accounting for private busness

8/12/2019 Accounting for Private Busness

1/60

GUIDE TO ACCOUNTING STANDARDSFOR PRIVATE ENTERPRISES

CHAPTER 45

FINANCIAL INSTRUMENTS


2/60

DISCLAIMER

This publication was prepared by the Guidance and Support Group of the Canadian Institute of Chartered Accountants (CICA). Ithas not been approved by any Board of Committee of the CICA or any Provincial Institute/Ordre.

The CICA and the authors do not accept any responsibility or liability that might occur directly or indirectly as a consequence of theuse, application or reliance on this material.

For information regarding permission, please contact [email protected]


3/60

1 The Canadian Institute of Chartered Accountants

Financial Instruments

TABLE OF CONTENTSParagraph

IntroductionBackground . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-3Overview of Section 3856 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4-5Scope . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6-7Recognition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8-9

Example Trade date accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9Classi cation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10-23

Liability or equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-23Preferred shares issued in a tax planning arrangement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Examples Liability vs. equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21Compound instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22-23

MeasurementInitial measurement of arms length transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24-30

Financing fees and transaction costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25-26Example Costs related to investment in equity instrument . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

Demand loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27-29Example Loan fees and costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

Loans at non-market interest rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30-31Example Off-market loan related to asset purchase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

Indexed nancial liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32Convertible nancial liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33-37

Residual method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35Relative fair value method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

Example Initial measurement of convertible liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37Initial measurement of related party transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38-39

Example Initial measurement of loan to manager . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39Subsequent measurement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40-76

Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40Cost/amortized cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41-68

Example Equity instrument measured at cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42Example Interest-bearing investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

Amortization of original purchase premium or discount, nancing fees and transaction costs . . . . . . . . . . . . . 44Example Investment in debt instrument issued at a discount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45Example Amortization of discount on off-market loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46Example Amortization of discount on employee interest-free loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

Impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48-68Decision tree Impairment process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49Example Identify assets to assess for impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50Example Indications of impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

Measurement of impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56-64Example Present value of future cash ows of a loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

Example Cash ow estimates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64Impairment of groups of assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65Reversals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66-68

Example Impairment reversal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68Fair value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69-73

Example Fair value sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71Example Calculating the change in fair value of a forward contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72Example Calculating the change in fair value of an interest rate swap . . . . . . . . . . . . . . . . . . . . . . . . . . . 73

Indexed nancial liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74-76Example Indexed nancial liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76


4/60

2


PresentationOffsetting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77-83Interest, dividends, gains, losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84-85

Derecognition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86-119Financial assets

Securitization transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87-102Illustration Typical securitization transaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

Measurement of interest held after a transfer of receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93-94Example Recording transfers with proceeds of cash, derivatives, and other liabilities . . . . . . . . . . . . . . . 93Example Recording transfers of partial interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

Servicing assets and liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95-100Example Recognizing a servicing liability in a transfer of receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . 97Example Sale of receivables with servicing retained . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98Example Recording transfers of partial interests with proceeds of cash, derivatives,

other liabilities, and servicing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100Fair value

Example Recording transfers if it is not practicable to estimate a fair value . . . . . . . . . . . . . . . . . . . . . . . 101Sales-type and direct nancing lease receivables

Example Recording transfers of lease nancing receivables with residual values. . . . . . . . . . . . . . . . . . . 102Financial liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103-119

Example Investment banker acting as agent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112Modi cation of line of credit or other revolving debt arrangement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113-114

Example Determining whether borrowing capacity exceeds that of the old arrangement and related accounting implications of fees and costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114

Extinguishing nancial liabilities with equity instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115-117Convertible liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118-119

Example Accounting on extinguishment of compound nancial instrument . . . . . . . . . . . . . . . . . . . . . . . 119Hedge accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120-147

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120-125Hedged item . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126-128Hedging item . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129Commodity hedge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130-131

Example Hedge of anticipated purchase of a commodity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131Currency hedge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132-136

Example Foreign currency hedge of anticipated purchase of a commodity . . . . . . . . . . . . . . . . . . . . . . . . 133Example Hedge of anticipated foreign currency transaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136

Hedge of interest rate risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137-140Example Interest rate swap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 138

Cross-currency interest rate swap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139-140Example - Cross-currency interest rate swap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140

Hedge of the net investment in a self-sustaining foreign operation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141Mechanics of hedge accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142-147

Example Effect of hedge accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144Examples Hedge of foreign currency anticipated transaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145Additional examples Hedge of foreign currency anticipated transaction . . . . . . . . . . . . . . . . . . . . . . . . . . 146Example Hedge of interest rate risk with interest rate swap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147

Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148-159AppendixDe nitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A1


5/60



INTRODUCTION

This publication has been produced in response to requests for guidance on the application of Section 3856, Financial Instruments ,in the CICA Handbook Accounting, Part II, Accounting Standards for Private Enterprises.

The CICA expresses its appreciation to the principal author of the publication, Jo-Ann Lempert, CA, and to Kate Ward, CA, for hertechnical review.

The guidance and illustrative examples provided are not authoritative. All decisions on the application of any accounting standard

need to be made based on a thorough understanding of the facts and circumstances of each transaction and through the applicationof professional judgment.

The guidance in this publication is current as of the date of publication. Judgment will need to be applied as practice evolves orSection 3856 is updated.

Gordon Beal, CA, M.EdDirector, Guidance and Support


6/60

4


BACKGROUND

1. The nancial instrument standards previously contained in Part V of the CICA Handbook were highly criticized for beingcomplex and often requiring resources that are beyond those cost-effectively available to many private enterprises. In somesituations, these standards required the use of fair value measurements for nancial instruments that sometimes involvedsophisticated nancial modelling and access to a variety of market price sources that many private companies did not have.Also, private companies struggled with determining impairment losses on nancial instruments due to multiple modelsexisting in previous standards. Lastly, the hedge accounting model, designed mainly for publicly accountable enterprises,increased the number of fair value measurements and imposed extensive documentation and analytical requirements which

private companies found to be very complex and onerous.

2. In response to these criticisms, the Canadian Accounting Standards Board (AcSB) decided to start afresh and so developedthe new CICA Handbook section, FINANCIAL INSTRUMENTS , Section 3856. This Standard simpli es the accounting for nan-cial instruments by providing a single accounting standard that applies to all nancial assets and nancial liabilities. Section3856 replaced several standards previously found in Part V of the CICA Handbook Accounting including TEMPORARYINVESTMENTS , Section 3010; ACCOUNTS AND NOTES RECEIVABLE , Section 3020; IMPAIRED LOANS , Section 3025; LONG-TERMDEBT , Section 3210; FINANCIAL INSTRUMENTS RECOGNITION AND MEASUREMENT , Section 3855; FINANCIAL INSTRUMENTS

DISCLOSURE AND PRESENTATION , Section 3860; FINANCIAL INSTRUMENTS DISCLOSURE AND PRESENTATION , Section3861; FINANCIAL INSTRUMENTS DISCLOSURES , Section 3862; FINANCIAL INSTRUMENTS PRESENTATION , Section 3863;and HEDGES , Section 3865.

3. In developing the new Standard, the AcSB maintained that the previously existing principles should continue to apply. How-

ever, in order to ensure that the costs of applying these principles would not exceed the bene ts of applying them, the AcSBmodi ed the application of these principles. The underlying principles guiding Section 3856 are as follows:

(a) Financial Instruments represent rights or obligations that meet the de nitions of assets or liabilities and should be reportedin nancial statements.

(b) Fair value is the most relevant measure for nancial instruments and the only relevant measure for derivative instruments.

