Financial Reporting (F7/FR)
Financial instruments
 Financial instrument.
Any contract that gives rise to both a financial asset of one entity and a financial liability or
equity instrument of another entity.
 Financial asset.
Any asset that is:
(a) Cash
(b) An equity instrument of another entity
(c) 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
favourable to the entity
Examples of financial assets include:
(a) Trade receivables
(b) Options
(c) Shares (when held as an investment)
 Financial liability.
Any liability that is:
(a) A contractual obligation:
(i) To deliver cash or another financial asset to another entity, or
(ii) To exchange financial instruments with another entity under conditions that are potentially
unfavourable.
Examples of financial liabilities include:
(a) Trade payables
(b) Debenture loans payable
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(c) Redeemable preference (non-equity) shares
 Equity instrument.
Any contract that evidences a residual interest in the assets of an entity, after deducting all of its
liabilities.
 Fair value.
Price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.
Purchasing Entity
1 Purchased shares
Financial asset
2 Purchased bonds
Financial asset
Issuing Entity
1 Issued ordinary
Equity
shares
2 issued nonEquity
cumulative
irredeemable
preference shares
3 issued redeemable Financial liability
preference shares
4 Issued simple bonds Financial liability
5 issued convertible
Financial liability +
bonds (convertible
Equity
into ordinary shares
Accounting by issuing entity
Recognition of financial liability
A financial liability should be recognised in the statement of financial position when the
reporting entity becomes a party to the contractual provisions of the instrument.
Initial measurement
 Measured at fair value which is normally consideration received
 Initial direct cost is charged to profit and loss if subsequent measurement is fair value
through profit or loss
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 Initial direct cost is capitalized if subsequent measurement is amortized cost
Direct cost Dr
Cash Cr
Financial liability Dr
Direct cost Cr
Classification of financial liabilities
On recognition, IFRS 9 requires that financial liabilities are classified as measured either:
(a) At fair value through profit or loss, or
(b) At amortised cost.
Financial liabilities will be carried at amortised cost, other than liabilities held for trading and
derivatives that are liabilities as these are measured at fair value through profit or loss.
A financial asset or liability at fair value through profit or loss meets either of the following
conditions.
(a) It is classified as held for trading. A financial instrument is classified as held for trading if it is:
(i) Acquired or incurred principally for the purpose of selling or repurchasing it in the near term
(ii) Part of a portfolio of identified financial instruments that are managed together and for
which there is evidence of a recent actual pattern of short-term profit-taking
(b) Upon initial recognition it is designated by the entity as at fair value through profit or loss.
Note: Reclassification of a financial liability after initial recognition is not allowed.
Note: Derivatives are always measured at fair value through profit or loss.
Note: Change in fair value attributed to change in credit risk to OCI. Remaining change in fair
value to profit or loss
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Financial Reporting (F7/FR)
Interest, dividend, gain, losses
 Interest, dividend, gain, losses related to financial liability should be treated in income
statement
 Dividend related to equity instrument should be treated in statement of changes in
equity
Note: Initial direct cost related to equity instrument should be debited to premium or
retained earnings. It means that these costs should also be treated in statement of changes
in equity.
Derecognition
An entity should derecognise a financial liability when it is extinguished – ie when the obligation
specified in the contract is discharged or cancelled or expires. It is possible for only part of a
financial liability to be derecognised. This is allowed if the part comprises:
(a) Only specifically identified cash flows; or
(b) Only a fully proportionate (pro rata) share of the total cash flows.
On derecognition, the amount to be included in net profit or loss for the period is calculated as
follows:
$
Carrying amount of liability (or the portion of liability) transferred
X
Less proceeds paid
(X)
Difference to profit or loss
X
Convertible--- debt and equity apportionment
A company issues $10 million of 6% convertible bonds at par. The bonds are redeemable at par
after four years or can be converted at any time up to that date into 20 ordinary shares for
every $100 of bonds. The market rate of interest for similar debt which is not convertible is 8%.
