Financial Instruments

Question 1

broadly, what is a financial instrument?

Answer 1

means of raising finance e.g. loans, shares etc.

Question 2

Why is IAS 39 Financial Instruments: Recognition and Measurement obselete

Answer 2

had a role to play in the global financial crisis

Question 3

what is the definition of a financial instrument

Answer 3

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

Question 4

what is a financial assets

Answer 4

cash, equity of another entity, or contractual right to receive cash

Question 5

what is a financial liability

Answer 5

any liability that is a contractual obligation to deliver cash

Question 6

what is an equity instrument

Answer 6

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

Question 7

examples of financial assets

Answer 7

cash
accounts receivable
loans receivable

Question 8

examples of financial liabilities

Answer 8

bank overdraft
accounts payable
loans payable
certain preference shares (those with a mandatory repayment date)

Question 9

examples of equity instruments

Answer 9

ordinary shares
certain preference shares (those with no mandatory repayment date)

Question 10

which financial standard deals with the classification of financial instruments

Answer 10

IAS 32 Financial Instruments: Presentation

Question 11

for the buyer, is a financial instrument an asset or liability

Answer 11

asset

Question 12

for the issuer of a financial instrument, why is it important to classify as an asset or liability correctly

Answer 12

can affect gearing

different accounting treatments apply to financial liabilities and financial assets

Question 13

how to determine whether to classify financial instruments issued as debt or equity

Answer 13

if it includes a contractual obligation to deliver cash or another financial asset then it is a liability

otherwise it in equity

Question 14

what are redeemable preference shares

Answer 14

preference shares that require a future repayment of the share capital

Question 15

should preference shares be issued as debt or equity

Answer 15

issuer has an obligation to deliver cash

should be treated as liability

Question 16

where should dividends on preference shares be expensed

Answer 16

finance costs

Question 17

what is a compound financial instrument

Answer 17

a financial instrument that contains both a liability and an equity component

Question 18

what is an example of a compound financial instrument

Answer 18

convertible bond

liability component = issuer has obligation to repay bond coupon

equity component = the bond holder has the option to convert to ordinary shares

Question 19

how should compound financial assets be recognised

Answer 19

liability and equity components should be recognised separately

Question 20

how to calculate liability component of a convertible bond

Answer 20

fair value of net proceeds

Question 21

how to calculate equity component of a convertible bond

Answer 21

fair value of whole bond - fair value of liability component

Question 22

what accounting standard deals with the recognition of financial instruments

Answer 22

IFRS 9 Financial Instruments

Question 23

under IFRS 9, when should financial instruments be recognised

Answer 23

when there is a contract between the entity buying the assets and the entity issuing the instrument

Question 24

when should financial instruments be derecognised, according to IFRS 9

Answer 24

when the right or obligation to receive or pay cash expired

Question 25

at what value should financial instruments be recognised at initially

Answer 25

at their fair value, on the day the asset was bought/liability issued i.e. amount of money that passed hands

Question 26

if a financial instrument is intended to be held until maturity, how should it be measured

Answer 26

Amortised cost method

Question 27

what does the effective interest method take into account

Answer 27

the premiums and discounts as well as the interest receivable

Question 28

what are the two ways in which assets can be measured over their lifetime

Answer 28

fair value or amortised cost

Question 29

why is amortised cost less volatile than fair value

Answer 29

spreads income over the lifetime of the asset

Question 30

what is the calculation for amortised cost

Answer 30

initial recognition + interest earned - interest received/payments made

Question 31

what are the two tests that need to be passed before an asset can be measured at amortised cost

Answer 31

business model test cash flow characteristics test

Question 32

what is the business model test

Answer 32

must be holding the financial asset to collect its contractual cash flows i.e. must be holding until maturity and not planning to trade before

Question 33

what is the cash flow characteristics test

Answer 33

the contractual cash flows must consist only of principal and interest i.e. cash flows connected to inflation would fail this test

Question 34

examples of some financial assets that can be measured at amortised cost

Answer 34

holding of loan stocks until maturity

Question 35

examples of financial assets that pass the cash flow characteristics but not the business model test

Answer 35

financial asset we plan to trade before maturity

Question 36

how should financial assets planned to be sold before maturity be measured

Answer 36

fair value through OCI

Question 37

what is an example of a financial asset that doesnt pass the cash flow characteristics test or the business model test

Answer 37

holding of ordinary shares

Question 38

how should the holding of ordinary shares be measured

Answer 38

at fair value through profit or loss

Question 39

under what heading in the SOFP are assets measured at amortised costs

Answer 39

Financial assets at amortised costs

Question 40

which financial standard deals with disclosures of financial instruments

Answer 40

IFRS 7 Financial Instruments: Disclosures

Question 41

why are disclosures important for financial instruments

Answer 41

enables users to evaluate significance of financial instruments on the entity's financial position and performance enables users to evaluate the risk related to financial instruments

Question 42

what does the equity component of a convertible bond represent

Answer 42

the premium paid to have the option to convert