AN OVERVIEW OF FINANCIAL REPORTING
WITHIN THE SCOPE OF
IFRS 7 – FINANCIAL INSTRUMENTS: DISCLOSURES
Assistant Professor Volkan DEMİR
T.C. Galatasaray University
0. INTRODUCTION
Financial instruments which have significant effects on an entity’s financial statements while
reporting on their performance and financial position, have been defined as being any contract
which gives rise to a financial asset for one entity, whilst giving rise to another entity’s
financial liability or equity instrument. Financial instruments consist of financial assets,
financial liabilities (debts) and contracts that include a right or a commitment on the financial
assets and financial liabilities (derivatives). Within the scope of the International Financial
Reporting Standards, there are 3 (three) standards which relate to financial instruments: IAS
32: Financial Instruments: Presentation, IAS 39: Financial Instruments: Recognition and
Measurements, IFRS 7: Financial Instruments: Disclosures. IAS 32 used to contain the
presentation and disclosure of financial instruments. However the disclosure of financial
instruments has been removed from IAS 32 as a result of the issuing of IFRS 7 on 1.1.2007.
Therefore in reference to the disclosure requirements, IFRS 7 has superseded IAS 32 and IAS
30: Disclosures in the Financial Statements of Banks and Similar Financial Institutions.
Whilst taking into account the presentation requirements of IAS 32 and the recognition and
measurement requirements of financial instruments according to IAS 39, the purpose of this
study is to examine the disclosure requirements of financial instruments according to IFRS 7.
1. IFRS AND FINANCIAL REPORTING
The aim of the International Financial Reporting Standards (IFRS) is to make all entities
present their financial performance and financial position fairly. The following modes of
financial reporting fall under the remit of the IFRS and must be disclosed (IAS 1: paragraph
8):
1

Balance Sheet (Financial Position Statement)

Income Statement

Cash Flow Statement

Statement of Change in Equity

Notes
Both financial reporting and activity reporting are significant when reporting on and
establishing an entity’s value. As shown in Figure 1, financial reporting is one of the two
basic components used to establish an entity’s value.
Enterprise Value
Reporting
Operational Reporting
Disclosures and Notes
A Statement of Changes in Equity
Cash Flow Statement
Income Statement
(Financial Performance Table)
Balance Sheet (Financial Position Table)
Financial Reporting
Traditional Operational
Reporting
Intellectual Capital
Reporting
IFRS
Figure 11: Components of Enterprise Value Reporting
There are two critical points concerning financial reporting according to the IFRS. One of
them is the technical language of the IFRS (SANCHEZ: 2006). This technical language
makes it difficult for non-expert financial statement users to reach the IFRS's financial
reporting standards. The other critical point is the immense challenge of understanding the
presentation and measurement principles of the IFRS unless the technical elements are fully
explained. (DAMANT: 2003:9).
1“Burgman,
Roland; Roos Göran: The Importance of Intellectual Capital Reporting: Evidence and
Implication, Journal of Intellectual Capital, Vol 8, No 2, 2007, p.29” was utilized while preparing this figure.
2
As we can understand from disclosures, financial reporting is a tool that is used for
transferring an entity’s financial information to the users of financial statements. As shown in
Figure 2, financial reports serve the users of financial statements:
USERS OF FINANCIAL STATEMENTS
INVESTORS
PUBLIC
EMPLOYEES
Users
of
Financial
Statements
GOVERNMENT
CUSTOMERS
CREDITORS
SUPPLIERS
Figure 2: Users of Financial Statements
Financial reporting today focuses on the presentation, measurement and recognition of
financial events and also on the disclosure of these events to financial information users.
Therefore, financial reporting - which is primarily required to focus on the needs of the
financial information users - must continue to be improved especially on the subjects related
to the disclosures and notes. (MUNTER and ROBINSON: 1999: 8,9).
2. FINANCIAL INSTRUMENTS UNDER THE SCOPE OF THE IFRS
Financial Instruments Standard is a project which was developed in 1989 by a common study
group consisting of the International Accounting Standards Committee2 (IASC) and the
Canadian Institute of Chartered Accountants (CICA). Two draft copies of this study were
issued, and as a result of the reviews received on the last draft, it was decided that the project
2
The current name of International Accounting Standards Committee (IASC) is International Accounting
Standards Board (IASB).
3
would be separated into two different standards. As a result of this, IAS 32 Financial
Instruments: Presentation and Disclosures standard was issued in June 1995 and IAS 39
Financial Instruments: Recognition and Measurement standard was issued in December 1998.
Afterwards, following some amendments, IAS 32 and IAS 39’s final scope was determined in
December 2003. (MISIRLIOĞLU: 2005: 3).
Due to these developments, the IASB removed the disclosures of financial instruments from
the scope of IAS 32 (IAS 30 for banks and similar financial institutions) and managed to
relocate them within another standard. IFRS 7 Financial Instruments: Disclosures standard
was effective from 1.1.2007 (IFRS 7: IN 8). Thus there are effectively 3 standards for the
reporting of financial instruments in financial statements:

IAS 32 Financial Instruments: Presentation

IAS 39 Financial Instruments: Recognition and Measurements

IFRS 7 Financial Instruments: Disclosures
Due to the IFRS's regulations concerning presentation, recognition and disclosures of
financial instruments, some basic changes are required for existing applications in the
countries of the European Union. These basic changes focus not only on the hedge accounting
applications, but also on the risk management of entities in order to successfully apply hedge
accounting. (MOORE: 2002: 22).
Financial instruments under the scope of the IFRS are shown in Figure 3:
4
BALANCE SHEET AS OF
31.12.....
Passive
Active
FINANCIAL LIABILITIES
FINANCIAL ASSETS
Financial Liabilities
Trade Payables
Marketable Securities Issued
Deposits (for Banks)
Cash in Hand
Banks
Cheques Received
Customers
Notes Receivable
Marketable Securities
Loans (for Banks)
DERIVATIVES
Forward Contracts
Options Contracts
Futures Contracts
Swap Contracts
Commodity Contracts
Figure 3: Financial Instruments
Financial instruments are defined in IAS 32 as follows: “Any contract that gives rise to a
financial asset of one entity and a financial liability or equity instrument of another entity.”
As the definition implies, financial instruments are not only recognised instruments but they
can also cover some unrecognised contracts which contain certain conditions (DYCKMAN ve
diğerleri: 1998: 674). Unrecognised financial instruments include those that do not fall under
the scope of IAS 39 but under that of the IFRS (eg, loan contracts) (EBSTEIN ve
JERMAKOWICZ: 2007: 165).
Example: Because of the positive conditions (eg. the pre-determined interest rate is less than
the interest rate on the date of maturity) a bank could have issued a letter of credit that
obligates cash payment to a customer. In this situation, although the letter of credit is not
recognised as a receivable for the entity’s assets or as a debt to the entity’s liabilities, it must
be evaluated as a financial instrument.
5
In parallel with the development of financial markets, the amount of these kinds of financial
instruments is increasing. Interest rate exchange contracts and maturity contracts, which have
been used frequently in recent years, are classed as these type of financial instruments.
The scope of financial instruments in the IFRS is quite wide. Any asset, liability and
derivative that is appropriate to the definition of a financial instrument is recognised and
reported according to IAS 32, IAS 39 and IFRS 7.
Table 13: Financial instruments within and out of the scope of IAS 32, IAS 39 and IFRS 7
Within the scope of IAS 32, IAS 39 and IFRS 7
Out of scope
Investment in subsidiaries (IAS 27)
Debt and equity investments
Investments in associates (IAS 28)
Joint ventures (IAS 31)
Loans and receivables
Own debt
Tax balances(IAS 12)
Employee benefits (IAS 19)
Cash and cash equivalents
Derivatives – for example:

Forward Contracts

Options Contracts

Futures Contracts

Swap Contracts

Commodity Contracts

Credit Derivatives
Own use commodity contracts
Derivatives on subsidiaries, associates and joint ventures
Embedded derivatives
Loan commitments held for trading
Other loan commitments
Financial guarantees
Insurance contracts (IFRS 4)
2.1. FINANCIAL ASSETS
2.1.1. Definition of Financial Assets
A financial asset that falls within the scope of IAS 32 is any asset that is either; cash, an
equity instrument of another entity, a contractual right to exchange financial instruments with
another entity or a contract that will or may be settled in the entity’s own equity instruments
(IAS 32: paragraph 11).
3
This table was prepared by using the information in “PRICEWATERHOUSECOOPERS: Financial
Instruments Under UFRS , 2006, p.4,5” .
6