Required
Show how the bonds should be recorded on issue in the statement of financial position
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$
Present value of interest payments
10,000,000 ×6% ×discount factor at 8% for time periods 1 to 4
= $600,000 × 3.312
1,987,200
Present value of principal payable at the end of four years
$10,000,000 ×discount factor at 8% at time 4
$10,000,000 × 0.735
7,350,000
–––––––––
Value of debt element
9,337,200
Total proceeds
10,000,000
–––––––––
Value of equity element (residual)
662,800
Accounting for redeemable preference shares: amrtised cost
A company issues 2 million redeemable preference shares of $1 each that will be redeemed after
five years. The holders of the preference shares are entitled to an annual dividend of 5%. The
issue price was at par and issue costs were $100,000.
The shares will be redeemed at par after five years, and redemption costs will be $34,000.
It has been calculated that the effective annual interest rate for this financial liability is 6.5% per
annum.
Required
Outline the treatment of the shares over the 5-year period.
 Original liability in the statement of financial position is $1,900,000 ($2,000,000 less
issue costs of $100,000).
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 When the shares are redeemed, the company will pay $2,000,000 + $34,000
=$2,034,000.
Excess of the redemption cost over the initial liability
134,000
Dividends payable over the life of the liability (5 years × $100,000)
500,000
––––––––
Total finance charge
634,000
Accounting for fixed rate debt: amortised cost
A company issues $10 million of 6% bonds at a price of 100.50 and issue costs are $50,000. The
bonds are redeemable after four years at a price of 104.00 and redemption costs will be
$44,000. (Note: A price of 104.00 means that the price is $104 for each $100 nominal value of
bonds).
It has been calculated that the effective annual interest rate for this financial instrument is 7%.
Required
Show how the bonds should be accounted for in each of the four years.
 Initial liability is ($10 million × 100.50/100) – $50,000 = $10,000,000.
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 When the bonds are redeemed, the company will pay the redemption price of 104 plus
the redemption costs of $44,000. The total redemption cost of the bonds is ($10 million ×
104/100) + $44,000 = $10,444,000.
Difference between redemption cost and initial liability
444,000
Interest paid ($10 million × 6% × 4 years)
2,400,000
–––––––––––
Total finance charge
2,844,000
More examples
Example
A company issues a bond (borrows).
The bond has an issue value of $1 million and pays a coupon rate of 5% interest for two years,
then 7% interest for two years (this known as a stepped bond).
Interest is paid annually on the anniversary of the bond issue. The bond will be redeemed at par
after four years. The effective rate for this bond is 5.942%
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Required
What is the amortised cost at the end of each year?
Accounting by purchasing entity
Recognition of financial asset
A financial asset should be recognised in the statement of financial position when the reporting
entity becomes a party to the contractual provisions of the instrument.
Initial measurement
 Measured at fair value which is normally consideration received
 Initial direct cost is charged to profit and loss if subsequent measurement is fair value
through profit or loss
 Initial direct cost is capitalized if subsequent measurement is amortized cost or fair value
through other comprehensive income
Direct cost Dr
Cash Cr
Financial asset Dr
Direct cost Cr
Classification of financial assets on recognition
On recognition, IFRS 9 requires that financial assets are classified as measured at either:
 Amortised cost
 Fair value through other comprehensive income; or
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 Fair value through profit or loss
The IFRS 9 classification is made on the basis of both:
(a) The entity's business model for managing the financial assets, and
(b) The contractual cash flow characteristics of the financial asset.
Debt instrument
Financial assets at amortised cost
A financial asset must be measured at amortised cost if both of the following conditions are
met:
1. the asset is held within a business model whose objective is to hold assets in order to
collect contractual cash flows; and
2. the contractual terms of the financial asset give rise on specified dates to cash flows
that are solely payments of principal and interest on the principal amount outstanding.
IFRS 9 introduces a business model test that requires an entity to assess whether its business
objective for a debt instrument is to collect the contractual cash flows of the instrument as
opposed to realizing any change in its fair value by selling it prior to its contractual maturity.
Note the following key points:
(a) The assessment of a 'business model' is not made at an individual financial instrument level.
(b) The assessment is based on how key management personnel actually manage the business,
rather than management's intentions for specific financial assets.
(c) An entity may have more than one business model for managing its financial assets and the
classification need not be determined at the reporting entity level. For example, it may have one
portfolio of investments that it manages with the objective of collecting contractual cash flows
and another portfolio of investments held with the objective of trading to realise changes in fair
value. It would be appropriate for entities like these to carry out the assessment for
classification purposes at portfolio level, rather than at entity level.
