1 | P a g e

Chapter 16

FINANCIAL INSTRUMENTS PRESENTATION (IAS -32)

Objective

The objective of this IAS is to enhance user’s understanding of the significance of financial

instruments to an entity’s financial position, performance and cash flows. The main issues are: -

Classification of financial instruments from the perspective of issuer;

Classification of related interest, dividend, losses and gains; and

The circumstances in which financial asset can be set off against the liability Scope

This IAS is applicable to all entities to all types of financial instruments except: - Those interests in subsidiaries, associates and joint ventures accounted for under IASs 27,

28 & 31, however, where IAS-39 is applied for these instruments, the requirements of this IAS will be operative;

Employer’s rights and obligations where IAS-19 is applicable; Insurance contracts where IFRS-4 is applicable except embedded derivatives; and

Contracts and obligations under share based payments under IFRS-2 except where this

IAS or IAS-39 is applicable This Standard shall be applied to those contracts to buy or sell a non-financial item that can be settled net in cash or another financial instrument, or by exchanging financial

instruments, as if the contracts were financial instruments, with the exception of contracts that were entered into and continue to be held for the purpose of the receipt or delivery of

a non-financial item in accordance with the entity’s expected purchase, sale or usage requirements.

There are various ways in which a contract to buy or sell a non-financial item can be

settled net in cash or another financial instrument or by exchanging financial instruments. Examples are: -

(a) When the terms of the contract permit either party to settle it net in cash or another

financial instrument or by exchanging financial instruments; (b) when the ability to settle net in cash or another financial instrument, or by

exchanging financial instruments, is not explicit in the terms of the contract, but the entity has a practice of settling similar contracts net in cash or another financial

instrument, or by exchanging financial instruments (whether with the counterparty, by entering into offsetting contracts or by selling the contract before its exercise or lapse);

(c) when, for similar contracts, the entity has a practice of taking delivery of the

underlying and selling it within a short period after delivery for the purpose of generating a profit from short-term fluctuations in price or dealer’s margin; and

(d) When the non-financial item that is the subject of the contract is readily convertible

to cash. Definitions

Financial instrument is any contract that gives rise to financial asset of one enterprise and

financial liability or equity instrument of another enterprise.

Financial asset is any asset that is:

a) Cash;

b) An equity instrument of another entity; c)A contractual right:

i. to receive cash or another financial asset from another entity; or

ii. to exchange financial assets or financial liability with another entity under

conditions that are potentially favorable to the entity; or

d) a contract that will or may be settled in the entity’s own instruments and is: i. a non-derivative for which the entity is or may be obliged to receive a variable

number of the entity’s own equity instruments; or

ii. a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s

own equity instruments.

For this purpose the entity’s own equity instruments do not include puttable

financial instruments classified as equity instruments in accordance with paragraphs 16A and 16B, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only

on liquidation and are classified as equity instruments in accordance with paragraphs 16C and 16D, or instruments that are contracts for the future receipt or delivery of the entity’s own equity instruments.

Examples of financial assets are cash, deposits in other companies, trade receivables, loan

to other companies, investment in debt instruments, investment in shares, and other equity

instruments. Financial liability is any liability that is: -

a) a contractual obligation: -

(i) to deliver cash or another financial asset to another entity; or (ii) to exchange financial assets or financial liability with another entity under

conditions that are potentially un-favorable to the entity; or b) a contract that will or may be settled in the entity’s own instruments and is:

(i) a non-derivative for which the entity is or may be obliged to deliver a variable

number of the entity’s own equity instruments; or (ii) a derivative that will or may be settled other than by the exchange of a fixed

amount of cash or another financial asset for a fixed number of the entity’s

own equity instruments. For this purpose, rights, options or warrants to acquire a fixed number of the

entity’s own equity instruments for a fixed amount of any currency are equity instruments if the entity offers the rights, options or warrants pro rata to all of its

existing owners of the same class of its own non-derivative equity instruments.

Also, for these purposes the entity’s own equity instruments do not include puttable financial instruments that are classified as equity instruments in

accordance with paragraphs 16A and 16B, instruments that impose on the

entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments

in accordance with paragraphs 16C and 16D, or instruments that are contracts for the future receipt or delivery of the entity’s own equity

instruments. As an exception, an instrument that meets the definition of a financial liability is classified as an equity instrument if it has all the features and meets the

conditions in paragraphs 16A and 16B or paragraphs 16C and 16D. Examples of financial liability are trade payables, loans from other companies and debt

instruments issued by the entity. Equity instrument: Any contract that evidences a residual interest in the assets of an entity

after deducting all of its liabilities. A derivative is a financial instrument:

Whose value changes in response to the change in an underlying variable such as

an interest rate, commodity or security price, or index;

3 | P a g e

That requires no initial investment, or one that is smaller than would be required for a

contract with similar response to changes in market factors; and

That is settled at a future date. Contract and contractual refer to an agreement between two or more parties that has

clear economic consequences that the parties have little, if any, discretion to avoid,

usually because the agreement is enforceable by law. Contracts, and thus financial instruments, may take a variety of forms and need not be in writing. A puttable instrument is a financial instrument that gives the holder the right to put the

instrument back to the issuer for cash or another financial asset or is automatically put back

to the issuer on the occurrence of an uncertain future event or the death or retirement of the instrument holder.

Puttable financial instruments will be presented as equity only if all of the following

criteria are met:

(i) the holder is entitled to a pro-rata share of the entity’s net assets on liquidation;

(ii) the instrument is in the class of instruments that is the most subordinate and all

instruments in that class have identical features;

(iii)the instrument has no other characteristics that would meet the definition of a

financial liability; and

(iv) the total expected cash flows attributable to the instrument over its life are

based substantially on the profit or loss, the change in the recognized net

assets or the change in the fair value of the recognized and un-recognized net assets of the entity (excluding any effects of the instrument itself). Profit or

loss or change in recognized net assets for this purpose is as measured in

accordance with relevant IFRSs.

In addition to the criteria set out above, the entity must have no other instrument

that has terms equivalent to (iv) above and that has the effect of substantially restricting or fixing the residual return to the holders of the puttable financial

instruments. Presentation Financial Liability and Equity

The issuer of a financial instrument shall classify the instrument, or its components parts, on

initial recognition as a financial liability, financial asset or an equity instrument in

accordance with the substance of the contractual arrangement and definitions of a financial liability, a financial asset and equity instrument.

Classification

A financial instrument is an equity instrument only if: -

a) the instrument includes no contractual obligation to deliver cash or another

financial asset to another entity or to exchange financial asset/liability with another entity under conditions which are potentially unfavorable to issuer; and

b) if the instrument will or may be settled in the issuer's own equity instruments, it is either:

a non-derivative that includes no contractual obligation for the issuer to deliver a variable number of its own equity instruments; or

a derivative that will be settled only by the issuer exchanging a fixed amount

of cash or another financial asset for a fixed number of its own equity instruments.

For this purpose, rights, options or warrants to acquire a fixed number of the

entity’s own equity instruments for a fixed amount of any currency are equity instruments if the entity offers the rights, options or warrants pro rata to all of its

existing owners of the same class of its own non-derivative equity instruments. Also, for these purposes the issuer’s own equity instruments do not include

instruments that have all the features and meet the conditions described in

paragraphs 16A and 16B or paragraphs 16C and 16D, or instruments that are

contracts for the future receipt or delivery of the issuer’s own equity instruments.

Illustration - preference shares

If an enterprise issues preference (preferred) shares that pay a fixed rate of dividend and that have a mandatory redemption feature at a future date, the substance is

that they are a contractual obligation to deliver cash and, therefore, should be

recognized as a liability. In contrast, normal preference shares do not have a fixed

maturity, and the issuer does not have a contractual obligation to make any payment. Therefore, they are equity. Illustration – putt-able instruments

A financial instrument that gives the holder the right to return it to the issuer for cash or another financial asset (a 'puttable instrument') is a financial liability – even if the amount of cash or other financial assets is determined on the basis of an index or

other variable that has the potential to increase or decrease, or when the legal form

of the puttable instrument gives the holder a right to a residual interest in the assets

of an issuer except when paragraph 16 A to 16 to 16 D of IAS 32 applied. (Mutual funds, unit trusts)

Illustration - issuance of fixed monetary amount of equity instruments

A contractual right or obligation to receive or deliver a number of its own shares or other equity instruments that varies so that the fair value of the entity's own equity

instruments to be received or delivered equals the fixed monetary amount of the contractual right or obligation is a financial liability. (To deliver/receive shares equal

to Rs. 100 or 10 ounces of gold) Illustration - Fixed amount of cash and fixed number of shares

When a contract that will be settled by the entity receiving or delivering fixed

number of shares for no future consideration or exchanging a fixed number of its

own shares for a fixed amount of cash or another financial asset, is an equity instrument. Example is Forward contract to repurchase fixed number of own shares

against fixed amount of cash.

c) A financial instrument may require the entity to deliver cash or another financial

asset, or otherwise to settle it in such a way that it would be a financial liability, in the event of the occurrence or non-occurrence of uncertain future events (or on the outcome of uncertain circumstances) that are beyond the control of both the issuer

and the holder of the instrument, such as a change in a stock market index,

consumer price index, interest rate or taxation requirements, or the issuer’s future

revenues, net income or debt-to-equity ratio. The issuer of such an instrument does not have the unconditional right to avoid delivering cash or another financial asset (or otherwise to settle it in such a way that it would be a financial liability). Therefore,

it is a financial liability of the issuer unless: (a) The part of the contingent settlement provision that could require settlement

in cash or another financial asset (or otherwise in such a way that it would be a financial liability) is not genuine; or

(b) The issuer can be required to settle the obligation in cash or another financial

asset (or otherwise to settle it in such a way that it would be a financial liability) only in the event of liquidation of the issuer.

Illustration – contract settled in cash or another financial asset

A contract that will be settled in cash or another financial asset is a financial asset or liability even if the amount of cash or another financial asset that will be received or

5 | P a g e

paid is based on changes in the market value of entity’s own equity. Example is a

net cash settled share option.

d) When a derivative financial instrument gives one party a choice over how it is settled (e.g. the issuer or the holder can choose settlement net in cash or by exchanging

shares for cash), it is a financial asset or a financial liability unless all of the settlement

alternatives would result in it being an equity instrument.

e) Compound Financial Instruments

Some financial instruments - sometimes called compound instruments - have both a

liability and an equity component from the issuer's perspective. In that case, IAS 32 requires that the component parts be accounted for and presented separately

according to their substance based on the definitions of liability and equity. The split is made at issuance and not revised for subsequent changes in market interest rates,

share prices, or other event that changes the likelihood that the conversion option

will be exercised. To illustrate, a convertible bond contains two components. One is a financial

liability, namely the issuer's contractual obligation to pay cash, and the other

is an equity instrument, namely the holder's option to convert into common shares. Another example is debt issued with detachable share purchase

warrants. When the initial carrying amount of a compound financial instrument is

required to be allocated to its equity and liability components, the equity component is assigned the residual amount after deducting from the fair value of the instrument as a whole the amount separately determined for the

liability component.

On conversion of a convertible instrument at maturity the entity de-recognizes the liability component and recognize it as equity. There is no gain/loss

recognition on conversion at maturity.

When an entity extinguishes a convertible instrument before maturity i.e.

redemption or repurchase in which original conversion privileges are unchanged, the entity allocates the consideration paid and transaction cost to liability and equity component at the date of transaction. The method is

same as used for original allocation of debt/equity. Interest, dividends, gains, and losses relating to an instrument classified, as a

liability should be reported in the income statement. This means that dividend payments on preferred shares classified as liabilities are treated as expenses.

On the other hand, distributions (such as dividends) to holders of a financial

instrument classified as equity should be charged directly against equity, not against earnings.

f) Treasury shares

The cost of an entity's own equity instruments that it has reacquired ('treasury shares') is deducted from equity. Gain or loss is not recognized on the purchase, sale, issue,

or cancellation of treasury shares. Treasury shares may be acquired and held by the entity or by other members of the consolidated group. Consideration paid or

received is recognized directly in equity. g) Off-setting

IAS 32 also prescribes rules for the offsetting of financial assets and financial liabilities. It specifies that a financial asset and a financial liability should be offset and the net

amount reported when and only when, an enterprise:

has a legally enforceable right to set off the amounts; and

intends either to settle on a net basis, or to realize the asset and settle the liability

simultaneously.