(c) Only items that are assets or liabilities should be reported as such in nancial statements.

(d) Special accounting for items designated as being hedged should be provided only for qualifying items.

OVERVIEW OF SECTION 3856

4. Section 3856 provides guidance on the accounting treatment of nancial instruments. It answers the following questions:

(a) What is a nancial instrument?

(i) The Standard lists several examples of common nancial instruments. It also describes transactions that resembleor may be nancial instruments but that are not dealt with in the Scope of the Standard (paragraph 6 of this chapter).

(b) When should a nancial instrument be recognized in the nancial statements?

(i) The Standard requires that nancial instruments be recognized when an entity becomes a party to a contract involv-ing nancial instruments, i.e., immediately (paragraph 8).

(c) How should a nancial instrument be measured when it is initially recognized and thereafter?

(i) The Standard requires that a nancial instrument be initially measured at its fair value plus, when it will be subse-quently measured at cost or amortized cost, any related transaction costs and nancing fees (paragraphs 24-25).

(ii) For subsequent measurement, the Standard requires the nancial instrument to be classi ed into one of the twofollowing categories:

Fair value (paragraphs 10 and 40)

Cost/Amortized cost (paragraphs 40-41).

The classi cation decision will be primarily based on the instruments characteristics but the entity may elect toclassify an instrument to the fair value category on initial recognition.

(iii) All nancial instruments classi ed into the cost/amortized cost category, must be assessed for impairment at theend of each reporting period (paragraph 48).

(d) How should a nancial instrument be presented?

(i) The Standard provides guidance on classifying a nancial instrument, or its component parts, as a liability or partof equity based on the substance of the arrangement (paragraph 12).


7/60



(ii) The equity component of a nancial liability that is convertible to equity must be recognized separately. Section3856 permits measuring the equity component as zero. If this measurement option is not chosen, the equity compo-nent may be measured using any rational method including the residual method and the relative fair value method(paragraph 33).

(iii) Section 3856 requires that preferred shares issued in a tax planning arrangement under speci ed sections of theCanadian Income Tax Act be presented at par, stated or assigned value as a separate line item in the equity sectionof the balance sheet, with a description indicating that they are redeemable at the option of the holder (paragraph20).

(iv) A nancial asset may be offset with a nancial liability only when both of the following criteria are met:

The entity currently has a legally enforceable right of offset; and

The entity intends to settle on a net basis, or, to realize the items simultaneously (paragraph 80).

(e) When is a nancial instrument derecognized?

(i) For transferred receivables, only when control has been surrendered (paragraph 86);

(ii) For a nancial liability, when it is extinguished (paragraph 103).

(f) When and how can hedge accounting be applied (paragraph 120)?

(i) Hedge accounting is optional.

(ii) Hedging is only permitted in speci c circumstances.

(iii) Hedge accounting will only be allowed when the critical terms of the hedging item and hedged item match.(iv) Speci c details of the hedging relationship must be documented.

(v) When hedge accounting is achieved, accounting for the hedging item is modi ed.

(vi) Hedge accounting cannot be electively discontinued, but is discontinued when the critical terms of the hedged itemand the hedging item no longer match.

(g) What is required to be disclosed regarding nancial instruments?

(i) In general, information that enables users to evaluate the signi cance of nancial instruments on the nancial posi-tion and performance of an entity must be disclosed (paragraph 148).


8/60

6


5. The following chart illustrates the application of Section 3856 to nancial instrument transactions.

General application of Section 3856, Financial InstrumentsHas the entity become a party to the contractual

provisions of a nancial instrument? Not sure Go to paragraph 6 of this chapter

Yes

Is the nancial instrument excluded from the scopeof Section 3856 as set out in paragraph 3856.03?

Yes Other standards may apply

No

Is the transaction with a related party? Yes Is the relationship solely in thecapacity of management (paragraph3856.09)?

No The transaction is measured inaccordance with RELATED PARTYTRANSACTIONS , Section 3840

NoYes

Will the instrument be measured at fair value or amortized cost subsequent to initial recognition?

Fair value

Investments in quoted equity instruments

Derivative contracts other than those linked to another private entityand those in qualifying hedging relationships

Other nancial instruments if fair value measurement is elected at ini-tial recognition (election is irrevocable)

Cost or amortized cost

Investments in unquoted equity instruments

Derivatives that are not measured at fair value

All other nancial assets and nancial liabilities not measured at fair

value

Initial measurement

Measure initially at fair valueTransaction costs are expensed in the period incurred

Measure initially at fair value plus or minus transaction costs and nancing fees, if applicable

Subsequent measurement

Fair value

Financial assets and liabilities other than hedginginstruments or indexed liabilities

Hedging instruments Indexed nancial liabilities

Amortize any initial premium or discount and anytransaction costs or nancing fees to net incomeover the expected life of the instrument

Derivative hedging instruments arerecognized at the earlier of: Date a payment is received or

made; and

Date the hedged instrument is rec-ognized (i.e., hedging instrumentreceipt or payment is accrued)

At each reporting date measure at thehigher of: the amortized cost of the debt; and

the amount that would be payableif the indexing formula was appliedon the reporting date

The adjustment for changes in valuedue to the indexing feature, if any, isrecognized immediately in net incomeas a separate component of interestexpense

Assess all nancial assets for indications ofimpairment at each reporting date Is there a signi cant change in the

expected timing or amount of future

cash ows?

Record the asset at the highest of:

PV of cash ows expected fromholding the asset

Selling price at balance sheet date

Expected net proceeds from liqui-dating collateral held

If previously impaired, assess for reversal ofcondition causing impairment in earlier period


9/60



SCOPE

6. What is a nancial instrument? De nitions of nancial asset and nancial liability are in paragraph 3856.05:

De nitions Examples of nancial instruments

Examples of items that are notaccounted for in the scope of Section3856

A nancial asset is any asset that is: cash

a contractual right to receive cashor another nancial asset fromanother party

a contractual right to exchange nancial instruments with another

party under conditions that are potentially favourable

an equity instrument of anotherentity (paragraph 3856.05(h))

cash

demand and xed-term deposits

commercial paper

bankers acceptances

treasury notes and bills

accounts, notes and loans receivable

bonds and similar debt instrumentsheld as investments

common and preferred shares andsimilar equity instruments held asinvestments

options, warrants, futures contracts,

forward contracts, and swaps (theseitems also meet the de nition of aderivative see below) (paragraph3856.02)

The cost incurred by an entity to purchase a right to reacquire its ownequity instruments from another

party; this is a deduction from equity(paragraph 3856.05(h))

Prepaid expenses

Inventories

Property, plant and equipment

Leased rights and assets (para-graph 3856.03(b))

Intangible assets such as patentsand trademarks

Income taxes

Investments in subsidiaries, vari-able interest entities, entities sub-

ject to signi cant in uence or jointventures (paragraph 3856.03(a)*A nancial liability is any liability that

is a contractual obligation: to deliver cash or another nancial

asset to another party; or

to exchange nancial instrumentswith another party under condi-tions that are potentially unfavour-able to the entity

accounts, notes and loans payable(3856.02(d))

bonds and similar debt instrumentsissued (paragraph 3856.02(e))

perpetual debt instruments

preferred shares, shares in co-oper-ative organizations and interestsin partnerships, and similar equityinstruments issued (paragraph3856.02(f))

options, warrants, futures contracts,forward contracts, and swaps (theseitems also meet the de nition of aderivative see below) (paragraph3856.02(g))

* See Sections 3051, 3055, 1590 and AcG-15 as appropriate.

7. Section 3856 applies to items that are created by contracts so payables and receivables that result from statutory require-ments, such as income or excise taxes, are not in the scope.

