Summary of ASPE 3856 Financial Instruments

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2 Purpose and Scope This section establishes standards for: Recognizing and measuring financial assets, financial liabilities and specified contracts to buy or sell non-financial items; The classification of financial instruments, from the perspective of the issuer, between liabilities and equity; The classification of related interest, dividends, losses and gains; The circumstances in which financial assets and financial liabilities are offset; When and how hedge accounting may be applied; and Disclosures about financial assets and financial liabilities. Definitions Certain financial assets and liabilities whose recognition, measurement, presentation and/or disclosure are specifically addressed in other Standards may be excluded from this Standard. Consult paragraph for specific exclusions. Amortized cost The amount at which a financial asset or financial liability is measured at initial recognition minus principal repayments, plus or minus the cumulative amortization of any difference between that initial amount and the maturity amount, and minus any reduction (directly or through the use of an allowance account) for impairment. Derivative Contract with all three of the following characteristics: Its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index, or other variable (sometimes called the underlying ), provided in the case of a non-financial variable that the variable is not specific to a party to the contract It requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and. It is settled at a future date. Financial asset Any asset that is: Cash; A contractual right to receive cash or another financial asset from another party; A contractual right to exchange financial instruments with another party under conditions that are potentially favourable; or An equity instrument of another entity. The cost incurred by an entity to purchase a right to reacquire its own equity instruments from another party is a deduction from its equity, not a financial asset. 2

3 Financial liability Any liability that is a contractual obligation: To deliver cash or another financial asset to another party; or To exchange financial instruments with another party under conditions that are potentially unfavourable to the entity. Recognition and Measurement General An entity recognizes financial assets and financial liabilities when the entity becomes party to the contractual provisions of the financial instrument. The following table summarizes the requirements for financial instrument recognition and measurement: Financial Assets Financial Liabilities Category Investment in equity instruments other than those quoted in an active market Investment in equity instruments that are quoted in an active market Derivative contracts other than derivatives that are: Designated in a qualifying hedging relationship (discussed in Other Considerations below); and Linked to, and must be settled by delivery of, equity instruments of another entity whose fair value cannot be readily determined Initial Measurement [Note 1] Fair value Subsequent Measurement [Note 2] Cost less any reduction for impairment Gains, Losses, Interest and Dividends Recognized in net income during the year in which the asset is derecognized or impaired Fair value Fair value Recognized in net income in the period incurred. Fair value Fair value Recognized in net income in the period incurred All other financial assets Fair value Amortized cost Recognized in net income during the year in which the asset is derecognized or impaired. Derivative contracts other than derivatives that are: Designated in a qualifying hedging relationship (discussed in Other Considerations below); and Linked to, and must be settled by delivery of, equity instruments of another entity whose fair value cannot be readily determined Fair value Fair value Recognized in net income in the period incurred All other financial liabilities Fair value Amortized cost Recognized in net income during the year in which the liability is extinguished. 3

4 Note 1: If the financial asset or financial liability will not be measured subsequently at fair value, the initial fair value is adjusted by financing fees and transaction costs that are directly attributable to its origination, acquisition, issuance or assumption. If the financial asset or financial liability will be measured subsequently at fair value, transaction costs are recognized in net income in the period incurred. Note 2: An entity may elect to measure any financial asset or financial liability at fair value by designating (i.e., making an accounting policy choice) that the fair value measurement applies: When the asset or liability is first recognized in accordance with this Section; or For an investment in an equity instrument in an active market that was previously measured at fair value, when the instrument ceases to be quoted in an active market. Any designation in accordance with this paragraph is irrevocable. Financial liabilities indexed to entity s financial performance/equity The issuer of a financial liability that is indexed to a measure of the entity s financial performance or to changes in the value of the entity s financial performance or to changes in the value of the entity s equity must account for the instrument as follows: The liability is initially measured in accordance with the table above; Interest expense is calculated using the stated interest rate, plus or minus the amortization of any initial premium or discount; and At each reporting date, the entity adjusts the carrying amount of the liability to the higher of: The amortized cost of the debt; and The amount that would be due at the balance sheet date if the formula determining the additional amount was applied at that date (the conversion or intrinsic value). The amount of the adjustment in accordance with paragraph (c) above must be recognized in net income and presented as a separate component of interest expense. Impairment At the end of each reporting period, an entity must assess whether there are any indications that a financial asset, or group of similar financial assets, measured at cost or amortized cost may be impaired. Handbook s.3856.a15 through.a16 discusses factors to consider when assessing a potential impairment. If it is determined that a significant adverse change in the expected timing or amount of the future cash flows from a financial asset, or group of similar financial assets, it must reduce the carrying amount of the asset, or group of assets, to the highest of the following: The present value of the cash flows expected to be generated by holding the asset, or group of assets, discounted using an appropriate current market rate of interest; The amount that could be realized by selling the asset, or group of assets, at the balance sheet date; and The amount the entity expects to realize by exercising its right to any collateral held to secure repayment of the asset, or group of assets, net of all costs necessary to exercise those rights. The carrying amount of the asset, or group of assets, must be reduced directly or through the use of an allowance account. The amount of the reduction must be recognized as an impairment loss in net income. 4

