Financial Instruments

Chapter 21
IFRS 9 (classification,
measurement), IAS 32
(definitions) and IFRS 7
(disclosure requirements)
Definition
Classification
Recognition (initial and
subsequent)
Disclosure 1
Introduction
Financial markets use a variety of
financial instruments (FI).
Inform users of Financial
Statements of the nature and
extent of related risks and how
those risks are managed.

2
Definitions
FINANCIAL INSTRUMENT:
Any contract
Gives rise to a FA for one entity &
FL or Equity instrument in another entity

EQUITY INSTRUMENT:
Net assets (A less L)
Any contract that results in a
Residual interest in the assets of an entity,
after deducting all of its liabilities
3
Financial Asset
FINANCIAL ASSET (FA):
 Cash;
 Equity instrument of another entity or
 Contractual right to:
◦ Receive cash or another FA from another entity;
◦ Exchange FA/FL under conditions that are potentially favourable; or
◦ Contract that will be settled in the entity’s own equity instruments

EXAMPLES (example 1 and 2):

 Cash, Trade receivables, Bills receivable, Loans receivable 
(Contractual right to receive payment of cash from debtor)
and investments in equity instruments, Bank deposit
(Contractual right of depositor to obtain cash from
institution), investments in shares, bonds, instruments,
accounts receivable and loans.

4
Definitions
FINANCIAL LIABILITY (FL):
 Any liability that is:
◦ Contractual obligation to deliver cash or to deliver another
FA to another entity, or
◦ Contractual obligation to exchange FI on potentially
unfavourable terms, or
◦ Contract that may or will be settled in the entity’s own
equity instruments.

EXAMPLES (example 20):

 Trade payables, Bills payable, Loans payable  (entity
contractually obligated to settle the creditor with
cash) and Debentures, Compulsory redeemable
preference shares, issue of debentures and other debt
instruments, accounts payable and loans

5
 Equity instruments vs debt
instruments
Equity instruments Debt instruments
An investment in another entity's equity instruments, An investment in an instrument where returns to the
other than non-convertible preference shares and holder are a fixed amount, there is a fixed (or
non-puttable ordinary and preference shares. variable) rate of return over the life of the instrument,
and contractual provisions stipulate the repayment
Examples: conditions of the principal amount.
Investments in listed and/or unlisted shares, options
and forward contracts, investments in convertible Examples:
debt. Trade accounts and loans receivable,and
investments in bonds and in preference shares that
have a fixed date of redemption.

6
Recognition at acquisition
date
For all financial assets:
• At fair value
• Including transaction costs
(except for assets at fair value
through profit or loss)

7
Subsequent measurement
At amortised cost = where future economic
benefits are from contractual cash flows,
instrument should have characteristics of
payment of future cash flows and intention
to hold until maturity/redemption.
At fair value, fair value adjustments for
DEBT instruments recognised in OCI.
At fair value, fair value adjustments for
EQUITY instruments recognised in OCI.
At fair value through profit or loss = for
those assets where future economic
benefits are from sale.
8
Classifications of FA
Two tests to consider:

1. Contractual cash flow characteristics (CCF

test)
◦ Cash flows occur on specific dates
◦ Relate to a repayment of principal sum & interest
◦ Equity instruments fail this test as there are no set
contractual cash flows (dividends are voluntary)
◦ Debt instruments generally pass this test.
◦ If FA does not meet the CCF test:
 FV through P/L
◦ If FA does meet the CCF test:
 Move on to the BM test

9
Classifications of FA
2. Business model (BM test)
◦ Intention of entity in holding FA to
 Sell = FV through P/L or
 Collect = FA at amortised cost or
 Sell & collect the contractual cash flows = FV
through OCI DEBT
◦ Entity does not intend dealing in financial
instruments
◦ If classification at AC or FVOCI would cause
an accounting mismatch = FV through P/L
 Must be determined on initial recognition
 Irrevocable (can’t change)

10
Accounting mismatch
Gains and losses of a FA and
corresponding FL are recognised
in different periods using differing
bases due to one being measured
at FV and the other at amortised
cost.
May choose to designate as FV
through P/L but:
◦ Initial recognition
◦ Irrevocable (can’t change)
11
Classification of FA – Amortised
Cost
Only applies to investments in
DEBT instruments
BOTH CCF test and BM (collect)
test must be met.
Remember: If accounting
mismatch = FV through P/L
instead!