RECOGNITION8. Financial instruments are initially recognized in nancial statements when the entity becomes a party to the contractual

provisions of the nancial instruments. This will normally happen when an entity commits to purchase or sell a nancialinstrument (otherwise referred to as the trade date). This approach accurately re ects the economic effects of transactionsand is the only recognition date that provides transparency for derivatives.


10/60

8


9. Example Trade date accounting

On December 30, 20X1, Buy Co. purchases 100 shares of a company for its fair value of an aggregate amount of $100. Thetransaction settles on January 2, 20X2 at which time, Buy Co. receives and pays for the shares. On December 31, 20X thefair value of the shares has increased to $115 in aggregate, and by the time the transaction settles on January 2, 20X2 thefair value of the shares has increased to $125.

Journal EntriesSubsequent measurement at amortized cost

(i.e., investment in private company shares)

Subsequent measurement at fair value

(i.e., investment in public company shares)December 30, 20X1

Dr. Investment in shares $100 Dr. Investment in shares $100Cr. Payable $100 Cr. Payable $100

December 31, 20X1 No Entry Dr. Investment in shares $15

Cr. Unrealised fair valueincrease* $15

January 2, 20X2Dr. Payable $100 Dr. Investment in shares $10

Cr. Cash $100 Dr. Payable 100

Cr. Unrealised fair valueincrease* $ 10

Cr. Cash 100* This description is not a required title, it is used simply to describe the change in fair value that is recognized in net

income.

CLASSIFICATION

10. Section 3856 requires few classi cation decisions. Freestanding derivatives (other than those in qualifying hedging rela-tionships and those that are linked to and settle with delivery of the equity instruments whose fair value cannot be readilydetermined) and investments in equities that are quoted in an active market must be measured at fair value subsequent to theirinitial recognition (paragraph 3856.12). On initial recognition, any nancial asset or nancial liability may be designated asmeasured at fair value. Also, fair value measurement may be elected for an equity instrument that ceases to be quoted in anactive market. Fair value measurement may be useful when the asset or liability will be hedged with a derivative but hedgeaccounting would or could not be applied. These elective applications of fair value measurement are irrevocable (paragraph3856.13).

11. It might make sense to use the irrevocable election to measure nancial instruments at fair value in the following situations:

(a) When investments that are eligible for amortized cost measurement are managed on a fair value basis. For example,when surplus cash is invested in a portfolio containing both interest-bearing and equity securities, it is often easier toassess the performance of the portfolio when all of the securities are measured on the same basis.

(b) Accounting for all investments on a fair value basis may simplify bookkeeping. Maintaining amortization schedules forinterest-bearing items is operationally more challenging than recording fair values and cash transactions.

(c) When it is unclear whether the nancial instrument is traded in an active market. It is important to understand the natureof the investment. For example, some mutual fund units are not redeemable daily so are not considered actively traded.However, it is usually easier and more useful to measure these investments at fair value.

(d) When fair value is more relevant for the users.

(e) To simplify the accounting for transaction costs. Transaction costs must be amortized over the life of any nancial instru-ment measured at amortized cost.

Liability or equity

12. Guidance on the classi cation of an issued nancing instrument between a nancial liability and an equity instrument isincluded under the heading Presentation in paragraphs 3856.20-.23.


11/60



13. In some cases, it may be dif cult to determine whether a nancial instrument should be considered a liability or equity. Forexample, some nancial instruments take the legal form of equity but are liabilities in substance because they require pay-ment to the holder of a xed or determinable amount. Others may combine features associated with equity instruments andfeatures associated with nancial liabilities, therefore making it dif cult to distinguish whether it is an equity or liabilityinstrument in its entirety.

14. In distinguishing whether a nancial instrument should be classi ed as a liability or equity instrument, the de nitions of theseinstruments should be considered as follows:

Paragraph 3856.05(e) An equity instrument is any contract that evidences a residual interest in the assets of an entityafter deducting all of its liabilities.

Paragraph 3856.05(j) A nancial liability is any liability that is a contractual obligation:(i) to deliver cash or another nancial asset to another party; or

(ii) to exchange nancial instruments with another party under conditions that are potentially unfavourable to theentity.

15. The substance of the contractual terms of a nancial instrument, rather than its legal form, governs its classi cation on theissuers balance sheet. This determination is made on initial recognition of the instrument, disregarding any non-substantiveor minimal features, and this classi cation is not revised unless the terms of the instrument change or it is removed from the

balance sheet.

16. When considering whether the nancial instrument, or its component parts, meets the de nition of a nancial liability, theexistence of a restriction on the ability of the issuer to satisfy an obligation, such as lack of access to foreign currency or theneed to obtain approval for payment from a regulatory authority, does not negate the issuers obligation or the holders rightsunder the instrument.

17. When an issuer has a contractual obligation to deliver a xed amount or an amount that varies either partially or fully inresponse to changes in a variable, other than the market price of the entitys own equity instruments, and the issuer is requiredto or is able to settle the contractual obligation by delivering enough of its own equity instruments to satisfy the obligation,this would be considered a nancial liability because the counterparty is guaranteed a xed value and is not subject to theresidual risk of the issuer.

18. When an issuer does not have a contractual obligation to deliver cash or another nancial asset or to exchange another nan-cial instrument under conditions that are potentially unfavourable, the instrument is equity. When the issuer is not contractu-ally obligated to distribute a pro rata share of any dividends or other distributions out of equity, even when the holder may be

entitled to such distributions, it is considered an equity instrument.19. The classi cation of a nancial instrument between liability and equity is not changed based on a change in estimate of the

probability of a future event occurring. If the future event passes, and the nancial instrument still exists, it is derecognized,and a new nancial liability or equity instrument is recognized based on the remaining terms. Similarly, the classi cationwould not be impacted by historical experience or intentions but would be based on the actual substance of the contractualarrangements themselves.

Preferred shares issued in a tax planning arrangement

20. The only exception to the above guidance applies to preferred shares issued in a tax planning arrangement under Sections 51,85, 85.1, 86, 87 or 88 of the Canadian Income Tax Act that are redeemable at the option of the holder. These shares should

be presented at par, stated or assigned value as a separate line item in the equity section of the balance sheet, with a suitabledescription indicating that they are redeemable at the option of the holder. When redemption is demanded, the shares are

reclassi ed as liabilities and measured at the redemption amount. Any adjustment is recognized in retained earnings.


12/60

10


21. Examples Instruments that would be considered a nancial liability vs. an equity instrument

Financial liability Equity instrumentAn entity receives $10,000 and promises to deliver the$10,000 or shares equal in value to $10,000 in 3 years time.

An entity receives $10,000 and promises to deliver 10,000shares in 3 years time.

An entity receives $10,000 and promises to deliver shares in3 years time equal to the value of gold at that time.

An entity receives $10,000 and promises to deliver a xednumber of shares at a xed date.

Preferred shares * issued in the amount of $10,000 to beredeemed at a xed date (as per the contractual arrangement)for a xed price and paying mandatory scheduled dividends.

Preferred shares * issued in the amount of $10,000 with nospeci ed repayment date, redeemable at the option of theissuer, with no stipulated dividend payments, when declared.

Preferred shares * issued in the amount of $10,000 to beredeemed at a xed date for a xed price without mandatorydividend payment, when declared.

Preferred shares * issued in the amount of $10,000 with nospeci ed repayment date, redeemable at the option of theissuer, paying mandatory scheduled dividends.

A retractable or mandatorily redeemable share that does notmeet the criteria to be classi ed as an equity instrument.

