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Topic 2: Financial instruments

Chapter 9
Financial Instruments:
Classification,
Recognition and
Measurement

Copyright © 2016 by McGraw-Hill Education (Asia). All rights reserved. 2

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Learning Objectives

1. Understand the definition and components of financial

instruments;
2. Distinguish whether a financial instrument is debt or equity;
3. Understand compound financial instruments and know how
to separate the debt and equity components;
4. Understand the categories of classification of financial
assets and liabilities;
5. Understand the initial recognition and the subsequent
measurement of financial assets and financial liabilities;
6. Account for the impairment of financial assets; and
7. Know when and how to derecognize financial assets and
financial liabilities.
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Content

1. Introduction
Introduction
2. Classification
3. Accounting for financial assets: IFRS 9
4. Accounting for debt & equity
5. Accounting for compounds (issuer)- IAS 32

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Overview of Standards Pertaining to

Financial Instruments
IAS 32 IFRS 9 IFRS 7

Definition and Definition and

classification classification and
Distinguishing reclassification
Disclosure of
financial liability and Recognition and financial instruments
equity derecognition
Accounting for and risk
compound financial Measurement
instruments subsequent to initial
Accounting for share recognition
repurchase and Accounting for
treasury stocks derivatives for trading
and hedging
Offsetting financial
assets and liabilities
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Overview

Contract

(2)

(1)

(3)

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Definition of Financial Instruments

Any contract that gives rise to a financial asset of one

entity and a financial liability or equity instrument of
another entity (IAS 32:11)

Financial assets
Classification
of Financial Financial liabilities
Instruments
Equity

Content

1. Introduction
2.
1. Classification
3. Accounting for financial assets: IFRS 9
4. Accounting for debt & equity
5. Accounting for compounds (issuer)- IAS 32

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Financial asset

(4) Contract settled in the

(2) Equity (3)Contractual right entity’s own equity instruments
(1) instrument to: and is:
Cash of another  (a)Receive  (a)A non-derivative =>
entity cash/another FA obligation to receive a
 (b)Exchange FI variable number of entity’s
with another own equity instruments
entity (favorable  (b)A derivative => settled
cash other than by the exchange
shares conditions)
of fixed amount of
cash/another FA for a fix
Trade receivables number of own equity
Loans receivable instrument.
Purchased call options
Purchased put options
Transactions in own equity

Financial liability

(2) Contract settled in the entity’s

(1)Contractual obligation to:
own equity instruments and is
(a) A non- derivative => obligation to
deliver a variable number of entity’s
(a)Deliver cash / (b) Exchange FI with
own equity instruments
another financial another entity
(b) A derivative => settled other than
asset (unfavorable conditions)
by the exchange of fixed amount of
cash/another FA for a fix number of
own equity instrument.
Trade payables Written call options
Transactions in own equity
Loan payables Written put options

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Classification as
equity instrument
(IAS 32:16)

(1) Instruments include (2) Instrument settled

no contractual in issuer’s own equity
obligation to instruments

(a) Deliver (b) Exchange (a)Non-derivative (b)Derivative

(i) cash or (ii) financial assets that include no instrument that will
another financial or liabilities with contractual be settled by
asset to another another entity obligation to exchanging a fixed
entity under potentially deliver a variable amount of cash/ FA
unfavorable number of own for a fixed number of
conditions equity instrument its own equity
instrument

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Note

Equity instrument
• Any consideration paid/ received
-> Deducted/ added directly to equity
• Change in FV -> not recognized

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Examples

1. Mickey Co. writes an option to deliver

1.000 shares of entity B
2. Mickey Co. writes an option to deliver its
shares for $1m
3. Mickey Co. writes an option to deliver
10m its shares for $1m

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Note

• Redeemable shares
• Mandatory dividends

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Example: Redeemable shares

• Entity A issues 1,000 shares with a par value of

Currency Unit (CU) 100 each. The holder of the
shares has the option to require Entity A to
redeem the shares at par at any given time.
• what would the shares have been classified?
• If the option to redeem the entity’s shares had
instead been at the discretion of the issuer, what
would the shares have been classified????

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Example: Mandatory dividends

• An entity issues preference shares with a par

value of CU 100 each. The preference shares are
non-redeemable but require the entity to make
annual dividend payments equal to a rate of 8%
on the par amount.

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Debt versus Equity

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Note

• Inventory
• PPE, Intangible
• Contract to buy/sell non-financial items
(held for the purpose of the receipt or
delivery of a non-financial)
• Liabilities/ assets not contractual in nature
Examples: income tax liabilities (IAS 12), constructive
obligations (IAS 37)

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Condition for Recognition as Equity:

Examples
Case A: Company X issues 1,000 units of mandatorily redeemable
preference shares (MRPS) with fixed redemption period for these
shares. Holders can also opt to redeem the shares at any time for a
fixed amount of cash
Answer: Issuer has no right to avoid delivering cash to settle its contractual
obligation. MRPS fails condition (a) above and is classified as a financial
liability. Dividend on MRPS is recognized as interest expense

Case B: Company Y enters into a contract to purchase oil by issuing a

variable amount of its own shares that is equivalent to the market value
of 1 million barrels of oil
Answer: Contract is non-derivative. Amount of obligation to be settled depends
on price of oil at settlement date. Obligation is settled by issuing a variable
number of its own shares indicates a financial liability. [Condition (b) above is
not met]
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Condition for Recognition as Equity:

Examples

Case C: Company Z issues 100 warrants to Company

S. Company Z will have to issue 100 units of its own
shares to Company S if the latter exercises the
warrants

Answer: Warrants are derivative instruments that are settled by Company Z

issuing a fixed quantity of its own shares in exchange for a fixed amount of
cash. For determining whether there is a contractual obligation to deliver cash
or another financial asset, it should be noted that an entity's own equity
instruments does not meet the definition of financial asset. The warrants meet
the conditions to be classified as an equity instrument.

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Example

• Entity A issues an instrument for which it

receives CU 100,000. Under the terms of
the issue, Entity A will repay the debt in 3
years time by delivering ordinary shares to
the value of CU 115,000.

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Example

• Entity B issues preference shares for CU 1,000.

The shares pay no interest and will be settled in 3
years time by Entity B delivering a number of its
own ordinary shares (which are correctly
classified as equity) as are equal to the value of
100 ounces of gold.

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Contingency Settlement Provision

• IAS 32:25 provides guidelines that a financial instrument is a

financial liability if the financial instrument contains contingency
settlement provisions
– Unavoidable obligation on part of issuer to deliver cash or financial
asset upon the occurrence or non-occurrence of certain future events
(e.g. revenue, net earnings, or a specified financial ratio) beyond the
control of issuer and holder of instrument
Except when:
a) The part of the contingent settlement provision that could require
settlement in cash or another financial asset is not genuine;
b) The issuer can be required to settle the obligation in cash or another
financial asset only in the event of liquidation of the issuer; OR
c) The instrument has all the features of a puttable instrument and meets
the conditions in para 16A and 16B of IAS 32
Then the financial instrument will be classified as equity.
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Công cụ tài chính phái sinh

(Derivative instrument)

• là các CCTC. Đó là một hợp đồng, mang

lại cho một bên là TSTC và đối với đối tác
khi đó CCPS này hoặc là nợ tài chính hay
VCSH.