Offsetting is usually inappropriate when: • several different financial instruments are used to emulate the features of a single

financial instrument (a ‘synthetic instrument’);

• financial assets and financial liabilities arise from financial instruments having the same primary risk exposure (for example, assets and liabilities within a portfolio

of forward contracts or other derivative instruments) but involve different

counterparties;

• financial or other assets are pledged as collateral for non-recourse financial liabilities;

• financial assets are set aside in trust by a debtor for the purpose of discharging an

obligation without those assets having been accepted by the creditor in settlement of the obligation (for example, a sinking fund arrangement); or

• obligations incurred as a result of events giving rise to losses are expected to be

recovered from a third party by virtue of a claim made under an insurance

contract.

h) Costs of issuing and reacquiring equity instruments

Costs of issuing or reacquiring equity instruments (other than in a business

combination) are accounted for as a deduction from equity, net of any related

income tax benefit. An entity typically incurs various costs in issuing or acquiring its own equity

instruments. Those costs might include registration and other regulatory fees, amounts paid to legal, accounting and other professional advisers, printing costs

and stamp duties. The transaction costs of an equity transaction are accounted for as a deduction from equity (net of any related income tax benefit) to the extent they are incremental costs directly attributable to the equity transaction that

otherwise would have been avoided. The costs of an equity transaction that is

abandoned are recognized as an expense. Transaction costs that relate to the issue of a compound financial instrument are

allocated to the liability and equity components of the instrument in proportion to the allocation of proceeds. Transaction costs that relate jointly to more than one

transaction (for example, costs of a concurrent offering of some shares and a stock exchange listing of other shares) are allocated to those transactions using a basis of allocation that is rational and consistent with similar transactions.

Examples-1

An enterprise issues 2,000 convertible bonds at the start of Year 1. The bonds have a three-

year term, and are issued at par with a face value of Rs.1,000 per bond giving total proceeds of Rs.2,000,000. 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 common shares.

When the bonds are issued the prevailing market interest rate for similar debt without conversion options is 9%. The entity has incurred Rs. 100,000 as issuance cost of compound

instrument. The effective rate considering the issuance cost of debt is 11% p.a. Required: -

Determine the debt and equity component?

Pass necessary double entries for all the three years?

Pass necessary double entries at the maturity date if the investor exercises cash option or

share option?

Example-2

On January 01, 1999 Entity A issued 10% convertible debentures with face value of Rs.

1,000,000 maturing at December 31, 2008. The debenture is convertible into ordinary shares

7 | P a g e

of entity A at Rs. 25 per share. Interest is payable half yearly in cash. The market interest rate

for non-convertible debenture at the issue date is 11%.

On January 01, 2004, the convertible debenture has a fair value of Rs. 1,700,000. Entity A makes a tender offer to the holders of the debentures for Rs. 1,700,000, which the holders

accepted. At the date of repurchase entity could have issued non-convertible debt with a

five-year term bearing a coupon rate of 8%. Required: Determine the debt and equity component at the issue of loan and what

accounting entries to be passed at the date conversion? Past Papers

The following information pertains to Crow Textile Mills Limited (CTML) for the year ended 30 June 2012:

(b) On 1 July 2011, 2 million convertible debentures of Rs. 100 each were issued. Each

debenture is convertible into 25 ordinary shares of Rs. 10 each on 30 June 2014. Interest is payable annually in arrears @ 8% per annum. On the date of issue, market interest rate for similar debt without conversion option was 11% per annum.

However, on account of expenditure of Rs. 4 million, incurred on issuance of shares, the effective interest rate increased to 11.81%. (08)

Required:- Prepare Journal entries for the year ended 30 June 2012 to record the above

transactions. (Show all necessary calculations)

FINANCIAL INSTRUMENTS RECOGNITION AND

MEASUREMENT

IAS – 39

SCOPE

IAS 39 applies to all types of financial instruments except for the following, which are scoped out of IAS 39:

interests in subsidiaries, associates, and joint ventures accounted for under IAS 27, IAS

28, or IAS 31; however IASs 32 and 39 apply in cases where under IAS 27, IAS 28, or IAS 31 such interests are to be accounted for under IAS 39 - for example, derivatives

on an interest in a subsidiary, associate, or joint venture;

employers' rights and obligations under employee benefit plans to which IAS 19 applies;

contracts requiring payment based on climatic, geological, or other physical variable, except derivatives embedded in such contracts are subject to IAS 39;

rights and obligations under insurance contracts, except IAS 39 does apply to

financial instruments that take the form of an insurance (or reinsurance) contract but that principally involve the transfer of financial risks and derivatives embedded in

insurance contracts;

financial instruments that meet the definition of own equity under IAS 32, however, the holder of this instrument will apply this IAS.

Leases IAS 39 applies to lease receivables and payables only in limited respects:

It applies to lease receivables with respect to de-recognition and impairment

provisions. It applies to lease payables with respect to the de-recognition provisions. IAS 39

applies to derivatives embedded in leases.

derivatives that are embedded in leases are subject to the embedded derivatives provisions of this Standard

Financial guarantees.

The financial guarantees are in the scope of IAS. Loan Commitments

(a) Loan commitments that the entity designates as financial liabilities at fair value through profit or loss. An entity that has a past practice of selling the assets resulting from its loan commitments shortly after origination shall apply this Standard to all its

loan commitments in the same class. (b) Loan commitments that can be settled net in cash or by delivering or issuing another

financial instrument. These loan commitments are derivatives. A loan commitment is not regarded as settled net merely because the loan is paid out in installments (for

example, a mortgage construction loan that is paid out in installments in line with the

progress of construction). (c) C commitments to provide a loan at a below-market interest rate. Contracts to buy or sell financial items Contracts to buy or sell financial items are also within

the scope of IAS 39. Contracts to buy or sell non-financial items Contracts to buy or sell non-financial items are

within the scope of IAS 39 if they can be settled net in cash or another financial asset and are not entered into and held for the purpose of the receipt or delivery of a non-financial

9 | P a g e

item in accordance with the entity's expected purchase, sale, or usage requirements.

Contracts to buy or sell non-financial items are inside the scope if net settlement occurs.

The following situations constitute net settlement: the terms of the contract permit either counterparty to settle net;

there is a past practice of net settling similar contracts;

there is a past practice, for similar contracts, of taking delivery of the underlying and selling it within a short period after delivery to generate a profit from short-term

fluctuations in price, or from a dealer's margin; or

the non-financial item is readily convertible to cash.

Definitions

A derivative is a financial instrument: Whose value changes in response to the change in an underlying variable such as

an interest rate, commodity or security price, or index;

That requires no initial investment, or one that is smaller than would be required for a

contract with similar response to changes in market factors; and

That is settled at a future date. Examples of derivatives

Forwards: Contracts to purchase or sell a specific quantity of a financial instrument, a

commodity, or a foreign currency at a specified price determined at the outset, with delivery or settlement at a specified future date. Settlement is at maturity by actual delivery

of the item specified in the contract, or by a net cash settlement. Interest Rate Swaps and Forward Rate Agreements: Contracts to exchange cash flows as of

a specified date or a series of specified dates based on a notional amount and fixed and

floating rates. Futures: Contracts similar to forwards but with the following differences: Futures are generic

exchange-traded, whereas forwards are individually tailored. Futures are generally settled

through an offsetting (reversing) trade, whereas forwards are generally settled by delivery of the underlying item or cash settlement. Options: Contracts that give the purchaser the right, but not the obligation, to buy (call

option) or sell (put option) a specified quantity of a particular financial instrument,

commodity, or foreign currency, at a specified price (strike price), during or at a specified

period of time. These can be individually written or exchange-traded. The purchaser of the option pays the seller (writer) of the option a fee (premium) to compensate the seller for

the risk of payments under the option. Caps and Floors: These are contracts sometimes referred to as interest rate options. An

interest rate cap will compensate the purchaser of the cap if interest rates rise above a

predetermined rate (strike rate) while an interest rate floor will compensate the purchaser if rates fall below a predetermined rate.

The amortized cost of a financial asset or financial liability is the amount at which the

financial asset or financial liability is measured at initial recognition minus principal repayments, plus or minus the cumulative amortization using the effective interest method

of any difference between that initial amount and the maturity amount, and minus any

reduction for impairment or un-collectability. The effective interest method is a method of calculating the amortized cost of a financial

asset or a financial liability and of allocating the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated

future cash payments or receipts through the expected life of the financial instrument or,

when appropriate, a shorter period to the net carrying amount of the financial asset or

financial liability. When calculating the effective interest rate, an entity shall estimate cash

flows considering all contractual terms of the financial instrument but shall not consider

future credit losses. The calculation includes all fees and points paid or received between

parties to the contract that are an integral part of the effective interest rate, transaction costs, and all other premiums or discounts.

IFRS 9

OBJECTIVE

IFRS 9’s objective is to establish principles for the financial reporting of financial assets that

will present relevant and useful information to users of financial statements for their assessment of amounts, timing and uncertainty of the entity’s future cash flows.

SCOPE

IFRS 9 generally has to be applied by all entities preparing their financial statements in

accordance with IFRS and to all types of financial assets within the scope of IAS 39,

including derivatives. Essentially any financial assets that are currently accounted for under IAS 39 will fall within

the IFRS 9's scope.

INITIAL RECOGNITION AND MEASUREMENT

An entity shall recognize a financial asset or financial liability in its statement of financial

position when and only and only when it becomes party to contractual provisions of the

instrument. All financial assets and financial liability in IFRS 9 are to be initially recognized at fair value,

plus, in the case of a financial asset or financial liability that is not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition of the financial

asset. Regular way purchase or sale of financial assets

A regular way purchase or sale of financial asset is recognized using either trade date

accounting or settlement date accounting.

When an entity uses settlement date accounting for an asset that is subsequently

measured at amortized cost, the asset is recognized initially at its fair value on the trade date.

CLASSIFICATION AND MEASUREMENT

IFRS 9 has two measurement categories: amortized cost and fair value. In order to

determine the financial assets that fall into each measurement category, it may be helpful

for management to consider whether the financial asset is an investment in an equity instrument as defined in IAS 32, 'Financial instruments: Presentation'. If the financial asset is

not an investment in an equity instrument, management should consider the guidance for debt instruments below.

Classification and measurement - Debt instruments

If the financial asset is a debt instrument, management should consider whether both the following tests are met:

■ The objective of the entity's business model is to hold the asset to collect the

contractual cash flows.

■ The asset's contractual cash flows represent only payments of principal and interest.

Interest is consideration for the time value of money and the credit risk associated with

11 | P a g e

the principal amount outstanding during a particular period of time.

If both these tests are met, the financial asset falls into the amortized cost measurement

category. If the financial asset does not pass either of the above tests, or only one of the

above tests, it is measured at fair value through profit or loss.

Even if both tests are met, management also has the ability to designate a financial asset as at fair value through profit or loss if doing so reduces or eliminates a

measurement or recognition inconsistency (‘accounting mismatch’). IFRS 9 retains only one of the three conditions in IAS 39 to qualify for using the fair value option. It removes

the conditions regarding being part of a group of financial assets that is managed and

its performance evaluated on a fair value basis and where the financial asset contains one or more embedded derivatives, as they are no longer necessary under the

classification model in IFRS 9.

Classification and measurement - Business model

Financial assets are subsequently measured at amortized cost or fair value based on the entity’s business model for managing the financial assets. An entity assesses whether its

financial assets meet this condition based on its business model as determined by the entity’s key management personnel.

Management will need to apply judgment to determine at what level the business

model condition is applied. That determination is made on the basis of how an entity

manages its business; it is not made at the level of an individual asset. Therefore, the entity’s business model is not a choice and does not depend on management’s intentions for an individual instrument; it is a matter of fact that can be observed by the

way an entity is managed and information is provided to its management.

Although the objective of an entity’s business model may be to hold financial assets in order to collect contractual cash flows, some sales or transfers of financial instruments

before maturity would not be inconsistent with such a business model.

The following are examples of sales before maturity that would not be inconsistent with a

business model of holding financial assets to collect contractual cash flows:

■ an entity may sell a financial asset if it no longer meets the entity’s investment policy,

because its credit rating has declined below that required by that policy;

■ when an insurer adjusts its investment portfolio to reflect a change in the expected duration (that is, payout) for its insurance policies; or

■ when an entity needs to fund capital expenditure.

However, if more than an infrequent number of sales are made out of a portfolio, management should assess whether and how such sales are consistent with an objective of collecting contractual cash flows. There is no set rule for how many sales constitutes

‘infrequent’; management will need to use judgment based on the facts and circumstances to make its assessment.

An entity’s business model is not to hold instruments to collect the contractual cash flows − for example, where an entity manages the portfolio of financial assets with the

objective of realizing cash flows through sale of the assets. Another example is when an

entity actively manages a portfolio of assets in order to realize fair value changes arising

from changes in credit spreads and yield curves, which results in active buying and selling of the portfolio.

Example 1 – Factoring An entity has a past practice of factoring its receivables. If the significant risks and

rewards have transferred from the entity, resulting in the original receivable being

derecognized from the balance sheet, the entity is not holding these receivables to

collect its cash flows but to sell them. However, if the significant risks and rewards of these receivables are not transferred from the entity, and the receivables do not, therefore, qualify for de-recognition, the client's

business objective may still be to hold the assets in order to collect the contractual cash flows.

Example 2 – Syndicated loans An entity’s business model is to lend to customers and hold the resulting loans for the

collection of contractual cash flows. However, sometimes the entity syndicates out

portions of loans that exceed their credit approval limits. This means that, at inception,

part of such loans will be held to collect contractual cash flows and part will be held-for-sale. The entity, therefore, has two business models to apply to the respective portions of the loans.