Cash: Entity’s cash in hand and in banks.
Cash in hand
Banks

An Equity Instrument of Another Entity: A contract that gives an entity the right to buy
the financial instruments of another entity, is defined as a financial asset. This kind of
financial asset is not classed as assets or liabilities of an entity, but as derecognised financial
assets that are called derivatives.
Generally, it is not difficult for entities to assess whether or not a financial asset should be
derecognised. But in some cases the derecognition decision for financial assets can be less
obvious. For example; if an entity sells its portfolio of trade receivables in order to earn
financial gain, then it would be less obvious whether or not those financial assets should be
derecognised (PWC: 2006: 14).

A Contractual Right to Exchange Financial Instruments With Another Entity: This
can be a contractual right which allows an entity to receive cash or another financial asset
from another company, or it can be the right to exchange financial assets and financial
liabilities with another entity under conditions which are potentially favourable to the entity.

A Contract That Will or May Be Settled In The Entity’s Own Equity Instruments: A
contractual right for one entity to buy another entity’s equity instruments. Common stock is
the most common of these financial instruments. Other than common stock, preferred stocks
issued by an entity are also a financial asset (MISIRLIOĞLU: 2005 : 4).
2.1.2. Classification and Measurement of Financial Assets
IAS 39 classifies financial assets into four groups (IAS 39: paragraph 9). The financial assets
that are defined in IAS 39 can be called passive investments. Passive investments are
financial investments upon which investors do not exert any effect (EPSTEIN and MIRZA:
2003).
7

Fair Value Through Profit or Loss: These are evaluated by fair value and the
difference of the fair value is reported on the income statement.

Held-To-Maturity Investments : These are evaluated by amortised cost.

Loans and Receivables : These are evaluated by amortised cost.

Available-For-Sale Finacial Assets : These are evaluated by fair value and the
difference of the fair value is reported on the equity.
2.2. FINANCIAL LIABILITIES
2.2.1. Definition of Financial Liabilities
Within the scope of IAS 32, a financial liability is a contractual obligation to deliver cash or
another financial asset to another entity. It could also be a contract that will or may be settled
in the entity’s own equity instruments (IAS 32: paragraph 11).

A Contractual Obligation to Deliver Cash or a Financial Asset: A contract that
gives an entity the right to pay its debt by delivering cash or financial asset to another
entity. The instruments that are in the short and long-term liabilities are as follows:
Financial Liabilities
Trade Payables

Equity Instrument: A contract that shows a residual interest in the assets of an entity
after deducting all of its liabilities (IAS 32: paragraph 11).
2.2.2. Classification and Measurement of Financial Liabilities
IAS 32 establishes principles for distinguishing between liability and equity. An instrument is
a liability when the issuer is, or can be, required to deliver either cash or another financial
asset to the holder. This is the critical feature that distinguishes a liability from an equity. All
relevant features need to be considered when classifying a financial instrument. For example:
(PWC: 2006: 6).
8

If the issuer can, or will, be forced to redeem the instrument, classification as a
liability is appropriate.

If the choice of settling a financial instrument in cash or otherwise is contingent on the
outcome of circumstances beyond the control of both the issuer and the holder, the
instrument is a liability as the issuer does not have an unconditional right to avoid
settlement.