(d) Although the objective of an entity's business model may be to hold financial assets in order
to collect contractual cash flows, the entity need not hold all of those assets until maturity. Thus
an entity's business model can be to hold financial assets to collect contractual cash flows even
when sales of financial assets occur.
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The requirement in IFRS 9 to assess the contractual cash flow characteristics of a financial asset
is based on the concept that only instruments with contractual cash flows of principal and
interest on principal may qualify for amortised cost measurement. By interest, IFRS 9 means
consideration for the time value of money and the credit risk associated with the principal
outstanding during a particular period of time.
Example
X purchased a loan on 1 January 20X5 and classified it as measured at amortised cost. (It has an
asset).
Terms:
Nominal value $50 million
Coupon rate 10%
Term to maturity 3 years
Purchase price $48 million
Effective rate 11.67%
Required
Calculate the amortised cost of the bond and show the interest income for each year to maturity
Financial assets at fair value through OCI
A financial asset must be measured at fair value through OCI if both of the following conditions
are met:
 the asset is held within a business model whose objective is achieved by both holding
collecting contractual cash flows and selling the financial assets; and
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 the contractual terms of the financial asset give rise on specified dates to cash flows that
are solely payments of principal and interest on the principal amount outstanding.
Note: For these instruments, fair value changes will go through other comprehensive income;
interest charges will be measured at amortised cost and go through profit or loss.
Example
X purchased a loan on 1 January 20X5 and classified it as measured at fair value through OCI.
Terms:
Nominal value $50 million
Coupon rate 10%
Term to maturity 3 years
Purchase price $48 million
Effective rate 11.67%
Fair values at each year end to maturity are as follows
31 December 20X5 $49.2 million
31 December 20X6 $49.5 million
31 December 20X7 $50.0 million
Required
Calculate the fair value adjustments and show the interest income for each year to maturity.
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Financial asset at fair value through profit and loss
A financial asset or liability at fair value through profit or loss meets either of the following
conditions.
(a) It is classified as held for trading. A financial instrument is classified as held for trading if it is:
(i) Acquired or incurred principally for the purpose of selling or repurchasing it in the near term
(ii) Part of a portfolio of identified financial instruments that are managed together and for
which there is evidence of a recent actual pattern of short-term profit-taking
(b) Upon initial recognition it is designated by the entity as at fair value through profit or loss.
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Even if a financial asset satisfies the amortised cost criteria a company is allowed at initial
recognition, to designate it as a financial asset to be measured at fair value through profit or
loss. This designation can only be made if it eliminates or significantly reduces a measurement
or recognition inconsistency. This designation is irrevocable.
Equity instrument
Fair value through profit or loss
This is the default position for equity investments.
Any transaction costs associated with the purchase of these investments are expensed, and not
included within the initial value of the asset.
The investments are then revalued to fair value at each year-end, with any gain or loss being
shown in the statement of profit or loss.
Example
An equity investment is purchased for $30,000 plus 1% transaction costs on 1 January 20X6.
At the end of the financial year (31 December 20X6) the investment is revalued to its fair value
of $40,000.
On 11 December 20X7 it is sold for $50,000.
Required
Explain the accounting treatment for this investment.
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Fair value through other comprehensive income
Instead of classing equity investments as fair value through profit or loss (FVPL), an entity may
designate the investment as 'fair value through other comprehensive income' (FVOCI). This
designation must be made on acquisition and can only be done if the investment is intended as
a long term investment. Once designated this category cannot later be changed to FVPL.
It is possible to designate an equity instrument as fair value through other comprehensive
income, provided specified conditions have been complied with as follows:
• The equity instrument cannot be held for trading, and;
• There must be an irrevocable choice for this designation upon initial recognition.
Note: Note that when an investment held at FVTOCI is sold, any gain or loss on disposal will
also go through OCI and be held in reserves. At disposal entities are permitted to transfer the
total gains and/or losses on the investment to retained earnings, but these amounts will not
appear in any statement of profit or loss.
Example
An equity investment is purchased for $30,000 plus 1% transaction costs on 1 January 20X6. It is
classified as at fair value through OCI.
