Ch 5 - Fin Instruments

Question 1

What are the 4 sections of FRS 102 that deal with FI?

Answer 1

Section 11 Basic Financial Instruments
Section 12 Other FI
Section 22 Liabilities equity

Question 2

What does Section 11 Basic Financial Instruments deal with?

Answer 2

How FI are measured
When they should be recognised in FS
Disclosure of FI in FS

Question 3

What does Section 22 Liabilities equity deal with?

Answer 3

classification of FI and their presentation in FS

Question 4

What does Section12 Other Fin Instruments deal with?

Answer 4

Not examinable

Question 5

Define a FI

Answer 5

‘any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity’

Question 6

Define a financial asset

Answer 6

Cash
An equity instrument of another entity (e.g. investment)
A contractual right to receive cash or another financial asset from another entity
A contractual right to change fin instruments on potentially favourable terms

Question 7

Define a finance liability

Answer 7

any liability that is a contractual obligation to

• Deliver cash or another financial asset to another entity
• To exchange financial instruments with another entity under conditions that are potentially unfavourable

Question 8

Define an equity instrument

Answer 8

any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities

Question 9

Give an example of a financial asset

Answer 9

Cash

Debtor

Question 10

What must the issuer of FI classify FI as

Answer 10

must classify FI as a financial liability, financial asset or equity instrument on initial recognition according to its substance

Question 11

How are the following classified in FS?

Redeemable preference shares

Answer 11

Liabiltiies

Question 12

How are the following classified in FS?

Irredeemable preference shares

Answer 12

Equity unless there is a mandatory obligation to pay a dividend (then would be liability)

Question 13

When is classification of financial liabilities and equity carried out and can it then be changed?

Answer 13

Classified at date of issue

Can’t then be changed

Question 14

How should Interest, dividends, losses and gains be classified?

Answer 14

The accounting treatment of interest, dividends, losses and gains relating to a FI follows the treatment of the instrument itself
Therefore, redeemable preference share dividends should be treated as interest expense in P&L
Irredeemable preference share dividends should be taken through P&L reserve in SOCE unless there is a mandatory obligation to pay the dividend
If there is an obligation to pay dividend, should be treated as an interest expense

Question 15

How should redeemable preference share dividends be treated in FS?

Answer 15

as interest expense in P&L

Question 16

How should Irredeemable preference share dividends be treated in FS?

Answer 16

should be taken through P&L reserve in SOCE unless there is a mandatory obligation to pay the dividend

If there is an obligation to pay dividend, should be treated as an interest expense

Question 17

How are financial assets initially recognised?

Answer 17

At FV, which is usually any cash paid to acquire the asset plus transaction costs

Question 18

How are financial liabilities initially recognised?

Answer 18

usually the net proceeds received

So any transaction costs need to be deducted on initial recognition

Question 19

How is FV defined?

Answer 19

amount for which an asset could be exchanged, a liability settled, or an equity instrument granted could be exchanged between knowledgable, willing parties in an arm’s length transaction

Question 20

What is the subsequent treatment of fin assets and liabilities after recognition?

Answer 20

In FAR Exam, all fin assets and liabilities will be measured at amortised cost using the effective interest rate method
Calc
BF (FV)
AddAmortisation (interest) = FV * effective interest rate
Less cash = nom value * coupon rate
= CF (amortised cost)

Question 21

What is a compound instrument?

Answer 21

financial instrument that has characteristics of both equity and a liability
E.g. a convertible bond

Question 22

Give an example of a compound instrument

Answer 22

E.g. a convertible bond

Question 23

How should compound instruments be dealt with per Section 22?

Answer 23

Section 22 requires compound instruments to use split accounting at the date of the issue

Question 24

How would a convertible bond be split per section 22?

Answer 24

Liability = obligation to pay annual interest and capital (calc PV of future cash flow using interest rate of equiv bond w no conversion option as discount rate)

Equity = option to convert to shares
Total value of bond less liability element = equity element

Then shown separately on FS

Question 25

How are compound instruments subsequently recognised in FS after recognition?

Answer 25

Going forward, the liability element will be held under amortised cost per FRS 102 Section 11 Going forward, the equity element won’t change

Question 26

What are treasury shares?

Answer 26

This is where companies acquire their own shares as an alternative to making dividend distributions and/or as a way to return excess capital to SH

Question 27

What is the treatment for a treasury share?

Answer 27

They should be deducted from equity i.e. they are shown as -ve equity No gain or loss should be recognised on their purchase Consideration paid or received should be recognised directly in equity

Question 28

What are the 2 main categories for disclosures required for FI?

Answer 28

Info about the significance of FI | Info about the nature and extent or risks arising from financial instruments and how the entity manages those risks

Question 29

What are the qualitative disclosures made up on for Fin Instruments?

Answer 29

``` Entity must disclose the carrying value of each class of FI The FV of each class of FI should also be disclosed ```

Question 30

What are the quantitative disclosures made up on for Fin Instruments?

Answer 30

``` Entity must disclose info to enable users to understand management’s attitude to risk Disclosures may focus on entity’s Credit risk Liquidity risk Market risk ```

Question 31

How are FI treated under FRS 105 regarding initial recognition?

Answer 31

As per FRS 102, transaction costs are added to a financial asset and deducted from the financial liability However, if the transaction cost is deemed immaterial, it should be expensed to P&L immediately

Question 32

How are FI treated under FRS 105 regarding subsequent recognition?

Answer 32

Equity investments are measured at cost less impairment | All other financial instruments are measured as follows

Question 33

What is the main diff between FRS 102 and FRS 105 re FI?

Answer 33

There is no revaluation or remeasurement to FV in FRS 105 and no requirement to use an effective interest rate (as per FRS 102)

Question 34

What is convertible debt?

Answer 34

Split into debt and equity elements However, a simplified approach is adopted where the debt element is recorded at the FV of a similar non-convertible liability

Question 35

What is the approach for calculating convertible debt?

Answer 35

A simplified approach is adopted where the debt element is recorded at the FV of a similar non-convertible liability Then equity is the balancing figure