An instrument which includes an option for the holder to give the inherent rights in
that instrument back to the issuer for cash or another financial instrument is a liability.
In addition, the treatment of interest, dividends, losses and gains in the income statement
follows the classification of the related instrument.
Not all instruments can be classified as either debt or equity. Some, known as compound
instruments, contain elements of both in a single contract. For example bonds, which are
convertible into equity shares either mandatorily or at the option of the holder, must be split
into liability and equity components. Each is then accounted for separately. The liability
element is determined first, by a fair valuation of the cash flow excluding any equity
component, and the residual is assigned to equity (IAS 32: paragraph 28).
Table 2 illustrates the decision process which determines whether an instrument is a financial
liability or equity instrument:
9
Table 24: Determining if a Financial Instrument is a Financial Liability or Not
Instrument
Ordinary shares
Redeemable
preference shares
with fixed
dividend each
year subject to
availability of
distributable
profits
Redeemable
preference shares
with discretionary
dividends
Convertible bond
which converts
into fixed number
of shares
Convertible bond
which converts
into shares to
the value of the
liability
Cash
obligation for
principal
Cash
obligation for
coupon/
dividends
Settlement
in fixed number
of shares
_
_
n/a
+
+
_
+
+
_
+
+
+
+
+
_
Classification
Equity
Liability
Liability for
principal and
equity for
dividends
Liability for bond
and equity for
conversion option
Liability
Financial liabilities are classified and evaluated as follows:

Fair Value Through Profit or Loss : These are evaluated by fair value and the
difference of fair value is reported on the income statement.

Held-To-Maturity Financial Liabilities : These are evaluated by amortised cost.
2.3. DERIVATIVE FINANCIAL INSTRUMENTS
2.3.1. Definition of Derivative Financial Instruments
Derivative financial instruments serve to create rights and obligations which permit the
transference (between the parties and the instrument) of one or more of the financial risks
4
This table was prepared by using the information in “PRICEWATERHOUSECOOPERS: Financial
Instruments Under UFRS , 2006, p.7”.
10
inherent in an underlying primary financial instrument (IAS 32: AG 15-16). When a
derivative financial instrument gives one party a choice over how it should be settled, it is
classed as a financial asset or a financial liability, unless all of the settlement alternatives
would result in it being an equity instrument (IAS 32: paragraph 26).
The most common derivative financial instruments can be defined as follows:
Forward Contract : When an entity buys a forward contract, it writes a contract on that day at
a stated price but pays no cash for a promised future delivery of the underlying asset at a
specified time and place in the future. At the time of delivery the entity receives the asset
purchased and pays the contract price. The entity’s profit (or loss) on the delivery date is the
difference between the market value of the asset and the contract price (COPELAND and
WESTON: 1992: 300, 301).
Futures Contracts: Forward and futures contracts are similar. The only difference is the daily
settled price of futures contracts. In fact, forward and futures contracts are very common in
daily life. For example, when an entity buys a car that will be delivered in six months, the
entity is in effect buying a future contract (COPELAND and WESTON: 1992: 301).
Swap Contracts: Swap contracts are the contracts used to exchange interest or foreign
currency between firms. An interest rate swap is a contract between firms in which interest
payments are based on a notational principle amount that is itself never paid or received
(COPELAND and WESTON: 1992: 656). Foreign currency swap is a contract between firms
in which foreign currencies are exchanged according to a settled rate and conditions
(COPELAND and WESTON: 1992: 301).
Commodity Contracts : A contractual obligation to buy or sell a commodity at a certain price
on a pre-determined future date (http://www.kobifinans.com.tr/bilgi_merkezi/0217/9778; 30
March 2007).
2.3.2. Classification and Measurement of Derivative Financial Instruments
A derivative financial instrument must have all three of the following characteristics (IAS 39:
paragraph 9):
11

A financial instrument contract’s value changes in response to certain parameters. The
parameters that provide value changes in the contract are; financial instrument price,
commodity price, foreign exchange rate, index of prices or rates, credit rating or credit
index etc.

When buying a contract of derivative financial instruments, initial net investment is
not usually required or, if an initial net investment is required, it will be lower than
would be required for other types of contracts.

