Financial Assets and Liabilities Guide

8/14/2014
Introduction
FINANCIAL
ASSETS AND
LIABILITIES
14/08/2014
FINANCIAL ASSETS AND LIABILITIES(IFRS

7,IFRS9,IAS 32,39)
Learning outcomes
Explain what financial instruments are
Define financial instruments in terms of
financial assets and financial liabilities
Distinguish between the categories of
financial instruments
Distinguish between debt and equity
capital
Account for compound instruments
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Introduction
IAS 32 Financial instruments: presentation

IAS 39 Financial instruments: recognition
Account for issue of equity shares & payment
and measurement
of equity dividends
for the issue of redeemable
preference shares and payment of preference
share dividends
Understand the recognition, Presentation and
disclosure of financial instruments
IFRS 7 Financial instruments: disclosures

IFRS 9 Financial instruments
Account

7,IFRS9,IAS 32,39)
Note :IFRS 9 was issued in 2009 and is

effective January 2015 but earlier adoption
is permitted will eventually replace IAS 39
&32
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7,IFRS9,IAS 32,39)
Definition of Financial instrument
Definition of financial asset
A financial instrument is any

contract that gives rise to a
financial asset of one entity and a
financial liability or equity on
another entity e.g.
Bonds ,stocks
and derivative
instruments
A financial asset is any asset that has:

A contractual right to receive cash or another
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7,IFRS9,IAS 32,39)
Accounting standards
Learning outcomes
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7,IFRS9,IAS 32,39)
financial asset from another entity

contractual right to exchange financial
assets/liabilities with another entity under
conditions that are potentially favorable
An equity instrument of another entity
E.G
Trade receivables(note), Options,
Investment in equity shares. Investment in
Bond, or loans
A
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7,IFRS9,IAS 32,39)
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Definition of financial
liability/asset
Definition of financial liability

A financial liability is any liability that is a
contractual obligation:
To deliver cash or another financial asset to another
entity, or
To exchange financial instruments with another
entity under conditions that are potentially un
favorable, or
That will or may be settled in the entitys own equity
instruments.
E.g. trade payables, Bonds, Debenture loans,
Redeemable preference shares
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7,IFRS9,IAS 32,39)
A 'contract' need not be in writing, but it
must comprise an agreement that has 'clear

economic consequences' and which the
parties to it cannot avoid, usually because
the agreement is enforceable in law.
There should be a contractual obligation
to receive cash or another financial
instrument
7
Examples

7,IFRS9,IAS 32,39)

7,IFRS9,IAS 32,39)
Which of the following are financial

Assets /liabilities
1. inventories,
2. property, plant and equipment
3. Investment in ordinary shares
4. Prepayment for goods or service
5. Income tax liability
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7,IFRS9,IAS 32,39)
Solution
Solution
1. Inventory :no present or contractual right
3.Investment in ordinary shares; Yes there

is contractual obligation and it is an
instrument of another entity.
4. Prepayment for goods or service. No
future economic benefit is goods or service
not a financial asset
5. Income tax liability. No it is a statutory
not contractual obligation.
to receive cash
2. property, plant and equipment; Control
of physical assets creates an opportunity
to generate an inflow of cash or other
assets, but it does not give rise to a
present right to receive cash or other
financial asset
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7,IFRS9,IAS 32,39)
Question to think about
When a company borrow a loan or sells

a Bond that's a financial liability
When a company lends out a loan or
buys a Bond that's a financial asset
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7,IFRS9,IAS 32,39)
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12
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Classification of financial
instruments
instruments(asset/liability)
A financial liability has a contractual obligation:
to deliver cash or another financial asset to another
entity, or to exchange financial instruments with
another entity under conditions that are potentially un
favorable, or
A financial asset has a contractual right to
receive cash or another financial asset from another
entity, or to exchange financial instruments with
another entity under conditions that are potentially
favorable
Eg Bonds ,loans ,redeemable preference shares
Classified in to 2
1. Asset /liability instruments
2. Equity instruments