Example 3 – Portfolio of sub-prime loans

An entity that operates in the sub-prime lending market purchases a portfolio of sub-prime loans from a competitor that has gone out of business. The loans are purchased at a substantial discount from their face value, as most of the loans are not currently

performing (that is, no payments are being received, in many cases because the

borrower has failed to make payments when due). The entity has a good record of

collecting sub-prime loan arrears. It plans to hold the purchased loan balances to recover the outstanding cash amounts relating to the loans that have been purchased. As the business model is to hold the acquired loans and not to sell them, the business

model test is met.

Classification and measurement - Contractual cash flows that are solely payments of

principal and interest

The other condition that must be met in order for a financial asset to be eligible for

amortized cost accounting is that the contractual terms of the financial asset give rise on

specified dates to cash flows that are "solely payments of principal and interest on the principal amount outstanding". In this case, interest is defined as consideration for the

time value of money and for the credit risk associated with the principal amount

outstanding during a particular period of time.

In order to meet this condition, there can be no leverage of the contractual cash flows. Leverage increases the variability of the contractual cash flows with the result that they do not have the economic characteristics of interest. Leverage is generally viewed as

any multiple above one.

However, unlike leverage, certain contractual provisions will not cause the ‘solely payments of principal and interest’ test to be failed. For example, contractual provisions that permit the issuer to pre-pay a debt instrument or permit the holder to put a debt

instrument, back to the issuer before maturity result in contractual cash flows that are

solely payments of principal and interest as long as the following certain conditions are

met:

■ The pre-payment amount substantially represents unpaid amounts of principal and interest on the principal amount outstanding (which may include reasonable additional compensation for the early termination of the contract).

Contractual provisions that permit the issuer or holder to extend the contractual term of

a debt instrument are also regarded as being solely payments of principal and interest, provided during the term of the extension the contractual cash flows are solely

13 | P a g e

payments of principal and interest as well (for example, the interest rate does not step up

to some leveraged multiple of LIBOR) and the provision is not contingent on future

events.

The following are examples of contractual cash flows that are not solely payments of

principal and interest:

■ Links to equity index, borrower’s net income or other non-financial variables.

■ Deferrals of interest payments where additional interest does not accrue on those deferred amounts.

■ Convertible bond (from the holder’s perspective).

If a contractual cash flow characteristic is not genuine, it does not affect the financial

asset's classification. In this context, ‘not genuine’ means the occurrence of an event

that is extremely rare, highly abnormal and very unlikely to occur.

Example 1 – Changing credit spread An entity has a loan agreement that specifies that the interest rate will change

depending on the borrower’s credit rating, EBITDA or gearing ratio. Such a feature will not fail the ‘solely payments of principal and interest’ test provided the adjustment is

considered to reasonably approximate the credit risk of an instrument with that level of

EBITDA, gearing or credit rating. That is, if such a covenant compensates the lender with higher interest when the borrower's credit risk increases then this is consistent with interest

being defined as the consideration for the credit risk and the time value of money.

However, if the covenant results in more than just compensation for credit or provides for some level of interest based on the entity's profitability that will not meet the test.

Example 2 – Average rates

An entity has a loan agreement where interest is based on an average LIBOR rate over a period. That is, the loan has no defined maturity, but rolls every two years with reference

to the two year LIBOR rate. The interest rate is reset every two years to equal the average two year LIBOR rate over the last two years. The economic rationale is to allow borrowers to benefit from a floating rate, but with an averaging mechanism to protect them from

short-term volatility. Such a feature will not fail the ‘solely payments of principal and

interest’ test provided the average rate represents compensation for only the time value of money and credit risk.

Classification and measurement - Non-recourse

A non-recourse provision is an agreement that, should the debtor default on a secured

obligation, the creditor can look only to the securing assets (whether financial or non-financial) to recover its claim. Should the debtor fail to pay and the specific assets fail to satisfy the full claim, the creditor has no legal recourse against the debtor's other assets.

The fact that a financial asset is non-recourse does not necessarily preclude the financial asset from meeting the condition to be classified at amortized cost.

If a non-recourse provision exists, the creditor is required to assess (to ‘look through to’) the particular underlying assets or cash flows to determine whether the financial asset's

contractual cash flows are solely payments of principal and interest. If the instrument's

terms give rise to any other cash flows or limit the cash flows in a manner inconsistent with

‘solely payments of principal and interest’, the instrument will be measured in its entirety at fair value through profit or loss.

There is limited guidance as to how the existence of a non-recourse feature may impact the classification of non-recourse loans at amortized cost. Judgment will, therefore, be

needed to assess these types of lending relationships.

Classification and measurement - Equity instruments

Investments in equity instruments are always measured at fair value. Equity instruments that are held for trading are required to be classified as at fair value through profit or loss.

For all other equities, management has the ability to make an irrevocable election on initial recognition, on an instrument-by-instrument basis, to present changes in fair value

in other comprehensive income (OCI) rather than profit or loss. If this election is made, all

fair value changes, excluding dividends that are a return on investment, will be reported in OCI. There is no recycling of amounts from OCI to profit and loss – for example, on sale

of an equity investment – nor are there any impairment requirements. However, the

entity may transfer the cumulative gain or loss within equity.

Example 1 – Investment in perpetual note An entity (the holder) invests in a subordinated perpetual note, redeemable at the

issuer's option, with a fixed coupon that can be deferred indefinitely if the issuer does not pay a dividend on its ordinary shares. The issuer classifies this instrument as equity under

IAS 32. The holder has the option to classify this investment at fair value through OCI

under IFRS 9, as it is an equity instrument as defined in IAS 32. Example 2 – Investment in a puttable share

An entity (the holder) invests in a fund that has puttable shares in issue – that is, the

holder has the right to put the shares back to the fund in exchange for its pro rata share of the net assets. The puttable shares may meet the requirements to be classified as

equity from the fund’s perspective, but this in an exception, as they do not meet the definition of equity in IAS 32. However, the holder does not have the ability to classify this

investment as fair value through OCI, as paragraph 96C of IAS 32 states that puttable should not be considered an equity instrument under other guidance. Investments in puttable shares are, therefore, required to be classified as fair value through profit or loss,

as they cannot be regarded as equity instruments for IFRS 9.

Example 3 – Dividend return on investment

An entity invests in shares at a cost of C12 and designates these at fair value through OCI. The fair value then increases to C22, giving rise to an unrealized gain of C10 in OCI.

The issuer then pays a special dividend of C10. This dividend is recorded in profit or loss in

accordance with IAS 18, ‘Revenue’; as such a dividend does not represent a recovery of part of the cost of the investment.

Example 4 – Hybrid equity instrument

An entity invests in preference shares that have a maturity date for the repayment of principal, but that also pays discretionary dividends based on the profits of the issuing

entity and give a right to share in the net assets on liquidation. These shares are considered a compound instrument by the issuer and are treated as part liability and

part equity. Under paragraph 4.7 of IFRS 9, a hybrid financial asset is to be classified in its

entirety. This investment in its entirety does not meet the definition of an equity instrument in IAS 32; it is not, therefore, eligible to use the fair value through OCI classification. The

contractual cash flows of this investment would need to be assessed. As it is not solely

receiving payments of principal and interest, it would be measured at fair value through profit or loss.

Equity Instruments at Cost

The standard removes the requirement in IAS 39 to measure unquoted equity investments at cost when the fair value cannot be determined reliably. However, it indicates that in

limited circumstances, cost may be an appropriate estimate of fair value – for example,

when insufficient more recent information is available from which to determine fair value;

15 | P a g e

or when there is a wide range of possible fair value measurements and cost represents

the best estimate of fair value within that range. However, IFRS 9 includes indicators of

when cost might not be representative of fair value. These are:

■ A significant change in the investee's performance compared with budgets, plans or

milestones.

■ Changes in expectation that the investee’s technical product milestones will be achieved.

■ A significant change in the market for the investee’s equity or its products or potential

products.

■ A significant change in the global economy or the economic environment in which

the investee operates.

■ A significant change in the performance of comparable entities or in the valuations implied by the overall market.

■ Internal matters of the investee such as fraud, commercial disputes, litigation, or changes in management or strategy.

■ Evidence from external transactions in the investee’s equity, either by the investee

(such as a fresh issue of equity) or by transfers of equity instruments between third

parties.

Given the indicators above, it is not expected that cost will be representative of fair value for an extended period of time.

Option to designate a financial asset at fair value through profit or loss

An entity may at initial recognition irrevocably designate a financial asset at fair through

profit or loss if doing so eliminates or significantly reduces a measurement or recognition inconsistency. Classification and measurement - Embedded derivatives

The accounting for embedded derivatives in host contracts that are financial assets is

simplified by removing the requirement to consider whether or not they are closely

related and should, therefore, be separated. The classification approach in the new standard applies to all financial assets, including those with embedded derivatives.

Many embedded derivatives introduce variability to cash flows. This is not consistent with

the notion that the instrument’s contractual cash flows solely represent the payment of

principal and interest. If an embedded derivative was not considered closely related under the existing requirements, this does not automatically mean the instrument will not

qualify for amortized cost treatment under the new standard. However, most hybrid

contracts with financial asset hosts will be measured at fair value in their entirety.

The accounting for embedded derivatives in non-financial host contracts and financial liabilities currently remains unchanged.

CLASSIFICATION OF FINANCIAL LIABILITIES

An entity shall classify all financial liabilities as subsequently measured at amortized cost

using the effective interest method, except for:

(a) Financial liabilities at fair value through profit or loss. Such liabilities,

including derivatives that are liabilities, shall be subsequently measured at fair

value. (b) Financial liabilities that arise when a transfer of a financial asset does not

qualify for de-recognition or when the continuing involvement approach applies. (c) Financial guarantee After initial recognition, an issuer of such a contract shall

measure it at the higher of:

(i) the amount determined in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets and

(ii) the amount initially recognized less, when appropriate, cumulative

amortization recognized in accordance with IAS 18 Revenue.

(d) Commitments to provide a loan at a below-market interest rate. After initial recognition, an issuer of such a commitment shall subsequently measure it at the higher of:

(i) the amount determined in accordance with IAS 37 and

(ii) the amount initially recognized less, when appropriate, cumulative

amortization recognized in accordance with IAS 18.

(e) Contingent consideration of an acquirer in a business combination to be

measured subsequently at fair value. OPTION TO DESIGNATE A FINANCIAL LIABILITY AT FAIR VALUE THROUGH PROFIT OR LOSS

An entity may, at initial recognition, irrevocably designate a financial liability as

measured at fair value through profit or loss when permitted by this IFRS or when doing

so results in more relevant information, because either:

(a) it eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as ‘an accounting mismatch’) that would

otherwise arise from measuring assets or liabilities or recognizing the gains and

losses on them on different bases; or

(b) a group of financial liabilities or financial assets and financial liabilities is managed and its performance is evaluated on a fair value basis, in accordance

with a documented risk management or investment strategy, and information about the group is provided internally on that basis to the entity’s key

management personnel, for example the entity’s board of directors and chief

executive officer.

Embedded Derivatives

An embedded derivative is a component of a hybrid contract that also includes a non-derivative host—with the effect that some of the cash flows of the combined instrument

vary in a way similar to a stand-alone derivative. An embedded derivative causes some

or all of the cash flows that otherwise would be required by the contract to be modified according to a specified interest rate, financial instrument price, commodity price,

foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific

to a party to the contract. A derivative that is attached to a financial instrument but is contractually transferable

independently of that instrument, or has a different counterparty, is not an embedded

derivative, but a separate financial instrument. Hybrid Contract with financial asset hosts

If a hybrid contact contains a host that is a financial asset, the whole of the contract will be measured at fair value through profit or loss account. Other Hybrid Contracts

If a hybrid contract contains a host that is not an asset within the scope of this IFRS, an embedded derivative shall be separated from the host and accounted for as a

derivative under this IFRS if, and only if:

(a) the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host;

(b) a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and

(c) the hybrid contract is not measured at fair value with changes in fair value

17 | P a g e

recognized in profit or loss (i.e. a derivative that is embedded in a financial liability

at fair value through profit or loss is not separated).

If an embedded derivative is separated, the host contract shall be accounted for in accordance with the appropriate IFRSs. This IFRS does not address whether an embedded derivative shall be presented separately in the statement of financial

position. If an entity is required by this IFRS to separate an embedded derivative from its host, but is unable to measure the embedded derivative separately either at acquisition or at the

end of a subsequent financial reporting period, it shall designate the entire hybrid

contract as at fair value through profit or loss. SUBSEQUENT MEASUREMENT OF FINANCIAL ASSETS

After initial recognition, an entity shall measure a financial asset at fair value or amortized cost as appropriate under categories of fair value or amortized cost.

SUBSEQUENT MEASUREMENT OF FINANCIAL LIABILITIES

After initial recognition, an entity shall measure a financial liability at fair value or

amortized cost as appropriate under categories of fair value or amortized cost. IMPAIRMENT AND UN-COLLECTABILITY OF FINANCIAL ASSETS

• Impairment losses are incurred only if there is objective evidence as a result of one

or more events that occurred after the initial recognition of the asset. The amount of the loss is measured as the difference between the asset’s CV and the PV of

estimated cash flows discounted at the financial asset’s original effective interest

rate. • Impairment of HTM investments and loans and receivables carried at amortized

cost is recognized through profit or loss. Any reversal of the loss is also recognized through profit or loss.