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Công cụ tài chính phái sinh

(Derivative instrument)

• CCTC phái sinh là CCTC mà phải thỏa mãn

đồng thời 3 đặc điểm sau:
- Nhà đầu tư ban đầu không phải bỏ vốn đầu tư,
hoặc nếu có thì rất thấp so với HĐ cơ sở.
- giá trị của HĐ sẽ thay đổi theo thời gian và sự
thay đổi này tùy thuộc vào đối tượng cơ sở
(thuộc HĐ cơ sở).
- HĐ phái sinh được thanh toán trong tương lai.

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Công cụ tài chính phái sinh

(Derivative instrument)

• Có bốn loại căn bản:

- forward contract (HĐ kỳ hạn)
- future contract (HĐ tương lai)
- Options (HĐ quyền chọn)
- Swap (Hđ hoán đổi).

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Content

1. Introduction
2. Classification
3. Accounting
Accounting for
for financial
financial assets:
assets: (IFRS
(IFRS 9)
9)
4. Accounting for debt & equity
5. Accounting for compounds (issuer)- IAS 32

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Classification of financial assets

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(1) Contractual Cash Flow Characteristics Test

• The debt instrument meets the contractual cash flow

characteristic test when the contractual terms give rise to
payments of principal and interest only on specified dates.
– The principle and interest payments should be for credit
risk and time value of money in a lending arrangement. The
payments could include compensation for liquidity risk and
profit margin
– If the payments are related to other volatilities and risks
such as equity price risk, commodity price risk or volatility
risk, the debt instrument would not satisfy the contractual
cash flow characteristic test.

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Contractual Cash Flow Characteristics Test – Examples

Ex 1: A bond's contractual terms specify payments of principal & interest on principal

linked to an inflation index. The inflation link is not levered and the principal is
protected.
The bond meets the contractual cash flow characteristics test. The interest rate is reset to
"real" interest rate based on the inflation link.
Ex 2: A bond’s contractual terms specify payments of principal and interest on
principal linked to an equity index.
The bond does not meet the contractual cash flow characteristics test.
Ex 3: A bond's contractual terms specify payments of principal and interest on
principal that is reset for a three month term based on the current 3-month LIBOR
rate.
A floating rate bond meets the contractual cash flow characteristics test.
Ex 4: loan pays an inverse floating interest rate.
The loan does not meet the contractual cash flow characteristics test.
Ex 5: A bond pays a floating interest rate with an interest rate cap (trần Lãi suất). The
bond contains payments of both fixed interest rates and variable interest rates.
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The bond meets the contractual cash flow characteristics test.

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(2)Business Model Test

• An entity's business model refers to how it manages its financial assets in order
to generate cash flows.
– It could be generated by the entity collecting the contractual cash flows
from the asset itself, selling the financial asset or both
– Determined on portfolio basis and NOT on the individual instrument itself
or reporting entity level
– Factors to be considered include but not limited to:
• How the performance of the financial assets are reported to key
management personnel?
• How manager of the business are compensated (e.g. based on FV
changes of the financial assets management)?
• What are the frequency, timing, and volume of sales in prior periods?
• Modification of cash flows from floating rates to fixed rates via
derivatives (e.g. interest rate swaps) does not change the business
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model.

Business Model Test – Examples

Ex1: An entity holds quoted bonds to collect their principal and
interest but would sell the investments to fund capital
expenditures if the need arises.
The business model is to hold bonds to collect contractual CFs
as sale is expected to be infrequent (1)
Ex 2: An entity holds bonds to meet its daily liquidity needs. The
entity actively manages the returns on the bonds.
The business model is to both hold bonds to collect contractual
cash flows and for sale (2)
Ex 3: An entity manages its loans with the objective of realizing
cash flows through sale of the loans. The decisions are made
based on the fair values of the loans, which result in active
buying and selling of loans.
The business model is to hold the loans for sale (2)
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Classification of financial assets

Debt Equity
Instrument Instrument
Hold Hold
=> AC => FVPL
(FVPL*) (FVOCI*)

Hold or sell Trading

=> FVOCI => FVPL

*Optional and irrevocable 33

Classification of financial assets (IFRS 9)

No
Contractual cash flows solely Equity instrument: FVOCI
for principal and interest? option selected?

Yes
No
Business model: Held to Business model: Held to collect
collect contractual CF only? contractual CF and for sale?

No No
Yes Yes

Yes No Yes
FVPL option used? FVPL option used?

No
Yes

I. AMORTIZED COST II. FAIR VALUE through P/L III. FAIR VALUE through OCI

Reclassifications possible! 34

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Measurement financial assets

• IFRS 9 indicates three classifications of financial instruments:
Classification Initial Subsequent Gain or losses
recognition measurement
FVPL Fair value Fair value • Dividends to PL
• Cash Interest to PL
• FV change to PL
Amortized Fair value + Amortized cost • Effective interest to PL
cost transaction balance • Impairment loss to PL
costs
FVOCI Fair value + Fair value • Dividends to PL/ Effective
transaction interest to PL
costs • Recognised in OCI for FV
changes and in P/L for
impairment losses (debt)
• Foreign exchange
Compare vs. gains or
IFRS
loss to 9 here
OCI for equity and
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to PL for debt

Đo lường CCTC

• Giá trị hợp lý (Fair value): giá nhận được khi bán một tài sản
hay để thanh toán một khoản nợ phải trả trong giao dịch thông
thường giữa các bên tham gia thị trường tại ngày đo lường.
• Giá gốc phân bổ (Amortised cost) của TSTC hay NTC là giá
trị mà TSTC hay NTC này được đo lường khi ghi nhận ban
đầu trừ giá trị gốc đã hoàn trả, cộng/hay trừ khấu hao lũy kế
theo lãi suất thực của chênh lệch giữa giá trị ghi nhận ban đầu
và giá trị khi đáo hạn, và trừ đi bất cứ khoản tổn thất không thu
hồi được.