A retractable or mandatorily redeemable share that: Is the most subordinated of all equity instruments issued

by the entity and participates on a pro rata basis in theresidual equity;

The redemption feature is extended to 100% of thecommon shares (and/or in-substance common shares),and the basis for determination of the redemption priceis the same for all shares;

All of the redeemable shares include substantially simi-lar characteristics to the enterprises common shares;for example, they do not include any substantive liqui-dation preferences or dividend distribution preferences.

The redemption event is the same for all the shares subject to the redemption feature, for example, redemptionon the resignation, termination, retirement or death ofthe shareholder.

* These shares are not subject to the exception above, i.e., they are not issued in a tax planning arrangement under Sec-tions 51, 85, 85.1, 86, 87 or 88 of the Canadian Income Tax Act.

Compound nancial instruments22. When a nancial instrument contains both liability and equity elements, each element should be classi ed in accordance with

its substance, taking into consideration the de nitions of a nancial liability and equity instrument. A nancial position ismore faithfully represented by separate presentation of the liability and equity components contained in a single instrumentaccording to their nature. For example, when a nancial liability includes detachable warrants or options, it is more a matterof form than substance that both liabilities and equity interests are created by a single nancial instrument rather than two ormore separate instruments.

23. The separate classi cation based on the substance of the contractual terms of the arrangement discussed above would stillapply when a nancial instrument contains components that are neither nancial liabilities nor equity instruments of theissuer. For example, an instrument that gives the holder the right to receive a non- nancial asset such as an amount of gold(i.e., a commodity) on settlement and an option to exchange that right for shares of the issuer contains both liability andequity elements. The issuer recognizes and presents the equity instrument (the exchange option) separately from the liabilitycomponents of the compound instrument, whether the liabilities are nancial or non- nancial.

MEASUREMENTInitial Measurement Arms length transactions

24. Financial instruments issued or acquired in arms length transactions are measured initially at fair value. Given that fair valueis the price that an arms length market participant would pay or receive in a routine transaction under the market conditionsat the time of initial recognition, a nancial instruments initial fair value will normally be the transaction price, that is, thefair value of the consideration given or received.


13/60



Financing Fees & Transaction Costs

25. The treatment of any nancing fees and transaction costs directly attributable to the origination, acquisition, issuance orassumption of nancial instruments depends on the subsequent measurement of the instrument. When the instrument will

be measured at fair value, transaction costs and nancing fees are recorded in income in the period incurred because theyare not part of the fair value of the nancial instrument and they do not meet the de nition of an asset necessary for separaterecognition (paragraph 3856.12). When the instrument will be measured at cost or amortized cost, nancing fees and trans-action costs are included in the initial measurement of the instrument. Transaction costs included in the initial measurementof an interest-bearing instrument are amortized over the life of the instrument (paragraphs 3856.07 and .A3). Standby feesand transaction costs associated with a line of credit or revolving debt arrangement are recognized as a prepaid expense andamortized over the life of the commitment because they are, in substance, analogous to an insurance premium. The fee is thecost associated with having the ability to draw down the loan over the term of the arrangement (paragraph 3856.A57).

26. Example Investment in equity instruments at cost

On February 14, 20X1, Investor Corporation invests $10,000 in 10,000 common shares of Private Corporation, givingInvestor Corp. a 10% voting interest in the company. Investor Corp. and Private Corp. are unrelated, and the price paid forthe acquisition of the common shares represented fair value of the shares at the purchase date. Investor Corp. also incurred$500 in legal fees to register the title of the shares in their name.Date EntryFebruary 14, 20X1 Dr. Investment in Private Corporation $10,500

Cr. Cash $10,500

Demand Loans

27. The fair value of a nancial liability with a demand feature is not less than the amount payable on demand, discounted fromthe rst date that the amount could be required to be paid. The maturity date of an item with no contractual repayment termscannot be later than the earliest date on which payment can be demanded. The initial fair value for such nancial liabilities isusually the price at which they are originated between the customer and the lender, that is, the demand amount. However, theeffect of discounting would need to be considered in a high interest rate environment for a loan payable on 30 days notice(paragraph 3856.A12).

28. The interest rate used to discount a nancial instrument payable on demand should be the rate available to the entity on asimilar nancial instrument maturing on, or as close as possible to, the rst date that the instrument could be required to be

paid. It incorporates any risk premium that a third party would charge for a nancial instrument of comparable credit qualityand terms (paragraph 3856.A13).


14/60

12


29. Examples Accounting for demand loans and revolving debt fees and costs

Example 1 Term loanExample 2 Demand loan with noterms of repayment Example 3 Revolving line of credit

Bank of Lenders agrees to lendBorrowing Corporation $100,000for 5 years, bearing annual interest at6%, payable monthly, with principal

repayable in full at maturity. Bank ofLenders is able to demand repaymentof the loan at anytime if speci edconditions are not met. On issuanceof the loan, Bank of Lenders chargesBorrowing Corporation transactioncosts in the amount of $1,250 to writethe loan and register collateral on it.

Borrowing Corporation arranges ademand loan with Bank of Lendersin the amount of $100,000. Bank ofLenders is able to demand repayment

of the loan at anytime. The loan carriesan annual interest rate of 6%. Onissuance of the loan, the bank chargesBorrowing Corporation a $1,250origination fee.

Borrowing Corporation arrangeswith Bank of Lenders to enter into arevolving line of credit with a limitof $100,000. Bank of Lenders is able

to demand repayment of the line atanytime. The line carries an annualinterest rate of 6%. On issuance ofthe line, the bank charges BorrowingCorporation a $1,250 annual standbyfee.

Dr. Cash $98,750 Dr. Cash $98,750 Dr. Prepaidexpenses $1,250

Cr. Loan payable $98,750

Cr. Loan payable $98,750

Cr. Cash $1,250

End of year 1 entryDr. Interest

expense* $250Dr. Interest

expense* $1,250Dr. Interest

expense* $1,250Cr. Loan

payable $250Cr. Loan

payable $1,250Cr. Prepaid

expenses $1,250This example uses the straight-lineamortization method but the effectiveinterest method can alternatively beused.* This account can be presented as aseparate component of interest expensein the income statement:

* This account can also be calledAmortization of Loan Fee or some-thing similar and can be presented as aseparate component of interest expensein the income statement.

* This account can also be as calledAmortization of Prepaid Feeor something similar and can be

presented as a separate componentof interest expense in the incomestatement.

Interest on bank loan $6,000

Amortization of loan fee 250

Total interest expense $6,250

Loans at non-market interest rates

30. A loan with an interest rate that is signi cantly less than a market rate of interest indicates that there is more to the transactionthan a pure lending/borrowing relationship. The present value of the difference between the rate on the loan and a fair marketlending rate may represent part of the price of an asset nanced by the loan, a government grant to incent the borrower toundertake certain commercial transactions, or compensation to an employee (see paragraph 47 below).

31. Example - Loan with a non-market rate of interest related to asset purchase

On February 14, 20X1, Seller Corporation nances Customer Co.s purchase of a $1,000 machine by extending payment

for 3 years. Interest is payable annually at 3%. The market rate of interest for a similar loan to an entity with Customerscredit rating is 5%.The loan is initially measured at its fair value of $946 (net present value of $30 of interest for 3 years and principalrepayment of $1,000 discounted at 5%). The transaction is accounted for as follows:Date Sellers books Customers booksFebruary 14, 20X1 Dr. Loan receivable $946 Dr. Machine $946

Cr. Revenue $946 Cr. Loan payable $946


15/60



Indexed Financial Liabilities

32. Private enterprises often issue debt that requires payments to be determined by reference to factors such as the value of theenterprises equity or performance measures such as earnings before interest, taxes, depreciation and amortization. Theseinstruments are initially measured at fair value, usually the proceeds of the issue, unless they are related party transactionsthat are outside the scope of Section 3856.