GAINS AND LOSSES

A gain or loss on a financial asset or financial liability that is measured at fair value shall be recognized in profit or loss unless:

(a) it is part of a hedging relationship;

(b) it is an investment in an equity instrument and the entity has elected to present gains and losses on that investment in other comprehensive income; or

(c) it is a financial liability designated as at fair value through profit or loss and the

entity is required to present the effects of changes in the liability’s credit risk in

other comprehensive income. A gain or loss on a financial asset that is measured at amortized cost and is not part of a hedging relationship shall be recognized in profit or loss when the financial asset is

derecognized, impaired or reclassified and through the amortization process. A gain or loss on a financial liability that is measured at amortized cost and is not part of a hedging

relationship shall be recognized in profit or loss when the financial liability is derecognized and through the amortization process.

A gain or loss on financial assets or financial liabilities that are hedged items and shall be

recognized in Profit and Loss Account or Other Comprehensive Income If an entity recognizes financial assets using settlement date accounting any change in

the fair value of the asset to be received during the period between the trade date and

the settlement date is not recognized for assets measured at amortized cost (other than impairment losses). For assets measured at fair value, however, the change in fair value

shall be recognized in profit or loss or in other comprehensive income. Investments in equity instruments

At initial recognition, an entity may make an irrevocable election to present in other

comprehensive income subsequent changes in the fair value of an investment in an equity instrument within the scope of this IFRS that is not held for trading.

If an entity makes the election, it shall recognize in profit or loss dividends from that

investment when the entity’s right to receive payment of the dividend is established in

accordance with IAS 18. Liabilities designated as at fair value through profit or loss

An entity shall present a gain or loss on a financial liability designated as at fair value

through profit or loss as follows: (a) The amount of change in the fair value of the financial liability that is attributable

to changes in the credit risk of that liability shall be presented in other

comprehensive income, and

(b) the remaining amount of change in the fair value of the liability shall be presented

in profit or loss unless the treatment of the effects of changes in the liability’s credit risk described in (a) would create or enlarge an accounting mismatch in profit or loss.

If the requirements in above paragraph would create or enlarge an accounting mismatch in profit or loss, an entity shall present all gains or losses on that liability

(including the effects of changes in the credit risk of that liability) in profit or loss. Reclassifications

An instrument’s classification is made at initial recognition and is not changed

subsequently, with one exception. Reclassifications between fair value and amortized cost (and vice versa) are required only when the entity changes how it manages its

financial instruments (that is, changes its business model). Such changes are expected to

be infrequent. The reclassification must be significant to the entity's operations and demonstrable to external parties. Any reclassification should be accounted for

prospectively. Entities are not, therefore, allowed to restate any previously recognized gains or losses. The asset should be re-measured at fair value at the date of a

reclassification of a financial asset from amortized cost to fair value; this value will be the new carrying amount. Any difference between the previous carrying amount and the fair value would be recognized in a separate line item in the income statement. At the

date of a reclassification of a financial asset from fair value to amortized cost, its fair

value at that reclassification date becomes its new carrying amount.

Examples of change in the business model that would require reclassification include:

■ An entity has a portfolio of commercial loans that it holds to sell in the short-term. Following an acquisition of an entity whose business model is to hold commercial loans

to collect the contractual cash flows, that portfolio is managed together with the

acquired portfolio to collect the contractual cash flows.

■ An entity decides to close its retail mortgage business and is actively marketing its mortgage loan portfolio.

The following are not changes in business model:

■ A change in intention related to particular financial assets.

■ A temporary disappearance of a particular market for financial assets.

■ A transfer of financial assets between parts of the entity with different business models.

19 | P a g e

DE-RECOGNITION

RECOGNITION OF GAIN LOSS ON DERECOGNITION

Entire financial asset

• The gain or loss is charged to profit and loss account on de-recognition of the

difference

a) The carrying amount and b) Consideration received plus any new asset less any new liability assumed

• The entity transfer the financial asset but retains a servicing contract, which may result in servicing asset or servicing liability

De-recognition principle can be applied to part when: -

a) Part comprise identifiable cash flows

b) Full proportionate share of cash flows of asset

c) Proportionate share of identifiable cash flows

The entity treats the transfer of asset when: -

a) No obligation to pay until it received

from the asset

b) The entity cannot sell or pledge the

asset

c) The cash flows collected are

immediately remitted to Buyer

The transfer of risks and

rewards are determined by the

exposure of an entity to

variability in cash flows before

and after transfer

Control is

determined by

the practical

ability of the

transferee to sell

asset in entirety

to a third party

• The entity transfer the financial asset which results in new financial asset or financial

liability or servicing liability, all resulting assets/liabilities are recognized at fair value Entire part of financial asset

• The previous carrying value of the parts is allocated between part continue to be

recognized and de-recognized on relative fair value at date of transfer

• The gain or loss is charged to profit and loss account of the difference of: - a) The carrying value of part de-recognized and;

b) The consideration received

• When the fair value is not determinable for separate parts then carrying value of

recognized part is fair value of total asset less consideration received for de-recognized asset.

Transfers that do not qualify for de-recognition

If a transfer does not result in de-recognition because the entity has retained substantially all the risks and rewards of ownership of the transferred asset, the entity shall continue to recognize the transferred asset in its entirety and shall recognize a

financial liability for the consideration received. In subsequent periods, the entity

shall recognize any income on the transferred asset and any expense incurred on

the financial liability. Continuing Involvement in transferred asset

Substantial risks / rewards neither transferred nor retained but entity control the asset.

• The related asset and liability is recognized to the extent: - Involvement in the form of guarantee, the asset will be recognized at lower of

carrying value of asset and maximum consideration to be payable Involvement in the form of written/purchased call option the amount of asset

transferred which the entity may purchase

Involvement in the form of written put option then at lower of fair value of asset transferred and option exercise price

• The liability will be recognized according to applicable provisions of IFRS9. However,

the associated liability is measured in such a way that the net carrying value of asset transferred and liability is the: -

Amortized cost of the rights/obligations retained by the entity (asset is measured at amortized cost.

Fair value of the rights and obligations retained (asset transferred is measured at FV) DE-RECOGNITION OF A FINANCIAL LIABILITY

A financial liability should be removed from the balance sheet when, and only when, it is

extinguished, that is, when the obligation specified in the contract is either discharged,

cancelled, or expired. Where there has been an exchange between an existing borrower and lender of debt

instruments with substantially different terms, or there has been a substantial modification of the terms of an existing financial liability, this transaction is accounted for as

extinguishments of the original financial liability and the recognition of a new financial liability. A gain or loss from extinguishments of the original financial liability is recognized in the

income statement.

HEDGE ACCOUNTING

Hedge accounting recognizes symmetrically the offsetting effects on net profit or loss of

changes in the fair values of the hedging instrument and the related item being hedged.

IAS 39 permits hedge accounting under certain circumstances provided that the hedging relationship is:

21 | P a g e

Formally designated and documented, including the entity's risk management objective

and strategy for undertaking the hedge, identification of the hedging instrument, the

hedged item, the nature of the risk being hedged, and how the entity will assess the hedging instrument's effectiveness; and

Expected to be highly effective in achieving offsetting changes in fair value or cash flows

attributable to the hedged risk as designated and documented, and effectiveness can be reliably measured. Hedging Instruments

A derivative measured at fair value through profit or loss may be designated as a hedging

instrument, except for some written options. A non-derivative financial asset or a non-derivative financial liability measured at fair value through profit or loss may be designated as a hedging instrument unless it is a financial

liability designated as at fair value through profit or loss for which the amount of its change in fair value that is attributable to changes in the credit risk of that liability is presented in other comprehensive income. For a hedge of foreign currency risk, the foreign currency risk

component of a non-derivative financial asset or a non-derivative financial liability may be

designated as a hedging instrument provided that it is not an investment in an equity

instrument for which an entity has elected to present changes in fair value in other comprehensive income. A proportion of the hedging instrument may be designated as the hedging instrument.

Generally, specific cash flows inherent in a derivative cannot be designated in a hedge relationship while other cash flows are excluded. However, the intrinsic value and the time

value of an option contract may be separated, with only the intrinsic value being designated. Similarly, the interest element and the spot price of a forward can also be

separated, with the spot price being the designated risk. Hedged Items

A hedged item can be:

a single recognized asset or liability, firm commitment, highly probable transaction,

or a net investment in a foreign operation; a group of assets, liabilities, firm commitments, highly probable forecast transactions,

or net investments in foreign operations with similar risk characteristics; a held-to-maturity investment for foreign currency or credit risk (but not for interest

risk or prepayment risk);

a portion of the cash flows or fair value of a financial asset or financial liability; or a non-financial item for foreign currency risk only or the risk of changes in fair value

of the entire item. in a portfolio hedge of interest rate risk (Macro Hedge) only, a portion of the portfolio

of financial assets or financial liabilities that share the risk being hedged. Qualifying criteria for hedge accounting

A hedging relationship qualifies for hedge accounting only if all of the following criteria are

met: a) The hedging relationship only exists for eligible hedged items and hedging

instruments.

b) At the inception of the hedging relationship there is a formal designation.

c) The hedging relationship meets all of the following hedge effectiveness

requirements: - i) There is an economic relationship between hedged item and hedging

instrument.

ii) The effect of credit risk does not dominate the value changes that result from that economic relationship.

iii) The hedge ratio of the hedging relationship is the same as that resulting from

the quantity of the hedged item that the entity actually hedges and the

quantity of the hedging instrument that the entity actually uses to hedge that quantity of hedged item.

CATEGORIES OF HEDGES A fair value hedge is a hedge of the exposure to changes in fair value of a recognized

asset or liability or a previously unrecognized firm commitment to buy or sell an asset at a

fixed price or an identified portion of such an asset, liability or firm commitment, that is

attributable to a particular risk and could affect profit or loss.

The gain or loss from the change in fair value of the hedging instrument is recognized immediately in profit or loss except if the investment in equity classified at fair value through OCI, the fair value gain/(loss) is recognized in OCI.

At the same time the carrying amount of the hedged item is adjusted for the corresponding gain or loss with respect to the hedged risk, which is also recognized immediately in net profit or loss except items designated at fair value through OCI.

The fair value gain / (loss) on hedging instrument relating to firm commitment as hedged

item is recognized in profit or loss account. A cash flow hedge is a hedge of the exposure to variability in cash flows that (i) is

attributable to a particular risk associated with a recognized asset or liability (such as all or some future interest payments on variable rate debt) or a highly probable forecast

transaction and (ii) could affect profit or loss. As long as a cash flow hedge meets the qualifying criteria, the hedging relationship shall be

accounted for as follows:

(a) the separate component of equity associated with the hedged item (cash

flow hedge reserve) is adjusted to the lower of the following (in absolute amounts):

(i) the cumulative gain or loss on the hedging instrument from inception of

the hedge; and (ii) the cumulative change in fair value (present value) of the hedged item

(ie the present value of the cumulative change in the hedged expected future cash flows) from inception of the hedge.

(b) the portion of the gain or loss on the hedging instrument that is determined to

be an effective hedge (ie the portion that is offset by the change in the cash flow

hedge reserve calculated in accordance with (a)) shall be recognized in other

comprehensive income. (c) any remaining gain or loss on the hedging instrument (or any gain or loss

required to balance the change in the cash flow hedge reserve calculated in

accordance with (a)) is hedge ineffectiveness that shall be recognized in profit or

loss. (d) the amount that has been accumulated in the cash flow hedge reserve in

accordance with (a) shall be accounted for as follows:

(i) if a hedged forecast transaction subsequently results in the recognition

of a non-financial asset or non-financial liability, or a hedged forecast

transaction for a non-financial asset or a non-financial liability becomes a firm

commitment for which fair value hedge accounting is applied, the entity shall remove that amount from the cash flow hedge reserve and include it directly

in the initial cost or other carrying amount of the asset or the liability. This is not

a reclassification adjustment (see IAS 1 Presentation of Financial Statements) and hence it does not affect other comprehensive income.

(ii) for cash flow hedges other than those covered by (i), that amount shall

be reclassified from the cash flow hedge reserve to profit or loss as a

23 | P a g e

reclassification adjustment (see IAS 1) in the same period or periods during

which the hedged expected future cash flows affect profit or loss (for example, in the periods that interest income or interest expense is recognised or when a forecast sale occurs).

(iii) however, if that amount is a loss and an entity expects that all or a

portion of that loss will not be recovered in one or more future periods, it shall

immediately reclassify the amount that is not expected to be recovered into

profit or loss as a reclassification adjustment (see IAS 1). Discontinuation of Hedge Accounting

Hedge accounting must be discontinued prospectively if: the hedging instrument expires or is sold, terminated, or exercised;

the hedge no longer meets the hedge accounting criteria - for example it is no longer effective;

for cash flow hedges the forecast transaction is no longer expected to occur; or

the entity revokes the hedge designation.

