What is Financial Instrument - Dr. Gholamreza Zandi Website

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FINANCIAL INSTRUMENTS
By:
Associate Professor Dr. GholamReza Zandi
zandi@segi.edu.my
IASB
• The IASB issued the first standard on
presentation and disclosure in IAS 32 Financial
Instruments: Presentation and Disclosure.
• The standards later split into:
– IFRS 7 Financial Instruments: Disclosure
– IAS 32 Financial Instruments: Presentation
2
IASB
• MFRS 139 Financial Instruments: Recognition
and Measurement
– Establishes principles for recognizing and
measuring financial instruments.
– Provides guidance on Derecognition, how to
assess impairment, determine fair value
3
What is Financial Instrument
• IAS 32 defines a financial instrument as a
contract that results in one entity obtaining a
financial asset and another entity taking on an
increase in its financial liabilities or its equity.
4
MFRS 132
MFRS 132 defines a financial instrument as ‘any contract that gives rise
to a financial asset of one entity and a financial liability or equity
instrument of another entity.’
Examples of primary instruments - receivables, payables and equity
securities
Examples of derivative instruments - financial options, futures and
forwards, interest rate swaps and currency swaps
Financial instrument is any contract that gives rise to both:
◦ A financial asset of one entity and
◦ A financial liability or equity instrument of another entity.
Example
• THT Ltd raised a loan of RM2million on 1
January 2012 from Bank Of Asia.
• Outline how the loan should be presented in
the financial statements of THT Ltd and Bank
of Asia?
6
Example
• The loan is a financial instrument that gives rise
to a financial asset for the Bank, owing at RM2m.
• For THT Ltd it is a financial liability, as RM2m is
owed to the Bank.
• Loan will be recorded as follows:
– Bank
Dr
Cr
• Loan receivable (financial assets) 2M
• Bank
2M
– THT Ltd
• Bank
• loan (financial liability)
2M
2M
7
Classification
• Equity Instruments
• Financial Liabilities
• Financial Assets
8
MFRS
• MFRS 132
– Financial instruments are categorized as
• Financial assets
• Financial liabilities
• Equity instruments
• MFRS 139, further
instruments into
classifies
financial
– Primary instruments
– Derivative
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Equity Instruments
 Any contract that evidences a residual interest in
the asset of an entity after deducting all of its
liabilities.
 Examples of equity are ordinary share, preference
shares, share options and warrants.
10
Financial Asset
• Any asset that is:
– Cash
– An equity instrument of another entity
– A contractual right:
• To receive cash or another financial asset from another
entity or
• To exchange financial assets or financial liabilities with
another entity under conditions that are potentially
favourable to the entity.
– A contract that will or may be settled in the entity’s
own equity instruments.
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Financial Liability
 Any liability that is:
◦ A contractual obligation
 To deliver cash or another financial asset to another entity or
 To exchange financial assets or financial liabilities with another
entity under conditions that are potentially unfavourable to the
entity
◦ A contract that will or may be settled in the entity’s
own equity instruments and is
 A non-derivative for which the entity is or may be obliged to
deliver a variable number of the entity’s own equity
instruments
 A derivative that will or may be settled other than by exchange
of a fixed amount of cash or another financial asset for a fixed
number of entity’s own equity instruments.
12
MFRS
• Primary instruments
• All financial instruments other than derivatives
–
–
–
–
Financial assets at FV through profit or loss
Held to maturity investments
Loans and receivables
Available for sale financial assets
• Derivatives are contracts that allow entities to
speculate or hedge against future changes in
the market.
13
IFRS 7
• To require companies to provide disclosures
that enable users to evaluate not only the
significance of financial instruments for the
company’s
financial
position
and
performance, but also ‘the nature and extent
of risks arising from financial instruments to
which the entity is exposed during the period
and at the end of the reporting period, and
how the entity manages those risk.
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IFRS 7
• Example
– Requires firms to disclose how its net income (or
net loss) for the period would have been affected,
if the exchange rate had been higher and lower
that it actually was at the reporting date.
15
Prior Literature
• Evidence suggest that after the release of
IFRS 7 mandated disclosure on currency risk,
investors revised their expectation on firm’s
exposures, and the stock returns sensitivity
to exchange rate changes became consistent
with the new information provided.
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Usefulness of Disclosures on Currency Risk
 It has a rationale only in imperfect capital
markets.
 Market prices are affected by currency risk, and
information about a firm’s currency risk exposure
should be taken into account in making decisions.
 If sensitivity analysis under IFRS 7 provides useful
information to investors about the effect of
currency risk on a firm’s value, then investors
should react to the new information after it is
disclosed in the annual report.
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IAS 32 Financial Instruments: Presentation
 To establish principles for presenting financial
instruments as liabilities or equity and for
offsetting financial assets and financial liabilities.
 Applies to the classification of financial
instruments, from the perspective of the issuer,
into financial assets, financial liabilities and
equity instruments;
 Classification of related interest, dividends, losses
and gains;
 Circumstances in which financial assets and
financial liabilities should be offset.
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Presentation of Liabilities &
Equity
An entity should identify the different components of the instrument
and to classify the components as to a financial asset, financial liability
or equity on initial recognition based on:
– the substance of the contractual arrangement (not merely
their legal form); and
– the definitions of financial liabilities, financial assets or equity
instruments.
Substance versus Legal Form
‘Puttable’ Instruments
A financial instrument that gives the holder the right to return the
instrument to the issuer for cash or another financial asset (a ‘puttable
instrument’) is a financial liability. Examples of ‘puttable’ instruments
which give the holders the options to return the instruments to the
issuer are unit trusts, open ended mutual funds and ownership units in
co-operatives.
Compound/Hybrid
Financial Instruments
 They are classified by the issuer according to the substance of
contractual arrangement and the definitions of a financial liability
and an equity instrument.
 Their components are classified separately as financial liabilities,
financial assets or equity instruments.
 For example, a bond that grants an option to the holder to convert
it into a fixed number of ordinary shares is a compound instrument
and it comprises two components:
• a financial liability (a contractual agreement to deliver cash or
other financial asset); and
• an equity instrument (an option to convert into ordinary shares).
Treasury Shares
 A company may repurchase its issued equity shares provided not all the shares are
repurchased. This is termed as share buy back.
 The company may cancel the shares or hold them. It is an option.
 If it cancels the shares bought back, then it is required to follow the legal
requirements as set out in the Companies Act 1965 regarding cancellation of
shares. The companies Act 1965 requires the company to transfer to the capital
redemption reserve an amount equal to the nominal capital cancelled.
 On the other hand, the shares may not be cancelled but held to be reissued at a
later date. Equity shares bought back but not cancelled are termed treasury
shares. The amount paid for the redemption is held in a separate account. In the
SOFP, the treasury shares should be deducted from equity.
 No gain or loss should be recognised in income statement on the purchase, sale,
issue or cancellation of the entity’s own equity instruments. Consideration paid or
received should be recognised directly in equity.
Interest, Dividends, Losses and Gains
• The accounting treatment and presentation of interest, dividends,
losses and gains depend on whether the items are related to
liability or equity.
• It they relate to financial liability, they should be reported in the
income statement as expense or income such as interest on bonds.
• If they relate to an equity instrument, they should be recorded
directly to the statement of changes in equity.
Offsetting a Financial Asset &
a Financial Liability
•
•
•
Financial assets and liabilities are presented separately.
However, a financial asset and liability shall be offset and the net
amount presented in the SOFP when an entity has a legally
enforceable right of offset and intends to settle on a net basis or to
realize the asset and settle the liability simultaneously.
Offsetting does not amount to Derecognition.
The End
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