Lecture 5: Financial Instruments

MFRS 132/IAS 32 Financial Instruments

Presentation
MFRS 7/IFRS 7 Financial Instruments Disclosure
MFRS 139/IAS 39 & MFRS 9/IFRS 9 Recognition
and Measurement
 Learning Outcomes
Understand the concept of financial instruments
Understand the classification of financial instruments
Analyze the disclosures related to financial instruments
Understand and apply the measurement and reporting of
each class of financial instruments
Distinguish between different types of hedges
Future developments in financial instruments (IFRS 9/
MFRS 9)

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 Background

significant growth in use of financial instruments

complex financial instruments that are hard to
classify
liability or equity?
the role of financial instruments in the current
economic crisis
different accounting practices and the lack of
visibility in financial statements

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 MFRS and Financial Instruments
MFRS 132 Financial Instruments: Presentation
MFRS 7 Financial Instruments: Disclosures
MFRS 139 Financial Instruments: Recognition
and Measurement

The IASB is constantly working on these standards.

There is a new standard called IFRS 9 to replace IAS 39.
Mandatory application of this standard is w.e.f. 1 January
2015.

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 MFRS 132: Financial Instruments
Presentation
toestablish principles for presenting financial
instruments as liabilities or equity for offsetting
financial assets and liabilities.
applies classification of financial assets,
financial liabilities and equity instruments from
the perspective of the issuer.
This standard is mainly on the classification as classification
determines the measurement and the disclosures about financial
instruments.

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 Definitions
financial Instrument
any contract that gives rise to a financial asset
of one entity and a financial liability or equity
instrument of another entity.
these can be
financial assets
financial liabilities
equity instruments

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 Financial Asset
cash
an equity instrument of another entity
a contractual right
examples?

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 Financial Liability
a contractual obligation
to deliver cash or another financial asset to
another entity or to exchange financial
assets or financial liabilities with another
company.
this transaction should be unfavourable to
the company.
examples?

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 Equity Instruments
any contract that evidences a residual
interest in the assets of an entity after
deducting all its liabilities.
examples?

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 Classification
Classify the following financial instruments for each
company:
Company A sold inventories to Company B in return for
a promissory note. Company B offers to pay with
treasury bills.
Company C issues preference shares that do not have a
fixed maturity and under which there is no contractual
obligation to make any payment.
Company D enters into a contract to deliver 5 million of
its own ordinary shares to another party in settlement
of an obligation. The contract results in a distribution
from the residual assets of the company.
Company E issues preference shares that pay a fixed
rate of dividend and that have a mandatory redemption
feature at a future date.

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 Classification

sometimes the distinction between liability and equity

instruments are not clear.
what happens when a company classifies a liability
instrument as an equity instrument?
gearing ratio?
long-term liabilities?
interest cover ratio?
interest expense?
Substance over form!
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 Preference Shares
come with various rights
redeemable
mandatorily redeemable
non-redeemable
dividends on such shares may be either fixed or
payable at the issuers discretion.
thepayments may be linked to payments on
another instrument
non-discretionary dividend
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 Compound (Hybrid) Instruments
these are financial instruments that carry the option to
be converted into shares.
convertible bonds issued by a company gives the
holder the option to keep them as bonds (liability
instrument) or convert them into shares (equity
instrument) based on a predetermined formula.
we need to divide this into its liability and equity
components and report them separately in our financial
statements.

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Compound (Hybrid) Instruments
Convertible Bonds

Liability Equity

PV of interest and Balance of the

redemption cost instrument

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 Example 1
Apple Berhad issues 2,000 convertible bonds at the start
of 2013. The bonds have a 3-year term and are issued at
par with a face value of RM1,000 per bond, giving total
proceeds of RM2 million. Interest is payable annually in
arrears at a nominal annual interest rate of 6%. Each
bond is convertible at any time up to maturity into 250
shares. When the bonds are issued the prevailing market
interest rate for similar debt without conversion option is
9%.
Required:
What is the value of the equity component of the bond?