If hedge accounting ceases for a cash flow hedge relationship because the forecast transaction is no longer expected to occur, gains and losses deferred in equity must be

taken to the income statement immediately. If the transaction is still expected to occur and the hedge relationship ceases, the amounts accumulated in equity will be retained in

equity until the hedged item affects profit or loss. If a hedged financial instrument that is measured at amortized cost has been adjusted for the gain or loss attributable to the hedged risk in a fair value hedge, this adjustment is

amortized to profit or loss based on a recalculated effective interest rate on this date such

that the adjustment is fully amortized by the maturity of the instrument. Amortization may

begin as soon as an adjustment exists and must begin no later than when the hedged item ceases to be adjusted for changes in its fair value attributable to the risks being hedged. EXAMPLES TO THE IAS

Example (Effective Interest Rate Method)

Debt is issued for $1,000. The debt is redeemable at $1,250. The term of the debt is five years

and interest is paid at 5.9% p.a. (Effective interest rate 10%)

Required: - Prepare amortization schedule using effective interest rate method and determine interest cost of each period to be charged to Profit and Loss Account? Example-Amortized Cost

A debt security has a stated principal amount of £5,000. This will be repaid in five years at

an interest rate of 6% per year, payable annually at the end of each year. The company

purchases the security on 1 January 20X4, at a discount, for £4,670. The company classifies the debt security as at amortized cost. (Effective interest rate is 7.65%)

Required: - Prepare amortization schedule using effective interest rate method and

determine interest income of each period to be charged to Profit and Loss Account? Example (Held for trading)

A debt security that is held for trading is purchased for £6,000. Transaction costs are £400. Required: - Provide accounting treatment for transaction cost and at what value the

investment to be recognized? Example AT FAIR VALUE THROUGH OCI

An investment in equity of other entities classified as available-for-sale is purchased for

£5,500 and transaction costs are £500.

Required: - Provide accounting treatment for transaction cost and at what value the investment to be recognized? Examples (Financial assets at fair value through profit or loss/OCI)

A company acquires, for cash, 500 shares at £5 per share and classifies them as at fair

value through profit or loss. At the year-end, the quoted price increases to £6. The

company sells the shares for £3,400 just after the year-end. Required: - Provide necessary journal entries to be passed at initial recognition, balance

sheet date and on disposal of investment if investment is held for trading and / or Through

OCI? Example (Call option purchased)

A company enters into a call option contract on 1 July 20X6. The contract gives it the right

to purchase 5,000 shares issued by another company on 1 December 20X6, at a price of

£15 per share. The company’s year-end is 31 October 20X6. The cost of each option is £1. On 31 October 20X6, the value of each option is £1.50. The share price on this date is £16. Required: - Provide necessary journal entries to be passed at initial recognition, balance

sheet date and on exercise of option?

Example - fair value hedge

A company purchases a debt instrument that has a principal amount of £1 million at a

fixed interest rate of 6% per year. The instrument is classed as an amortized cost. The fair

value of the instrument is £1 million.

The company is exposed to a risk of the decline in the fair value of the instrument if the market interest rate increases because of the fixed interest rate. The company enters into an interest rate swap. It exchanges the fixed interest rate

payments it receives on the bond for floating interest rate payments, in order to offset the risk of a decline in fair value. If the derivative hedging instrument is effective, any decline in

the fair value of the bond should be offset by opposite increases in the fair value of the derivative instrument. The company designates and documents the swap as a hedging

instrument. On entering into the swap, the swap has a fair value of zero.

Assuming market interest rates have increased to 7%, the fair value of the bond will have decreased to £960,000. The Swap has a fair value of £ 39,000 at the same date.

Required: - Provide necessary journal entries to be passed? Example –cash flow hedge

A company trades in £ sterling. It expects to purchase a piece of plant for 1 million euros in

one year from 1 May 20X6. In order to offset the risk of increases in the euro rate, the company enters into a forward contract to purchase 1 million euros in 1 year for a fixed

amount (£650,000). The forward contract is designated as a cash flow hedge. At inception,

the forward contract has a fair value of zero. At the year-end of 31 October 20X6, the euro has appreciated and the value of 1 million

euros is £660,000. The machine will still cost 1 million euros so the company concludes that

the hedge is 100% effective. Required: - Provide necessary journal entries to be passed at the date of settlement and

what will be the treatment of any gain on the contract?

CLASSIFY THE FOLLOWING INSTRUEMENTS

1 Investment in marketable bond

Tamara acquires a bond. The bond is listed and matures in 18 months. Management has

purchased the bond because it expects the price to increase in the short-term. It intends to

sell the bond whenever it believes the price has peaked, but definitely within the next 30 days. 2 Investment in equity shares

Tamara acquires 5% of the equity shares in Go, a start-up business in the Netherlands, which it believes has good prospects. She expects Go to be listed within 2 years and hopes to

make a substantial return on its investment over 3-5 years.

25 | P a g e

3 Investment in debt security

Tamara has invested surplus cash in a bond denominated in euros. The maturity of the

bond is 3 years and management intends to hold the bond to maturity, when it will use the proceeds for a planned acquisition in Germany.

4-Fixed interest debt

Tamara issues a CHF 10m fixed-interest note with a three-year term. 5 Trade Receivable

Tamara has sold goods to a customer, which is invoiced in Singapore Dollars. The Customer

is expected to pay for the goods in 30 days. 6 Short position in securities

Tamara hears a rumor that the share price of Black Dog will fall within the next 3 days. She borrows Black Dog shares from a broker for 5 days and immediately sells them in the

market. On day 5, she intends to buy shares at a lower price in the market and return them to the broker. DETERMINE THE DERECOGNITION OF FOLLOWING INSTRUEMENTS

Question 1

Star sells part of its short-term trade receivable portfolio. There is full recourse in the event of

default. Can Star de-recognize the trade receivable sold? Question 2

Sun sells a non-readily obtainable equity security to Satellite. At the same time, Sun also enters into a forward purchase agreement with Satellite to reacquire the equity security in 6

months time at its then current market price. Can Sun de-recognize its investment in the equity security? Question 3

Aton owns 10.000 shares in Kot, a quoted undertaking. Aton transfers these shares to the bank, on the following terms:

The consideration received by Aton is $20,000. Aton has a call option to buy the shares

from the bank. The repurchase will take place at fair value at the date that the option is exercised.

Should Aton recognize the asset? Question 4

Aton owns 10,000 shares in Small, an unquoted undertaking. The shares have a carrying

value of $20,000. A transfers these shares to a bank, on the following terms: The consideration received by Aton is $20,000. Aton has a call option to buy the shares

from the bank for $25,000 in three years time.

Should Aton recognize the asset? Question 5

Artright, a public limited company, produces artifacts made from precious metals. Its customers vary from large multinational companies to small retail outlets and mail order

customers. On 1 December 2003, Artright has a number of finished artifacts in inventory which are valued at cost $4 million (selling value $5·06 million) and whose precious metal content was

200,000 ounces. The selling price of artifacts produced from a precious metal is determined

substantially by the price of the metal. The inventory value of finished artifacts is the metal

cost plus 5% for labor and design costs. The selling price is normally the spot price of the metal content plus 10% (approximately). The management were worried about a potential

decline in the price of the precious metal and its effect on the selling price of the inventory.

Therefore it sold futures contracts for 200,000 ounces in the metal at $24 an ounce at 1 December 2003. The contracts mature on 30 November 2004.

The management have designated the futures contracts as cash flow hedges of the

anticipated sale of the artifacts. Historically this has proved to be highly effective in

offsetting any changes in the selling price of the artifacts. The finished artifacts were sold for $22·8 per ounce on 30 November 2004. The costs of setting the futures contracts in place

were negligible.

The metal’s spot and futures prices were as follows: Spot price Futures price per ounce

$ per ounce for delivery 30 November2004

$

1 December 2003 23 24 30 November 2004 21 21

Using the principles of IAS39 ‘Financial Instruments: recognition and measurement’:

Discuss whether the cash flow hedge of the sale of the inventory of artifacts is effective and how it would be accounted for in the financial statements for the year ended 30 November 2004?

PRACTICE QUESTIONS ON IAS 39 CLASSIFICATION

Q-1

(a) AB Co sells an investment in shares, but retains a call option to repurchase

those shares at any time at a price equal to their current market value at the

date of repurchase.

(b) CD Co sells an investment in shares and enters into a 'total return swap' with

the buyer. Under a 'total return swap' arrangement, the buyer returns any

increases in value to the seller, and the seller compensates the buyer for any

decrease in value plus interest.

(c) EF Co enters into a stock lending agreement where an investment is lent to a

third party for a fixed period of time for a fee.

(d) GH Co sells title to some of its receivables to a debt factor for an immediate cash payment of 90% of their value. The terms of the agreement are that GH

Co has to compensate the factor for any amounts not recovered by the

factor after six months.

Required: - Discuss whether the following financial instruments would be

derecognized?

Q-2

XYZ Co purchased a two year Rs. 20 million 6% debenture at par on 1 January 20X1

when the market rate of interest was 6%. Interest is paid annually on 31 December. The market rate of interest on debentures of equivalent term and risk changed to

7% on 31 December 20X1.

Required: - Show the charge or credit to the income statements for the two years to 31 December 20X2 if the debentures are held:

(a) at amortized cost

(b) at fair value through profit or loss

(c) at fair value as an available-for-sale financial asset.

(d) Fair value is to be calculated using discounted cash flow techniques.

Q-3

Green Tree Co had the following financial instrument transactions affecting the

year ended 31 December 20X2:

27 | P a g e

(1) Purchased 4% debentures in MT Co on 1 January 20X2 (their issue date) for

Rs.100,000 as an investment. Green Tree intends to hold them until their redemption after six years at a premium of 17%. Transaction costs of Rs. 2,000

were incurred on purchase. The internal rate of return of the bond is 6.0%.

(2) Entered into a speculative interest rate option costing Rs. 7,000 on 1

September 20X2 to borrow Rs. 5,000,000 from GF Bank commencing 31 March

20X3 for six months at 5.5%. Value of the option at 31 December 20X2 was Rs. 13,750.

(3) Purchased 25,000 shares in EG Co in 20X1 for Rs. 2.00 each as an investment.

Transaction costs on purchase or sale are 1% purchase/sale price. The share

price on 31 December 20X1 was Rs.2.25 – Rs. 2.28. Green Tree sold the shares

on 20 December 20X2 for Rs. 2.62 each.

(4) Sold some shares in BW Co ‘short' (i.e. sold shares that were not yet owned)

on 22 December 20X2 for Rs. 24,000 (the market price of the shares on that

date) to be delivered on 10 January 20X3. The market price of the shares at

31 December 20X2 was Rs. 28,000.

Required: - Show the accounting treatment and relevant extracts from the financial

statements for the year ended 31 December 20X2?

Q-4

An entity lends Rs. 1,000 to entity B for five years and classifies the asset under loans

receivables. The loan carries no interest. Instead, entity expects other future

economic benefits, such as an implicit right to receive goods on preferential terms.

On initial recognition, the market rate of interest for similar five year loan is 10% per

annum.

Required: - Calculate the amortized cost of the loan?

Q-5

On January 01, 20x5, an entity purchases 10% Rs. 10 million 5 year bonds with interest payable on July 01 and January 01 each year. The bond’s purchase price is

Rs. 10,811,100. The premium of Rs. 811,100 is due to market yield for similar bonds

being 8%. Assuming there are no transaction costs, the effective interest rate is 8%. The entity classifies the bond as at fair value through profit or loss account. The

entity prepares its financial statements at March 31. On March 31, 20x5, the yield on

bonds with similar maturity and credit risk is 7.75%. At that date, the fair value of this

bond calculated by discounting 10 semi annual cash flows of Rs. 500,000 and

principal payment of Rs. 10 million at maturity at the market interest rate of 7.75% amounted to Rs. 11,127,710.

Required: - Pass necessary journal entries at initial recognition and at March 31,

20x5?

Q-6

On January 01, 20x1, an entity whose functional currency is PKR purchase a foreign

currency (FC) denominated bond for its fair value of FC 1,000. The bond has 5 years

remaining to maturity and a principal amount of FC 1,250. Interest is payable

annually at 4.7% (that is FC 59) on December 31, each year. Assuming there are no

transaction costs, the effective interest rate is 10%. The entity classifies the bond as

available for sale.

The relevant exchange rates are as follows: -

Average Closing

rate rate

FC=PKR FC=PKR

1-1-x1 PKR 1.50

31-12-x1 PKR 1.75 PKR 2.00

31-12-x2 PKR 2.25 PKR 2.50

31-12-x3 PKR 2.35 PKR 2.20

31-12-x4 PKR 2.05 PKR 1.90 31-12-x5 PKR 2.10 PKR 2.30

IMPARIMENT

Q-1

The company issuing the 4% debentures in example 3 (1) gets into financial trouble

at the end of the first year (31.12.X2 – all interest has been paid up to this date). On

this date the liquidator of the company that issued the bond informs you that no

further interest will be paid and only 75% of the maturity value will be repaid, on the

original repayment date. The market interest rate on similar bonds is 7% on that

date.

Required: - How much is the impairment and how should it be reported in the

financial statements?

Q-2

Broadfield Co purchased 5% debentures in X co. on 1 January 20x3 (The issue date)

for Rs. 100,000. The term of the debentures was 5 years and the maturity value is Rs.