7,IFRS9,IAS 32,39)
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instruments(equity)
An entity recognize a financial asset or

a financial liability in the statement of
financial Position when, and only
when, it becomes a party to the
contractual provisions of the
instrument.
contractual obligation/ right
Although the holder of an equity instrument may be
entitled to receive dividends , the holder cannot under

law force the issuer to declare dividends, so the issuer
does not have a contractual obligation to make such
distributions
E.g. common stoke and preference shares
Note: redeemable preference shares are classified as a
liability because the issuer has a contractual
obligation to deliver cash to the order on the
redemption date.(if the company bought then its in
asset
7,IFRS9,IAS 32,39)
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Derecognition of financial
asset/liability
when, and only when, the
contractual rights to the cash flows of the
financial asset have expired
Liability when, and only when, the
obligation specified in the contract is
discharged, cancelled or expires

7,IFRS9,IAS 32,39)

7,IFRS9,IAS 32,39)
16
Measurement of financial
instrument
Asset
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Recognition of financial
instruments
An equity financial instrument does not give rise to a
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7,IFRS9,IAS 32,39)
How the instrument is measured depends
on its classification
a liability /asset or equity
We will start with Liabilities then assets and
conclude with a equity
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Subsequent measurement of
financial liability
Measurement of financial Liability

all financial Liabilities are initially
Liabilities incurred for speculative purposes
measured at fair value. This is likely to be

the purchase consideration received for the
financial liability less issue costs
Fair value =Cost discount issue costs
Transaction costs/gains are expensed to the
income statement
are measured at fair value any gains

/losses are taken to the income statement
All other liabilities are measured
at
amortised cost using the effective
interest rate method
Examples of liabilities include, loans
payable and deep discount bonds
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7,IFRS9,IAS 32,39)
19
Method used to calculate how much should

be charge to income statement and in the
statement of Financial position
amount or the face value of the bond/loan

Effective interest rate=the periodic
interest rate charged for the debt
Coupon payment =periodic payment
made toward the interest
At maturity =par value should be paid
together with the interest outstanding
repayments
Interest is charged at the effective rate

Note: Financial management principles
needed to apply this method
21
Reminders BAC 331 features of

debt
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7,IFRS9,IAS 32,39)
Example
Discount means fair value amount received
A K2, 500 8 % bond debt is redeemable at
is less than face value

Par means amount received is equal to face
value
Premium means amount received is greater
than face value
K3, 125. The debt will mature after 5 years.

The effective rate of interest is 10%
What is the annual rate of interest to be
charged
What is the annual rate of interest to be paid

7,IFRS9,IAS 32,39)
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debt
Debt can be at discount ,par or premium
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Par value or nominal value=the principle
Amortised cost=Initial cost + interest-

7,IFRS9,IAS 32,39)

7,IFRS9,IAS 32,39)

debt
Amortised cost method
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7,IFRS9,IAS 32,39)
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debt
Solution
annual rate of interest to be charged is 10%
of the Of outstanding amount (not fixed)

annual rate of interest to be paid is 8% of
Amortised cost=Initial cost + interest-
par value (fixed) 2,500 X 0.08 =200
repayments

7,IFRS9,IAS 32,39)
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Method used to calculate how much should be

charge to income statement and in the statement
of Financial position
25
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7,IFRS9,IAS 32,39)
Solution
Example
A company issues 4% loan notes with a nominal

value of K100, 000. The loan notes are issued at
a discount of 2.5% and K2, 670 of issue costs are
incurred. The loan notes will be repayable at a
premium of 10% after 5 years. The effective rate of
interest is 7%.
a)What amount will be recorded as a financial
liability when the loan notes are issue
b)What amounts will be shown in the income
statement and statement of financial
position for years 1 5?
c) Show the journal entries for (a)and (b)
7,IFRS9,IAS 32,39)
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27
a)Liability initially recorded at fair value

Fair Value =Cost discount-issue cost
Cost =100,000
Discount=2,500(100,000 x 0.025)
Issue cost K2,670
Fair Value =100,000-2,500-2670
K 94,830
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7,IFRS9,IAS 32,39)
Solution
1
2
3
4
5
Cash paid 4%
Finance cost are charged to the income statement
Closing
The closing balance is the liability in the statement of
financial position
Year Finance cost(i/s)
(4,000)
97,468
(4,000)
100,290
(4,000)
103,310
(4,000)
106,542
(4,000)
(110,000)
0
Note the balance at year 5 would have been (110,00) which is repaid
as principle
If interest is paid at the beginning subtract from the opening
balance then calculate the finance charge
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94,830
97,468
100,290
103,310
106,542
Finance
costs 7%
6,638
6,822
7,020
7,232
7,457