Lãi suất thực (The effective interest) là lãi suất để chiết khấu các
khoản phải trả hay thu về trong tương lai của CCTC tính cho cả kỳ hạn của
CCTC hay khi thích hợp tính cho kỳ ngắn nhất về giá trị ghi sổ ròng của
CCTC 36

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Accounting for financial assets

1/ Accounting for FA at Amortized cost

2/ Accounting for FA at FVPL
3/ Accounting for FA at FVOCI
4/ Reclassifications among categories
5/ Impairment

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1/Accounting for FA at amortized cost

Amortized Cost: Definition
The amount at which the financial asset is measured at initial
recognition minus the principal repayments, plus or minus the
cumulative amortisation using the effective interest method of any
difference between that initial amount and the maturity amount and,
for financial assets, adjusted for any loss allowance

• Effective interest rate (EIR)

– An entity need to estimate the expected cash flows taking into
consideration all the contractual terms of the financial instrument
(e.g. prepayment terms, extension terms, call and similar
options).
– The entity should NOT consider the expected credit losses
– The effective interest calculation itself includes all fees and
points paid or received between parties to the contract,
transaction costs, and all other premiums or discounts. 38

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Amortized Cost: Condition

• A financial asset is measured at amortized cost if:

1. The business model’s objective of holding the assets is to
collect contractual cash flows
2. The contractual terms of the financial assets provide only
principal and interest payments on specified dates

Prepayment is considered as payment of principal and interest if:

1. Prepayment term is not contingent on future events, e.g. term
offers protection from credit deterioration, change in control of
issuer and changes in tax laws
2. Prepayment represent unpaid amounts of principal and interest
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1/Accounting for FA at amortized cost

Dr Investment in debt security ……. XX,XXX

Dr Unamortized premium…………. XX,XXX
Cr Cash ………………………………. XX,XXX
Purchase of investment

Dr Cash ……………………………….. XX,XXX

Cr Interest income ……………………. XX,XXX
Recognition of interest income

Dr Interest income/amortized premium XX,XXX

Cr Unamortized premium …………. XX,XXX
Amortization of premium for first half-year

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Illustration 9.7- Measurement at amortized cost

 1/7/X4
 Investment (bond) cost......................................................$ 102.700
 Principal at maturity:........................................... ......$ 100.000
 Premium on purchase:...................................................$ 2.700
 Coupon rate:...................................................4,5%
 Cash interest income per annum:...................................$ 4.500
 Years to maturity from inception:..................6,5 years
 Effective interest rate:.......................................4,02%
 Cash interest income for half – year 20X4:......................$ 2.250
 Fair value at 31 Dec 20X4:............................................$ 104.000

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Illustration 9.7- Measurement at amortized cost

Amortized Unamortized Principal Ending gross carrying

Cash interest Effective interest premium premium premium amount
Date 4.50% 4.02%
(1) (2)=(6)*4,5% (3)=(7)*4,02% (4)=(2)-(3) (5) (6) (7)=(5)+(6)
1/7/X4 2,700 100,000 102,700
31/12/X4 2,250 2,064 186 2,514 100,000 102,514
31/12/X5 4,500 4,121 379 2,135 100,000 102,135
31/12/X6 4,500 4,106 394 1,741 100,000 101,741
31/12/X7 4,500 4,090 410 1,331 100,000 101,331
31/12/X8 4,500 4,074 426 905 100,000 100,905
31/12/X9 4,500 4,056 444 461 100,000 100,461
31/12/X10 4,500 4,039 461 (0) 100,000 100,000

Total 29,250 26,550 2,700

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2/Accounting for FA at FVTPL

• A financial asset is measured at FVTPL if
1. Not measured at amortized cost; and
2. Not measured at FVOCI

• Two sub-categories of FVTPL:

1. Financial instruments that are “held for trading:” A financial asset or a
financial liability is considered to be held for trading if there is an intention of
selling or repurchasing it in the near term, or if it is an item within a portfolio
for which there is evidence of a recent pattern of short-term profit-taking; and
2. Any financial asset or financial liability designated as an item in this category
at initial recognition. The designation is also referred to as the application of
the “fair value option:”

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2/ Accounting for FA at FVPL

• Journal entries for measurement at FVPL (debt security)

Dr Investment in debt equity ……. XX,XXX
Cr Cash ……………………………. XX,XXX
Purchase of investment

Dr Cash ………………………. ……. XX,XXX

Cr Interest income ……………….. XX,XXX
Cr Investment in debt security ….. XX,XXX
Year-
Recognition of interest income using effective interest method end
entries
Dr Investment in debt equity .……. XX,XXX
Cr Gain in fair value ………………….. XX,XXX
Recognition of increase in FV

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Illustration 9-11a- FA as FVPL – Debt security

Refer to details in Illustration 9-7

 Investment cost......................................................$ 102.700
 Principal at maturity:........................................... ......$ 100.000
 Premium on purchase:...................................................$ 2.700
 Coupon rate:...................................................4,5%
 Cash interest income per annum:...................................$ 4.500
 Years to maturity from inception:..................6,5 years
 Effective interest rate:.......................................4,02%
 Cash interest income for half – year 20X4:......................$ 2.250
 Fair value at 31 Dec 20X4:............................................$ 104.000

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Illustration 9-11a- FA as FVPL – Debt security

Refer to details in Illustration 9-7

 Investment cost......................................................$ 102.700
 Principal at maturity:........................................... ......$ 100.000
 Premium on purchase:...................................................$ 2.700
 Coupon rate:...................................................4,5%
 Cash interest income per annum:...................................$ 4.500
 Years to maturity from inception:..................6,5 years
 Effective interest rate:.......................................4,02%
 Cash interest income for half – year 20X4:......................$ 2.250
 Fair value at 31 Dec 20X4:............................................$ 104.000

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2/ Accounting for FA at FVPL

• Journal entries for measurement at FVPL (equity security)

Dr Investment in equity security … XX,XXX

Cr Cash ……………………………. XX,XXX
Purchase of equity security

Dr Investment in equity security … XX,XXX

Cr Gain/Loss in fair value ………… XX,XXX
Recognition of increase in fair value to profit/loss

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2/Accounting for FA at FVPL

• Journal entries for measurement at FVPL (equity security)

[continued]
Dr Gain/loss in FV ….……….……. XX,XXX
Cr Investment in equity security ….. XX,XXX
Recognition of decrease in fair value to profit/loss

Dr Cash ……………..….………. XX,XXX

Cr Investment in equity security ….. XX,XXX
Sale of equity security

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Illustration 9-11b- FA as FVPL – Equity security

Vào ngày 1/7/20X4, Cty Omega mua 10.000 cổ phiếu (shares) của cty
Delta với giá 2,8$/CP. Omega phân loại CP này vào nhóm FA –
FVTPL. Vào cuối năm tài chính (31/12/X4), giá cổ phiếu của Delta là
3,5$/CP. Ngày 31/3/X5, Omega bán toàn bộ cổ phiếu của Delta với giá
3,3$/CP.