At the end of the financial year (31 December) the investment is revalued to its fair value of
$40,000. On 11 December 20X7 it is sold for $50,000.
Required: Explain the accounting treatment for this investment.
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Factoring of accounts receivable
In a factoring agreement, a business entity (the ‘seller’) makes an arrangement with a ‘factor’.
The ‘seller’ transfers its accounts receivable (invoices) to the ‘factor’, and in return receives an
immediate payment of an agreed percentage of the receivables.
The factor will agree to make an immediate payment to the entity of (say) up to 80% of the
value of the invoices it has undertaken to collect.
For example, if a company arranges for the factoring of its accounts receivable and its monthly
invoices to customers are $100,000 in total, the factor may agree to pay the company $80,000
each month as an advance on the money receivable (charging interest on the advance), with the
balance payable, less the factor’s fees, when the debts are eventually collected.
The key issue in accounting for receivables that are subject to a factoring arrangement is to
decide whether the company should derecognise the receivables (and remove them from its
statement of financial position). This decision should be based on whether the key risks and
rewards of ownership of the receivables have passed to the factor.
1. If they have not passed to the factor, the receivables have not been sold and the
payments from the factor that relate to those receivables should be treated as a loan.
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2. If they have passed to the factor, the receivables have been sold and should be removed
from the statement of financial position. Any profit or loss should be recognised in the
statement of profit or loss.
The key issue is who bears the risk of bad debts. In a factoring agreement, the terms of the
agreement will specify what happens in the event of bad debts.
 The factor may agree to bear all the risk of bad debt losses. This is a ‘nonrecourse
agreement’ for which the factor charges a higher fee.
 The factor may not accept the risk of bad debts, so that any bad debt losses are incurred
by the client company. (This is called a ‘with recourse’ factoring agreement).
With a non-recourse factoring agreement, it is appropriate for the client company to
derecognise its receivables, and account for the cash from the factor as sales income and for
the balance as receivables due from the factor, rather than its original customers.
Example
Entity G transferred title to its trade receivables of $200,000 at 31 January Year 1, to a
factor. The factor paid 80% of the value of the receivables. The agreement provided that if
less than 80% of the receivables proved to be recoverable Entity G would have to make good
the factor’s losses.
If the factor recovers more than 80% of the value of the receivables, it will keep the
difference.
Required
Consider how this transaction should be dealt with in the books of Entity G.
Answer
The risk of bad debts remains with Entity G because:
 if less than 80% of the receivables prove to be recoverable it will have to pay part of
the $160,000 back to Entity G
 if more than 80% of the receivables prove to be recoverable the excess belongs to the
factor
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Therefore, in substance, there has been no ‘sale’. The receivables should remain in the
statement of financial position of Entity G and the $160,000 should be recorded as a secured
loan.
Re-classification of financial assets
Although on initial recognition financial instruments must be classified in accordance with
the requirements of IFRS 9, in some cases they may be subsequently reclassified. IFRS 9
requires that when an entity changes its business model for managing financial assets, it
should reclassify all affected financial assets. This reclassification applies only to debt
instruments, as equity instruments must be classified as measured at fair value
Impairment and uncollectability of financial assets
The new impairment model in IFRS 9 is based on providing for expected losses (rather than
dealing with losses after they have arisen) and applies to financial assets held at amortised cost
and FVTOCI. The financial statements should reflect the general pattern of deterioration or
improvement in the credit quality of financial instruments.
On initial recognition of the asset the entity creates a credit loss allowance equal to 12 months'
expected credit losses. This is calculated by multiplying the probability of a default occurring in
the next 12 months by the expected credit losses that would result from that default.
If credit risk increases significantly subsequent to initial recognition, the allowance recorded to
represent 12 months' expected credit losses is replaced by an allowance for lifetime expected
credit losses. If credit quality then improves, the 12 month loss basis is reinstated.
The movement in the allowance is recognised as an impairment gain or loss in profit or loss.
On financial assets carried at fair value gains and losses are recognised in profit or loss. Any
impairment loss should be recognised in net profit or loss for the year even though the financial
asset has not been derecognised.