7,IFRS9,IAS 32,39)
28
Solution
B)Amount to be shown in income statement
Year Opening
26
1
2
3
4
5
29
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6,638
6,822
7,020
7,232
7,457
Non-current
liabilities(SFP)
97,468
100,290
103,310
106,542
0

7,IFRS9,IAS 32,39)
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Solution
Example 2
A company issues 0% loan notes at their
nominal value of K20, 000. The loan notes are
repayable at a premium of K5, 900 after 3 years.
The effective rate of interest is 9%.
a)What amount will be recorded as a
financial liability when the loan notes are
issued?
b)What amounts will be shown in the
statement of profit or loss and statement of
financial position 1 -3-?
c)Show the journals for (a) and (b)
Journal entries
a)when loan is issued
Dr
cashbook
N.C.Liability
94,830
During the years(1-5)

Finance Charge
N.C.Liability
as calculated
as calculated
Payments(year 1-5)
N.C.Liability
Cash book
loan Repayment year 5
N.C.Liability
Cash book
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Cr
94,830
4,000
4,000
110,000
110,000

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7,IFRS9,IAS 32,39)
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Solution
32
solution
B)Amount to be shown in income statement
a)Liability initially recorded at fair value

Fair Value =Cost discount-issue cost
Cost =20,000
Discount=0
Issue cost =00
Fair Value =K20,000
Year
Opening
20,000
Finance
costs 9%
1,800
21,800
1,962
23,762
2,138
Cash paid 0%
Closing
(0)
21,800
(0)
23,762
(0)
(25,900)
The loan notes are repaid at par i.e. K20, 000, plus a premium of K5,
900 at the end of yea 3.
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Solution
Preference shares
K20,000
During the years(1-3)

Finance Charge
as calculated
N.C.Liability
loan Repayment year 3
N.C.Liability
25,900
Cash book
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7,IFRS9,IAS 32,39)
34
Redeemable preference shares are classified as
When the loan notes are issue:
Dr cash book
Cr Loan notes

7,IFRS9,IAS 32,39)
a liability because the issuer has a contractual

obligation to deliver cash to the order on the
redemption date.(if the company bought then
its in asset
Irredeemable preference shares are classified as
equity
Redeemable shares are initially measure at fair
value and subsequent at amortised cost if not
held for resale
K20,000
as calculated
25,9000
35
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example
Solution
On 1 April 2007, a company issued 80,000 K1

redeemable preference shares with a coupon rate of
8% at par. They are redeemable at a large premium
which gives them an effective finance and cost of 12%
per annum.
How would these redeemable preference shares
appear in the financial statements for the years
ending 31 March 2008 and 2009?
Show the journal entries
Annual payment =80,000 x K1 x 8% =

Period Opening
Finance Cash
ended
balance
cost
paid
31 March
@ 12% @8%
2008
80,000
2009
83,200
9,600
9,984
(6,400)
(6,400)
i/s
7,IFRS9,IAS 32,39)
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Solution
86,784
SFP

7,IFRS9,IAS 32,39)
38
all financial assets are initially measured at
fair value. This is likely to be the purchase

consideration paid to acquire the financial
asset
Dr cash book K80,000

Cr Ncliability
K80,000
2. Finance charge during the period
Dr interest expense amount calculated
Cr Ncliability amount calculated
3Cash payment
Dr
Ncliability
6400 (per year)
Cr
Cash book
6400
7,IFRS9,IAS 32,39)
Transaction costs are expensed to the
income statement
39
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Subsequent measurement depends upon
whether the financial asset is an investment

held for Speculative(sale) or to hold it till
maturity

7,IFRS9,IAS 32,39)

7,IFRS9,IAS 32,39)
40
financial assets
financial assets
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83,200
Measurement of Financial assets
Journals
1. When stock is issued
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K6,400
Closing
balance
41
Assets can be measured using either of the

following methods.
1. Fair value method-based on the
consideration received or given( any gain
/losses are taken to income statement)
2. Amortised
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The business model test
The amortised cost = initial cost + interestrepayments.

