Financial Instruments (Basic)

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Ezra Armstrong
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Financial Instruments (Basic) Suggested Solutions Initial

Purchase order to purchase goods when placing an order

USD in 90 days A contract to sell a building for RM5 million on

that it will continue to be accurate in the future.

1 Financial Instruments (Basic) Suggested Solutions Initial recognition Test your knowledge Which one should be recognised? Purchase order to purchase goods when placing an order Unconditional trade or loan receivables Forward contract to buy USD in 90 days A contract to sell a building for RM5 million on 31/12/16 Forward sale contract of a commodity 13 is received or that it will continue to be accurate in the future. one should act upon such information without appropriate professional advice entity.

2 Which are basic financial instruments? Test your knowledge basic debt instruments Trade receivable Basic financial instrument? Loan to subsidiary Investment in structured debt offered by a local bank 18 Which are basic financial instruments? Test your knowledge (cont d) Trade receivable Loan to subsidiary Investment in structured debt offered by a local bank Investment in unquoted ordinary shares Investment in quoted ordinary shares Investment in convertible preference shares Investment in puttable preference shares Derivative contracts Financial guarantee contract given to subsidiary Basic financial instrument? 20 is received or that it will continue to be accurate in the future. one should act upon such information without appropriate professional advice entity.

3 Which are basic financial instruments? Test your knowledge (cont d) initial measurement Basic financial instrument? Initial measurement Trade receivable Loan to subsidiary Investment in structured debt offered by a local bank Investment in unquoted ordinary shares Investment in quoted ordinary shares Investment in convertible preference shares Investment in puttable preference shares Derivative contracts Financial guarantee contract given to subsidiary Transaction price Transaction price (present value) Transaction price Transaction price (excl. transaction s) 21 Debt instruments initial and subsequent measurements Test your knowledge? Initial measurement? Subsequent measurement? Goods sold to customer on 30-day credit term financing Undiscounted transaction price Goods sold to customer on 2-year interest-free credit PV of cash flows Interest-free loan to subsidiary, repayable in 5 years PV of cash flows Loan to subsidiary subject to interest at 3.5% p.a., repayable in 5 years. Market interest rate for similar loans = 7% p.a. PV of cash flows Convertible bond t a basic debt instrument 24 is received or that it will continue to be accurate in the future. one should act upon such information without appropriate professional advice entity.

4 Initial measurement Example: Interest-free loan to a subsidiary Interest-free loan of RM50,000 to a subsidiary for 3 years. Market rate of interest for similar loans is 5% p.a. Present value of the loan receivable RM50,000 (1.05) 3 = RM43,192 Debit Credit Loan to subsidiary 43,192 Investment in subsidiary 6,808 Cash 50, Initial measurement Example: Interest-free loan to a staff Interest-free loan of RM10,000 to a staff for 2 years. Market rate of interest for similar loans is 7% p.a. Present value of the loan receivable RM10,000 (1.07) 2 = RM8,734 Debit Credit Staff loan 8,734 Employee benefits expense 1,266 Cash 10, is received or that it will continue to be accurate in the future. one should act upon such information without appropriate professional advice entity.

5 Transition to MPERS Parent Provides RM5 million loan to a subsidiary on 1 Jan Interest free, repayable at the end of 5 years. Market rate of similar loan is 7% p.a. Subsidiary 1 Jan Dec 2014 / 1 Jan Dec 2015 PERS carrying amount RM5 million RM5 million RM5 million MPERS carrying amount RM3,564,931 RM3,814,476 RM4,081,489 Transition to MPERS Retrospective adjustment 33 Equity investments initial and subsequent measurements Case A: Test your knowledge Company A subscribes to the rights issue of a quoted share. Subscription price = RM1 per rights share. Is this a basic equity investment? How does Company A measure the investment on initial recognition? Transaction price (excl. transaction s) How does Company A subsequently measure the investment? 35 is received or that it will continue to be accurate in the future. one should act upon such information without appropriate professional advice entity.