Convertible Financial Liabilities

33. Private enterprises also often issue debt that includes an option for the holder to acquire equity of the issuer under speci edcircumstances (compound instrument). These options are similar in nature to options or warrants that are issued with theliability but detachable thereafter. The equity component may be measured as zero or based on fair value measurements asexplained below. It is especially important to disclose the terms of the instrument when the zero measurement alternative ischosen to ensure that readers of the nancial statements are aware of the terms of the conversion option.

34. Acceptable methods for initially measuring the separate liability and equity elements of an instrument include the following:

(a) The equity component is measured as zero; the entire proceeds of the issue are allocated to the liability component.

(b) Residual method the more easily measurable component is measured rst, and the residual amount is allocated to theremaining component.

(c) Relative fair value method the total proceeds of the instrument is allocated to the components in proportion to theirrelative fair values.

The sum of the carrying amounts assigned to all the components in an arrangement on initial recognition is always equal tothe carrying amount of the instrument as a whole. No gain or loss is realized from recognizing and presenting the componentsof the instrument separately.

Residual value method

35. Using the residual method, the more easily measurable component is measured rst, and the residual amount (after deductingfrom the entire proceeds of the issue the amount separately determined for the component that is more easily measurable) isallocated to the less easily measurable component. Note that IFRSs require use of the residual value method but the equity

portion must be calculated as the residual after deducting the fair value of the liability from the proceeds of the issue.

Relative fair value method

36. When the issuer can reliably estimate the fair value of each of the liability and equity components, the proceeds may be allo-cated proportionately. This method is used infrequently because of the dif culty of establishing fair value measurements for

private enterprises.


16/60

14


37. Example Initial measurement of convertible liability

Capital Corporation (Capital) needs to raise $10,000 to fund its operations and is having dif culty nding nancing. Itissues bonds in the aggregate amount of $10,000 repayable in 5 years and with an annual interest rate of 6%. The bonds areconvertible on a one-for-one basis into common shares of the Corporation in the event of default of the bonds terms. Theconversion feature was measured using the Black-Scholes Model at $250 on initial issuance of the bond.Conversion feature is measured at zeroDr. Cash $10,000

Cr. Liability $10,000Cr. Conversion feature (equity) 0

Conversion feature is measured at fair value residual methodDr. Cash $10,000


Liability and conversion feature are measured pro rata relative fair value methodDr. Cash $10,000


From Capitals perspective, the bond comprises two components: a nancial liability (a contractual arrangement to delivercash or other nancial assets) and an equity instrument (a conversion option granting the holder the right, for a speci ed

period of time and upon satisfaction of certain conditions, to convert into common shares of Capital). Capital presents theliability and equity components separately on its balance sheet when the equity component is allocated a value. See para-graph 155 below for examples of the disclosures required for convertible liabilities.

Initial Measurement Related party transactions

38. Related party transactions are measured in accordance with RELATED PARTY TRANSACTIONS , Section 3840 except for thosethat involve parties whose sole relationship with an entity is in the capacity of management. Management is de ned in para-graph 3840.04(d) as follows:

Paragraph 3840.04(d) Management: any person(s) having authority and responsibility for planning, directing andcontrolling the activities of the reporting enterprise. (In the case of a company, management includes the directors, of cersand other persons ful lling a senior management function. When an independent committee of the board of directors isestablished in accordance with regulatory requirements, to represent the non-controlling interests of an enterprise, thedirectors serving on that committee are deemed not to be related parties for the transaction under consideration.)

39. Example Non-interest bearing loan to manager

Mr. Manager receives a non-interest-bearing, ve-year housing loan in the amount of $25,000 on January 1, 20X1 fromhis employer, Bonus Corporation. The loan is due in full on January 1, 20X6. Because Mr. Managers only associationwith the Company is in his capacity as a manager, i.e., he does not own shares of Bonus Corporation, Bonus would have tomeasure this transaction on January 1, 20X1 at its fair value in accordance with Section 3856.07. Assuming the prevailingmarket interest rate for a similar loan for ve years with a similar credit rating were 5%, Bonus Corporation would recordthe following entry on initial recognition of the loan:Dr. Loan receivable $19,588.15Dr. Compensation expense 5,411.85

Cr. Cash $25,000.00


17/60



Subsequent measurementOverview

40. Most measurements in Section 3856 can be applied on an instrument-by-instrument basis, i.e., most are not policy choices.The following chart summarizes the subsequent measurement requirements.

Cost/Amortized cost (paragraph 41 below) Measurement at cost/amortized cost (when not designated at fair value)

Investments in equity instruments not quoted in an active market

Derivatives designated in a qualifying hedging relationship

Derivatives that are linked to, and must be settled by delivery of, equity instruments of another entity whose fair valuecannot be readily determined

All other nancial assets not measured at fair value

Financial liabilitiesFair value (paragraph 69 below)

Mandatory fair value measurement Optional fair value measurement Investments in equity instruments quoted in an active

market

Derivatives not designated in a qualifying hedging

relationship Derivatives that are linked to, and must be settled by

delivery of, equity instruments of another entity whosefair value can be readily determined

Any nancial asset or nancial liability designated oninitial recognition

Equity instruments that cease to be quoted in an active

market

Indexed nancial liabilities (paragraph 74 below)At each reporting date, indexed nancial liabilities are measured at the higher of: the amortized cost of the debt; and

the amount that would be payable if the indexing formula was applied at that date.

Adjustments for changes in the value of the embedded feature are recognized immediately in net income as a separatecomponent of interest expense.

Cost/Amortized cost

41. Amortized cost is de ned in paragraph 3856.05(a) as follows: Paragraph 3856.05(a) Amortized cost is the amount at which a nancial asset or nancial liability is measured at

initial recognition minus principal repayments, plus or minus the cumulative amortization of any difference between thatinitial amount and the maturity amount, and minus any reduction (directly or through the use of an allowance account)for impairment (see paragraphs 3856.A3-.A6).

The term cost is not speci cally de ned in Section 3856. A laymans de nition describes cost as the amount paid to acquirethe nancial instrument.

42. Example Investment in equity instruments at cost (continued from paragraph 26 below)

On December 31, 20X1, Investor Corp.s year-end, the fair value of this investment has increased to $12,500. InvestorCorp. would record the following entries throughout the 2011 year related to this investment:Date EntryDecember 31, 20X1 No entry because the investment is classi ed by Investor Corp. to be measured

at cost, no adjustment is required for the change in fair value.


18/60

16


43. Example Investment in Guaranteed Investment Certi cates (GICs)

On February 14, 20X1, Investor Corporation decides to invest $10,000 in a 30-month Bank of Canadiana non-redeemableGIC which guarantees a return of 2.40%. Investor Corp. did not pay any fees or transaction costs associated with thisinvestment. At December 31, 20X1, the interest rates on similar GICs have decreased to 2.05%, thereby increasing the fairvalue of this investment by year-end. Investor Corp. would record the following entries throughout the 20X1 year relatedto this investment:Date Entry

February 14, 20X1 Dr. Investment in GIC $10,000Cr. Cash $10,000

December 31, 20X1 Dr. Interest receivable $ 210Cr. Interest income $ 210

The increase in fair value of the investment is ignored because the investment is measured at amortized cost.

Amortization of initial purchase premium or discount, nancing fees and transaction costs

44. Any systematic amortization of premiums/discounts, fees and/or costs to net income may be used. The effective interestmethod is theoretically preferred but Section 3856 permits use of alternative methods such as the straight-line method. Inmany situations, the difference between the effective interest method and straight-line amortization will not be material.