12
Classification of FA – FV through
OCI (DEBT instruments)
Only applies to investments in
DEBT instruments
BOTH CCF test and BM (sell &
collect) test must be met.
Remember: If accounting
mismatch = FV through P/L
instead!

13
Classification of FA – FV through
OCI (EQUITY instruments)
May elect to classify as FV through OCI
(EQUITY) if FA is:
◦ Investment in EQUITY instruments that is
 NOT held for trading
 NOT contingent consideration in an IFRS 3 business
combination
May choose to designate as FV through OCI
(EQUITY) but:
◦ Initial recognition
◦ Irrevocable (can’t change)
Reclassification to P/L is prohibited.
If do not elect to classify as FV through OCI
(EQUITY) then use FV through P/L as default.
14
Classification of FA – FV through
P/L
Last resort – cannot be classified
as AC nor FV through OCI.

15
Measurement
 Wehave 2 basic measurement models
available for financial instruments:
◦ Fair value
 The price that would be
 Received to sell an asset or
 Paid to transfer a liability
 In an orderly transaction between market participants
 At measurement date
◦ Amortised cost
 The amount at which the FA/FL is measured at initial
recognition minus the principal repayments
 Less / Add: cumulative amortisation using the effective
interest rate method to account for the difference
between the initial amount and maturity amount.
 NB for FA: adjustments are also made for any loss
allowance
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 Measurement - FA
Initial measurement:
◦ Fair value
◦ May require adjustment for
transaction costs
Classification Initial measurement
FV through P/L Fair value *
FV through OCI (DEBT or Fair value + Transaction costs
EQUITY)
Amortised cost Fair value + Transaction costs
* For FV through P/L, transaction costs are EXPENSED

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Transaction costs
Transaction costs are:
◦ Incremental costs that are
◦ Directly attributable to the
acquisition, issue or disposal of a
FA/FL
An incremental cost is one that:
◦ Would not have been incurred
◦ If the entity had not acquired, issued
or disposed of the financial
instrument
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Measurement of FA – Amortised
Cost
Initially measured at FV plus transaction
cost
Subsequently measured by using the
effective interest rate and need to take
into account any loss allowances/tested for
impairment
◦ Rate that discounts future cash flows to the net
carrying amount (present value)
All gains/losses recognized in P/L
If tested, students will be given the
effective interest rate i.e. you will not be
required to calculate the rate
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Example 6
 Eternity Ltd purchased 10% debentures for
R200 000 on 1 Jan 20X5, (redeemable at
R250 000 on 31 Dec 20X7).
 They intended to hold them to collect contractual cash
flows.
 Transaction costs were 1% of the cost.
 The fair value on 31 Dec 20X5 was
R260 000 and on 31 Dec 20X6 was
R280 000.
 The asset was not considered to be credit-impaired at any
stage.
 The relevant expected credit losses were as follows:
◦ 1 Jan 20X5 = R7 000
◦ 31 Dec 20X5 = R10 000
◦ 31 Dec 20X6 = R12 000
 Required: Prepare the journal entries for 31 Dec X5 and
X6.
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 Effective interest rate: 16,6386%
Solution 6: Effective interest
rate table
Step 1: Debt or equity instrument? Debentures = debt
instrument
Step 2: FA or FL? FA
Step 3: Classify
Intention to collect = FA at amortised cost
Step 4: Initial measurement
FV + transaction cost = R200 000 + (1% x R200
000) = R202 000
Step 5: Effective interest rate table
Step
Date6: Journalise
O/B Interest Receipts C/B
31 Dec 202 000 33 610 (20 000) 215 610
X5 (step 3)
31 Dec 215 610 35 874 (20 000) 231 484
X6
31 Dec 231 484 38 516 (20 000) 250 000
X7
(250 000) 21
Solution 6
1 January 20X5
DR FA: Debentures (SOFP) 202 000
CR Bank (SOFP) 202 000
Purchase of debentures (200 000 + 2 000)
DR Impairment loss (P/L) 7 000
CR FA: Debentures: Loss 7 000
allowance (SOFP)
Recognise loss allowance for X5
31 December 20X5
DR Bank (SOFP) 20 000
CR Interest income (P/L) 33 610
DR FA: Debentures (SOFP) 13 610
Interest earned on debentures for X5
DR Impairment loss (P/L) 3 000
CR FA: Debentures: Loss 3 000 22
Solution 6
31 December 20X6
DR Bank (SOFP) 20 000
CR Interest income (P/L) 35 874
DR FA: Debentures (SOFP) 15 874
Interest earned on debentures for X5
DR Impairment loss (P/L) 2 000
CR FA: Debentures: Loss 2 000
allowance (SOFP)
Remeasuring loss allowance for end of X5 (increase)