5 Reversal of impairment When the extent of impairment of a previously written-down asset, or group of assets, decreases and the decrease can be related to an event occurring after the impairment was recognized (such as a return to profitability of the customer or issuer), the previously recognized impairment loss must be reversed to the extent of the improvement, directly or by adjusting the allowance account. The adjusted carrying amount of the financial asset, or group of assets, must be no greater than the amount that would have been reported at the date of the reversal had the impairment not been recognized previously. The amount of the reversal is recognized in net income in the period the reversal occurs. Presentation Liabilities and equity The issuer of a financial instrument must classify the instrument, or its component parts, as a liability or as equity in accordance with the substance of the contractual arrangement on initial recognition and the definitions of a financial liability and an equity instrument. Financial instrument that contains both a liability and equity element The issuer of a financial instrument that contains both a liability and an equity element, including warrants or options issued with and detachable from a financial liability, must classify the instrument s component parts separately. Handbook s.3856.a28 to.a38 provides additional guidance relating to retractable or mandatorily redeemable shares, compound financial instruments and convertible debt. Acceptable methods for initial measurement of the separate liability and equity elements of an instrument include the following: The equity component is measured as zero. The entire proceeds of the issue are allocated to the liability component. The less easily measurable component is allocated the residual amount after deducting from the entire proceeds of the issue the amount separately determined for the component that is more easily measurable The sum of carrying amounts assigned to the liability and equity components on initial recognition is always equal to the carrying amount that would be ascribed to the instrument as a whole. No gain or loss arises from recognizing and presenting the components of the instrument separately. Preferred shares issued in a tax planning arrangement An entity that issues preferred shares in a tax planning arrangement under Sections 51, 85, 85.1, 86, 87 or 88 of the Income Tax Act (Canada) must present that shares at par, states or assigned value as a separate line item in the equity section of the balance sheet, with a suitable description indicating that they are redeemable at the option of the holder. When redemption is demanded, the issuer must reclassify the shares as liabilities and measure them at the redemption amount. Any adjustment is recognized in retained earnings. Offsetting of a financial asset and a financial liability A financial asset and a financial liability must be offset, and the net amount reported in the balance sheet, only when an entity: Currently has a legally enforceable right to set off the recognized amounts; and Intends either to settle on a net basis, or to realize the asset and settle the liability simultaneously 5

6 Derecognition Transfers of receivables An entity derecognizes receivables transferred to another entity only when control has been surrendered. Financial liabilities An entity must remove a financial liability (or part of a financial liability) from its balance sheet when it is extinguished (i.e., when the obligation is discharged or cancelled, or expires). Where the terms of a debt instrument are substantially modified, or where a replacement debt instrument has substantially different terms than those of the one it replaces, it is accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. The difference between the carrying amount of a financial liability (or part of a financial liability) extinguished or transferred to another party and the fair value of the consideration paid, including any non-cash assets transferred, liabilities assumed or equity instruments issued, are recognized in net income for the period. Disclosure An entity must disclose information that enables the users of its financial statements to evaluate the significance of financial instruments to its financial position and performance. Item Financial assets Transfers of receivables Impairment Disclosure The carrying amount of each of the following categories (either on the face of the balance sheet or in the notes): Financial assets measured at amortized cost; Financial assets measured at fair value; and Investments in equity instruments measured at cost less any reduction for impairment. [Note 1] If the entity transferred financial assets and accounts for the transfer as a sale, disclose: Gain or loss from all sales during the period; Accounting policies for: Initially measuring any retained interest (including methodology used in determining its fair value); and Subsequently measuring the retained interest; and Description of the transferor s continuing involvement with the transferred assets, including, but not limited to, servicing, recourse and restrictions on retained interests. [Note 2] Carrying amount of impaired financial assets, by type of asset, and the amount of any related allowance for impairment. 6