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3/Accounting for FA at FVOCI

• A financial asset (debt security) is measured at FVOCI if:
1. The business model’s objective of holding the assets is to collect
contractual cash flows and for sale
2. The contractual terms of the financial assets give payments of
only principal and interest on specified dates
• FVOCI aims to provide amortized cost information in P/L and
FV carrying amount in the statement of financial position

Type Recognition
Interest income Profit and loss based on effective interest method
Derecognition of financial Cumulative gain or loss in OCI recycled from
asset equity to P/L
Recognised in OCI for FV changes and in P/L for
FV changes
impairment losses
FX differences OCI with other FV changes
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3/Accounting for FA at FVOCI

• Relevant Journal entries for measurement at FVOCI (debt

security)
Dr Investment in debt security (FVOCI) XX,XXX
Cr Cash ………………………………. XX,XXX
Purchase of investment

Dr Cash ………………………………. XX,XXX

Cr Interest income ……….…………. XX,XXX
Cr Investment in debt security(FVOCI) XX,XXX
Recognition of interest income using effective interest method

Dr Investment in debt security(FVOCI) XX,XXX

Cr Equity ……………………(OCI) XX,XXX
Fair value adjustment to equity (deferred gains)

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Illustration 9.9- Measurement at FVOCI

Refer to details in Illustration 9-7
 Investment cost......................................................$ 102.700
 Principal at maturity:........................................... ......$ 100.000
 Premium on purchase:...................................................$ 2.700
 Coupon rate:...................................................4,5%
 Cash interest income per annum:...................................$ 4.500
 Years to maturity from inception:..................6,5 years
 Effective interest rate:.......................................4,02%
 Cash interest income for half – year 20X4:......................$ 2.250
 Fair value at 31 Dec 20X4:............................................$ 104.000

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3/ Accounting for FA at FVOCI

FVOCI Equity Securities
• Equity securities that are not held for trading and not contingent
consideration recognized by the acquirer in a business combination for
which IFRS 3 applies can be measured at FVOCI if elected.
– Cumulative gain or loss in OCI CANNOT be recycled to P/L for
FVOCI equity securities. However, the entity may transfer the
cumulative gains or losses within equity.
– Foreign exchange differences arising from the equity instrument is
presented in OCI as equity instruments are not monetary items.
– Dividend income on such investments are recognized in profit or loss
unless it represents a recovery of part of the cost of investment.
– No requirement to test FVOCI equity securities for impairment

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3/Accounting for FA at FVOCI

• Relevant journal entries for FVOCI equity securities

Dr FVOCI Investment ………………. XX,XXX

Cr Cash ………………………………. XX,XXX
Purchase of FVOCI investment

Dr FVOCI Investment ……………. XX,XXX

Cr Equity ……………………..……. XX,XXX
Fair value adjustment to equity (deferred gain)

Dr Cash ………………………….……. XX,XXX

Cr FVOCI Investment ……………. XX,XXX
Sale of FVOCI investment

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FVOCI Equity Securities: Example

• On 1 June 20x4, Omega Company purchased 10,000 units of shares in Delta
Technology at $2.80 per share. Omega classified the investment as FVOCI. The
price of Delta Technology shares rose to $3.50 per share on 31 December 20x4,
the financial year-end of Omega. On 31 March 20x5, Omega sold all its shares in
Delta Technology at $3.30 per share.

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4/Reclassification among categories

Reclassifications: Amortized Cost to FVPL
• Reclassifications between categories (amortized cost, FVOCI or
FVPL) are prospective

• From amortized cost into FVPL

– The difference in FV and carrying amount on the
reclassification date is recognized as profit or loss.

• Journal entries for reclassification from amortized cost into FVTPL

Dr Investment in debt security …. XX,XXX
Cr Gain in fair value ………….….. XX,XXX
Recognition of difference between FV and carrying amount to
profit/loss on reclassification date

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4/Reclassification among categories

Reclassifications: FVPL to Amortized Cost

• From FVPL into amortized cost

– The FV at reclassification date is the new carrying amount
– Effective interest rate is recalculated based on the fair value at
the date of reclassification.

• Journal entries for reclassification from FVPL into amortized cost

Dr Unamortized premium …. XX,XXX
Cr Investment in debt security ... XX,XXX
Reclassification of investment in debt security to unamortized premium to
reflect the FV as the new carrying amount

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4/Reclassification among categories

Reclassifications: Amortized Cost to FVOCI
• From amortized cost into FVOCI:
– The difference in FV and carrying amount on the
reclassification date is recognized in other comprehensive
income.

• Journal entries for reclassification from amortized cost to

FVOCI
• Journal entries are similar to reclassification from
amortized costs to FVPL
• Except that the gains in FV are recognized in OCI instead
of profit or loss

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4/ Reclassification among categories

Reclassifications: FVTOCI to Amortized Cost
• From FVOCI into amortized cost:
– Cumulative gain or loss in OCI is adjusted against the FV at
reclassification date. Effective interest rate is not adjusted

• Journal entries for reclassification from FVOCI into amortized cost

Dr Fair value reserve (OCI) XX,XXX
Cr Investment in debt security XX,XXX
Adjust cumulative gain/loss in OCI to investment in debt security

Dr Unamortized premium XX,XXX

Cr Investment in debt security XX,XXX
Reclassification of investment in debt security to unamortized
premium to reflect the fair value as the new carrying amount

59

4/ Reclassification among categories

Reclassifications: FVPL to FVOCI

• From FVOCI to FVPL:

– Fair value at reclassification date becomes new carrying
amount. Cumulative gain or loss previously in OCI is
reclassified from equity to profit or loss as a reclassification
adjustment on reclassification date
• Journal entries for reclassification from FVOCI into FVPL
Dr Fair value reserves (OCI) XX,XXX
Cr Gain/loss in fair value XX,XXX
Adjust cumulative gain/loss in OCI to P/L as a reclassification adjustment

• From FVPL to FVOCI

− Fair value at reclassification date is the new carrying amount
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5/ Impairment of financial asset

Impairment requirements of IFRS 9 apply to:

 assets measured at amortised cost,
 assets measured at FVOCI with recycling,
 loan commitments (not at FVTPL),
 financial guarantee contracts (not at FVTPL),
 lease receivables (IFRS 16),
 contract assets (IFRS 15).

61

5/ Impairment of financial asset

FVOCI
Amortized Cost (debt
Instrument)

Recognized
Impairment is
OCI and not
shall reduce CA
reduce CA of
of FA
FA

Dr Impairment Dr Impairment
gain or loss (p/l) gain or loss (p/l)
Cr FA Cr OCI (Equity)

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Overview of the 3
approaches to impairment
Specific
Simplified
approach for
approach for
purchased or
certain trade
General originated
receivables,
approach credit-
contract assets
impaired
and lease
financial
receivables
assets.