23
FV through OCI (DEBT)
Initially
measured as if it were at
amortised cost (start with FV + transaction
costs) using effective interest rate.
Subsequently measured at fair value at
each reporting date
Changes in value accounted for as follows:
◦ Fair value adjustments recognised in OCI will be
reclassified to P/L when the FA is derecognized
◦ Any other changes recognized directly in P/L
Must account for loss allowances and test
for impairment

24
FV through OCI (DEBT)
Step 1: Measure FA as if it was at
amortised cost, recognise interest
income and foreign gains/losses in P/L
Step 2: Recognise the loss allowance to
reflect the expected credit losses in
OCI. Recognise changes in loss
allowance in P/L
Step 3: Remeasure to FV at the end of
each reporting date in OCI. This amount
will be reclassified to P/L when it is
derecognised
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Example 8
 Eternity Ltd purchased 10% debentures for
R200 000 on 1 Jan 20X5, (redeemable at
R250 000 on 31 Dec 20X7).
 The debentures will be classified as FV through OCI
(DEBT)
 Transaction costs were 1% of the cost.
 The fair value on 31 Dec 20X5 was
R260 000 and on 31 Dec 20X6 was
R280 000.
 The asset was not considered to be credit-impaired at any
stage.
 The relevant expected credit losses were as follows:
◦ 1 Jan 20X5 = R7 000
◦ 31 Dec 20X5 = R10 000
◦ 31 Dec 20X6 = R12 000
 Required: Prepare the journal entries for 31 Dec X5 and
X6.
26
 Effective interest rate: 16,6386%
Solution 8: Steps
Step 1: Debt or equity instrument? Debentures = debt
instrument
Step 2: FA or FL? FA
Step 3: Classify
FV through OCI (DEBT)
Step 4: Initial measurement
FV + transaction cost = R200 000 + (1% x R200
000) = R202 000
Step 5: Effective interest rate table
Step
Date6: Journalise
O/B Interest Receipts C/B
31 Dec 202 000 33 610 (20 000) 215 610
X5 (step 3)
31 Dec 215 610 35 874 (20 000) 231 484
X6
31 Dec 231 484 38 516 (20 000) 250 000
X7
(250 000) 27
Solution 8
1 January 20X5
DR FA: Debentures (SOFP) 202 000
CR Bank (SOFP) 202 000
Purchase of debentures (200 000 + 2 000)
DR Impairment loss (P/L) 7 000
CR FA: Debentures: Loss 7 000
allowance (OCI)
Recognise loss allowance for X5

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Solution 8
31 December 20X5
DR Bank (SOFP) 20 000
CR Interest income (P/L) 33 610
DR FA: Debentures (SOFP) 13 610
Interest earned on debentures for X5
DR Impairment loss (P/L) 3 000
CR FA: Debentures: Loss 3 000
allowance (OCI)
Remeasuring loss allowance for end of X5 (increase)
DR: FA: Debentures (SOFP) 44 390
CR FV gain (OCI) 44 390
Increase in FV of debentures (260 000 – 215 610 [202 000
+ 13 610])

