments under IFRS 9, investment properties under IAS 40, defined benefit
plans, and biological assets under IAS 41.

4. What is the fair value hierarchy? The fair value hierarchy categorizes the
inputs to valuation techniques used to measure fair value into three levels:
Level 1 (quoted prices in active markets for identical assets or liabilities), Level
2 (inputs other than quoted prices included within Level 1 that are observable
for the asset or liability), and Level 3 (unobservable inputs).

5. How are changes in fair value of financial instruments recognized? Changes

in fair value of financial instruments are recognized in profit or loss for those
classified as FVTPL (Fair Value Through Profit or Loss) and in other
comprehensive income for those classified as FVTOCI (Fair Value Through
Other Comprehensive Income), with some exceptions based on the type of
financial instrument.

6. What are the pros and cons of using fair value as a measurement basis? Pros
include relevance and timeliness of financial information. Cons include potential
volatility in earnings and challenges in measuring fair value accurately when
market data is not available.

7. Can fair value measurement be subjective? Yes, fair value measurement can
be subjective, especially when it involves unobservable inputs or when there is
no active market for the asset or liability.

8. What is the difference between fair value and historical cost? Historical cost
is based on the original transaction price of an asset or liability, while fair value
reflects current market conditions and the price that could be received or paid
in an orderly transaction.

9. Why might a company choose to measure investment properties at fair value?

Companies may choose to measure investment properties at fair value to
provide more relevant information about the current market conditions and
potential profitability of their investments.

10. What disclosures are required for fair value measurements? Disclosures
include the fair value hierarchy level, a description of valuation techniques and
inputs used, and for Level 3 fair value measurements, a reconciliation of
opening balances to closing balances, significant unobservable inputs used, and
quantitative sensitivity analysis.

11. How does fair value impact financial reporting? Fair value impacts financial
reporting by providing up-to-date and relevant financial information that
reflects current market conditions, affecting both the balance sheet and the
income statement.

12. What are the implications of fair value measurement for financial analysis?
For financial analysis, fair value measurements can enhance the comparability
of financial statements across companies and improve the quality of information
available for assessing an entity's performance and financial position.

13. How do changes in fair value affect the income statement and equity?
Changes in fair value that are recognized in profit or loss affect the income
statement immediately, while those recognized in other comprehensive income
affect equity and bypass the income statement until specific events trigger their
reclassification.

14. What challenges do companies face when measuring fair value? Challenges
include determining the appropriate valuation techniques, dealing with illiquid
markets, and managing the subjectivity and variability of estimates, especially
with unobservable inputs.

15. When is fair value not appropriate as a measurement basis? Fair value is not
appropriate when it cannot be reliably measured, such as when there is no
active market for the asset or liability and alternative valuation methods do not
provide reliable estimates.

16. What role do auditors play in fair value measurements? Auditors review the
methods and assumptions used in fair value measurements to ensure they
comply with accounting standards and reflect reasonable market participant
expectations.

17. How is the fair value used in impairment testing? Fair value is used to
determine the recoverable amount of assets in impairment testing. If the fair
value (less costs to sell) or the value in use of an asset is less than its carrying
amount, an impairment loss may be recognized.

18. What is the impact of fair value measurements on financial instruments?

Depending on their classification, changes in the fair value of financial
instruments can significantly impact a company's financial statements, affecting
earnings volatility and equity.
19. Can fair value measurements affect a company's strategic decisions? Yes,
fair value measurements can influence strategic decisions, especially in asset
management and investment properties, where values can guide decisions on
asset acquisitions, disposals, or redevelopment.

20. What are the types of financial instruments under IFRS 9? Financial
instruments under IFRS 9 include debt instruments, equity instruments, and
derivatives such as forwards, futures, swaps, and options.

21. What factors influence the classification of financial instruments in IFRS 9?

Classification is based on the business model for managing the financial assets
and the contractual cash flow characteristics of the financial asset.