63

General approach:
Three stage model ( three-bucket model)

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Simplified approach

 To assist entities that have less sophisticated credit risk

management systems, IFRS 9 introduced a simplified
approach under which entities do not have to track changes in
credit risk of financial assets (IFRS 9.BC5.104).
Instead, lifetime ECL are recognised from the date of initial
recognition of a financial asset (IFRS 9.5.5.15).
 The simplified approach is required for:
- trade receivables or contract assets (IFRS 15) and do not
contain a significant financing component
- lease receivables accounted for under IFRS 16 (IFRS 9.5.5.15)

65

Specific approach

for purchased or originated credit-impaired financial assets

For these assets, entity recognises only the
cumulative changes in lifetime ECL since initial
recognition of such an asset (IFRS 9.5.5.13-14).
Purchased or originated credit-impaired financial
asset is an asset that is credit-impaired on initial
recognition.

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Measurement of expected credit losses (ECL)

Definition of credit losses

Credit loss is the difference between all contractual cash flows that
are due to an entity in accordance with the contract and all the cash
flows that the entity expects to receive, discounted at the
original effective interest rate (EIR) or credit-adjusted EIR

Cash flows used in ECL measurement

 expected life of a financial instrument,
 all contractual terms of the financial instrument (e.g. prepayment,
extension, call and similar options),
 collaterals held,
 other credit enhancements integral to the contractual terms.

67

Measurement methodology

IFRS 9 does not give specific methodology requirements for

measuring ECL, instead it provides general guidance stating that the
measurement of ECL should reflect (IFRS 9.5.5.17):
a. an unbiased and probability-weighted amount that is determined
by evaluating a range of possible outcomes,
b. the time value of money, and
c. reasonable and supportable information that is available without
undue cost or effort at the reporting date about past events, current
conditions and forecasts of future economic conditions.
There are two common approaches to ECL measurement applied in
practice:
 loss rate approach
 adjusted Basel PD/LGD/EAD approach
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Simplified loss rate approach to lifetime ECL

suitable for non-financial entities (provision matrix)
. Under a loss rate approach, lifetime ECL are calculated using a
provision matrix which can be constructed using the following steps:
 receivables are segmented based on different credit loss patterns (e.g.
based on customer type, product type, geographical region, collateral
etc.),
 ageing of receivables is prepared (e.g. not past due, past due 1-30 days,
31-60 days, 90+ days)
 historical loss patterns are calculated and treated as a starting point is
estimating loss rate,
 historical data is adjusted to take into account reasonable and
supportable information that is available without undue cost or effort at
the reporting date about current conditions and forecasts of future
economic conditions.

69

Example: Lifetime ECL for trade receivables using a provision matrix

Entity A is a service provider and has 2 types of customers:

individual customers (B2C) and business customers (B2B). Entity A
believes that B2C / B2B segmentation best reflects credit loss
patterns. Sales are usually made on credit, therefore Entity A has a
significant balance of trade receivables outstanding at each reporting
date. As there is no significant financing component, Entity A
recognises lifetime ECL for all its trade receivables.

For the purpose of this example, loss rate is calculated based on

sales made in January of a given year. In real life, the loss rate
should be based on data from several months, but it cannot be too
old as it may yield outdated results. The illustrative calculation of
loss rate for B2C customers is presented below.
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Example: Lifetime ECL for trade receivables using a provision matrix

receivables
payments outstanding receivables ageing loss rate
sales in January 100,000 not overdue 2.0%
paid on time 50,000 50,000 overdue 1-30 days 4.0%
paid 1-30 days after due
date 27,000 23,000 overdue 31-60 days 8.7%
paid 31-60 days after due
date 15,000 8,000 overdue 61-90 days 25.0%
paid 61-90 days after due
date 6,000 2,000 overdue 91+ days - not paid at all 100.0%
As as 31 December 20X1, Entity A prepared ageing of its trade receivables and calculated
lifetime ECL as follows:
amount ageing loss rate ECL allowance
300,000 not overdue 2.0% 6,000
140,000 overdue 1-30 days 4.0% 5,600
60,000 overdue 31-60 days 8.7% 5,217
23,000 overdue 61-90 days 25.0% 5,750
5,000 overdue 91+ days 100.0% 5,000
27,567

71

Impairment (IFRS 9)

General approach Simplified approach

3 stages No stages (lots of assessment not necessary)

Loss allowance Loss allowance = life – time ECL

12-month ECL Life – time ECL  Trade receivables

 All financial assets subject  Contract assets (IFRS 15)
to impairment • Do not contain significant financing component
• Contain significant financing component, but
Except for: chosen to measure loss allowance at lifetime ECL
Trade receivables or  Lease receivables (IAS 17)
contract assets (IFRS 15)
without significant financing • if chosen to measure loss allowance at lifetime
component ECL

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General approach:
Three stage model ( three-bucket model)

73

12-month expected credit losses (ECL)

On 31 December 20X1, Entity A lends Entity B $100,000.

Entity B will repay the loan in 5 annual instalments
amounting to $25,000 (i.e. $125,000 in total). Calculation of
ECL will be based on PD/LGD/EAD model:
PD – probability of default (assessed by Entity A)
EAD – exposure at default (= amortised cost of the loan)
LGD – loss given default (i.e. what % of EAD will not be
recovered at default, this should take into account any collaterals
held)
Tham
khảo

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12/31/2001 (100,000)
Cash flows 12/31/2002 25,000
12/31/2003 25,000
of the loan: 12/31/2004 25,000
12/31/2005 25,000
12/31/2006 25,000
EIR 7.9% =XIRR(B17:B22,A17:A22)

opening balance interest in closing balance

year 1 Jan P/L cash flow 31 Dec
Schedule for 2002 100,000 7,926 (25,000) 82,926
amortised 2003 82,926 6,573 (25,000) 64,500
cost 2004 64,500 5,127 (25,000) 44,627
2005 44,627 3,537 (25,000) 23,164
2006 23,164 1,836 (25,000) (0)
PD PD Marginal
reporting date EAD (marginal) (cumulative) LGD EIR ECL 12- month
12/31/2001 100,000 3% 3% 80% 7.9% 2,224 ECL
12/31/2002 82,926 3% 6% 80% 7.9% 1,709 (discounted)
12/31/2003 64,500 3% 9% 80% 7.9% 1,231
12/31/2004 44,627 4% 13% 80% 7.9% 1,053
12/31/2005 23,164 4% 17% 80% 7.9% 506
lifetime ECL (discounted) 6,722
75

Illustration 9.7

 Investment date:………….1 July X4

 Investment cost......................................................$ 102.700
 Principal at maturity:........................................... ......$ 100.000
 Premium on purchase:...................................................$ 2.700
 Coupon rate:...................................................4,5%
 Cash interest income per annum:...................................$ 4.500
 Years to maturity from inception:..................6,5 years
 Effective interest rate:.......................................4,02%
 Cash interest income for half – year 20X4:......................$ 2.250
 Fair value at 31 Dec 20X4:............................................$ 104.000

Illustration 9.16
• In Illustration 9-7: As at 31/Dec/X4, the entity calculates the loss allowance based
on 12-month expected credit loss as there were no significant increases in
expected credit losses since the initial recognition on 1 July X4. The 12-month
ECL as at 31/12/X4 amounted to $ 2,000

