Financial instruments and Provisions

Question 1

What is a liability?

Answer 1

• Obligation from past event
• Outflow of economic benefits
• Reliably measureable

Question 2

What is equity?

Answer 2

• No obligation or variable returns
• Residual interest (share of what is leftover)

Question 3

If preference shares have fixed non-discretionary dividend and/or are redeemable and the company can’t opt out, what is it?

Answer 3

• Legally, equity
• Substance (IAS 32) = liabiltiy / debt

Question 4

How do you represent 2m 50p 3% bonds?

Answer 4

• Interest payable (1000000 nominal value x 3% = 30000)
• Obligation to repay the bonds in 2018
• Either of these is sufficient to identify the bond as debt

Question 5

How would you represent 12 million ordinary shares of 25p?

Answer 5

• Shareholders expect to receive dividends, although they have no right to (once declared there is, but if no declaration, no liability)
• Shareholders have no right to receive back the money they paid for the shares
• Equity instrument

Question 6

What is the key role of IAS 32?

Answer 6

• Establish principles for presenting financial instruments as liabilities or equity and for offsetting financial assets and liabilities

Question 7

In what way can classification of a financial instrument by the issuer as either debt or equity have a significant impact on entity’s financial statement?

Answer 7

• Affecting gearing
• Affecting reported earnings
• Affecting debt covenants

Question 8

How do you classify issued preference shares where the payment is at discretion of the directors, they are cumulative and non-redeemable?

Answer 8

• Equity
• Because non-redeemable unless the directors say so

Question 9

How do you measure financial liabilities (not at FV) under IFRS?

Answer 9

• Amortised cost using effective interest rate method

Question 10

What is £5000 worth of inventory held by Short Ltd as sold by Sam Ltd on 30 day payment terms?

Answer 10

• Inventory is not a financial instrument (its a physical asset)
• Trade payable of £5000 = financial liability because they need to pay
• Trade receivable of £5000 = financial asset as it has right to receive cash

Question 11

What is £20000 in advance for a 12 month insurance policy?

Answer 11

• Paid for service in advance
• Recorded as a prepayment
• Future economic benefit

Question 12

What is 100000 ordinary shares which are acquired by Long?

Answer 12

• Equity instrument of Stevens Ltd as they give the holder residual interest in Steven after deducting liablities
• Ordinary shares are a finanical asset of Long

Question 13

What is a 200000 mortgage borrowed by Right under Sam?

Answer 13

• Contractual obligation for Right of 200000 means its a financial liability
• Financial asset for Sam who can receive it

Question 14

Smith declared following dividends: 4 million ordinary
3 million dividend prefernce shares redeemable in 2019

Answer 14

• Classified according to the underlying financial instrument:
• dividends payable on ordinary shares (equity instrument) should be charged directly against equity = statement of changes in equity
• Redeemable preference shares (liability) recognised in expense in profit or loss

Question 15

On 1 January 2017 an entity issued 10,000 6% convertible bonds at a par value of £100. Each
bond is redeemable at par or convertible into four shares on 31 December 2018. Interest is
payable annually in arrears. The market rate of interest for similar debt without the
conversion option is 8%.
a) Measure the liability and equity components of these bonds on 1 January 2017
b) Explain how both will be accounted for in the year ended 31 December 2017

Answer 15