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 MFRS 7 Financial Instruments:
Disclosures
To require entities to provide disclosures that
enable users to evaluate:
the significance of financial instruments for the
entitys financial position and performance
the nature and extent of risks arising from
financial instruments to which the entity is
exposed and how the entity manages them

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 MFRS 7 Financial Instruments:
Disclosures
I. Significance of financial instruments
carryingamounts of each category of financial
instruments
impairment and allowance for credit losses
fair value of each class of financial instruments
gains/losses, income/expenses resulting from financial
instruments
accounting policies

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 MFRS 7 Financial Instruments:
Disclosures
II. Nature and extent of risks
credit risk
liquidity risk
market risk

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 Objectives of MFRS139 (now MFRS 9)
to establish principles for recognising and
measuring
financial assets,
financial liabilities and
contracts to buy and sell a non-financial
item that can be settled net in cash or
by some other financial instruments.
also deals with derecognition of financial
a s s e t s a n d l i a b i l i t i e s, a n d h e d g e
accounting.

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 MFRS139
Recognition and Initial Classification
recognition
a financial instrument is recognised
when the entity becomes a party to the
c o n t r a c t u a l p ro v i s i o n s o f t h e
instrument.
initial classification of financial assets
fair value through profit or loss
(FVTPL)
loans and receivables
held-to-maturity investments

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 Fair Value through Profit or Loss (FVTPL)
held-for-trading assets
assets acquired for the purpose of
short-term resale.
example
Company A has extra cash and
purchases the shares of a listed entity
as an investment to be released in 5
months.

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 Loans and Receivables
n o n - d e r i v a t i v e a s s e t s w i t h f i x e d o r
determinable payments that are
not quoted in an active market and
not held as FVTPL or
not held as available-for-sale assets
example
Company B lends RM200,000 to Company C
at a commercial interest rate of 5% for 3
years. Regular payments will take place
quarterly.

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 Held-to-maturity Investments
non-derivative assets with fixed or
determinable payments that an entity
intends to hold until they mature.
example
Company D invests RM300,000 in a 3
y e a r, 5 % c o r p o rat e b o n d . T h e
company intends to hold this bond
until maturity.

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Subsequent Measurement
FVTPL Fair Value

Held to Amortised
maturity Cost

Loans and
receivables

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 Measurement Methods
amortised cost
effective interest rate method
effective interest rate is the rate that
discounts estimated future cash
payments or receipts through the
expected life of the financial
instrument to the net carrying amount
of the financial asset or liability

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 Example 2
On 1 January 2015, Company Z invests in a
4-year 7% RM100,000 bond issued at a
discount, RM98,000. The bond carries an
annual interest rate of 7%, payable at end
of each year. The company intends to keep
this investment until maturity.

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 Measurement Methods
fair value
the principal market (or most advantageous
market)
if no active market, use valuations
techniques
market approach
cost approach
income approach
the fair value hierarchy categorises the
inputs used in valuation techniques
priority is market price (exit price)
Level 1
Level 2

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 REPORTING
Fair Value
FVTPL Gains/Losses to
Income Statement

Held to Amortised Cost

maturity Impairment test is
necessary.

Loans and
receivables

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 Example 3
On 1 January 2015, Orange Berhad
acquires a financial asset for RM30,000
and classifies it as an available-for-sale
investment. By 31 December 2015, the fair
value of the financial assets has increased
to RM45,000. On 24 March 2016, the entity
sells the financial asset for its fair value of
RM48,000 (no transaction cost).

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 Hedging
companies enter into hedge arrangements for
protection against risks such as
interest rate risk, foreign exchange risk, price risk
protects the income statement from volatility
hedging instruments
forward contracts
futures
options

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 Types of Hedges
fair value hedge
cash flow hedge

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 Replacement for IAS 39: IFRS 9
mandatory application on 1 January 2015.
major change will be to drop the category of
available-for-sale (AFS) assets.
three major classifications proposed by IFRS 9
financial assets at FV through profit or loss
(FVTPL)
financial assets at FV through OCI(FVTOCI)
financial assets at amortised cost

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