6 Equity investments initial and subsequent measurements Case B: Test your knowledge Company B subscribes to the rights issue of a quoted share with free detachable warrant. Subscription price = RM1 per rights share. Is this a basic equity investment? Two separate instruments How does Company B measure the investments on initial recognition? Share is a basic equity investment; transaction price (excl. transaction s) Warrant is not a basic equity investment; fair value How does Company B subsequently measure the investments? 36 Equity investments initial and subsequent measurements Case C: Test your knowledge Company C subscribes to warrant of a quoted share. Subscription price = RM1 per warrant. Is this a basic equity investment? How does Company C measure the investment on initial recognition? What if the fair value is RM1.20 per warrant?? What if both warrant and share are unquoted? Cost less impairment 37 is received or that it will continue to be accurate in the future. one should act upon such information without appropriate professional advice entity.

7 Financial liabilities initial and subsequent measurements Test your knowledge? Initial measurement? Subsequent measurement? Goods purchased from supplier on 30-day credit term financing Undiscounted transaction price Goods purchased from supplier on 2-year interestfree credit PV of cash flows Loan received from a bank PV of cash flows Puttable preference shares t a basic financial liability 57 Financial liabilities vs. Equity classification Test your knowledge Liability or equity or compound instrument? Mandatorily redeemable preference shares Liability Puttable convertible preference shares Compound Irredeemable convertible unsecured loan stock Compound Unsecured loan stock with detachable warrant Treasury shares held by issuer Two separate instruments (Reduction of) equity 73 is received or that it will continue to be accurate in the future. one should act upon such information without appropriate professional advice entity.

8 kpmg Section 4 Activity 1 suggested solution: Identification, categorisation and measurement Section 4 Activity 1 suggested solution: Identification, scope and measurement RM 000 Property, plant and equipment 1,000 Prepaid lease payments 43,934 Goodwill 856 Other intangible assets 889 Investments in associates 2,025 Other investments Equity investments Corporate bonds 1,637 2,000 3,637 Total non-current assets 52,341 A B C D Financial Section Initial asset/liability? 11 or 12? measurement 1 Subsequent measurement 2 TP / FV FV / C PV AC Current equity investments 243 TP / FV FV / C Receivables Trade receivables 15,710 TP AC Prepayments 4,052 19,762 Inventories 19,210 Cash and cash equivalents 2,415 TP AC Total current assets 41,630 Total assets 93,971 Equity 43,425 Loans and borrowings 10,000 PV AC Finance lease obligations 11,450 Deferred income 954 Deferred tax liabilities 4,584 Total non-current liabilities 26,988 Finance lease obligations 2,474 Pension liability 1,000 Deferred income 300 Trade payables 12,784 TP AC Current tax liabilities 2,000 Forward foreign exchange - FV FV contracts Bank overdrafts 5,000 TP AC Total current liabilities 23,558 Total liabilities 50,546 Total equity and liabilities 93,971 1 TP = Transaction price, PV = Present value of cash flows, FV =. 2 AC =, FV = Far value, C = Cost less impairment. independent member firms affiliated with KPMG entity. All rights reserved. 1