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Illustration 9.7
Amortized Unamortized Principal Ending gross carrying
Cash interest Effective interest premium premium premium amount
Date 4.50% 4.02%
(1) (2)=(6)*4,5% (3)=(7)*4,02% (4)=(2)-(3) (5) (6) (7)=(5)+(6)
1/7/X4 2,700 100,000 102,700
31/12/X4 2,250 2,064 186 2,514 100,000 102,514
31/12/X5 4,500 4,121 379 2,135 100,000 102,135
31/12/X6 4,500 4,106 394 1,741 100,000 101,741
31/12/X7 4,500 4,090 410 1,331 100,000 101,331
31/12/X8 4,500 4,074 426 905 100,000 100,905
31/12/X9 4,500 4,056 444 461 100,000 100,461
31/12/X10 4,500 4,039 461 (0) 100,000 100,000

Total 29,250 26,550 2,700

Illustration 9.16:

31 Dec X4: Dr Impairment loss (P/L): 2.000

Cr- Loss allowance for bond: 2.000

31 Dec X4: Gross carrying value:.....102,514

Less: Loss allowance:.(2.000)
Amortized cost as 31 dec X4:.............100.514
77

Purchased or originated credit-impaired

financial asset and credit adjusted EIR

• For purchased or originated credit-impaired financial

assets, interest is calculated using credit-
adjusted effective interest rate (EIR). This means that
initial ECL are included in the estimated cash flows
when calculating EIR (IFRS 9.5.4.1(a); B5.4.7).

Tham
khảo

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Example: Purchased credit-impaired financial

asset and credit adjusted EIR

On 1 January 20X1, Entity X issues a bond with a face value of

$10,000 and a fixed annual coupon of $600 (i.e. 6%) payable on 31
December each year until maturity date, which is 31 December
20X6. In 20X2, Entity X run into financial difficulties and did not
pay the coupon due on 31 December 20X2 which resulted in
significant reduction in market prices of this bond. On 1 January
20X3, Entity A acquires this bond for $5,000 as it believes that
Entity X will be able to partially repay the face value on
redemption date. Entity A expects to receive $8,000 on 31
December 20X6, but it does not expect to receive any coupon
payments.
Tham
khảo
79

On 1 January 20X3, Entity A calculates credit adjusted EIR based on

expected cash flows that include initial ECL:
Contractual cash flows
Date Amount
Date Amount
1/1/2003 (5,000)
1/1/2003 600 <- past due coupon
1/1/2003 600
12/31/2003 600
12/31/2003 600
12/31/2004 600
12/31/2004 600
12/31/2005 600
12/31/2005 600
12/31/2006 10,600
12/31/2006 10,600
contractual EIR: 33%
Expected cash flows
Date Amount
Date Amount 1/1/2003 (5,000)
1/1/2003 - 1/1/2003 -
12/31/2003 - 12/31/2003 -
12/31/2004 - Tham
12/31/2004 -
12/31/2005 - khảo
12/31/2005 -
12/31/2006 8,000 12/31/2006 8,000
credit adjusted EIR: 12,5% 80

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Example (cont)

Let’s now assume that on 1 January 20X6 Entity A revises its

estimates and expects to receive $8,500, which it finally receives on
31 December 20X6. On 1 January 20X6, $8,500 to be received on
31 December 20X6 and discounted using the original credit-
adjusted EIR has a present value of $7,558. Under the original
accounting schedule presented above, the bond has a carrying value
of $7,113 on 1 January 20X6. Therefore, Entity A recognises an
impairment gain amounting to $445. The accounting schedule for
this bond is updated as follows:
Tham
khảo

81

Schedule for amortised cost using credit adjusted EIR

opening balance impairment closing balance
year 1 Jan gain interest in P/L cash flow 31 Dec
2003 5,000 - 623 - 5,623
2004 5,623 - 701 - 6,325
2005 6,325 - 789 - 7,113
2006 7,113 - 887 (8,000) (0)
On 1 January 20X6, Entity A revises its estimates and expects to receive 8.500
which it finally receives on 31 December 20X6.

Schedule for amortised cost using credit adjusted EIR - after revision to cash flows

opening balance impairment interest in closing balance

year 1 Jan gain P/L cash flow 31 Dec
2003 5,000 - 623 - 5,623
2004 5,623 - 701 - 6,325
2005 6,325 - 789 - 7,113
2006 7,113 445 942 (8,500) -

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Content

1. Introduction
2. Classification
3. Accounting for financial assets: (IFRS 9)
4. Accounting
4. Accounting for
for debt
debt &
& equity
equity
5. Accounting for compounds (issuer)- IAS 32

83

4.1. Transactions in own equity

liability

Transactions in own equity

EQUITY RESIDUAL

Settled by the entity receiving or Exchanging a fixed number of its

delivering a fixed number of its own own shares for a fixed amount of
shares for no future consideration cash or other financial assets

LIABILITY LIABILITY EQUITY

# own shares own shares for 100 own shares
$100K

Any consideration paid/received Deducted / added directly to equity

Changes in FV Not recognized
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Transactions in own equity- example -1

During the year 20Z4, Raiser issued 100 000 warrants at 6 cents each. The warrant
gives its holders the right to purchase 1 ordinary share of Raiser for 1 EUR, but the
warrant expires on 31 December 20Z5. At the time of issue, the market value of
Raiser's shares was 1.10 EUR per share.
By 31 December 20Z5, warrant holders exercised 75 000 warrants.
How should these transactions be recognized in the financial statements of Raiser at
the time of issue and as of 31 December 20Z5?
Note: 1 share has a nominal value of 70 cents.

1. Initial recognition of warrant

Classification of warrant: own shares + fixed amount => equity instrument

Warrant premium: 0.06

N. of warrants: 100,000
Total consideration received: 6,000

85

4.2. Treasury shares

Treasury
= own shares of an entity

ASSET = own shares of an entity

Purchase of own shares:

Debit – Equity
Credit: Cash/Payable

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4.3.Interest, dividends, gain and loss

LIABILITY EQUITY

Profit or loss Equity

Example: - Dividends payable on mandatorily - Dividends payable on
redeemable preference shares ordinary shares

Dividends – preference shares:

Debit: Financial expenses
Credit: Cash/payable

Dividends – ordinary shares

Debit: Equity
Credit: cash/payable
87

Accounting financial liability

Example 2
•On 1 January 20X1, Raiser plc. took a loan from BeeBank (at market
conditions) amounting to 50 mil. with the interest of 7% p.a. to be paid in
arrears on 31 December each year. Final maturity of the loan is on 31
December 20X7 and Raiser paid the fee of 500 000 covering the bank's
costs for assessment of Raiser's financial situation, opening the loan
facility and drafting the loan contract.
•During 20X5, Raiser suffers financial difficulties and the bank agrees to
modify the existing loan. On 1 January 20X6, new terms are agreed as
follows:
•- Raiser will not pay any interest for the years 20X6 and 20X7
•-from 20X8, Raiser will pay the interest of 8.5%
•-the final maturity date is postponed to 31 December 20X10
•- Raiser needs to pay the fee of 400 000 related to the modification of the
loan contract.
•How should this transaction appear in the financial statements of Raiser?
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Example 2: Solution