130,000. The effective rate of interest on the debentures is 10% and Broadfield

classified the investment as amortized cost under IFRS 9. At the end of 20x4 X co.

went into liquidation. All interest had been paid until that date. On December 31,

20x4 the liquidator of X co. announced that no further interest would be paid and

only 80% of the maturity value would be repaid, on original repayment date. The

market rate on similar bonds is 8% on that date. Required: -

a) What value should the debentures have been stated at just before the

impairment became apparent?

b) At what value should the debentures be stated at December 31, 20x4, after

the impairment?

c) How will the impairment be reported in the financial statements for the year

ended December 31, 20x4?

Q-3

On January 01, 20x3, an entity purchased Rs. 10 million 5 year bond with semiannual interest of 5% payable on June 30 and December 31 each year. The bond’s

purchase price was Rs. 10,811,100 which resulted in a bond premium of Rs. 811,100

and an effective interest rate of 8% (4% semiannual basis). The entity classified the

bond as Held to maturity.

On December 31, 20x5 when the interest for the half year ended received, the

investee filed for liquidation. The liquidator later confirmed that only 2% pa in arrear

and 25% of the principal amount on maturity.

Required: - calculate impairment loss and pass necessary entries at the day of

impairment and in the term of the instrument?

HEDGING

29 | P a g e

Q-1

Bruntal is a manufacturer and retailer of gold jewellery. On 1 October 20X1, the cost of Bruntal's inventories of finished jewellery was Rs. 8.280 million with a gold content

of 24,000 troy ounces. At that date their sales value was Rs. 9.938 million.

The selling price of gold jewellery is heavily dependent on the current market price

of gold (plus a standard percentage for design and production costs).

Bruntal's management wished to reduce their business risk of fluctuations in future cash inflow from sale of the jewellery by hedging the value of the gold content of

the jewellery. In the past this has proved to be an effective strategy.

Therefore it sold futures contracts for 24,000 troy ounces of gold at Rs. 388 per troy

ounce at 1 October 20X1. The contracts mature on 30 September 20X2.

The jewellery was sold for Rs. 9.186m on 30 September 20X2 when the spot price of

gold per troy ounce was Rs. 352.

Required: - Discuss how the above transaction would be treated in the financial

statements for the year ended 30 September 20X2?

Q-2

Beta company sign a contract on 01 November 20x1 to purchase an asset on 01

November 20x2 for Euro 60,000,000. Beta reports in US $ and hedges this transaction

by entering into a forward contract to buy Euro 60,000,000 on 01 November 20x2 at

US $ 1=Euro 1.5.

Spot and forward exchange rates at the following dates are: -

Spot Forward(for delivery on

1-11-x2)

1-11-x1 US$ 1=Euro 1.5 US$ 1=Euro 1.5

31-12-x1 US$ 1=Euro 1.2 US$ 1=Euro 1.24

1-11-x2 US$ 1=Euro 1.0 US$ 1=Euro 1.10

Required: -

Show the double entries to these transactions at 01 November x1, 31 December x1 and 1 November x2?

CONTINUING INVOLVEMENT

Q-1

Entity A holds a portfolio of trade receivables with a carrying value of Rs. 500 million.

Entity A enters into a factoring arrangement with entity B under which it transfers the portfolio to entity B in exchange for Rs. 490 million of cash. Entity A transfers the

credit risk but retains the late payment risk up to a maximum of 180 days. After 180

days, the receivable is deemed to be in default and credit insurance takes effect.

A charge is levied on the entity A for these late payments using a current rate of 6%.

The fair value of the guarantee of late payment is Rs. 2 million. Apart from late

payment risk, entity A does not retain any credit risk or interest rate risk and does not

carry out servicing of the portfolio. There is no active market for the receivables.

Required: - Pass necessary journal entries if: -

a) If no default in late payment

b) The late payment occurs and Rs. 4 Million charged to entity A

Q-2

Entity A has a portfolio of high yielding corporate bonds with an amortized carrying value of Rs. 102 million. The bonds are not traded in the market place and are not

readily obtainable. On January 01, 20x6, entity A sells the bonds to entity B for a

consideration of Rs. 100 million, but retain a call option to buy the portfolio at Rs. 105

million on December 31, 20x6. On that date the amortized cost of the bonds will be

Rs. 106 million. The fair value of the bonds at the date of transfer amounted to Rs. 104 million.

Required: -

Pass necessary entries?

Q-3

Entity A has 15% equity holding in entity B acquired few years back for Rs. 40 million.

This holding is treated as an OCI Investment and current fair value is Rs. 104 million.

There is no active market in entity B shares. On January 01, 20x6, the entity A sells its

15% investment in entity B to bank C for a consideration of Rs. 100 million, but retains

a call option to purchase the investment for Rs. 105 million on December 31, 20x7.

Required: -

Pass necessary journal entries?

Continuing Involvement Questions

Q-4

On January 01, 20x0, an entity purchases 10% Rs. 10 million 10 year bonds with

interest payable annually on December 31, each year. The bond’s purchase price

is Rs. 10,811,100, which results in a bond premium of Rs. 811,100 and an effective

interest rate of 8.75%. The bonds were classified by the entity as held to maturity.

On December 31, 20x5, when the bonds amortized cost and fair value amounted

to Rs. 10,407,192 and Rs. 10,749,395 respectively, the entity sells Rs. 1 million bonds

and realizes a gain. On January 01, 20x8 after the end of tainting period, the entity reclassifies the Rs. 9

million bonds as held to maturity. On that date, the fair value of bond was Rs.

9,488,165. The bonds new effective interest rate is 7%. Required: - Provide extract to the financial statements for the years 20x5 to 20x9?

Q-5

On January 01, 20x6 bank A enters into an agreement to sell a portfolio of held for

trading listed debt securities to an investment fund in exchange for a cash payment

of Rs. 6 million. The securities are subject to a call option that allows the bank to repurchase the securities for a price of Rs. 6.7 million on December 31, 20x6. The

securities fair value at the date of transfer is Rs. 6.5 million. The options fair value is Rs.

0.5 million. The investment fund has the practical ability to sell to a third party.

Assume that at December 31, 20x6, the fair value of the shares increases to Rs. 7

million and the bank exercises the option.

Required: - Provide accounting treatment on December 31, 20x5 and 20x6?

Q-5

Entity A has high yielding portfolio of corporate bonds with an amortized cost of Rs.

102 million. The bonds are not readily obtainable. On January 01, 20x6, entity A sells

the bonds to entity B for a consideration of Rs. 100 million, but retains a call option

to purchase the portfolio for Rs. 105 million on December 31, 20x6. On that date, the

31 | P a g e

amortized cost of the bonds will be Rs. 106 million. The fair value of the bonds at the

date of transfer amounted to Rs. 104 million. Required: - discuss the accounting treatment of the above situation?

DERECOGNITION

Q-1

The directors of QN Limited owes Rs. 90,000 to MN Bank on 5% interest bearing non

amortizing note payable in five years, plus accrued and unpaid interest , due immediately, of Rs. 4,500. MN Bank agrees to a restructuring to assist QN, which is

suffering losses and is threatening to declare bankruptcy. The interest rate is

reduced to 4%, the principal is reduced to Rs. 72,500 and the accrued interest is

forgiven outright. Future payments will be normal term. However, given the QN

current condition, the market rate of interest would have been 12%.

Required: - Discuss the implications of above restructuring and pass necessary

journal entries?

Q-2

The directors of QN Limited owes Rs. 90,000 to MN Bank on 5% interest bearing non

amortizing note payable in five years, plus accrued and unpaid interest , due

immediately, of Rs. 4,500. MN Bank agrees to a restructuring to assist QN, which is

suffering losses and is threatening to declare bankruptcy. The interest rate is

reduced to 4.5%, the principal is reduced to Rs. 85,000. The loan term has been

shortened to 3 years from 5 years in order to reduce the risk. QN Limited agreed to

the new terms.

Required: - Discuss the implications of above restructuring and pass necessary

journal entries?

Q-3

Hungry company on July 01, 2008 enters into an agreement with Rich Company to

sell a group of its receivables without recourse. A total face value of Rs. 200,000 accounts receivables against which a 5% provision for doubt full debts has been

created is involved. The factor will charge 20% interest computed on weighted

average to maturity of the receivables of 36 days plus a fee of 3%. A 5% holdback will be retained.

Hungry customers return goods for the value of Rs. 4,800.

Required: - Discuss the implications of above restructuring and pass necessary

journal entries?

Q-4

An entity has investment in mortgaged loans having amortized cost of Rs.14.5

million is being sold to, but the right to service the loan retained. Servicing right

requires monthly collections of principal and interest and forwarding these to the

holders of investments.

a) The present value of future servicing is Rs. 1.2 while the investment without

servicing can be sold for Rs. 13.6 million.

b) The present value of future servicing is Rs. 1.2 and the selling price of

investment without servicing is Rs. 13.1 million

c) The present value of future servicing is Rs. (1.1) and the selling price of

investment without servicing is Rs. 14.6 million.

Required: - Discuss the implications of above restructuring and pass necessary

journal entries?

RECLASSIFICATION

Q-1

On 01 January 20x9, an entity reclassifies a Rs. 9 million bond from HFT to at

Amortized Cost. On the date of the reclassification, the bond’s amortized cost is Rs. 9,198,571 and the original effective interest rate is 8.75%. The bond’s fair value is Rs.

9,488,165. The coupon rate on bond is 10% pa. The new effective rate at the date

of reclassification is 7% pa. The bond’s remaining term is two years.

Required: - provide accounting for reclassification date and pass necessary

accounting entries for the next two years?

33 | P a g e

PAST PAPERS ON IFRS 9 AND IAS 39 Q. 1

a) F Limited has branches in many countries. Whilst preparing the annual

accounts for the year ended June 30, 2002 the accountant of the company

observed the following:

I UK branch has an inventory as on June 30, 2002 valued at Pound Sterling

1,000,000. The exchange rate of one pound sterling on the date of purchase of inventory was Rs. 90 and on June 30, 2002 was Rs. 80. The net realizable

value of inventory as on June 30, 2002 was pound sterling 1,100,000.

II. US branch has an inventory as on June 30, 2002 valued at US $ 1,000,000. The exchange rate of one US dollar on the date of purchase of inventory was Rs.

60 and on June 30, 2002 was Rs.65. The net realizable value of inventory as on

June 30, 2002 was US $ 950,000. The branch has recorded the inventory at net

realizable value in its financial statements.

You are required to explain how the above positions shall be reflected in the financial statements of the branch and the financial statements of F Limited.

(06)

b) Financial statements of LBS Limited showing following financial instruments:

I Investment in Term Finance Certificates quoted on stock exchanges carrying

markup @ 17% per annum payable semiannually.

II Long terms loans obtained from a financial institution carrying markup @ 2%

above the State Bank of Pakistan’s discount rate.

III Foreign currency long-term loans provided by the company to one of its

associated concern carrying interest @ 2% above London Inter Bank Market

Rate. (LIBOR)

You are required to classify the above financial instrument into following financial

risks as required under IAS 32 (Financial Instrument: Disclosure and Presentation)

1. Exposed to interest rate price risk

2. Exposed to interest rate cash flow risk

3. Exposed to currency risk (06)

Q.2

Foreign investment Ltd., has “Investment Held for Trading” in 1,000 shares of Y Ltd.

which was purchased at Rs.20. The fair value of shares on Jan 01, 2002 was Rs.30

and on Dec 31, 2002 was Rs.35. The shares were indicated at cost in the accounts

for the year ending Dec 31, 2001. The shares were sold at Rs.32 on March 27, 2003. Show th1e working in the books for the year ending Dec 31, 2002 and on disposal in

accordance with IAS 39. Explain the term “Held for Trading” and describe the

disclosure in the financial statements for the year ending Dec 31, 2002. (10) Q.3

(a) With reference to the International Accounting Standard 39 ‘Financial

Instruments Recognition and Measurement’, please explain:

(i) What are financial assets? Give three examples. (06)

(ii)How should a financial asset be recognized initially? (03)

(iii) What are the classifications of financial assets for subsequent

measurement? (03)

(iv) How should each of these financial assets be subsequently measured?

(03)

(b) What is the status of application of IAS-39 in Pakistan? (03)

Q.4

Explain the concept of ‘Embedded Derivative’ as discussed in International

Accounting Standards 39 (Financial Instrument: Recognition and Measurement). (06)

Q.5

Gilgit Company Limited holds 800,000 shares of a listed company namely Hunza

Foods Limited, which were purchased for Rs 84,400,000 as a long-term investment.

On January 15, 2007, Hunza Foods Limited announced the issuance of one right

share for every 5 shares held by the shareholders of the company. Face value of

the shares is Rs 100 per share. On the date of book closure, market value of the

share (cum right) was Rs 106 per share. The initial quoted price of the right was Rs 4

per right.

Required:

Suggest the necessary journal entries in the books of Gilgit Company Limited in case

of each of the following options:

Option # 1 If the rights are not exercised but are sold at Rs 6 per right.

Option # 2 If the rights are not exercised and are allowed to expire.

Option # 3 If the following transaction take place:

− 200,000 shares are sold at cum right price for Rs 23,000,000;

- The right to purchase 120,000 additional shares at Rs 100 per

share is exercised. Immediately after the book closure, the

shares were quoted at Rs 103 per share (ex-right); and

− 100,000 shares originally held are sold at Rs 107 per share, after the exercise of the rights. (16)

Q.6

Red Limited has carried out the following transactions during the year ended June 30, 2008.