The interest will be charged at the effective rate. This
is the internal rate of return of the instrument
This test establishes whether the entity holds
Amortised cost is only used if the 2 test are met

1.The business model test
2.Contractual cash f low characteristics
test
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7,IFRS9,IAS 32,39)
43
the financial asset to collect the contractual

cash flows or sell the financial asset prior
to maturity to realize changes in fair value.
If its to collect the cash flows then the asset has
passed this test and the amortized cost method
can be used
IF its for sell the fair value should be used
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The contractual cash flow

characteristics test

7,IFRS9,IAS 32,39)
Example
This test determines whether the contractual
A company invests K5, 000 in 10% loan notes. The loan
terms of the financial asset give rise to cash

flows on specified dates that are solely of
principal and interest based upon the
principleamount outstanding.
.If this is not the case, the test is failed and the
financial asset cannot be measured at
amortised cost but at fair value.
EG convertible bonds have a right to convert the
bond to equity so dont qualify
notes are repayable at a premium after 3 years. The

effective rate of interest is 12%. The company intends to
collect the contractual cash flows which consist solely of
repayments of interest and capital and have therefore
chosen to record the financial asset at amortised cost.
What amounts will be shown in the income statement
and statement of financial position for the financial
asset for years 1 -3?
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7,IFRS9,IAS 32,39)
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Solution
Year Opening Investment
Income 12%
1
5,000
600
2
5,100
612
3
5,212
625
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7,IFRS9,IAS 32,39)
46
Solution
Cash
Closing
received 10%
(500)
5,100
(500)
5,212
(500)
(5,337)
0

7,IFRS9,IAS 32,39)
44
1.
Journals
When loan is given
Dr asset (investment)
Cr Cash book
K5,000
K5,000
2. Investment income during the period

Dr Asset(investment )
amount calculated
Cr investment income
amount calculated
3Cash payment
Dr Cash book
5,000 (per year)
Cr
Asset(investment )
5,000
4 Final receipt repayment
Dr cash book
5,337
Cr
Asset(investment )
5,337
47
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7,IFRS9,IAS 32,39)
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Measurement of Equity
instrument
instrument held for trading
The equity instruments are measured

Measured at Fair value through Income
depends on whether they are held for

trading or as an investment (not for trading)
statement
This means that equity instrument is always recorded
at market value in the statement of financial position
The difference between original price and the market
price is taken to the income statement under
investment income
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7,IFRS9,IAS 32,39)
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instrument not held for trading
Example
company in November 2007 at a cost of K4. 20 per
share. At 31 December 2007 the shares a market
value of K4.90. The company is planning on
selling these shares in April 2008.
Prepare extracts from the statement of profit
or loss for the year ended 31 December 2007
and a statement of financial position as at that
date.
The difference between original price and the market

price is taken to the reserves in the statement of
comprehensive income
7,IFRS9,IAS 32,39)
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solution
This an investment held for trading purposes as the
company plans to sell these shares. The investment
should therefore be measured at fair value through
income statement.
Statement of profit or loss
Investment Income (10,000 x (4.90 4.20))
7,000
Statement of Financial Position
Current assets
Investments (10,000 x 4.90)
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(2) A company invested in 10,000 shares of a listed
Measured at Fair value through other

comprehensive income
Other comprehensive income is income and expenses
that are not recognized in the income statement but
are recorded in reserves
This means that equity instrument is always recorded
at market value in the statement of financial position
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7,IFRS9,IAS 32,39)
49,000
53

7,IFRS9,IAS 32,39)
52
Solution
Journals
Initial investment
Dr investment in equity K42,000 (4.2 x 10,000)
Cr cash book
K42,000
Change in market value
Dr investment in equity 700((4.9-4.2)x10,000)
Cr investment income
700
Note if the price has gone down the asset is cr and
investment expense Dr
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Example 2
Solution
The investment is a financial asset at fair value
through through other comprehensive income.
Statement of profit or loss
Revaluation reserves (20,000 x (3.40 3.80)) (8,000)
A company invested in 20,000 shares of a listed

company in October 2007 at a cost of K3.80 per share.
At 31 December 2007 the shares have a market value of
K3.40. The company is not planning on selling these
shares in the short term.
Prepare extracts from the statement of profit or
loss for the year ended 31 December 2007 and a
statement of financial position as at that date
7,IFRS9,IAS 32,39)
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Statement of Financial Position

