Chapter 9 - Financial Assets and Financial Liabilities

Question 1

What is a financial instrument?

Answer 1

a contract between two parties that creates a financial asset for one, and liabilities or equity for another.

Question 2

give some examples of financial instruments.

Answer 2

investments in shares, bonds, and receivables, trade payables, long term loans and equity share capital

Question 3

What is a financial asset?

Answer 3

a non-physical asset such as:
- cash
- an equity instrument of another entity
- a contractual right to receive cash or another financial asset (e.g., receivables or purchased bonds)
- a contractual right to exchange financial assets or liability on favourable terms

Question 4

What is a financial liability?

Answer 4

a contractual obligation to deliver cash or another financial asset.
contractual obligation to exchange financial assets or liabilities on unfavourable terms

Question 5

What are unfavourable terms?

Answer 5

issuing an option to buy shares at a value below market price

Question 6

On inception how are financial liabilities recognised?

Answer 6

• at its fair value. Usually the net proceeds of the cash received less any costs of issuing the liability

Question 7

What is amortised cost for financial liabilities?

Answer 7

• any cash repaid, reducing the liability
• any interest accrued, using the effective interest rate

Question 8

Fair value through profit and loss is used when for liabilities?

Answer 8

for liabilities held for trading or derivatives

Question 9

What is the effective rate of interest?

Answer 9

spreads all of the costs of the liability (trans fees, issue discounts, annual interest payments and redemption premiums) to profit and loss over the term of the instrument.

Question 10

What is the calculation for amortised cost?

Answer 10

initial value + effective interest - interest paid

Question 11

What is a compound instrument?

Answer 11

one that has characteristics of both a financial liability and equity

Question 12

What is a common example of a compound instrument?

Answer 12

a bond or loan allowing the lender the choice of redemption in the form of cash or a fixed number of equity shares

Question 13

How are compound instruments accounted for?

Answer 13

using split accounting

Question 14

what will the compound instrument be split into?

Answer 14

• a liability component (the obligation to repay cash)
• an equity component (the obligation to issue a fixed number of shares)

Question 15

How is the debt split calculated?

Answer 15

Present value of cash flows discounted at the rate for non-convertible bonds

Question 16

How is the equity split calculated?

Answer 16

balancing figure:
Cash received less liability

Question 17

All financial assets are intially measured at what?

Answer 17

fair value

Question 18

What are the 2 different treatments for financial assets?

Answer 18

1. fair value through profit or loss (FVPL)
2. fair value through other comprehensive income (FVOCI)

Question 19

What is FVPL?

Answer 19

Initial recognition: Fair value (acquisition costs written off to SPL)
Subsequent treatment: Revalue each reporting date with gain or loss taken to SPL

Question 20

What is FVOCI?

Answer 20

Initial recognition: Fair value plus acquisition costs
Subsequent treatment: Revalue each reporting date with gain or loss taken to OCI

Question 21

what conditions must be met for an entity designate the equity investment through FVOCI?

Answer 21

• the equity instrument cannot be held for trading
• on acquisition there must be an irrevocable designation by the entity to treat the investment as FVOCI, and this cannot be changed later

Question 22

How are debt instruments valued?

Answer 22

• amortised cost
• FVOCI
• FVPL

Question 23

What is the default classification for debt instruments?

Answer 23

• fair value through profit and loss

Question 24

What 2 tests must be passed for debt instruments to be value at amortised cost?

Answer 24

Business model test
Contractual cash flow characteristics test

Question 25

What is the business model test for amoritised cost?

Answer 25

considers the entity's intention. The entity must intend to hold the investment to redemption (i.e. the investment cannot be sold before maturity).

Question 26

What is the contractual cash flow characteristics test for amortised cost?

Answer 26

This test considers the cash to be received as a result of holding the investment. The contractual terms of the financial asset must give rise to cash flows that are solely of principal and interest.

Question 27

If designated as amortised cost what happens?

Answer 27

- the asset is initially recognised at fair value (price paid) plus transaction costs - the interest income is calculated using the effective rate of interest on an amortised cost table

Question 28

What is the business model for FVOCI for debt instruments?

Answer 28

- requires the entity to intend to hold the investment to maturity but allows for the possibility of selling the asset in order to acquire another higher-return asset

Question 29

What is the Contractual cash flow characteristics test for FVOCI for debt instruments?

Answer 29

the contractual terms of the financial asset must give rise to cash flows that are solely of principal and interest

Question 30

If designated as FVOCI for debt instruments what happens?

Answer 30

- the asset is initially recognised at fair value plus transaction costs - interest income is calculated using the effective rate of interest on an amortised cost table - at the reporting date the asset is revalued to fair value, with any gain or loss recognised in other comprehensive income. This gain is reclassified to P&L on disposal of asset

Question 31

What happens if investment fails the test to be classified otherwise?

Answer 31

the default classification for debt investment is fair value through profit or loss (FVPL

Question 32

What is the justification for debt instruments to be classified as FVPL?

Answer 32

the entity acquires these investments for trading purposes, so gains or losses should be shown in the SPL.

Question 33

What happens when debt instruments are classified as FVPL?

Answer 33

initially are measured at fair value but transaction costs are written off to P&L. investments revalued to fair value at each year end, with gain or loss shown in P&L

Question 34

When should a financial liability be derecognised?

Answer 34

when the obligation is extinguished

Question 35

when would an obligation be extinguished?

Answer 35

- when the contract is discharged, cancelled or expired

Question 36

the difference between any consideration transferred and the carrying amount of the financial liability or asset is recognised where?

Answer 36

the P&L

Question 37

When would a financial asset be derecognised?

Answer 37

- the contractual rights to the cash flows expires or, - the entity transfers substantially all of the risks and rewards of the financial asset to another party

Question 38

what is factoring of receivables?

Answer 38

- where an entity arranges for another organisation (a factor) to manage and collect the entity's receivables and receives an advance on the value of those receivables in return

Question 39

What is factoring with recourse?

Answer 39

Risk and reward therefore control, not transferred to the fatcor. Receivables not derecognised, treat proceeds as a loan

Question 40

What is factoring without recourse?

Answer 40

Risk and reward therefore control, transferred to factor. Receivables derecognised, a treat proceeds as a reduction in receivables