Contracts of derivative financial instruments are settled at a future date.
As derivative financial instruments are the contracts that are held to achieve profit, they
should be characterized as financial instruments held for trading. Therefore they are evaluated
by fair value.
3. DISCLOSURES AND NOTES
It is necessary for entities to provide information to their shareholders and to disclose
information by applying some specific regulatory authority. Moreover, listed companies tend
to disclose more than the legally required amount of information in their annual reports by
considering the positive effect that this may have on their image and company name.
However, there is some information that companies do not want to disclose. This concerns
the trade secrecy. Basically, trade secrecy is based on the assumption that exposing certain
information will be disadvantageous for the company. For example, a company does not want
its rivals to have detailed information about a new product that will be put on the market in
the future. Similarly, a company also does not want its customers to learn the unit cost of its
products and as a result the company's profit (BENDREY and others: 2005: 22).
In order to present financial statements in a fair manner, the IFRS requires that the
presentation of financial statements includes additional information, disclosures and the
exposition of some qualitative information. According to the IFRS, the disclosures relating to
the financial statements of entities are disclosed through the notes section.
12
Due to the IFRS, 'notes' contain additional information relating to the balance sheet, the
income statement, the statement of change in equity and the cash flow statement. These 'notes'
provide narrative descriptions or disaggregations of items disclosed in those statements and
gives information about items which does not qualify for recognition in those statements (IAS
1: paragraph 11).
4. IFRS 7 FINANCIAL INSTRUMENTS: DISCLOSURES
IFRS 7 incorporates the disclosures relating to the financial instruments within the scope of
IAS 32 Financial Instruments: Disclosures and Presentation and replaces IAS 30 Disclosures
in the Financial Statements of Banks and Similar Financial Institutions. Thus the disclosures
of all financial instruments and for all types of entities are located in a single standard. The
disclosure requirements contained in IFRS 7 are less prescriptive than those for banks which
are found in IAS 30 and there are no longer any bank-specific disclosure requirements.
All the disclosures of IFRS 7, except the risk disclosures, must be a part of the financial
instruments according to the minimum disclosure requirement of the materiality concept of
IAS 1 Presentation of Financial Statements. The qualitative and quantitative risk disclosures
required by IFRS 7 may be provided in the financial statements or incorporated by reference
from the financial statements to another statement.
IFRS 7 basically presents the following information: (McDONNELL: 2006: 24):

Required balance sheet and income statement disclosures by categories (eg.
instruments held for trading or held-to-maturity)

Information relating to the provisions of impared assets

Additional information about fair value of collateral and other credit enhancements
used to manage credit risk

Market risk sensitivity analyses
13
4.1. SCOPE OF IFRS 7
IFRS 7 takes into consideration all risks arising from all financial instruments, including those
instruments that are not recognised on a balance sheet. However there are no exceptions for
small and medium sized entities in IFRS 7 and the IASB also considers this issue in reference
to the financial reporting project for small and medium sized entities (PACKER: 2006).
IFRS 7 disclosures must be presented based on the accounting policies that are harmonious
with the IFRS including consolidation adjustments. Internal information which is required for
risk management purposes cannot be prepared using these accounting policies. Thus it must
be amended accordingly.
IFRS 7 does not cover the following issues (other than the exceptions in the standard) (IFRS
7: paragraph 3):

Interest in subsidiaries, associates and joint ventures that are recognised within the
scope of IAS 27 Consolidated and Separate Financial Statements, IAS 28 Investments
in Associates and IAS 31 Interest in Joint Ventures,

Employees' rights and obligations arising from employee benefits plans within the
scope of IAS 19 Employee Benefits,

Contracts for contingent payments in business combinations,

Insurance contracts as defined in IFRS 4 Insurance Contracts,

Financial instruments, contracts and obligations under share-based payment
transactions to which IFRS 2 Share-Based Payment applies, except that this IFRS does
apply to contracts within the scope of paragraphs 5–7 of IAS 39.
4.2. BALANCE SHEET DISCLOSURES OF IFRS 7
IFRS 7 does not prescribe the location of the required balance sheet disclosures. An entity can
either present the required disclosures on the face of the balance sheet or in the notes for
financial statements. According to IFRS 7, an entity is permitted to classify financial
instruments which are appropriate to the nature of the information disclosed and the
characteristics of the instruments.
14
IFRS 7 requires additional detailed information for each of the financial asset and liability
categories.
4.2.1. Loans and Receivables at Fair Value Through Profit or Loss
As a result of the IAS 39 fair value option amendment, IFRS 7 includes disclosure
requirements for loans and receivables at fair value through profit or loss, as introduced in
IAS 32. These include the maximum credit exposure, the impact of credit derivatives on the
credit exposure, the change in the fair value of the loan and receivable, and any related credit
derivatives due to changes in credit risk, both during the period and cumulatively since
designation (IFRS 7: paragraph 9).
4.2.2. Financial Liabilities at Fair Value Through Profit or Loss
IFRS 7 contains the requirement from IAS 32 that disclosures concerning the change of the
fair value of a financial liability due to credit risk must be included, as introduced as part of
the amendment to IAS 39 for the fair value option. In addition, IFRS 7 also requires the
disclosure of the particular method used in order to determine the change in the fair value due
to credit risk. Unless an alternative method gives a better approximation, entities are required
to use the methodology described in IFRS 7 (IFRS 7: paragraph 10).
4.2.3. Other Miscellaneous Balance Sheet Disclosures