(a) On July 1, 2007, the company has received a loan of Rs. 100 million from

Green Limited – a related party which is due for repayment after three years

and does not carry any interest. The market interest rate for similar loans is

15% per annum. Red Limited is subject to taxation at the rate of 35%. (b) On August 1, 2007, the company granted 200,000 employees’ stock options

at Rs. 5, when the market price was Rs. 13 per share. 95% of the options were

exercised between March 1, 2008 and April 30, 2008. The remaining options

lapsed. The share capital of the company is divided into shares of Rs. 10

each.

(c) The company holds 500,000 shares of Green Limited (GL), a listed company,

which were purchased many years ago at Rs. 10 per share. The transaction

cost on purchase was Rs. 120,000. The shares were classified as available for

sale. On May 31, 2008, the fair value of GL’s shares was Rs. 20 per share. On

the same day, GL was acquired by Orange Limited (OL), a listed company.

As a result, Red Limited received 200,000 shares of OL which had a market

value of Rs. 65 per share, on that date.

35 | P a g e

Required:

Prepare journal entries to record the above transactions including the effect of deferred tax thereon, if any, in the books of Red Limited, for the year ended June

30, 2008. (21)

Q.7

During the year ended December 31, 2008, a Pakistani Sugar Company (PSC) was

facing severe problems in meeting its foreign currency obligations especially in view of the steep increase in the foreign exchange rates. In October 2008, PSC

commenced negotiations with the foreign lenders for restructuring of loans.

Following is a summary of the foreign exchange liabilities of the company as of

December 31, 2008 prior to making adjustments on restructuring:

Lenders

SBD JICA AFI

Loan amount (US$) 350,000 500,000 270,000

Remaining number of installments

including

due on December 31, 2008

5 4 3

Interest / markup rate 2.50% 3.00% 2.00%

The loans are repayable in equal annual installments. All the above liabilities are

appearing in PSC’s books at the exchange rate of US$ 1 = Rs. 65 which was the rate

at the beginning of the year. The exchange rate as at the end of the year is US$ 1 =

Rs. 80.

Agreements with SBD and AFI were finalized and signed before year-end, however,

the agreement with JICA was finalized in January 2009 but before finalization of the

financial statements. Following is the information in respect of rescheduling

agreements. Lenders

SBD JICA AFI

Revised value of loan amount (US$) 370,000 525,000 280,000 Revised present value as per original effective

interest rate (US$)

390,000 535,000 250,000

Revised present value as per market interest

rate for similar instruments (fair value) (US$)

400,000 510,000 220,000

First installment due on 31-Dec-10 31-Dec-11 31-Dec-12 Required:

(a) Prepare accounting entries in the books of PSC to record the

(i) effect of exchange differences.

(ii) effect of rescheduling, if any.

(b) In respect of each of the above loans, identify the amounts to be reported as

current portion of the loan in the financial statements, as at December 31,

2008.

(11)

Q.8

Arif Industries Limited (AIL) owns and operates a textile mill with spinning and

weaving units. Due to recurring losses, AIL disposed of the weaving unit for an amount of Rs. 100 million on July 1, 2007 and invested the proceeds in Pakistan

Investment Bonds (PIBs). Details of investment in PIBs are as follows:

(i) The PIBs were purchased through a commercial bank at face value. The

bank initially charged premium and investment handling charges of Rs.

4,641,483. At the time of purchase, AIL had envisaged to liquidate the investment after four years and utilize the realized amount for expansion of its

spinning business. The bank had agreed to repurchase the PIBs on June 30,

2011, at their face value.

(ii) The markup on PIBs is 15% for the initial two years and 20% for the remaining

three years. The effective yield on investment at the time of purchase was

15.50%.

However, due to economic turmoil in the European and American markets, the

existing spinning unit is working below its rated capacity. Therefore, on June 30, 2009

AIL decided to defer the expansion plan by one year. The bank agreed to extend

the holding period accordingly but reduced the repurchase price by 2%.

Required:

Compute the amount of interest income (including the effect of revision of holding

period, if any) to be recognized in the financial years ended(ing) 2009, 2010, 2011

and 2012. (15)

Q.9

Global Investment Limited (GIL) is listed in Pakistan. During the year ended 30

September 2011, GIL entered into the following contracts with a UAE based

company:

(i) On 28 September 2011 GIL committed to buy certain financial assets on 3 October 2011 for AED 20,000. The fair value of these assets on balance sheet

date and settlement date was AED 21,000 and AED 21,500 respectively.

(ii) On 29 September 2011 GIL agreed to sell certain financial assets on 4 October 2011 having a carrying value of AED 34,000 (Rs. 809,200) for AED

35,000. The fair value of these assets on the balance sheet date and

settlement date was AED 35,200 and AED 34,800 respectively.

The above types of financial assets are classified by GIL as held for trading.

Exchange rates on the relevant dates were as under: Date 1 AED = Rs.

28 September 2011 24.00

29 September 2011 23.00

30 September 2011 23.50

03 October 2011 25.00

04 October 2011 26.00

Required:

Prepare accounting entries to record the above transactions on the relevant dates

in accordance with International Financial Reporting Standards, using:

(a) Trade date accounting

(b) Settlement date accounting (16)

37 | P a g e

Q.10

Zee Power Limited (ZPL) has been facing short term liquidity issues during the financial year ended on 31 December 2011. As a result, the following transactions

were undertaken:

(i) On 27 December 2011, ZPL sold its investment in listed Term Finance Certificates

(TFCs) to Vee Investment Company Limited with an agreement to buy them

back in 10 days. Relevant details are as follows:

Rupees

Sale price 10,150,000

Buy back price 10,183,337

Value in ZPL’s books as on 27 December 2011 10,144,332

Market price as on 31 December 2011 10,163,125

ZPL intends to hold these TFCs till maturity.

(ii) On 1 January 2009, ZPL had obtained a bank loan of Rs. 100 million at 10% per

annum. The interest was payable annually on 31 December and principal

amount was repayable in five equal annual installments commencing from

31 December 2009. On 1 January 2011, the bank agreed to facilitate ZPL as follows:

¤ Balance amount of the principal would be paid at the end of the loan’s

term i.e. on 31 December 2013. ¤ With effect from 1 January 2011, interest would be paid at the rate of 10.5%

per annum.

The market rate for similar debt is 10%.

(iii)On 1 July 2011, ZPL sold its plant and machinery to Kay Leasing Limited, a related

party, for Rs. 90 million and leased it back for five years at semi-annual rentals

amounting to Rs. 9.66 million, payable in arrears on June 30 and December

31. The carrying amount of plant and machinery on the date of sale was Rs.

80 million and its fair value was Rs. 60 million.

The lease qualifies as an operating lease and the rentals are based on fair

market rate.

Required:

Prepare journal entries to record the above transactions in the books of Zee Power

Limited. (18)

Q.11

The following information pertains to Crow Textile Mills Limited (CTML) for the year

ended 30 June 2012:

(a) Stocks include 4,000 maunds of cotton which was purchased on 1 April 2012 at a cost of Rs. 6,200 per maund. In order to protect against the impact of

adverse fluctuations in the price of cotton, on the price of its products, CTML

entered into a six months futures contract on the same day to deliver 4,000

maunds of cotton at a price of Rs. 6,300 per maund.

At year end i.e. 30 June 2012, the market price of cotton (spot) was Rs. 5,500

per maund and the futures price for September delivery was Rs. 5,550 per

maund. All necessary conditions for hedge accounting have been complied

with. (05) (b) On 1 July 2011, 2 million convertible debentures of Rs. 100 each were issued.

Each debenture is convertible into 25 ordinary shares of Rs. 10 each on 30

June 2014. Interest is payable annually in arrears @ 8% per annum. On the

date of issue, market interest rate for similar debt without conversion option was 11% per annum. However, on account of expenditure of Rs. 4 million,

incurred on issuance of shares, the effective interest rate increased to 11.81%.

(08)

Required:

Prepare Journal entries for the year ended 30 June 2012 to record the above transactions. (Show all necessary calculations)

Q-12 On 1 January 2009 Qasmi Investment Limited (QIL) purchased 1 million 12% Term Finance

Certificates (TFCs) issued by Taj Super Stores (TSS), which operates a chain of five Super

Stores. The terms of the issue are as under:

• The TFCs have a face value of Rs. 100 each and were issued at a discount of 5%. These are redeemable at a premium of 20% after five years.

• Interest on the TFCs is payable annually in arrears on 31 December each year.

Effective interest rate calculated on the above basis is 16.426% per annum. Due to a property dispute, TSS had to temporarily discontinue operations of two stores in

2010. Consequently, TSS was unable to pay interest due on 31 December 2010 and 31

December 2011. At the time of finalization of accounts for the year ended 31 December 2010, QIL was quite

hopeful of recovery of the interest and therefore, no impairment was recorded. However, in 2011, after a thorough review of the whole situation, QIL’s management concluded that

it would be able to recover the face value of the TFCs along with the premium on the due date i.e. 31 December 2013, but the interest for the years 2010 to 2013 would not be received. Accordingly, QIL recorded impairment in the value of the TFCs on 31 December

2011.

In 2012, TSS reached an out of court settlement of the property dispute and the stores became operational. Subsequently, QIL and TSS agreed upon a revised payment schedule

according to which the present value of the agreed future cash flows on 31 December 2012 is estimated at Rs. 115 million.

Required:

Prepare journal entries in the books of QIL for the years ended 31 December 2011 and 2012. Show all the relevant computations. (14)

Q-13 Omega Limited (OL) is incorporated and listed in Pakistan. On 1 May 2012, it acquired 20,000 ordinary shares (2% shareholding) in Al-Wadi Limited (AWL), a Dubai based company at a cost of AED 240,000 which was equivalent to Rs. 6,000,000. The face value of the shares is AED 10 each. OL intends to hold the shares to avail benefits of regular dividends and capital gains. On 1 June 2013, AWL was acquired by Hilal Limited (HL), which issued three shares in HL in exchange for every four shares held in AWL. Other relevant information is as under: -

AWL HL

Final dividend received on March 31, 2013:

-

Cash 15%

Bonus shares 10%

Final cash dividend received on 10 April

2014

20%

39 | P a g e

Fair value per share as at: - 31 December

2012

AED

13.00

01 June 2013 AED 14.00

AED 18.00

31 December 2013 AED

19.50

Exchange rates on various dates were as

follows: -

31-Dec

12

31 Mar

13

01 Jun

13

31 Dec

13

10 Apr

14

1

AED

25.00 26.50 28.00 28.70 28.20

Required: -

Determine the amounts (duly classified under appropriate heads) that would be

included in OL’s statement of comprehensive income for the year ended 31

December 2013 in respect of the above investment. (08)

Q-14

The financial statements of Bravo Limited (BL) for the year ended 30 September

2013 are under finalization and the following matters are under consideration:

On 1 October 2011, BL acquired 160,000 12% debentures of Rs. 100 each, for Rs.

15.5 million and classified them as ' held to maturity'.

On 30 September 2013, in view of financing requirements for a new project, BL is

uncertain about holding the debentures till redemption. Therefore, it has decided

to reclassify the debentures as 'available for sale'.

Other relevant information is as follows:

• The debentures carry a fixed interest rate of 12%, payable annually in arrears.

• The effective rate of interest is 14.09%.

• The debentures are redeemable at Rs. 105 on 30 September 2015.

• The market value per debenture as of 30 September 2012 and 2013 was Rs. 102

and Rs. 104 respectively. (06)

For each of the above matters, compute the related amounts as they would

appear in the statements of financial position and comprehensive income of Bravo

Limited for the year ended 30 September 2013 in accordance with IFRS. (Ignore

corresponding figures).

Q-15

Dynamic Steel Limited (DSL) signed an agreement on 1 June 2013 for import of

equipment for SK 50 million. According to the agreement, the plant was delivered on 1 November 2013 and invoice thereof was paid on 1 December 2013.

In order to hedge the commitment to pay SK 50 million, on 1 June 2013, DSL entered

into a forward contract to buy the required SK on 1 December 2013 at a fixed

exchange rate of SK 1=Rupees 15. Exchange rates on various dates are as follows:

1-Jun-

2013

30-

Sep-

2013

1-Nov-

2013

1-Dec-

2013

SK 1

Spot rate

Rs.

14.50 12.00 11.15 10.00

Forward

rate Rs.

15.00 12.39 11.35 -

It is DSL's policy to adjust any gain or loss arising on forward contracts to the carrying

value of the imported goods. DSL’s accounting year end is 30 September.

Required:

Prepare accounting entries relating to the above transactions, on each of the

above dates, in accordance with the requirement of IFRS. (16)

Q-16

The financial statements of Integrity Steel Limited (ISL) for the year ended 31 March

2015 are in the final stage of their preparation and the following matters are under

consideration:

On 1 April 2014, ISL entered into a contract with Invest Bank. Under the contract, ISL

deposited an amount of USD 5 million, at an interest of 2.5% per annum with a

maturity date of 31 March 2017. Interest will be received on maturity along with the

principal. Further, an additional 2% interest per annum would be payable by Invest

Bank in the event the value of USD increases by 5% or more. The contract is in line

with ISL’s policy of making low risk investments in foreign as well as local currencies.