45. Example Investment in Government of Canada Treasury Bill

On January 1, 20X1, Investor Corporation decides to invest in a one-year $10,000 GOC treasury bill to yield 1.45%:Principal amount of T-bill $10,000Initial investment ($10,000 discounted at 1.45%) $ 9,857Interest income recognized over the year $ 143For interim reporting purposes, the interest may be recognized using any systematic and rational method including straight-line amortization (approximately $12 per month).

46. Example Loan at non-market rate of interest (continued from paragraph 31 above)

The net amount of the loan of $946 accretes to $1,000 over its three-year term. The accretion can be determined using anysystematic method, including the effective interest method at 5%, or the straight-line method, and can either be shownin net income as part of interest income (Sellers perspective, interest expense for Customer) or on a separate line withininterest income/expense. Sellers entries are as follows:Date Effective interest method Straight-line amortizationDecember 31, 20X1 Dr. Loan receivable $41 Dr. Loan receivable $42

Cr. Interest income $41 Cr. Interest income $42February 14, 20X2 Dr. Cash $30 Dr. Cash $30

Cr. Loan receivable $24 Cr. Loan receivable $24Cr. Interest income 6 Cr. Interest income 6

December 31, 20X2 Dr. Loan receivable $42 Dr. Loan receivable $42Cr. Interest income $42 Cr. Interest income $42

February 14, 20X3 Dr. Cash $30 Dr. Cash $30Cr. Loan receivable $24 Cr. Loan receivable $24Cr. Interest income 6 Cr. Interest income 6

December 31, 20X3 Dr. Loan receivable $43 Dr. Loan receivable $42Cr. Interest expense $43 Cr. Interest income $42

February 14, 20X4 Dr. Cash $1,030 Dr. Cash $1,030Cr. Loan receivable $1,024 Cr. Loan receivable $1,024Cr. Interest expense 6 Cr. Interest expense 6

(Customers entries would mirror those of Sellers.)


19/60



47. Example Interest-free loan to manager (continued from paragraph 39 above)

Entries to be made over the term of the loan are as follows. Both the straight-line amortization method and the effectiveinterest method are illustrated:Straight-line Amortization Method Effective Interest Amortization Method

January 1, 20X1Dr. Loan receivable $19,588.15Dr. Compensation expense 5,411.85

Cr. Cash $25,000.00December 31, 20X1

Dr. Loan receivable $1,082.37 Dr. Loan receivable $979.41Cr. Interest income $1,082.37 Cr. Interest income $979.41

December 31, 20X2Dr. Loan receivable $1,082.37 Dr. Loan receivable $1,028.38

Cr. Interest income $1,082.37 Cr. Interest income $1,028.38December 31, 20X3

Dr. Loan receivable $1,082.37 Dr. Loan receivable $1,079.80Cr. Interest income $1,082.37 Cr. Interest income $1,079.80

December 31, 20X4Dr. Loan receivable $1,082.37 Dr. Loan receivable $1,133.79

Cr. Interest income $1,082.37 Cr. Interest income $1,133.79December 31, 20X5

Dr. Loan receivable $1,082.37 Dr. Loan receivable $1,190.48Cr. Interest income $1,082.37 Cr. Interest income $1,190.48

January 1, 20X6Dr. Cash $25,000.00 Dr. Cash $25,000.00

Cr. Loan receivable $25,000.00 Cr. Loan receivable $25,000.00

Impairment

48. The carrying amount of any nancial asset measured at cost or amortized cost must be reduced if there is a decline in valuethat is speci c to the issuer of the instrument. A decline in value of a stock or group of stocks generally does not give riseto an impairment loss if it relates to an overall decline in equity markets. Similarly, a decline in the value of interest-bearing nancial instruments that related to an increase in interest rates does not create an impairment loss. Section 3856 speci es oneimpairment model applicable to all nancial assets measured at cost or amortized cost. This model requires the impairmentloss to be determined on the basis of the difference between the current carrying amount of the asset and the cash ows theenterprise could expect to receive in the most favourable outcome. The reduction may be recognized directly or through theuse of an allowance account with the offset recognized directly in net income. Losses recognized in previous periods may bereversed if the circumstances related to the original write-down improve.


20/60

18


49. Decision tree Process for assessing impairment

Step 1: Identify assets to be assessed for impairment Investments in private equity instruments measured at cost

Investments in interest-bearing instruments measured at amortized cost that are individually signi cant, e.g., bonds, loans, etc.

Financial assets measured at amortized cost that share similar characteristics, e.g., accounts receivable

Step 2: Are there indications that the asset or group of similar assets is impaired? No No action

Yes

Step 3: Has there been a signi cant adverse change during the period in the expectedtiming or amount of future cash ows from the asset(s)?

No No action

Yes

Step 4: Is carrying amount higher than highest of: Present value of cash ows expected to be generated by holding the asset(s)

Expected net proceeds from selling the asset(s) at the balance sheet date

Expected net value of collateral held

No No action

Yes

Action : Reduce carrying amount to highest of three amounts

In subsequent periods

Step 5: Has the situation identi ed in Step 2 improved? No No action

Yes

Step 6: Is the carrying amount lower than the highest of: Present value of cash ows expected to be generated by holding the asset(s)

Expected net proceeds from selling the asset(s) at the balance sheet date Expected net value of collateral held

No No action

Yes

Action: Increase carrying amount to lower of: the amount calculated in Step 6; and

the carrying amount that would have been recorded had the asset not been previ-ously impaired


21/60



50. Example Impairment assessment

Investor Corporation holds a portfolio of debt and equity securities amounting to $25,000. This portfolio is comprised of$15,000 of investments in equity securities of three private companies, and $10,000 in debt securities. Investor Corp. hasdetermined the following for its impairment review:Equity instruments to be reviewed individually: $5,000 investment in preferred shares of Company A

$3,000 investment in common shares of Company B

$7,000 investment in special shares of Company CDebt securities to be reviewed individually due to their signi cance: $6,000 investment in bonds of Company DDebt securities to be reviewed individually due to their shared industry characteristic: $3,000 aggregate investment in bonds of various companies in the utilities sector The remaining $1,000 are individually insigni cant and would be reviewed only when information comes to the attentionof Investors management.

51. A nancial asset is impaired when the holder expects a signi cant adverse change in either the amount or timing of futurecash ows. For an investment in an equity instrument, the most signi cant potential decrease in future cash ows arisesfrom the inability to sell the shares at a price that recovers the initial investment. Uncertainty about an entitys future cash-generating ability generally results in a decline in the fair value of the entity. Indications that the investment might be at risk

include:(a) It becomes probable that the issuer will enter bankruptcy or other nancial reorganization;

(b) The issuer experiences a signi cant adverse change in the technological, market, economic or legal environment inwhich it operates. The effect of possible changes in the industry in which the issuer operates needs to be assessed. Thisincludes changes in:

(i) the technology used to produce the entitys product;

(ii) the competitive environment in which it operates, including changes in the way the product is distributed thatincrease the number of suppliers with reasonable access to the entitys customers;

(iii) national or local economic conditions;

(iv) environmental sensitivities or laws; or

(v) tax laws.

52. Accounts receivable are similar in nature to interest-bearing assets such as loans, bankers acceptances, guaranteed invest-ment certi cates, term notes and bonds. Although the same process for recognizing and measuring impairment applies toaccounts receivable as to other nancial assets, the model should not result in a change in process from existing practice.Indications that an interest-bearing asset is impaired include:

(a) The customer or issuer appears to be experiencing signi cant nancial dif culty. This may be evident by:

(i) late payments or defaults in either the instrument held by the creditor or investor or in debts owed to other creditorsor investors;

(ii) a breach of a non- nancial contract; or

(iii) concessions granted to the customer.

(b) It becomes probable that the customer or issuer will enter bankruptcy or other nancial reorganization.