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Solution 8
31 December 20X6
DR Bank (SOFP) 20 000
CR Interest income (P/L) 35 874
DR FA: Debentures (SOFP) 15 874
Interest earned on debentures for X5
DR Impairment loss (P/L) 2 000
CR FA: Debentures: Loss 2 000
allowance (OCI)
Remeasuring loss allowance for end of X5 (increase)
DR: FA: Debentures (SOFP) 4 126
CR FV gain (OCI) 4 126
Increase in FV of debentures (280 000 – 275 874 [260 000
+ 15 874])

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FV through OCI (EQUITY)
Initiallymeasured at FV +
transaction costs
Recognise at fair value at each
subsequent reporting date
Fair value adjustments
recognised in OCI that may
NEVER be reclassified to P/L
Dividend income recognized in
P/L
No loss allowances and not
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Example 10
 Stubborn Limited invested in 1 000 shares of
Help-us Limited on 1 Jan 20X8. Each share cost
R100. Broker fees cost R8 000.
 On initial recognition the management of
Stubborn Limited elected to present the FV
changes of the equity investment in OCI.
 Help-us declared dividends of R1 per share on 15
Dec 20X8. The dividend had not yet been
received.
 At 31 Dec 20X8, the investment had a fair value
of R120 000.
 On 5 Jan 20X9, the dividend was received.

 Required:
Prepare the journal entries for the year
ended 31 Dec 20X8 and 20X9 32
Solution 10: Steps
Step 1: Debt or equity instrument? Shares = equity
instrument
Step 2: FA or FL? FA
Step 3: Classify
FV through OCI (EQUITY)
Step 4: Initial measurement
FV + transaction cost = R100 000 + R8 000 = R108
000
Step 5: Journalise

33
Solution 10
1 January 20X8
DR FA: Investment (SOFP) 100 000
CR Bank (SOFP) 100 000
Investment in financial asset.
DR: FA Investment (SOFP) 8 000
CR Bank (SOFP) 8 000
Transaction costs capitalised (FV through OCI).
15 December 20X8
DR Div Receivable (SOFP) 1 000
CR Dividend income (P/L) 1 000
Dividend income earned.

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Solution 10
31 December 20X8

DR: FA Investment (SOFP) 12 000

CR Gain on FA (OCI) 12 000

FV change at year end.

(R120 000 FV – R108 000 Books)
5 January 20X9

DR Bank (SOFP) 1 000

CR Dividend receivable (SOFP) 1 000

Dividends receivable for the year.

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FV through P/L
Initiallymeasured at FV (transaction
costs are expensed)
Recognise at fair value at each
subsequent reporting date.
Fair value adjustments recognised in
profit or loss, closed off to retained
earnings
Dividend income recognized in P/L
No loss allowances and not tested for
impairment
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Example 11
 Grime Limited purchased 25 000 shares at a
total cost of R25 000 on 1 Nov 20X5.
 At 30 Dec 20X5, a dividend of R1 000 was
declared.
 At year end, 31 Dec 20X5, the FV of the shares
was R55 000. Grime Ltd purchased these
shares with the intention to sell in the short
term (i.e. shares are held for trading  FV
through P/L).
 Initial directly attributable costs amounted to
R2 500.

 Required: Prepare the journal entries.

37
Solution 11: Steps
Step 1: Debt or equity instrument? Shares = equity
instrument
Step 2: FA or FL? FA
Step 3: Classify
Held for trading = FV through P/L
Step 4: Initial measurement
FV = R25 000
Transaction costs expensed = R2 500
Step 5: Journalise

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Solution 11
1 November 20X5

DR FA: Investment (SOFP) 25 000

CR Bank (SOFP) 25 000

Purchase of shares – FVTPL as the shares are held for trading.

DR Transaction costs (P/L) 2 500

CR Bank (SOFP) 2 500

Payment of transaction costs.

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Solution 11
30 December 20X5

DR Div Receivable (SOFP) 1 000

CR Dividend income (P/L) 1 000

Dividend income earned.