Non-current assets
Investments (20,000 x 3.40)
55
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Journals
56
Off setting not allowed except when the entity
Initial investment
Dr investment in equity K76,000 (3.8 x 20,000)
Cr cash book
K76,000
Change in market value
Cr investment in equity
8000((3.4-3.8)x20,000)
Dr Revaluation reserves 8000
Note if the price has gone up the asset is Dr and
Reserves Cr
7,IFRS9,IAS 32,39)
Has a legally enforceable right to set off the

amounts, and
Intends either to settle on a net basis or to realize the
asset and settle the liability simultaneously
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Compound instruments
58
IAS
32 required compound financial

instruments be split into their component
parts:
A financial liability (the debt)
An equity instrument (the option to convert
into shares).
These must be shown separately in the
financial statements.
characteristics of both equity and liability .E.g.

debt that can be converted into shares like
convertible bonds

7,IFRS9,IAS 32,39)

7,IFRS9,IAS 32,39)
Compound instruments
This is a financial instrument that has
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7,IFRS9,IAS 32,39)
Offsetting financial
assets/financial liabilities
Solution
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68.000
59
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10
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Compound instruments how to

split and record
Compound instruments how to

split and record
Step 3
Step 1
Basing on the amortized cost method ,and using
Calculate liability component first by finding the value of

the bond( present value of future cash flows assuming
non-conversion)
Apply discount rate equivalent to interest on similar nonconvertible debt instrument (i.e. discount the cash flows at
the market rate of interest)
Step 2
Calculate the equity component by
deducting the present value of the debt from the proceeds
of the issue
the amount of liability found as the opening

balance calculate amounts to be recorded in
income statement and statement of financial
position
Step 4
Calculate the conversion amount basing on
information given
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7,IFRS9,IAS 32,39)
Note use financial management principles on

calculating present value(time value of money )
61
Reminders BAC 331 present value
The process of finding the present

value is called discounting

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Present Value is the current value of the

future sum discounted back to the
present at an appropriate interest rate.
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PV= FV
or
(1+r) n
PV = FV = ( 1+r)- n
discount factor
PV is the present value to be calculated

FV is the future value given
r is the interest rate
n is the number of periods interest is earned
63

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Solution
Example
( 1+r)- n
Barclays bank issues 2500o 5% loan that
attracts interest rate of 10 % and is

repayable in full after three years.
What is the present value of the loan?
Year Cash
flow
1
1,250
2
3
3
1,250
1,250
25000
Discount factor
( 1+0.1)- 1 =0.909
Fv X discount factor
Present value
1,250X0.909=1,136
( 1+0.1)- 2 =0.826
1+0.1)- 3 =0.751
(
(1+0.1)-3 0.7513
1,250X0.826=1,033
1,250X0.751=939
25000X0.751=18,775
PV=1,136+1033+939+18,782=21,890
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alternative
PV =
PV =
1- (1+r)-n
r
+ Par(1+r)-n
PVA is present value of an annuity to be calculated

a is the installment payment/receipt
r is the interest rate
n is number of periods interest is given
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TIME VALUE OF MONEY
67
Example compound instrument
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1,250 1- (1.1)-3
0.1
+25000(1+0.1)-3
3,108.56+18,782.87
21,891.43
TIME VALUE OF MONEY
68
Example compound instrument

The present value of K1 payable at the end of year, based on rates of
2% and 9% are as follows:
A company issues 2% convertible bonds at their nominal

value of K36, 000.
End of year
1
2
3
The bonds are convertible at any time up to maturity

into 120 ordinary shares for each K100 of bond.
Alternatively the bonds will be redeemed at par after 3
years.
2%
0.98
0.96
0.94
9%
0.92
0.84
0.77
What amounts will be shown as a financial liability and as

equity when the convertible bonds are issued?
Similar non-convertible bonds would carry an interest

rate of 9%.
What amounts will be shown in the income statement and

statement of financial position for years 1 3?
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Solution

7,IFRS9,IAS 32,39)
70
solution
Step 1 Calculate liability component

Cash flow = 2% x 36,000 = 720
YearCash flow Discount factor 9%Present value
1
720
0.92
662.4
2
720
0.84
604.8
3
720
0.77
554 .4
3
36,000
0.77
27,720
29,541.6
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7,IFRS9,IAS 32,39)
Calculate the equity component

proceeds of the issue-liability component
36,000- 29,541.6=6,458
Journal entry
When the convertible bonds are issued:
Dr Bank
K36, 000
Cr Financial Liability
K29,542
Cr Equity
K6,458
71
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Solution
Solution
Step 4 Calculate the conversion of bond
Caring amount as at end of year 3
Equity
6,458
Bond
36,000
42,458
120 ordinary shares for each K100 of bond.
Step 3 measurement of liability amortized cost