(c) The market for nancial instruments issued by the obligor disappears.(d) Liquidity for the type of instrument decreases due to a lack of popularity for that type of investment.

(e) A signi cant adverse change in the technological, market, economic or legal environment in which the customer orissuer operates (see paragraph 51 above).

53. The following events or circumstances do not necessarily indicate impairment:

(a) An active market disappears because an entitys nancial instruments are no longer publicly traded.

(b) The issuers credit rating is downgraded. However, any downgrade should be evaluated to determine whether theamounts or timing of cash ows from the nancial instrument held are at risk of signi cant change.


22/60

20


(c) A decrease in the fair value of a nancial asset below its cost or amortized cost may be due to changes in the risk-freeinterest rate or other exogenous factors.

54. Section 3856 does not de ne signi cant; judgment is required. The assessment should consider the cash ows that areexpected to be derived over the period of time that the entity expects to hold the nancial asset, including any applicable

proceeds of disposal. Examples of situations that might be considered a signi cant adverse change include a change in expec-tation of collection of a receivable from 60 days to 180 days or receiving notice that a past due receivable will be settled for$0.80 on the dollar.

55. Example Indications of impairment

Lendor Corporation has lent one of its customers, Big Box Incorporated (Big Box), $10,000 on February 14, 20X1. ByDecember 31, 20X1, it is clear that customer trends have changed and one of Big Boxs competitors has introduced a new

product to the market that is really taking off, leaving Big Boxs product out of date and not nearly as popular as it oncewas. Big Box has also approached Lendor Corporation to renegotiate and extend its repayment terms because it has beenhaving dif culty with its cash ow considering recent events.Lendor Corp. should consider the fact that Big Box has asked to extend its repayment terms as well as the downturn in BigBoxs economic situation to be indications of a signi cant adverse change in the expected timing or amount of future cash ows associated with its loan receivable.

Measurement of impairment

56. When a signi cant adverse change in future cash ows from the asset is expected, any impairment loss is calculated in accor-dance with paragraph 3856.17. The write-down, if any, is to the highest of three possible amounts:(a) The present value of the cash ows expected to be generated by holding the asset(s), discounted using a current market

rate of interest appropriate to the asset(s);

(b) The amount that could be realized by selling the asset(s) at the balance sheet date; and

(c) The amount expected to be realized by exercising rights to collateral held to secure the repayment of the asset(s), net ofall costs necessary to exercise the rights.

57. Section 3856 assumes the holder of the asset will take whatever action is necessary to maximize cash ows from impaired nancial assets. However, it does not presume a course of action. This means that the reporting entity may manage an assetin a different manner from that corresponding to the measurement. For example, collateral backing an asset may be worthmore than either the present value of the assets future cash ows or the amount that could be realized on sale of the asset.The value of the collateral would be used even if the reporting entity does not intend foreclosing on the asset and realizing

the collateral. Even though, conceptually, the net realizable amount from a hypothetical sale of the asset should be equal tothe higher of the net realizable value of the collateral and the net present value of the future cash ows, Section 3856 doesnot presume that markets for these assets are liquid or perfect.

58. The interest rate to be used to discount future cash ows is determined based on judgment. The rate should re ect the typeof asset under consideration. For example, a loan should be remeasured using the rate that would be charged for a loan withcomparable term, conditions and quality at the balance sheet date. Cash ows from other interest-bearing assets should bediscounted using current yields for the asset, if observable, or a comparable asset.

59. If the reporting entity has granted concessions to a borrower by reducing the interest rate below the current market rate, theamount of the loss reported will include a component for foregone interest. This is illustrated in the example in paragraph 60.


23/60



60. Example Present value of future cash ows of a loan

Richco extended a $120,000, three-year loan to Sadco in 20X0. Sadco is required to pay interest only at 10% with principaldue in full June 30, 20X3. Sadco lost its most signi cant customer to bankruptcy shortly after the loan was extended.Sadco made all required payments in 20X0. In January 20X1, Sadco asked for a reduction in the interest rate to 5% and anextension in the nal payment to June 30, 20X4. The loan is not collateralized. Depending on market rates of interest, theimpairment loss Richco calculates is:Market interest rate 5% 10% 12%

Present value of renegotiated cash ows $121,040 $103,703 $104,330Carrying amount of loan 120,000 120,000 120,000Impairment loss recognized $ 0 $ 11,297 $ 15,670

Because the loan has been renegotiated to amarket rate of interest,no impairment loss isrecognized.

The impairment lossrepresents the difference

between the new interestrate and the market rate.If the term of the loanhad not been extended,the loss would have been$9,917.

The impairment lossrepresents the difference

between the new interestrate and the market rate.

Subsequent to recognizing the write-down, Richco recognizes interest at 5%. If Sadco rebuilds its customer base, all or partof the loss might be reversed. (See paragraph 66 below.)

61. Impairment losses realized on unquoted equity instruments or derivative assets that are linked to, and must be settled bydelivery of, unquoted equity instruments are more dif cult to measure than interest-bearing investments. Estimates of the fairvalue of the shares and cash ows that might reasonably be expected over the anticipated hold period are required. Futurecash ows might be discounted using the required yield for an investment with comparable terms and risk or possibly usingan estimate of the entitys weighted average cost of capital.

62. It is not always necessary to perform the three calculations in paragraph 3856.17. The best estimate of a selling price for anasset may be equivalent to the present value of its cash ows and there may be no collateral backing the asset.

63. Estimates of the amount and timing of expected future cash ows from impaired nancial assets should re ect manage-ments best judgment, based on reasonable and supportable assumptions, taking into account the range of possible outcomes.Although making reliable estimates of the amounts and timing of expected future cash ows from a group of assets is con-strained by limitations on the availability of information as well as the inability to assess the effect on individual accounts,there is a presumption that reasonable assumptions can still be made.


24/60

22


64. Example Cash ow estimates (continued from paragraph 55 above)

Lendor Corporations loan to Big Box Incorporated has a carrying amount of $100,000 on December 31, 20X1. After muchdiscussion with Big Boxs management, Lendor Corp. has agreed to extend the repayment period to mature February 14,20X6 instead of the original maturity date of February 14, 20X4.Assume that the loan is priced at 3.25%, paid monthly and that a current market rate of interest appropriate to Big Box is4.5%.

Probability Outcome

Probability weighted

gross cash ows Present value5% No payments $ 0 $ 05% $30,000 principal plus interest until Feb. 20X4 1,852 1,572

10% $50,000 and interest until Feb. 20X5 6,029 5,09720% $70,000 and all interest 16,708 14,07960% $100,000 principal and all interest 68,125 57,220

$92,714 $77,968

The amount that Big Box expects to realize by exercising its right to collateral net of all costs necessary to exercise thoserights is $70,000.Lendor Corp. records an impairment in the amount of $22,032 through net income at December 31, 20X1 as follows:

Dr. Credit loss $22,032

Cr. Loan receivable (or allowance for loan loss) $22,032By December 31, 20X2, the present value of the cash ows expected to be generated by holding the loan is estimatedat $78,700, while the amount expected to be realized by exercising their rights to collateral (net of all costs necessary toexercise those rights) is $72,000. However, Lendor does not record the increase because there is no indication that theconditions that caused it to evaluate the loan for impairment have improved (see paragraph 66 below).

Impairment of groups of assets

65. When history suggests that bad debt losses will be experienced on some assets in a group but it is not yet apparent whichassets will default, an allowance for impairment is calculated, e.g., an allowance for doubtful accounts receivable. Wheninformation becomes available about the impairment of speci c assets in the group, those assets are removed from the groupand assessed for impairment on an individual basis.