DR FA: Investment (SOFP) 30 000

CR Gain on FA held at FV (P/L) 30 000

Remeasurement to FV at year end (FV through P/L).

(R55 000 – R25 000)

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Classifications of FL
Financial liabilities are classified as:
◦ Amortised cost UNLESS
◦ It meets the criteria to be classified as
FV through P/L
 Held for trading OR
 Is acquired or incurred principally for the purpose of
selling/repurchasing it in the near term OR
 Is a derivative OR
 On initial recognition, is part of a portfolio of
identified financial instruments that are managed
together and for which there is evidence of a recent
actual pattern of short-term profit-making
 Designated on initial recognition

41
Classifications of FL
1)FL at amortised cost at effective
interest rate
◦ Not held for trading
◦ Not designated as FVTPL on acquisition

2)FL at FV through P/L

◦ Criteria:
 Held for trading  Purchased with intention
to sell/repurchase in short term OR
 Designated as FV through P/L on acquisition

42
Measurement of FL
1. AMORTISED COST:
◦ Initially measured at FV less transaction
costs
◦ Subsequently measured by
 Using the effective interest rate

2. FV through P/L:

◦ Initially measured at FV
◦ Expense transaction costs
◦ Subsequently measured at FV
◦ FV changes/adjustment
(increases/decreases)
43
Example 21
Tempo Limited issued 150 000 R10
debentures on 1 January 20X4 at R10
each. Tempo paid transaction costs of
R100 000. The debentures have a coupon
rate of 10% and are compulsory
redeemable on 31 December 20X7 for
R12 each. These debentures are classified
at amortised cost.

Required: Prepare the journal entries for

the year ended 31 Dec 20X4
◦ Effective interest rate: 16,32688%
44
Solution 21: Effective interest
rate table
Step 1: Debt or equity instrument? Debentures = Debt
instrument
Step 2: FA or FL? FL
Step 3: Classify
FL at amortised cost
Step 4: Initial measurement
FV - transaction cost = R1 500 000 – R100 000) = R1
400 000
Date O/B
Step 5: Effective Interest
interest rate table Payments C/B
Step
31 Dec6: Journalise
1 400 000 228 576 (150 000) 1 478 576
X4
31 Dec 1 478 576 241 405 (150 000) 1 569 982
X5
31 Dec 1 569 982 256 329 (150 000) 1 676 311
X6
31 Dec 1 676 311 273 689 (150 000) 1 800 000
X7 45
Solution 21
1 January 20X4
DR Bank (SOFP) 1 500
000
CR FL: Debentures (SOFP) 1 500
000
Issue of debentures
DR FL: Debentures (SOFP) 100 000
CR Bank (SOFP) 100 000
Transaction costs capitalised
31 December 20X4
DR Interest expense (P/L) 228 576
CR FL: Debentures (SOFP) 228 576
Interest expense on debentures for X4
DR FL: Debentures (SOFP) 150 000
CR Bank (SOFP) 150 000
46
Payment of annual debenture interest at coupon rate
Example 22
 Mousse Limited issued 100 000 10% debentures
on 1 Jan 20X5, proceeds totaling R200 000.
 Mousse designated these debentures to be held
at FV through P/L.
 Transaction costs incurred by Mousse Limited
came to a total of R1 000.
 Coupon interest of R20 000 is paid on 31 Dec
20X5
 On 31 Dec 20X5 the debentures had a fair value
of R300 000.

 Required: Prepare the journal entries.

47
Solution 22: Effective interest
rate table
Step 1: Debt or equity instrument? Debentures = Debt
instrument
Step 2: FA or FL? FL
Step 3: Classify
FV through P/L
Step 4: Initial measurement
FV = R200 000
Transaction costs expensed = R1 000
Step 5: Effective interest rate table
Step 6: Journalise
Date O/B Interest Payments C/B
1 Jan X5 200 000 200 000
31 Dec 200 000 20 000 (20 000) 200 000
X5

48
Solution 22
1 January 20X5
DR Transaction costs (P/L) 1 000
CR Bank (SOFP) 1 000
Transaction costs on the issue of debentures.
DR Bank (SOFP) 200 000
CR FL: Debentures (SOFP) 200 000
Issue of debentures.