1. Original effective interest rate

Year Cash flow Liability b/f Interest Cash paid Liability c/f
1-Jan-
20X1 0 49,500,000 49,500,000
20X1 1 -3,500,000 49,500,000 3,557,448 -3,500,000 49,557,448
20X2 2 -3,500,000 49,557,448 3,561,576 -3,500,000 49,619,024
20X3 3 -3,500,000 49,619,024 3,566,002 -3,500,000 49,685,026
20X4 4 -3,500,000 49,685,026 3,570,745 -3,500,000 49,755,771
20X5 5 -3,500,000 49,755,771 3,575,829 -3,500,000 49,831,600
20X6 6 -3,500,000 49,831,600 3,581,279 -3,500,000 49,912,880
20X7 7 -53,500,000 49,912,880 3,587,120 -53,500,000 0
7.19%

Effective interest rate

Formula used:
=IRR(C16:C23)
89

Example 2: Solution

2. PV of CF under new terms

Year Cash flow Discount factor Present value

1-Jan-
20X6 0 -400,000 1.000 -400,000
20X6 1 0 0.933 0
20X7 2 0 0.870 0
20X8 3 -4,250,000 0.812 -3,451,163
20X9 4 -4,250,000 0.758 -3,219,766
20X10 5 -54,250,000 0.707 -38,343,695
-45,414,624

Discount factor
Formula used:
=1/(1+7.19%)^year

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Example 3:

The same example as before - however, the new terms are agreed on 1 January
20X6 as follows:
- Raiser will not pay any interest for the years 20X6 and 20X7
-from 20X8, Raiser will pay the interest of 13%
-the final maturity date is postponed to 31 December 20X13
- Raiser needs to pay the fee of 400 000 related to the modification of the loan
contract.
Fair value of the new loan based on the similar loans is 50 500 000.
How should this transaction appear in the financial statements of Raiser?

91

Example 3: Solution

1. Original effective interest rate

Year Cash flow Liability b/f Interest Cash paid Liability c/f
1-Jan-
20X1 0 49,500,000 49,500,000
20X1 1 -3,500,000 49,500,000 3,557,448 -3,500,000 49,557,448
20X2 2 -3,500,000 49,557,448 3,561,576 -3,500,000 49,619,024
20X3 3 -3,500,000 49,619,024 3,566,002 -3,500,000 49,685,026
20X4 4 -3,500,000 49,685,026 3,570,745 -3,500,000 49,755,771
20X5 5 -3,500,000 49,755,771 3,575,829 -3,500,000 49,831,600
20X6 6 -3,500,000 49,831,600 3,581,279 -3,500,000 49,912,880
20X7 7 -53,500,000 49,912,880 3,587,120 -53,500,000 0
7.19%

Effective interest rate

Formula used:
=IRR(C13:C20)
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Example 3: Solution

1. Original effective interest rate

Year Cash flow Liability b/f Interest Cash paid Liability c/f
1-Jan-
20X1 0 49,500,000 49,500,000
20X1 1 -3,500,000 49,500,000 3,557,448 -3,500,000 49,557,448
20X2 2 -3,500,000 49,557,448 3,561,576 -3,500,000 49,619,024
20X3 3 -3,500,000 49,619,024 3,566,002 -3,500,000 49,685,026
20X4 4 -3,500,000 49,685,026 3,570,745 -3,500,000 49,755,771
20X5 5 -3,500,000 49,755,771 3,575,829 -3,500,000 49,831,600
20X6 6 -3,500,000 49,831,600 3,581,279 -3,500,000 49,912,880
20X7 7 -53,500,000 49,912,880 3,587,120 -53,500,000 0
7.19%

Effective interest rate

Formula used:
=IRR(C13:C20)
93

Example 3: Solution

2. PV of CF under new terms

Year Cash flow Discount factor Present value

1-Jan-
20X6 0 -400,000 1.000 -400,000
20X6 1 0 0.933 0
20X7 2 0 0.870 0
20X8 3 -6,500,000 0.812 -5,278,249
20X9 4 -6,500,000 0.758 -4,924,348
20X10 5 -6,500,000 0.707 -4,594,175
20X11 6 -6,500,000 0.659 -4,286,141
20X12 7 -6,500,000 0.615 -3,998,759
20X13 8 -56,500,000 0.574 -32,427,928
-55,909,600

Discount factor
Formula used:
=1/(1+7.19%)^year 94

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Example 3: Solution

3. Comparison as of 1 January 20X6

PV of original financial liability: 49,831,600

PV of new financial liability: 55,909,600
Difference: 6,078,000
Difference in %: 12.20%

Accounting for
extinguishment

95

Example 3: Solution

4. Loan under new terms

Year Cash flow Liability b/f Interest Cash paid Liability c/f
20X5 0 50,500,000 50,500,000
20X6 1 0 50,500,000 4,402,126 0 54,902,126

20X7 2 0 54,902,126 4,785,863 0 59,687,988

20X8 3 -6,500,000 59,687,988 5,203,050 -6,500,000 58,391,038
20X9 4 -6,500,000 58,391,038 5,089,994 -6,500,000 56,981,032
20X10 5 -6,500,000 56,981,032 4,967,083 -6,500,000 55,448,115
20X11 6 -6,500,000 55,448,115 4,833,457 -6,500,000 53,781,572
20X12 7 -6,500,000 53,781,572 4,688,183 -6,500,000 51,969,755
20X13 8 -56,500,000 51,969,755 4,530,245 -56,500,000 0
8.72%

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Content

1. Introduction
2. Classification
3. Accounting for financial assets: IFRS 9
4. Accounting for debt & equity
5. Accounting
5. Accountingforforcompounds
compounds(issuer)- IASIAS
(issuer)- 32 32

97

Compound Financial Instruments

Definition of compound financial instruments

Instruments that have both debt
Non-derivative host instrument and
(host) or equity (embedded
embedded derivative
derivative) instruments
Accounting standards

IAS 32: Accounting from the issuer’s IFRS 9: Accounting from the
perspective investor’s perspective

Example of convertible bond (option to convert it into ordinary shares)

Issuer’s perspective
Investor’s perspective
Lower coupon rate leads to lower
Investor willing to accept lower
cash outflow and potential dilution in
coupon rate in return for right to
EPS should holders exercise
exercise the equity option
conversion right
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Accounting from Holder’s Perspective