Reversals

66. At each reporting date all assets previously identi ed as impaired are reviewed to determine whether all or part of the impair-ment loss should be reversed. When an increase in value of the asset can be related to an improvement in the condition(s) thatcaused the loss, a gain is recognized. The carrying amount of the asset may not be increased above the amount that wouldhave been reported at the reporting date had an impairment loss not been previously recorded. (Refer to paragraph 49 above,steps 5 and 6.) The amount of the reversal is recognized in net income in the period the reversal occurs.

67. Examples of circumstances that might indicate that an impairment reversal may be possible include:

(a) The customer or issuer previously experiencing signi cant nancial dif culty seems to be doing better. This may be evident by faster payments, the absence or cure of events of default, or a commitment to resume interest or principal payments.

(b) Renegotiation of a contract to incorporate commercial terms appropriate to a party free from liquidity, solvency, or prof-itability concerns, or reinstatement of dividend payments.

(c) Emergence from receivership or bankruptcy protection.

(d) An improvement in the technological, market, economic or legal environment in which the customer or issuer operates.A recovery in the fair value of an investment in an equity instrument above its cost might be indicative of improvement,

but the reporting entity should consider whether the improvement is speci c to the issuer and sustainable through itsintended holding period. Other indicators might include:

(i) Increased popularity of the issuer or customers product

(ii) Structural changes in the customer or issuers industry such as new technology or a change in the number ofcompetitors

(iii) Changes in external variables such as environmental or tax laws.


25/60



68. Example Impairment reversal (continued from paragraph 64 above)

By December 31, 20X2, it is clear that the new product introduced by Big Boxs competitor is faulty and receivessigni cant negative exposure in the media. As a result, the market now has renewed interest in Big Boxs products notingtheir stable reputation for high quality and reliability. Big Boxs management recently contacted Lendor Corp. to con rmtheir intention to repay the loan in full over the next ve years. Lendor is cautiously optimistic and revises its estimate ofexpected cash ows as follows:

Probability Outcome

Probability

weighted outcome Present value0% No further payments $ 0 $ 05% $40,000 principal and all interest 2,515 2,2075% $60,000 principal and all interest 3,515 3,077

10% $80,000 principal and all interest 9,029 7,89480% $100,000 principal and all interest 88,233 77,074

$103,292 $90,253

The value of the collateral has increased to $75,000.Lendor increases the carrying amount of the loan to Big Box from $77,968 to $90,253 and records the following entry:

Dr. Loan receivable (or allowance for loan losses) $12,285Cr. Credit loss $12,285

Fair value

69. Fair value is de ned in paragraph 3856.05(f) as follows:

Paragraph 3856.05(f) Fair value is the amount of the consideration that would be agreed upon in an arms lengthtransaction between knowledgeable, willing parties who are under no compulsion to act. (Paragraph 3856.A7 providesrelated application guidance.)

70. In practice, this de nition can be dif cult to apply. As such, there are a few things to keep in mind when trying to determinefair value for a particular instrument:

(a) Fair value measurement presumes the going concern assumption applies. This means that fair value is not an amount anentity would pay in a forced transaction, involuntary liquidation or distressed sale.

(b) Fair value re ects the credit quality of the instrument, including any collateral or other credit enhancements.

(c) Quoted prices in an active market are the best evidence of fair value so long as they re ect actual and regularly occurringmarket transactions on an arms length basis, which will be the case when prices are readily and regularly available froman exchange, dealer, broker, industry group, pricing service or regulatory agency.

(d) When current rates or prices are unavailable, the price of the most recent transaction may provide evidence of the currentfair value considering whether there have been any signi cant changes in the economic circumstances since the time thatthe most recent transaction took place.

(e) In the absence of a recent transaction for the instrument that is being measured, fair value may be based on a recent pricefor a similar proxy instrument.

(f) In some cases, it may be prudent to consider engaging the use of a specialist or valuator in determining fair value.


26/60

24


71. Example Fair value sources by instrument

Instrument Fair value or proxyEquity instrument quoted in an active market Latest closing price

Non-option derivatives Mid-market prices or rates consistent with prices that would be supplied by banksQuote from a derivatives dealer

Option derivatives Bid prices for purchased options and ask prices for issuedoptions (mid-market prices may be used)Quote from a derivatives dealer Software packages

Interest-free or low interest loans Present value of all future cash receipts discounted using the prevailing market rates of interest for a similar instrument(as to currency, term, type of interest rate, or other relevantfactors) with a similar credit rating

72. Example Calculating the change in fair value of a forward contract

ABC Corporation (ABC), purchases a forward contract (a derivative) on January 15, 20X1 to purchase $100,000 USD onAugust 1, 20X1 at a rate of 1.045. ABC will receive $100,000 USD in exchange for $104,500 CAD on August 1, 20X1.The spot rate on January 15, 20X1 was 1.05.

On March 31, 20X1. ABCs year-end, the forward rates for US dollars, as published in the local newspaper or reputablewebsite, are as follows:1-Month 2-Months 3-Months 4-Months 5-Months 6-Months

Forward rate 1.049 1.048 1.046 1.047 1.046 1.045The change in the fair value of the foreign currency forward contract at March 31, 20X1 is calculated as follows:

f(t) = (F(t) K)e r f (T t) de ned as follows:f(t) = forward contract value at time tF(t) = forward exchange rate at time tK = price per contract at inceptionrf = Canadian risk free interest rateT-t = duration of the contract in years.

When the effect of time value is not material, the change in the intrinsic value of the contract may be used as a proxy forthe change in its fair value. The effect of time value is small when the interest rates are low, when the contract is of shortduration or when the change in the intrinsic value of the forward contract is not material. The change in intrinsic value iscalculated as follows:Foreign currency forward contract x (contract rate contract rate in effect at the period-ended)Using the example above, the change in fair value of the foreign currency forward contract is estimated as follows:$100,000 * (1.047 forward rate in 4 months time 1.045 contracted rate) = $200.The Company would record the following entry to record the change in fair value of the forward contract:Dr. Derivative asset $200

Cr. Unrealised gain on derivative (net income) $200Alternatively, the providing nancial institution might provide an estimated fair value for the forward contract.


27/60



73. Example Calculating the change in fair value of an interest-rate swap

On January 1, 20X1, Coverage Corporation borrowed $5,000,000 repayable in ve years at prime plus 1.5%. On June 1,20X1, Coverage Corporation decides to enter into an interest rate swap to minimize its exposure to uctuations in the primerate. Under the swaps terms, Bank of Lenders pays Coverage Corporation prime plus 1.5% and Coverage pays Bank ofLenders 3.5% xed for the remaining term of the loan.If Coverage Corporation does not want to apply hedge accounting, Coverage Corporation is required to measure the swapat fair value at each reporting period. The fair value of the swap can be estimated with the use of commercially available

software and prices or by requesting an approximate fair value of the swap from Bank of Lenders.To verify whether the estimate received from the bank is reasonable, the following technique can be used:

Notional amount $5,000,000 Number of months remaining in swap agreement 54 monthsPrime Rate

Current 1.30%Expected average High end of range 3.80%Expected average Low end of range 3.30%

Interest rate of the debtVariable 2.80%

Interest rate of the swap

Fixed 3.50%Discount rate risk-free rate based on remaining term swap 2.00%Discounted cash ows High/Low estimateHighFixed rate $5,000,000 x 3.50% = $(175,000)Variable $5,000,000 x 3.80% = $190,000Difference per year $15,000Difference per month $ 1,250Present value of future cash ows $64,500LowFixed rate $5,000,000 x 3.50% = $(175,000)

Variable $5,000,000 x 3.30% = $165,000Difference per year $(10,000)Difference per month $ (833)Present value of future cash ows $(43,000)External valuationMark-to-ma

accounting for private busness

Documents