The impairment loss is the difference between its acquisition cost (net of any principal
repayment and amortisation) and current fair value (for equity instruments) or recoverable
amount (for debt instruments), less any impairment loss on that asset previously recognised in
profit or loss.
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Financial instruments: disclosure requirements
IFRS 7: Financial instruments: Disclosure requires two types of disclosure about financial
instruments, in order to allow users to evaluate:
 the significance of financial instruments for the entity’s financial position and
performance, and
 the nature and extent of the risks arising from the use of financial instruments
during the period, and how the entity has managed those risks.
Disclosure of the impact on the entity’s financial position and performance
IFRS 7 contains a large amount of detail, but its main disclosure requirements relating to
disclosure of the impact of financial instruments on the entity’s financial performance and
position are as follows:
In the statement of financial position or in notes:
 Categorisation of financial instruments in the statement of financial position or in the
notes to the financial statements (these categories are explained later)
 Amounts given as security in respect of financial liabilities
 Details of any defaults on loans.
In the statement of profit or loss, disclosures should include:
 Net gains or losses on each category of financial asset or liability
 Total interest income and total interest expense (calculated using the effective interest
method) arising from financial instruments that are not in the category ‘at fair value
through profit or loss’
 Impairment losses for each class of financial asset.
Disclosure of the risks arising from the use of financial instruments
IFRS 7 states that: ‘An entity shall disclose information that enables users of its financial
statements to evaluate the nature and extent of risks arising from financial instruments to
which the entity is exposed at the end of the reporting period.’ The perceived risks from using
financial instruments include credit risk, liquidity risk and market risk. IFRS 7 requires qualitative
and quantitative disclosures about these risks.
Qualitative disclosures include, for each type of risk:
 the exposure to risks and how they arise
 the entity’s objectives, policies and processes for managing those risks, and
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 any changes to the above from the previous period.
Quantitative disclosures of risks should be made, according the different types of risk.
Credit risk is defined as ‘the risk that one party to a financial instrument will cause a
financial loss for the other party by failing to discharge an obligation’. The most obvious
example of credit risk with financial instruments is the risk that a borrower or a deposittaking institution (such as a bank) will fail to pay interest or will fail to repay the principal
lent or deposited. Disclosures about credit risk should include:
 the maximum exposure to credit risk, without taking into account any assets held as
security
 details of any assets held as security
 information about the credit quality of the financial assets
 an age analysis of financial assets which are ‘past due’ but not impaired (showing
for how long the amounts owed are overdue)
 an analysis of financial assets which are ‘impaired’.
Liquidity risk is defined as ‘the risk that an entity will encounter difficulty in meeting
obligations associated with financial liabilities’. In other words it is the risk that the entity
will be unable to pay what it owes when the payment is due for settlement. Disclosure is
required of:
 a maturity analysis for financial liabilities showing the remaining contractual
maturities (showing when the amounts owed are payable)
 how the liquidity risk relating to the payment of these liabilities is managed.
Market risk is defined as ‘the risk that the fair value or future cash flows of a financial
instrument will fluctuate because of changes in market prices’. For example, a company holding
shares or bonds in other companies as an investment is exposed to market risk. Market risk is
categorised into currency risk, interest rate risk and other price risks. The main disclosure
requirement in IFRS 7 relating to market risk is the provision of a sensitivity analysis for each
category of market risk.
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Chapter end exercise
Q1 TS purchased 100,000 of its own equity shares in the market and classified them as
treasury shares. At the end of the accounting period TS still held the treasury shares.
Which of the following is the correct presentation of the treasury shares in TS’s closing
statement of financial position in accordance with IAS 32 Financial Instruments
Presentation?
A As a current asset investment
B As a non-current liability
C As a non-current asset
D As a deduction from equity
Q2 IAS 32 Financial Instruments: Presentation classifies issued shares as either equity
instruments or financial liabilities. An entity has the following categories of funding on
its statement of financial position:
(1) A preference share that is redeemable for cash at a 10% premium on 30 May 2020
(2) An equity share which is not redeemable and has no restrictions on receiving dividends
(3) A loan note that is redeemable at par in 2022
(4) An irredeemable loan note that pays interest at 7% a year
Applying IAS 32, how would each of the above be classified in the statement of financial
position?