Derecognition: Certain information is required when all or a part of the transferred
financial assets do not qualifiy for derecognition.

Collateral given: In addition to the terms and conditions of financial assets pledged as
collateral, disclosure relating to the carrying amount is also required.

Collateral received: An entity must disclose the fair value, terms and conditions of
assets received as collateral which the entity has right to sell or repledge in the absence
of default.
15

Allowance for credit losses: While IAS 30 requires only disclosure of loans and
advances, IFRS 7 requires disclosure of reconciliation of the allowances for credit
losses for all financial assets.

Compound financial instruments with multiple embedded derivatives: Disclosure must
consist of the existence of multiple embedded derivatives whose values are
interdependent (eg, callable convertible debt)

Defaults and breaches: Disclosure is required for the details and carrying amounts of
liabilities that are in default.
4.3. INCOME STATEMENT DISCLOSURES OF IFRS 7
Similar to the balance sheet disclosures, an entity is permitted to present the required
disclosures either on the face of the income statement or in the notes for the financial
statements. Although the income statement disclosures that are required by IFRS 7 are not
detailed as the requirements of IAS 30, they are more prescriptive than those required in IAS
32. For example, IAS 32 only requires a separate disclosure of the net gains or net losses of
financial instruments carried at fair value through profit or loss, whereas IFRS 7 requires the
disclosure of this information for all categories of financial assets and financial liabilities.
4.3.1. Income Statement Disclosures Defined by IFRS 7
IFRS 7 basically contains the following income statement disclosures (IFRS 7: paragraph 20):

Net profit or loss for each category of financial assets and liabilities

Impairment losses for each category of financial assets

Total interest income and total interest expense (calculated using the effective interest
method) for financial assets and liabilities not measured at fair value through profit or
loss

Fee income and expense arising from trust and other fiduciary activities that result in
the holding or investing of assets on behalf of individuals, trusts, retirement benefit
plans, and other institutions.
16
4.3.2. Other Income Statement Disclosures Defined by IFRS 7
4.3.2.1. Accounting policies
IAS 1 requires a disclosure for certain accounting policies of an entity. But IFRS 7 requires
specific disclosures of certain policies relating to financial instruments. IFRS 7's application
guide provides more specific guidelines for the required accounting policies. IFRS 7 presents
disclosures based on the criteria of the following issues:

Designating financial assets and financial liabilities according to fair value through
profit or loss,

Designating financial assets as held-for-sale

Using an allowance account (eg, bad debt reserve).
4.3.2.2.Hedge Accounting
IFRS 7 expands the scope of the required disclosures relating to the gain or loss on a hedging
instrument. IFRS 7 also presents the disclosures of the amount of ineffectiveness recognised
in profit or loss for cash flow hedges, hedges of net investments in foreign operations, and the
gain or loss on the hedging instrument and hedged item attributable to hedged risk for fair
value hedges (IFRS 7: paragraph 22, 23, 24).
Table 3 designates the hedge accounting disclosure requirements of IFRS 7:
Table 3: Hedge Accounting Disclosure Requirements of IFRS 7 (ERNST & YOUNG : 2006:
3).
Disclosure
Description of the hedged risk and hedging instrument with
related fair values
Fair Value
Cash Flow
Hedges
Hedges
X
X
When hedged cash flows are expected to occur
X
Forecast transaction no longer expected to occur
X
Gain or loss recognized in equity and reclassifications to P&L
X
Gain or loss from hedging instrument and hedged risk
Ineffectiveness recognized in P&L (Profit and Loss)
Net
Investments
Hedges
X
X
X
X
17
4.3.2.3. Fair Value
IFRS 7 contains disclosures from IAS 32 relating to the methods and certain assumptions
used to determine a fair value for different categories of financial assets and financial
liabilities. Required disclosures must contain the following elements:

Whether fair value is based on a quoted price or a valuation method,

Whether fair value is based on a valuation method that includes assumptions not
supported by market prices or rates and the amount of profit recognised,

The effect of possible alternative assumptions that are used in a valuation method.
Although those can be answered with a qualitative analysis, it is agreed that a quantitative
analysis will be required for the value analysis of different categories of financial instruments
(ERNST & YOUNG : 2006: 3).
IAS 32 requires disclosure of the nature and carrying amount of financial assets whose fair
value cannot be realiably measured as well as the disclosure of the reason behind this
situation. IFRS 7 expands the IAS 32 requirement to include the way in which the entity
intends to dispose of such financial instruments.
4.4.
RISKS
ARISING
FROM
FINANCIAL
INSTRUMENTS
AND
THEIR
DISCLOSURES
On the reporting date entities must disclose the quality and level of the risks arising from
financial instruments towards the users of financial statement. This information must be
presented appropriately so that the users may evaluate it. IFRS 7 focuses on those risks (credit
risk, liquidity risk, market risk) arising from financial instruments and requires the disclosure
of how an entity manages those risks (MIRZA and others: 2007: 376).
4.4.1. Risk Disclosures
4.4.1.1. Qualitative Risk Disclosures
IFRS 7 demands qualitative disclosures, also required by IAS 32, relating to the risks (credit
risk, liquidity risk, market risk) and also requires information on the objectives and policies
18
for managing such risks at a senior level within the company. IFRS 7 expands the required
disclosures in order to demand information on the methods used to manage and measure risk
by an entity (MIRZA and others: 2007: 377).
4.4.1.2. Quantitative Risk Disclosures
IFRS 7 expands the quantitative disclosures of IAS 32 which are based on the information
available to key management personnel of an entity which is disclosed to risk (IFRS 7:
paragraph 34). IFRS 7 requires the disclosure of the total of all risks (eg, location, currency,
economic condition etc.) and also demands to know how an entity determines those risks.
4.4.2. Risk Types
4.4.2.1. Credit Risk
IFRS 7 requires disclosure of the credit position of each financial instrument class before a
consideration of collateral or other credit enhancements received, disclosure of net value of
each impairment loss and the description of collateral or other credit enhancements available.
IFRS 7 considers the maximum credit exposure for loans and receivables, deposits placed and
derivative financial instruments that are evaluated by fair value (IFRS 7: paragraph 36). The
credit risk disclosures of IFRS 7 contain (IFRS 7: paragraph 37):

Information relating to the credit quality of overdue or impaired financial assets,

Definition and fair value of collateral held by the entity as security and other credit
enhancements,

Collateral of which the entity has taken control.
Disclosure of financial assets that are overdue at the reporting date but that are not impaired is
very important for many entities. Overdue information may not be readily available or it may
not be captured by an entity’s credit system until such time that it becomes overdue by a
critical amount of time (ERNST & YOUNG : 2006: 4).
19
4.4.2.2. Liquidity Risk
Although IAS 30 requires banks to disclose contractual maturity information relating to both
financial assets and financial liabilities, IFRS 7 does not require the disclosure of contractual
maturity information of financial assets because it is less prescriptive (IFRS 7: paragraph 39).
Financial liabilities must be disclosed by contractual maturity based on undiscounted cash
flows that may or may not be consistent with the internal information available for
management. One of the difficulties of the preparation of maturity analysis is the derivative
financial instruments that normally involves a series of cash flows. The application guidance
in IFRS 7 determines that net amounts must be included in the analysis for pay float/receive
fixed interest rate swaps for each contractual maturity category when gross cash flows are
exchanged. Therefore, contractual amounts to be exchanged in a derivative financial
instrument (eg. currency swap) should be included in the maturity analysis that is based on
gross cash flows (IFRS 7: B 14).
The application guidance in IFRS 7 recommends that time frames should be used while
preparing a contractual maturity analysis for financial liabilities. IFRS 7 expands the liquidity
risk disclosures by including the description of how liquidity risks are managed (MIRZA and
others: 2007: 377).
4.4.2.3. Market Risk
An entity should present disclosures relating to sensitivity analysis of its market risk. Those
disclosures should include the effect of risk on the financial statements, techniques and
assumptions used in sensitivity analysis (EBSTEIN and JERMAKOWICZ: 2007: 171). IFRS
7 requires the disclosure of market risk sensitivity analysis and demands the addition of the
effects of reasonably possible changes in risk variables on the balance sheet date and also
information on the techniques and assumptions used in analysis (IFRS 7: paragraph 40).
Market risk is defined as the chance that the fair value or future cash flows of financial
instruments will fluctuate because of changes in market prices and this includes interest rate
risk, foreign currency risk and other price risk (IFRS 7: Appendix A). IFRS 7’s application
guide provides information relating to reasonably possible change and contains the following
information:
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
Economic environment in which the entity operates