• Under IFRS 9, compound financial assets are not bifurcated

– The entire instrument is classified on basis of their business
model and contractual cash flow characteristics
– Generally, the embedded derivative with its host instrument
is likely to contain cash flows that are NOT solely
payments of principal and interest and it will fail the
contractual cash flow characteristic test. Therefore, the
hybrid instrument would NOT qualify for amortized cost
measurement and would be FVTPL

99

Accounting from the Issuer’s Perspective

• IAS 32:28 requires an issuer to evaluate the terms of a

non-derivative financial instrument to determine if it
contains both a liability and an equity component
– If so, the components should be classified separately (i.e. the
financial liability and its equity element are bifurcated)
– On initial recognition, the issuer re-measure the FV of the
liability first, the equity component is the residual (total
proceeds – FV of the liability)

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Accounting from the Issuer’s Perspective

Compound financial instruments

= non-derivative financial instrument with both LIABILITY and Equity element

Conventional loan Call option to shares

Example: convertible bond

1. Set FV of the whole instrument

2. Calculate the FV of the liability

Classify + present separately component
3. FV of equity = 1-2
At the issuance + not revised!
101

Illustration 1: Initial Recognition of Debt and Equity

Scenario
• Convertible bond issued at par on 1 Jan 20x0
• Nominal value of $100,000.000
• Repayable at 31 December 20x3
• Annual coupon at 4% per annum
• Interest payments were paid at the end of each half-
yearly period (2% per half-year)
• Convertible at $1 of bond to 0.75 ordinary shares

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Illustration 1: Incremental Method of Allocation between Debt

and Equity Components

Debt Component

PV of interest payment (2,000,000 x PVIFA3%,8) ……. $14,039,380

PV of principal at maturity (100,000,000 x PVF3%,8) .. 78,941,000
PV of debt component …….……………………………. $92,980,380

Note:
1. Discount rate based on effective market interest rate of 3%
2. PVIFA3%,8 is PV of ordinary annuity at 3% for 8 (semi-annual)
periods
3. PVF3%,8 is the PV of $1 at the end of period 8 at 3% discount

103

Illustration 1: Incremental Method of Allocation between Debt

and Equity Components

Equity Component
Value of equity = $100,000,000 – Value of debt component
= $100,000,000 – $92,980,380
= $7,019,620

Note:
Both equity value and bond discount are the difference between nominal
amounts and PV of debt.

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Illustration 1: Incremental Method of Allocation between Debt

and Equity Components

Interest expense
• Should reflect the effective borrowing cost of the bond after taking into
account the issuer’s risk characteristics
• Effective interest rate = market interest rate at time of issue
• Coupon interest payment is < than market rate and does not reflect true cost of
capital
• Interest expense will be understated; and net earnings will be overstated, if it
is recorded based on coupon rate
• Implicit exchange of equity rights for a lower coupon rate
• Reduction in interest rate is not a “free lunch”
– Income statement should reflect the economic cost of borrowing
– Effective interest expense:
 Coupon interest expense + amortization of discount on the bond

105

Illustration 1: Amortization Schedule of Bond Discount

Date Cash Effective Amortized Unamortize Carrying

interest interest discount d discount amount

1 Jan 20x0 $7,019,620 $92,980.380

30 Jun 20x0 $2,000,000 $2,789,411 $789,411 6,230,209 93,769,791
31 Dec 20x0 2,000,000 2,813,094 813,094 5,417,115 94,582,885
30 June 20x1 2,000,000 2,837,487 837,487 4,579,628 95,420,372
31 Dec 20x1 2,000,000 2,862,611 862,611 3,717,017 96,282,983
30 June 20x2 2,000,000 2,888,489 888,489 2,828,528 97,171,472
31 Dec 20x2 2,000,000 2,915,144 915,144 1,913,384 98,086,616
30 June 20x3 2,000,000 2,942,598 942,598 970,786 99,029,214
31 Dec 20x3 2,000,000 2,970,786 970,786* 0 100,000,000
Total $16,000,000 $23,019,620 $7,019,620

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Journal Entries Pertaining to Amortization of Bond

Dr Amortization of discount (I/S) ……….. XX,XXX

Cr Unamortized discount (B/S) ………… XX,XXX
Amortization of discount for first half-year

Dr Interest expense (I/S) ………………... XX,XXX

Cr Cash (B/S) ……………………………. XX,XXX
Cash interest paid
Or combined as follows
Dr Interest expense (I/S) ………………... XX,XXX
Cr Cash (B/S) ……………………………. XX,XXX
Cr Unamortized discount (B/S) ………… XX,XXX
Interest paid for period ended 30 June 20x0

107

Partial Conversion of a Bond before Maturity

• Convertible bonds are exercised if there is economic interest (e.g. when

stock price has appreciated considerably and when conversion will yield
immediate capital gain)

The following are recorded when partial conversion occurs:

1. Issue of paid-up shares on conversion,
2. The balance in the unamortized discount on the bond that is adjusted
proportionately
3. A proportionate amount of capital reserve that is transferred to issued
share capital
4. The carrying value of the bond attributable to the partial conversion is
derecognized

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Illustration 2: Amortization Schedule with Partial Conversion

Date Cash Effective Amortized Unamortize Carrying

interest interest discount d discount amount

1 Jan 20x0 $7,019,620 $92,980.380

30 Jun 20x0 $2,000,000 $2,789,411 $789,411 6,230,209 93,769,791
31 Dec 20x0 2,000,000 2,813,094 813,094 5,417,115 94,582,885
30 June 20x1 2,000,000 2,837,487 837,487 4,579,628 95,420,372
Partial (915,926) (19,084,074)
conversion
31 Dec 20x1 1,600,000 2,290,089 690,089 2,973,613 77,026,387
30 June 20x2 1,600,000 2,310,792 710,792 2,262,821 77,737,179
31 Dec 20x2 1,600,000 2,332,115 732,115 1,530,706 78,469,294
30 June 20x3 1,600,000 2,354,079 754,079 776,627 79,223,373
31 Dec 20x3 1,600,000 2,376,701 776,627 0 80,000,000

109

Journal Entries Pertaining to Conversion of Bond

Conversion of bond as at 30 June 20x1

Dr 4% Bond payable 20,000,000 (20%
x $100 million)
Dr Capital reserve – Equity options 1,403,924 (20% x
$7,019,620)
Cr Ordinary shares 20,487,998
(Residual)
Cr Unamortized discount on bond 915,926
Conversion of bond to equity

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Redemption of Compound Financial Instruments

• The issuing firm may wish to redeem the instrument if there

are interest rate changes subsequent to the issue of a
compound financial instrument.
– E.g. if I/R had fallen significantly since the date of issue,
the issuing firm could redeem the instrument and reissue
another one with a lower I/R (make economic sense to save
interest expense)
– IAS 32 AG33 guides accounting for redemption.
– The consideration paid and transaction costs are allocated
to the liability and equity components of instrument at
transaction date.

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