As an equity instrument
As a financial liability
A
1 and 2 only
3 and 4 only
B
2 and 3 only
1 and 4 only
C
2 only
1, 3 and 4
D
1, 2 and 3
4 only
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Q3 How should convertible debt be classified in accordance with IAS 32 Financial
Instruments Presentation?
A As either a liability or equity based on an evaluation of the substance of the contractual
arrangement
B As separate liability and equity components, basing the liability element on the present value
of future cash flows
C As equity in its entirety, on the presumption that all options to convert the debt into equity will
be exercised in the future
D As a liability in its entirety, until it is converted into equity
Q4 How should the proceeds from issuing a compound instrument be allocated between
liability and equity components in accordance with IAS 32 Financial Instruments
Presentation?
A The liability component is measured at fair value and the remainder is allocated to the equity
component
B The equity component is measured at fair value and the remainder is allocated to the liability
component
C The fair values of both the components are estimated and the proceeds allocated
proportionately
D The equity component is measured at its intrinsic value and the remainder is allocated to the
liability component
Q5 In the current financial year, Natamo has raised a loan for $3m. The loan is repayable in
10 equal half-yearly instalments. The first instalment is due six months after the loan
was raised. Which of the following correctly recognises the loan in Natamos next
financial statements?
A As a current liability
B As a non-current liability
C As equity
D As both a current and a non-current liability
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Q6 On 1 January 20X2 LMN issued $2,000,000 8% convertible debt at par. The debt is
repayable, or convertible, at a premium of 10% four years after issue. The effective
interest rate for the debt is 14%. The present values $1 receivable at the end of each
year, based on discount rates of 8%, 10% and 14% are:
8%
10%
14%
1
0.926
0.909
0.877
2
0.857
0.826
0.769
3
0.794
0.751
0.675
4
0.735
0.683
0.592
End of year
What is the finance charge to LMN’s profit or loss for the year ended 31 December 20X3?
A $160,000
B $248,000
C $260,000
D $274,000
Q7 On 1 March 20X2 PQR purchased a debt instrument from the market for $105,000, the
par value of the instrument was $100,000. At 31 December 20X2 the fair value of the
instrument is $112,000 and the amortised cost has been calculated to be $104,000.
PQR does not hold this type of asset for contractual cash flows.
At what amount should the investment be included in PQR’s statement of financial position as
at 31 December 20X2?
A $100,000
B $104,000
C $105,000
D $112,000
Q8 On 1 January 20X2 XYZ issued $1,000,000 4% convertible loan notes, at a discount of 95.
The loan notes are redeemable in five years at a premium of 10%. What are the total finance
costs that should be charged to profit or loss over the fiveyear term of the convertible loan
notes?
A $350,000
B $345,000
C $250,000
D $200,000
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Q9 On 1 October 20X3, Bertrand issued $10 million convertible loan notes which carry a
nominal interest (coupon) rate of 5% per annum. The loan notes are redeemable on 30
September 20X6 at par for cash or can be exchanged for equity shares. A similar loan
note, without the conversion option, would have required Bertrand to pay an interest
rate of 8%. The present value of $1 receivable at the end of each year, based on discount
rates of 5% and 8%, can be taken as:
5%
8%
1
0·95
0·93
2
0·91
0·86
3
0·86
0·79
Which of the following correctly recognises the convertible loan in Bertrand’s statement of
financial position on initial recognition (1 October 20X3)?
Equity
Non-current liability
$000
$000
A
810
9,190
B
nil
10,000
C
10,000
nil
D
40
9,960
Q10
In accordance with IFRS 9 Financial Instruments, under what circumstances must
a loan asset be classified at fair value through other comprehensive income?
A The entity’s business model is to hold the asset to collect contractual cash flows
B The entity’s business model is to hold the asset to collect contractual cash flows and sell the
asset
C The asset is expected to be held until its maturity
D To eliminate an accounting mismatch using the “fair value option”
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Financial Reporting (F7/FR)
Q11
Skeptic is about to dispose of an equity investment in another entity which is
measured at fair value through other comprehensive income. Skeptic expects to make a
gain on disposal; a cumulative fair value gain has already been recognised over the
period of holding this asset.