Year Opening
Finance
Cash paid 2% Closing
costs 9%
1
29,542
2,65
(720)
31,481
2
31,481
2,853
(720)
33,594
3
33,594
3,023
(720)
(36,000)
I/S
14/08/2014
X shares for 36,000 bond

( 120X 36,000) /100
=43,200
The difference between the Caring amount and the
conversion amount is recorded as either discount or
premium 42,458-43,200=742 discount
0
SFP

7,IFRS9,IAS 32,39)
73
14/08/2014
Disclosure must be made for each type of financial

instrument (Liability ,asset or equity)
dividends depends upon the accounting

treatment of the underlying instrument
itself. E.g.
Equity dividends declared are reported
directly in equity
Dividends on redeemable preference shares
classified as a liability are an expense in the
income statement .
7,IFRS9,IAS 32,39)
74
Disclosure
Interest dividends ,loses and gains

The accounting treatment of interest and
14/08/2014

7,IFRS9,IAS 32,39)
gains expenses and losses should be shown

appropriately
75
14/08/2014

7,IFRS9,IAS 32,39)
76
Any questions
14/08/2014

7,IFRS9,IAS 32,39)
77
13

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8/14/2014

FINANCIAL ASSETS AND LIABILITIES(IFRS

IAS 32 Financial instruments: presentation

Account for issue of equity shares & payment

IFRS 7 Financial instruments: disclosures

FINANCIAL ASSETS AND LIABILITIES(IFRS

Note :IFRS 9 was issued in 2009 and is

FINANCIAL ASSETS AND LIABILITIES(IFRS

Definition of Financial instrument

Definition of financial asset

A financial instrument is any

A financial asset is any asset that has:

FINANCIAL ASSETS AND LIABILITIES(IFRS

FINANCIAL ASSETS AND LIABILITIES(IFRS

financial asset from another entity

FINANCIAL ASSETS AND LIABILITIES(IFRS

Definition of financial liability

FINANCIAL ASSETS AND LIABILITIES(IFRS

A 'contract' need not be in writing, but it

must comprise an agreement that has 'clear

FINANCIAL ASSETS AND LIABILITIES(IFRS

FINANCIAL ASSETS AND LIABILITIES(IFRS

Which of the following are financial

FINANCIAL ASSETS AND LIABILITIES(IFRS

1. Inventory :no present or contractual right

3.Investment in ordinary shares; Yes there

FINANCIAL ASSETS AND LIABILITIES(IFRS

Question to think about

When a company borrow a loan or sells

FINANCIAL ASSETS AND LIABILITIES(IFRS

FINANCIAL ASSETS AND LIABILITIES(IFRS

An entity recognize a financial asset or

contractual obligation/ right

Although the holder of an equity instrument may be

entitled to receive dividends , the holder cannot under

FINANCIAL ASSETS AND LIABILITIES(IFRS

FINANCIAL ASSETS AND LIABILITIES(IFRS

An equity financial instrument does not give rise to a

FINANCIAL ASSETS AND LIABILITIES(IFRS

How the instrument is measured depends

FINANCIAL ASSETS AND LIABILITIES(IFRS

Measurement of financial Liability

Liabilities incurred for speculative purposes

measured at fair value. This is likely to be

are measured at fair value any gains

FINANCIAL ASSETS AND LIABILITIES(IFRS

Method used to calculate how much should

amount or the face value of the bond/loan

Interest is charged at the effective rate

needed to apply this method

Reminders BAC 331 features of

FINANCIAL ASSETS AND LIABILITIES(IFRS

Discount means fair value amount received

A K2, 500 8 % bond debt is redeemable at

is less than face value

K3, 125. The debt will mature after 5 years.

FINANCIAL ASSETS AND LIABILITIES(IFRS

Reminders BAC 331 features of

Debt can be at discount ,par or premium

Par value or nominal value=the principle

Amortised cost=Initial cost + interest-

FINANCIAL ASSETS AND LIABILITIES(IFRS

FINANCIAL ASSETS AND LIABILITIES(IFRS