Required:

Explain how the above investment should be measured in ISL’s books of account at

31 March 2015? (05)

41 | P a g e

Answers to examples E-1

Date Interest cost Payment Balance Principal 0 1,000

1 100 59 41 1,041

2 104 59 45 1,086

3 109 59 50 1,136

4 114 59 55 1,191

5 118 59 59 1,250

E-2 Date Interest cost Payment Balance Principal

01-01-x4 4,670

31-01-x4 357 300 57 4,727

31-01-x5 362 300 62 4,789

31-01-x6 366 300 66 4,855

31-01-x7 371 300 71 4,926

31-01-x8 374 300 74 5,000

E-3

Debit Credit Rs. Rs. Held for trading asset 6,000

Profit or loss 400

Bank 6,400

E-4 Debit Credit Rs. Rs. At fair value through OCI 6,000

Bank 6,000

E-5 Held for Trading Debit Credit At FV through OCI Debit Credit Purchase date (500x5) Rs. Rs. Rs. Rs. Held for trading asset 2,500 At FV through OCI 2,500

Bank 2,500 Bank 2,500

Reporting date (3,000-2,500)

Held for trading asset 500 At FV through OCI 500

Profit or loss 500 OCI 500

Disposal date

Bank 3,400 Bank 3,400

Held for trading asset 3,000 At FV through OCI 3,000

Profit or loss 400 Profit or loss 400

Fair value gain (column) 500

Retained earnings 500

E-6

Debit Credit 1-7-x6 Rs. Rs. Derivative asset 5,000

Bank 5,000

31-10-x6

Derivative asset 2,500

Profit or loss 2,500

E-7 [Fair value Hedge) Debit Credit RS. Rs. At fair value through PL 1,000,000

Bank 1,000,000

Swap asset identified at nil value

Swap asset 39,000

Profit or loss 39,000

Profit or loss 40,000

At fair value through PL 40,000

Bank 60,000

Interest income 60,000

Bank 10,000

Interest income 10,000

E-8 (Cash Flow Hedges) 01-05-x6 31-10-x6

Fair value of hedged item 650,000 660,000

Notional gain/(loss) on Hedged item (10,000)

Fair value of hedging instrument -- 10,000

Fair value gain/(loss) on hedging

instrument

10,000

Effectiveness 10,000/10,000x100 100%

Froward exchange contract asset 10,000

Other Comprehensive income 10,000

Classifying the following instruments a) This investment is classified as at fair value through profit or loss

b) This investment is classified as at fair value through other comprehensive income

c) This investment is classified as at amortized cost

d) This loan is classified as at amortized cost

e) This debtor will be classified as at amortized cost

43 | P a g e

f) This is a liability to be classified as at fair through profit or loss

De-recognition of financial assets/liabilities a) The trade receivables will not be de-recognized as only the right over cash flows has been

transferred but the risks before transfer and after transfer has not been changed.

b) The securities have an active market and the re-purchase price is also at market value therefore the

securities will be de-recognized.

c) The shares have been sold at market value and will be bought back at market value therefore, the

shares will be de-recognized as the risks and rewards stand transferred.

d) The shares have been sold but will be bought back at fixed price and shares have no active market

as well therefore, the risks and rewards have not been transferred to bank. The shares will not

be de-recognized and receipts will be treated as loan from bank.

A-5 01-12-2003 30-11-2004

Rs. (000) Rs. (000)

Hedged item

Cost of inventory 4,000

Sale value 5,060 4,560

Loss on hedged item (500)

Hedging instrument

Fair value of future contract -- 600

[200,000x24-200,000x21]

Future Exchange asset 600

Other comprehensive income 600

Effectiveness [600/500]x100 120%

As the inventory has been sold on 31-11-2004, therefore,

whole of fair value gain on hedging instrument is charged

to profit or loss account.

Other comprehensive income 600

Profit or loss account 600

Bank 4,560

Sales 4,560

Cost of sales 4,000

Inventory 4,000

PRACTICE QUESTIONS ON IAS 39 CLASSIFICATION A-1 a) The call option will be treated as derivative and may be favorable or un-favorable depending

on the market price in the future.

b) The swap will also be a derivative and may be financial asset or financial liability depending

upon the favorableness or un-favorableness.

c) The stocks will be derecognized and receivable will be recognized at fair value and any fair

value gain / (loss) will be charged to profit or loss account.

d) The debtors will remain the financial statement of seller and the amount received will be

recognized as loan. The interest on loan will be recognized over the period at effective tax

rate. The debtors will continue to be recognized as the risks attached with the debtors before

transfer and after transfer rest with the seller.

A-2 a) AT AMORTIZED COST

Date Interest income

Receipt Balance Principal

Rs. (000) Rs. (000) Rs. (000)

Rs. (000)

01-01-

20x1

20,000

31-12-

20x1

1,200 1,200 -- 20,000

31-12-

20x2

1,200 1,200 -- 20,000

b) AT FAIR VALUE THROUGH PROFIT OR LOSS

Date Interest income

Receipt Balance Principal Fair value gain/(loss)

Fair value

Rs. (000) Rs. (000) Rs. (000)

Rs. (000) Rs. (000) Rs. (000)

01-01-

20x1

20,000 -- 20,000

31-12-

20x1

1,200 1,200 -- 20,000 (189) 19,811

31-12-

20x2

1,389 1,200 189 20,000 -- 20,000

PV=FV= [(Annuity factor x periodic cash flow) + (discount factor x redemption value)]

PV=FV= [1,121+18,690]=19,811

At 7%

Annuity factor = 0.9345

Discount factor=0.9345

c) Under IFRS 9 the investment in debt securities cannot be classified as at fair value through

other comprehensive income.

A-3 1) Investment in debentures

Date Interest income

Receipt Balance Principal

Rs. (000) Rs. (000) Rs. (000)

Rs. (000)

01-01-

20x2

102,000

31-12-

20x2

6,120 4,000 2,120 104,120

31-12-

20x3

6,247 4,000 2,247 106,367

31-12-

20x4

6,382 4,000 2,382 108,749

45 | P a g e

31-12-

20x5

6,525 4,000 2,525 111,274

31-12-

20x6

6,676 4,000 2,676 113,950

31-12-

20x7

6,837 4,000 2,837 116,787

2) Interest rate option

Debit Credit 01-Sep-20x2 Rs. Rs. Interest rate option asset 7,000

Bank 7,000

31-Dec-20x2

Interest rate option asset 6,750

Profit or loss 6,750

3) Held for trading investment

Debit Credit 20x1 Rs. Rs. HFT investment (25,000x2) 50,000

Profit or loss 500

Bank 50,500

31-Dec-20x1

HFT investment 6,250

Bank 6,250

[25,000x2.25]-50,000

Bank 65,500

HFT investment 56,250

Profit or loss 9,250

[25,000x2.62]-56,250

4) Short selling

Debit Credit 22-12-20x2 Rs. Rs. Bank 24,000

HFT liability 24,000

10-Jan-20x3

Profit or loss 4,000

HFT liability 4,000

A-4 Debit Credit 0 year Rs. Rs. Loan receivable 621

Profit or loss 379

Bank 1,000

End of year one and so on

Loan receivable 62

Profit or loss 62

Amortization schedule Date Interest

income Receipt Balance Principal

Rs. (000) Rs. (000) Rs. (000)

Rs. (000)

0 621

1 62 -- 62 683

2 68 -- 68 751

3 75 -- 75 826

4 83 -- 83 909

5 91 -- 91 1,000

FV=PV= [Annuity factor x periodic cash flow] + [discount factor x redemption value]

FV=PV= 0 + 0.620 x 1,000 = 621

A-5 Debit Credit Rs. RS. January 01, 20x5

HFT investment 10,811,100

Bank 10,811,100

March 31, 20x5

HFT investment 816,610

Profit or loss account 816,610

A-6 Classification as at amortized cost

Date Interest income

Receipt Balance Principal

FC FC FC FC 0 1,000

1 100 59 41 1,041

2 104 59 45 1,086

3 109 59 50 1,136

4 113 59 54 1,190

5 119 59 60 1,250

Interest income in PKR/principal amount in PKR

Date Interest income

Principal

FC PKR 0 1,000x1.50=1,500

1 100x1.75=175 1,041x2=2,082

2 104x2.25=208 1,086x2.5=2,715

3 109x2.35=256 1,136x2.2=2,500

4 113x2.05=232 1,190x1.90=2,261

5 119x2.10=250 1,250x2.30=2,875

47 | P a g e

IMPAIRMENT A-1 Carrying value of loan = 104,120

Present value of loan at original effective interest rate = [Annuity factor x periodic cash flows +

Discount factor x redemption value]

Present value = 0 + 0.456 x 87,750

= 40,024

Impairment loss = 64,096

The impairment loss will be charged to profit or loss account.

A-2 a) The carrying value at impairment test date =110,500

b) The carrying value of asset just after the impairment date =78,135

c) Impairment loss to be reported in profit or loss account = 32,365

W- 1 Amortization schedule Date Interest income Receipt Balance Principal

Rs. Rs. Rs. Rs. 01-01-x3 100,000

31-12-x3 10,000 5,000 5,000 105,000

31-12-x4 10,500 5,000 5,500 110,500

W-2 Present value of revised cash flows at original effective rate [(Annuity factor x periodic cash flow) + (Discount factor x redemption value)]

[0 + 0.7513 x 104,000] = 78,135

A-3 Impairment loss = 10,363,003-2,860,960 = 7,502,043

W-1 Amortization schedule

Date Interest income Receipt Balance Principal Rs. Rs. Rs. Rs.

01-01-x3 10,811,100

30-06-x3 432,444 500,000 (67,556) 10,743,544

31-12-x3 429,742 500,000 (70,258) 10,673,286

30-06-x4 426,931 500,000 (73,069) 10,600,217

31-12-x4 424,009 500,000 (75,991) 10,524,226

30-06-x5 420,969 500,000 (79,031) 10,445,195

31-12-x5 417,808 500,000 (82,192) 10,363,003

W-2 Present value of revised cash flows at original effective rate

[(Annuity factor x periodic cash flow) + (Discount factor x redemption value)]

3.6298 x 200,000 + 0.854 x 2,500,000

725,960+2,135,000

2,860,960

HEDGING A-1 Bruntal Company 01-10-x1 30-09-x2

Rs. (000) Rs. (000)

Hedged item

Cost of inventory 8,280

Sale value 9,938 9,186

Loss on hedged item (9,938-9,186) (752)

Hedging instrument

Fair value of future contract -- 864,000

[24,000x388-24,000x352]

Future Exchange asset 864,000

Other comprehensive income 864,000

Effectiveness [864,000/752,000]x100 114%

As the inventory has been sold on 31-11-2004, therefore,

whole of fair value gain on hedging instrument is charged

to profit or loss account.

Other comprehensive income 864,000

Profit or loss account 864,000

Bank 9,186

Sales 9,186

Cost of sales 8,280

Inventory 8,280

A-2 Beta Company 01-11-x1 31-12-x1 1-11-x2 $ (000) $ (000) $ (000) Hedged item [60,000x1.5], [60,000x1.2] 90,000 72,000 60,000

Notional gain on hedged item to date -- 18,000 30,000

Hedging instrument

Fair value of future contract

[60,000x1.5],[60,000x1.24]

90,000 74,400 66,000

[60,000x1.10]

Cumulative loss on hedging instrument -- (15,600) (24,000)

Effectiveness [18,000/15,600], [30,000/24,000] -- 115% 125%

Other comprehensive income 15,600 8,400

Future exchange liability 15,600 8,400

The amount to be retained in SOCE will be lower of

cumulative notional gain on hedged item or cumulative

loss on hedging instrument, as the lower is loss on

hedging instrument, therefore it will be retained in

SOCE.

49 | P a g e

There are two options available one is to offset with the

cost of asset or amortize it over the useful life and

pattern of depreciation over the years.

Fixed asset 60,000

Bank 60,000

Future exchange liability 24,000

Bank 24,000

Fixed asset 24,000

Fair value loss in SOCE 24,000

If loss adjusted with cost of asset it will look like this.

DERECOGNITION A-1 Rs. Rs. Carrying value of liability 90,000+4,500 94,500 Present value of future cash flows at original effective

rate

[Annuity factor x periodic cash flows + discount factor

x redemption value]

[4.329 x 2,900+0.7835x72,500]=(12,554+56,804) 69,358

Change 25,142

%age change 25,142/94,500x100 27%

The fair value of new liability@ 12%

[3.604x2,900+72,500x0.5674] 10,453+41,136 51,590

Old liability 94,500

Profit or loss account 42,910

New liability at fair value 51,590

A-2

Rs. Rs. Carrying value of liability 90,000+4,500 94,500 Present value of future cash flows at original effective

rate

[Annuity factor x periodic cash flows + discount factor

x redemption value]

4,500+[2.723 x 3,825+0.8638x85,000]=88,338 88,338

Change 6,162

%age change 6,162/94,500x100 6.52%

Old liability 6,162

Deferred gain 6,162