7 Item Bonds, debentures and similar securities, mortgages, other long-term debt Secured Recognized at balance sheet date Issued financial liability that contains both a liability and equity component Issued financial instrument that is indexed to the entity s equity or an identified factor Preferred shares issued in a tax planning arrangement Derivatives Disclosure Disclose: Title or description of the liability; Interest rate; Maturity date; Amount outstanding, separated between principal and accrued interest; Currency in which the debt is payable if it is not repayable in the currency in which the entity measures items in its financial statements; and Repayment terms, including the existence of sinking fund, redemption and conversion provisions. Also disclose the aggregate amount of payments estimated to be required in each of the next five years to meet repayment, sinking fund or retirement provisions of financial liabilities. In addition to the disclosures for unsecured financial liabilities, also disclose the carrying amount of any financial liabilities that are secured as well as the: Carrying amount of assets it has pledged as collateral for liabilities; and Terms and conditions relating to its pledge. Whether any financial liabilities were in default or in breach of any term or covenant during the period that would permit a lender to demand accelerated repayment and whether the default was remedied, or the terms of the liability were renegotiated, before the financial statements were completed. Disclose, when relevant: Exercise date or dates of the conversion option; Maturity or expiry date on the option; Conversion ratio or the strike price; Conditions precedent to exercising the option; and Other terms that could affect the exercise of the option, such as the existence of covenants that, if contravened, would alter the timing or price of the option. Disclose information that enables users of the financial statements to understand the nature, terms and effects of the indexing feature, the conditions under which a payment will be made and the expected timing of any payment. Disclose: On the face of the balance sheet, the total redemption amount for all classes of such shares outstanding; The aggregate redemption amount for each class of such shares; and The aggregate amount of any scheduled redemptions required in each of the next five years. Disclose: Notional and carrying amounts of all derivative assets measured at fair value; Notional and carrying amounts of all derivative liabilities measured at fair value; Method used to determine the fair value of all derivatives measured at fair value; and Notional and accrued amounts of all interest rate and cross-currency interest rate swaps in designated hedging relationships. [Note 3] 7

8 Item Items of income Risks and uncertainties Disclosure Disclose following items of income, expense, gains or losses either on the face of the statements or in the notes to the financial statements: Net gains or net losses recognized on financial instruments; Total interest income; Total interest expense on current financial liabilities; Interest expense on long-term financial liabilities, separately identifying amortization of premiums, discounts and financing fees; and Amount of any impairment loss or reversal of a previously recognized loss. For each significant risk arising from financial instruments, and separately for derivatives, an entity must disclose: Exposures to risk and how they arise; and Any change in risk exposures from the previous period. For each type of risk arising from financial instruments, an entity must disclose concentrations of risk. Concentrations of risk arise from financial instruments that have similar characteristics and are affected similarly by changes in economic and other conditions. Note 1: Accounts and notes receivable must be segregated so as to show separately trade amounts, amounts owing by related parties and other unusual items of significant amount. The amounts and, when practicable, maturity dates of accounts maturing beyond one year must be disclosed separately. Note 2: If an entity has transferred financial assets in a way that does not qualify for derecognition, disclose the: Nature and carrying amount of the assets; Nature of the risks and rewards of ownership to which the entity remains exposed; and Carrying amount of the liabilities assumed in the transfer. Note 3: When an entity measures the fair value of a derivative asset or liability using a quote from a derivatives dealer, it discloses that fact and the nature and terms of the instrument. An entity must also disclose sufficient information about derivatives that are linked to, and must be settled by delivery of, equity instruments of another entity whose fair value cannot be readily determined to permit the reader to assess the potential implications of the contract. The information includes: Name of the issuer of the equity instrument; Description of the equity instrument; and Terms under which settlement will take place. 8

9 Other considerations Hedge accounting Hedge accounting is optional. The purpose of hedge accounting is to recognize offsetting gains, losses, revenues and expenses (including the effects of changes in cash flows) for the hedged and hedging items in net income in the same period or periods. For the purposes of this Guide, the discussion focuses on the types of hedging relationships permitted under ASPE; however, additional guidance on hedge accounting is provided in Handbook s through s as well as s Hedging relationships An entity may designate only the following hedging relationships: An anticipated transaction denominated in a foreign currency hedged with a forward contract to mitigate the effect of changes in future foreign currency exchange rates; An anticipated purchase or sale of a commodity hedged with a forward contract to mitigate the effect of future price changes of commodity; An interest-bearing asset or liability hedged with an interest rate swap to mitigate the effect of changes in interest rates; A foreign currency denominated interest-bearing asset or liability hedged with a cross-currency interest rate swap to mitigate the effect of the change in interest rates and foreign currency exchange rates; and The net investment in a self-sustaining foreign operation hedged with a derivative or non-derivative financial instrument to mitigate the effect of changes in foreign currency exchange rates. 9

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