9 kpmg Section 4 Activity 2 suggested solution: Objective evidence of impairment Section 4 Activity 2 suggested solution: Objective evidence of impairment Case 1: If the removal of Entity X from being listed in Bursa Malaysia is due to significant financial difficulty of the entity, there is an objective evidence of impairment and impairment loss should be recognised in the profit or loss of Entity A for investment in Entity X. Case 2: (a) There is objective evidence of impairment as Entity Z has defaulted in its interest and principal repayments. As the present value of the future principal and interest payments discounted at the loan s original effective interest rate will be lower than the carrying amount of the loan, an impairment loss is to be recognised in the profit or loss of Bank A. (b) There is objective evidence of impairment as Entity Z has defaulted in its interest and principal repayments. Nevertheless, as Bank A will receive interest on interest, the present value of the future principal and interest payments, discounted at the loan s original effective interest rate, will equal the carrying amount of the loan therefore no impairment loss is to be recognised in the profit or loss of Bank A. Case 3: As the granting of concession, i.e. in this case waiver of interest due by Bank Y to Company Z relates to the latter s financial difficulty, there is objective evidence of impairment and impairment loss should be recognised accordingly in the profit or loss of Bank Y. Case 4: There is a clear indication of objective evidence of impairment. Therefore, Entity A should recognise impairment loss of the investment in Company ATC in its profit or loss. However, if the financial reorganisation of Company ATC is not due to financial difficulties but rather, due to merger with another Company X, there would not be objective evidence of impairment and impairment loss would not be recognised in this instance. Case 5: The disappearance of an active market for XYZ s securities mainly because the securities are no longer publicly traded is not an objective evidence of impairment. Nevertheless, if the decision to de-list is due to certain financial difficulties of the issuer, the disappearance of an active market for XYZ securities in this case would warrant objective evidence of impairment. Case 6: The asset is measured at fair value with changes in fair value recognised in profit or loss. independent member firms affiliated with KPMG entity. All rights reserved. 1

10 kpmg Section 4 Activity 3 suggested solution: Impairment loss calculation Section 4 Activity 3 suggested solution: Impairment loss calculation 1. The impairment loss is measured as the difference between the carrying amount of the loan and the present value of the estimated future cash flows on the loan, discounted using the original effective interest rate of 10.53%. Given that only RM25 million in principal and the 31 December 20X2 interest payment are expected to be received, the present value based on this original effective interest rate is calculated as follows (assumed that accrued interest is paid at 31 December 20X1 and therefore excluded from the calculation): Present value of estimated future cash flows = RM5 million + RM25 million (1.1053) 2 = RM24,987,147 Thus, impairment loss = Carrying amount Present value of estimated future cash flows = RM49,539,207 RM24,987,147 = RM24,552,060 Relevant journal entries: Dr. Impairment loss profit or loss Cr. Loan to Entity Y RM24,552,060 RM24,552,060 An impairment loss of RM24,552,060 is recognised in the profit or loss. 2. The loan s estimated future cash flows comprise: RM25 million in principal and the 31 December 20X2 interest payment, plus fair value of the securities less any s expected to obtain and sell the collateral. Impairment loss is calculated as the difference between the loan s carrying amount and the present value of the estimated future cash flows, taking into account the recoverable amount from the collateral. However, the collateral itself should not be recognised on Entity ABC s statement of financial position until the securities meet the recognition criteria for financial assets. independent member firms affiliated with KPMG entity. All rights reserved. 1

11 Activity 4 Compound instrument: Suggested solution (1) Total proceeds FV of liability Equity component Worked example: Convertible bonds Proceeds from convertible bonds issue PV of annual interest payments PV of principal at end of year 5 PV of liability (i.e. fair value of liability) A B C D = B + C RM 50,000 8,425 37,363 45,788 Residual (i.e. fair value of equity component) E= A -D 4, Activity 4 Compound instrument: Suggested solution (2) Date 1/1/X1 31/12/X1 31/12/X2 31/12/X3 31/12/X4 31/12/X5 Interest 6% Amor. of discount Bond discount Net bond liability Interest paid 4,212 45,788 2,000 2, ,465 46,535 2,000 2, ,673 47,327 2,000 2, ,833 48,167 2,000 2, ,057 2,000 2, ,000 Initial measurement Debit Credit 1/1/X1 Cash 50,000 Financial liability 45,788 Equity 4,212 Subsequent measurement Debit Credit 31/12/X1 Interest expense 2,747 Financial liability 747 Cash 2,000 te: The above entries ignore deferred tax. 71 is received or that it will continue to be accurate in the future. one should act upon such information without appropriate professional advice entity.

Financial Instruments: Presentation INTRODUCTION

IAS 32 Financial Instruments: Presentation INTRODUCTION Objective Scope Application The stated objective of IAS 32 is to establish principles for presenting financial instruments as liabilities or equity