Reasonably possible changes over the next reporting period
Market risk contains three types of risk (EBSTEIN and JERMAKOWICZ: 2007: 154):
Currency (foreign exchange) risk: The risk arises on the value of financial instruments due
to the effect of reasonably possible changes in foreign currency
Interest rate risk: The risk arises on the value of financial instruments due to the effect of
reasonably possible changes in market interest rates
Price risk: The risk arises on the value of financial instruments due to the effect of marketable
security transactions in similar markets and other factors.
5. CONCLUSION
Classification, measurement, recognition and disclosures of financial instruments are
comprehensive and detailed subjects of the IFRS. The standards related to the financial
instruments within the scope of the International Financial Reporting Standards are; IAS 32:
Financial Instruments: Presentation, IAS 39: Financial Instruments: Recognition and
Measurements, IFRS 7: Financial Instruments: Disclosures. IFRS 7 Financial Instruments:
Disclosures is the only standard that arranges the disclosures relating to financial instruments
but it would not be sufficient to research only this standard and not take into consideration the
classification, measurement and recognition of financial instruments. Therefore this study has
considered the subject of financial instruments as a whole and all the standards which relate to
financial instruments were summarized as simply as possible.
IFRS 7 superseded the disclosure requirements of IAS 32 and IAS 30: Disclosures in The
Financial Statements of Banks and Similar Financial Institutions on 1.1.2007. Financial
instruments consist of financial assets, financial liabilities and derivative financial
instruments. The purpose of the IFRS is to guide the preparation of financial statements and
notes in order to present all the information needed by the users of financial statements
(information). In the same way, the requirements of IFRS 7 are concentrated on the
information relating to financial instruments in order to make it more evident.
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Financial instruments have an important place within the assets and liabilities of an entity as
well as in its income statement. An entity's related parties require detailed disclosures on
classification and measurement of financial instruments, risks that may arise from them, how
the entity manages those risks and the specific types of risks. This information is necessary
because the purpose of an entity's related parties is to evaluate not only the quantitative risks
but also the qualitative risks, and ultimately make the correct decisions about the entity.
Difficulties occur in the measurement of financial instruments rather than in their
classification. Those difficulties arise from the measurement of the fair value of the
instruments. A measurement of fair value requires some calculations for those financial
instruments that do not have an active market and the entity should disclose its accounting
policies and assumptions relating to measurement methods in accordance with the IFRS.
As IFRS 7 has only been effective since the beginning of 2007, criticism concerning the
difficulties and the complicated elements of the standard is possible. However, it is apparent
that those difficulties and problems can be solved by combining academic information and
practical experiences.
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MISIRLIOĞLU,
Ufuk:
Finansal
Araçların
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TÜRKİYE
MUHASEBE
STANDARTLARI:
Uluslararası
Finansal
Raporlama
Standartları (IFRS/IAS) ile Uyumlu Türkiye Muhasebe Standartları, Türkiye Muhasebe
Standartları Kurulu Yayınları, 2006
http://www.kobifinans.com.tr/bilgi_merkezi/0217/9778; 30 Mart 2007
http://www.tmsk.org.tr
http://www.iasb.org
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