22. How does IFRS 9 define a financial asset and financial liability? A financial
asset is any asset that is cash, a contractual right to receive cash or another
financial asset from another entity, or an equity instrument of another entity. A
financial liability is any obligation to deliver cash or another financial asset to
another entity.

23. What are the measurement categories for financial assets under IFRS 9?
The categories include Amortized Cost (AC), Fair Value through Other
Comprehensive Income (FVTOCI), and Fair Value through Profit or Loss
(FVTPL).

24. How is fair value determined for investments not traded in active markets?
Fair value for these investments may be determined using valuation techniques
such as discounted cash flow models or other valuation models that include
both observable and unobservable inputs.

25. What is the difference between the cost model and the fair value model in
accounting for investment properties? Under the cost model, investment
properties are depreciated and measured at cost minus any accumulated
depreciation. Under the fair value model, properties are measured at fair value,
and changes in fair value are recognized in profit or loss.

26. What are the requirements for fair value measurement under IFRS 13? The
standard requires fair value measurements to reflect the assumptions that
market participants would use based on the characteristics of the asset or
liability, including a consideration of risk.

27. What is the purpose of fair value disclosures according to IFRS 13?
Disclosures aim to provide users of financial statements with clear and detailed
information about the valuation techniques and inputs used in determining fair
value, as well as the impact of fair value measurements on financial position and
performance.

28. How is fair value used in the agriculture sector under IAS 41? Biological
assets are measured at fair value less estimated point-of-sale costs, with
changes in fair value included in profit or loss.
29. What are bearer plants and how are they accounted for under IFRS? Bearer
plants are plants used in agricultural activity that are not intended to be
harvested but rather used to produce crops. They are accounted for under IAS
16 (Property, Plant, and Equipment), not IAS 41.

30. What is the impact of fair value measurements on financial stability and risk
management? Fair value measurements can introduce volatility in financial
statements, affecting perceived stability and influencing risk management
decisions.

31. How do fair value adjustments affect a company's equity? Fair value
adjustments can directly impact equity through changes in other comprehensive
income or retained earnings, depending on whether the gains or losses are
realized or unrealized.

32. What challenges do entities face when implementing fair value accounting
for complex financial instruments? Challenges include a lack of active markets,
reliance on complex valuation models, and the need for significant judgment
and estimation in determining inputs for those models.

33. How does fair value accounting impact decision-making in financial

management? Fair value accounting provides current market information that
can influence strategic decisions such as hedging, investment, and asset
management.

34. What are the ethical considerations in fair value estimation? Ethical
considerations include the objectivity and reliability of fair value estimates, the
potential for manipulation of estimates, and the transparency of the
assumptions used in valuation models.

35. Can fair value accounting affect a company's tax liabilities? Yes, fair value
changes can affect taxable income and tax liabilities, especially if they involve
realized gains or losses that are subject to tax.

36. What role do external auditors play in the fair value measurement process?
Auditors evaluate the appropriateness of fair value measurements and
disclosures, focusing on the methodologies, assumptions, and data used in the
valuation process.

37. How do regulatory frameworks influence fair value accounting practices?

Regulatory frameworks provide guidelines and standards that govern how fair
value is measured, reported, and disclosed, ensuring consistency and
comparability across entities.

38. What are the common pitfalls in fair value measurement that companies
should avoid? Common pitfalls include using inappropriate valuation models,
relying on outdated or irrelevant data, and failing to adjust for changes in
market conditions.
39. How do changes in fair value affect compliance with financial covenants?
Fluctuations in fair value can affect covenant calculations, potentially leading to
breaches if asset values decline or liabilities increase significantly.

40. What are the implications of using the PPE revaluation model? Using the
PPE revaluation model allows an entity to adjust the carrying amount of
property, plant, and equipment to reflect fair value, potentially increasing the
book value of assets and thereby enhancing reported equity. This can provide
more accurate financial information to investors, reflecting current values
rather than historical costs. However, it can lead to increased volatility in
reported earnings, require frequent and potentially costly evaluations, and
affect compliance with debt covenants based on financial ratios.