49
Solution 22
31 December 20X5
DR Interest expense (P/L) 20 000
CR FL: Debentures (SOFP) 20 000
Interest expense on debentures
DR FL: Debentures (SOFP) 20 000
CR Bank (SOFP) 20 000
Interest paid to debenture holders
DR FV adjustment on FL (P/L) 100 000
CR FL: Debentures (SOFP) 100 000
Remeasurement of debentures at year end.

50
Settlement in entity’s own
equity instruments
A contract that will be settled with
a FIXED number of its own equity
instruments in exchange for a
FIXED amount of cash/FA =
EQUITY instrument
A contract that will be settled with
a VARIABLE number of its own
equity instruments who’s value
equals a FIXED amount = Financial
LIABILITY
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Example 39
Us Ltd buys a machine worth R600 000
on 1 Aug 20X5 from Me Ltd.
Us Ltd share had a market price of R4
on 1 Aug 20X5 and R6 on 31 Dec X5.

Required: Prepare journals for the

following scenarios:
◦ Us issues 120 000 shares on 31 Dec X5 in
exchange for the machine
◦ Us issues R600 000 shares on 31 Dec X5 in
exchange for the machine
52
Solution 39
Issues 120 000 shares (FIXED
number of shares) = EQUITY
1 instrument
Aug 20X5
DR Machine (SOFP) 600 000
CR Stated capital – deferred shares 600
(SOFP) 000
Purchase machine for fixed number of shares.
31 Dec 20X5
DR Stated capital – deferred shares 600 000
(SOFP)
CR Stated capital (SOFP) 600
000
Issue of 120 000 shares

53
Solution 39
Issues shares worth R600 000
(VARIABLE number of shares) =
1 Financial
Aug 20X5 LIABILITY
DR Machine (SOFP) 600 000
CR FL: Debenture(SOFP) 600
000
Purchase machine for variable number of shares.
31 Dec 20X5
DR FL: Debenture (SOFP) 600 000
CR Stated capital (SOFP) 600
000
Issue of 100 000 shares

54
Interest, dividends, gains and
losses
If the instrument is classified as:
◦ FA/FL = recognise interest,
dividends, gains and losses in P/L
◦ Equity instrument = recognise
interest, dividends, gains and losses
in EQUITY

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Offsetting of FA and FL
FAand FL may NOT be offset against
each other unless:
◦ Entity has legally enforceable right to
set-off
 Right to offset must not be contingent on a
future event
 Must be legally enforceable in all these
circumstances:
 Normal course of business
 Event of default
 Event of insolvency / bankruptcy
◦ Entity intends to realise asset and settle
liability simultaneously or on a net basis
56
Disclosure
Following figures must be separately
disclosed:
◦ Finance costs from FL (P/L)
◦ FV adjustments in P/L
◦ FV adjustments in OCI
◦ Impairment loss reversal on FL
SOCIE
◦ Gains/losses on FA at FV through OCI (column)
SOCI  P/L & OCI
Notes to the financial statements
◦ Fair value gain/(loss)
◦ Less: Tax on fair value gain/(loss)
◦ FV adjustment on FI, net of tax
57
Disclosure
Accounting policy note:
◦ Criteria for recognition
◦ Basis of measurement
Note disclosure:
◦ Extent and nature
◦ Significant terms and conditions
◦ Movements in balances at each
reporting date
◦ Other details, e.g. face value, date of
maturity, interest rates, etc.
58
Disclosure
Statement of comprehensive
income disclosure
◦ Dividends
◦ Interest income/expense
◦ Fair value adjustments
◦ Profit/loss on sale of financial asset

59
IFRS vs. IFRS for SMEs
IFRS IFRS FOR SMEs
1 Financial Instruments are Financial Instruments are
measured at FV or measured at
amortised cost • FV through profit or
loss or
• Amortised cost
2 FV gains and losses
recognised in P/L
3 For investments in equity
instruments, may
designate FV gains and
losses through OCI
There are fewer
disclosure requirements

60