What is the accounting treatment of the gains in the year of disposal in accordance with
IFRS 9 Financial Instruments?
Gain on disposal
Cumulative gain
A
Credit profit or loss
Reclassify to profit or loss
B
Credit other comprehensive income
Not reclassified to profit or loss
C
Credit other comprehensive income
Reclassify to profit or loss
D
Credited profit or loss
Transfer to retained earnings
Q12
Which of the following is not a method of valuing financial assets in accordance
with IFRS 9 Financial Instruments?
A Transaction price
B Fair value
C Amortised cost
D Equity method
Q13
IAS 32 Financial Instruments: Presentation classifies issued shares as either equity
instruments or financial liabilities. Classify the following instruments
Instrument
A preference share that is redeemable for cash at a 10% premium in six years’ time
An equity share which is not redeemable and has no restrictions on receiving dividends
A loan note that is redeemable at par in eight years’ time
An irredeemable loan note that pays interest at 7% a year
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Financial Reporting (F7/FR)
Q14
The following scenario relates to questions 1-5.
Pingway issued a $10 million 3% convertible loan note at par on 1 April 2015 with interest
payable annually in arrears. On 31 March 2018 the loan note holder can choose between
conversion into 20 equity shares for each $100 of loan note or redemption at par in cash. The
nominal value of an equity share is $0.50. The effective rate of interest for this loan is 8%.
The present value of $1 receivable at the end of the year, based on discount rates of 3% and 8%
can be taken as:
3%
8%
$
$
1
0·97
0·93
2
0·94
0·86
3
0·92
0·79
End of year
1 How many equity shares will be issued if all of the convertible loan note holders convert the
notes into equity on the conversion date?
A 100,000
B 2,000,000
C 1,000,000
D 4,000,000
2 At what amount will the convertible loan notes be recognised in the statement of financial
position as at 1 April 2015?
A $8.674 million
B $10 million
C $9.368 million
D $7.9 million
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Financial Reporting (F7/FR)
3 Which of the following cost behaviour patterns best describes how the finance costs will be
expensed to profit or loss over the three year term of the convertible loan notes?
A Low in year one, increasing in years two and three
B High in year one, decreasing in years two and three
C On a straight line basis over the three years
D Only charge profit or loss on conversion of the loan notes
4 Pingway has a number of loan assets classified as at fair value through other comprehensive
income. It intends to sell these assets in the next financial year and hopes to make a gain on the
sale of the investments.
How should any gain on the disposal of the equity investments be accounted for when they are
sold?
A Recognise any gain immediately in profit or loss
B Recognise any gain in other comprehensive income and reclassify any cumulative gain to
profit or loss
C Recognise any gain in other comprehensive income but do not reclassify any cumulative gain
to profit or loss
D Recognise any gain directly in equity
5 In accordance with IFRS 9 Financial Instruments, under what circumstances must a loan asset
is classified at fair value through other comprehensive income?
A The entity’s business model is to hold the asset to collect contractual cash flows
B The entity’s business model is to hold the asset to collect contractual cash flows and sell the
asset
C The asset is expected to be held until its maturity
D To eliminate an accounting mismatch using the “fair value option”
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Financial Reporting (F7/FR)
Q15
Bertrand issued $10 million convertible loan notes on 1 October 2015 that carry a
nominal interest (coupon) rate of 5% per annum. They are redeemable on 30 September
2018 at par for cash or can be exchanged for equity shares in Bertrand on the basis of 20
shares for each $100 of loan. A similar loan note, without the conversion option, would
have required Bertrand to pay an interest rate of 8%.
When preparing the draft financial statements for the year ended 30 September 2016, the
directors are proposing to show the loan note within equity in the statement of financial
position, as they believe all the loan note holders will choose the equity option when the loan
note is due for redemption. They further intend to charge a finance cost of $500,000 ($10 million
× 5%) for each year up to the date of redemption.
The present value of $1 receivable at the end of each year, based on discount rates of 5% and
8%, can be taken as:
5%
8%
1
0·95
0·93
2
0·91
0·86
3
0·86
0·79
End of year
Prepare extracts to show how the loan notes and the finance charge should be treated by
Bertrand in its financial statements for the year ended 30 September 2016.
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