IFRS for SMEs IFRS Foundation-World Bank

The IFRS for SMEs 2 Topic 2.1(a) Section 11 Basic Financial Instruments Michael Wells

Sections 11 & 12 Introduction 3 Financial instruments split into two sections: Sec. 11 Basic Financial Instruments Sec. 12 Other Financial Instruments Issues Together the two sections cover recognising, derecognising, measuring, and disclosing financial assets and financial liabilities

Sections 11 & 12 Introduction 4 Section 11 is relevant to all SMEs Section 12 is relevant If: SME owns or issues exotic financial instruments instruments that impose risks or rewards that are not typical of basic financial instruments SME wants to do hedge accounting

Sections 11 & 12 Accounting choice 5 Entity may choose to apply either: Sections 11 and 12 in full, or Recognition and measurement provisions of IAS 39 and the disclosure requirements in Sec 11 & 12 No option to use IFRS 9 The option chosen applies to all financial instruments (not individually) To change option, follow Section 10

Sections 11 & 12 Basic principles Basic principle of Section 11: Amortised cost model for all basic FI except investments in ordinary or preference shares that are publicly traded or whose fair value can be measured reliably these are fair value through profit or loss (FVTPL). Basic principle of Section 12: FI not covered by Section 11 are at FVTPL 6

Section 11 Scope 7 All basic financial instruments except those covered by other sections of IFRS for SMEs: Investments in sub, associate, JV (see Sections 9, 14, 15) Entity s own equity (see Sec 22, 26) Leases (see Section 20) Employee benefit assets and liabilities (see Section 28)

Sections 11 & 12 Definitions Financial instrument Contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity Includes cash But commodities that are near cash like gold are not financial instruments 8

Sections 11 & 12 Definitions Basic financial instrument* Cash Debt instrument (accounts, notes, and loans receivable and payable) that meet conditions on next slide Ordinary and preference shares that are not convertible and not puttable 9 *These notes do not discuss loan commitments

Section 11 Basic debt instruments 10 Debt instruments are in Section 11 if: Returns to holder are fixed, variable referenced to an observable rate, or combination of fixed and variable No special provision could cause holder to lose principal Prepayment conditions are not contingent on a future event No special conditional returns

Section 11 Basic debt instruments Examples of basic debt instruments: Trade accounts and notes receivable and payable Loans from banks and other 3rd parties Accounts payable in foreign currency Loans to/from subsidiaries or associates that are due on demand Debt instrument that becomes immediately due if issuer defaults All of these measured at amortised cost 11

Section 11 Basic debt instruments Examples of NOT basic debt instruments: Investment in convertible or puttable shares Swaps, forwards, futures, options, rights, and other derivatives Loans with unusual prepayment conditions (based on tax change, accounting change, linked to company performance) All of these are FVTPL under Section 12 12

Section 11 Recognition and measurement 13 Initial recognition: When entity becomes a party to the contractual provisions of the instrument

Section 11 Recognition and measurement 14 Initial measurement: At transaction price Include transaction costs except for FI that will be measured at FVTPL Impute interest if payment is deferred beyond normal terms or below-market interest

Section 11 Recognition and measurement 15 Initial recognition-measurement examples: Loan made to another entity: Measure at PV of interest and principal payments Goods sold to customer (purchased from supplier) on normal credit terms: Measure receivable (payable) at undiscounted invoice price

Section 11 Recognition and measurement Initial recognition-measurement examples: Goods sold (purchased) on 2-year interest free credit: Measure at current cash sale price or PV of receivable or payable Example: We sell goods for 1,000, payment due 2yrs, interest-free. Cash price = 857.IRR = 8%. Journal entries Debit Credit At time of sale Receivable 857 16 Sales Revenue 857 Year 1 Receivable 69 8% x 857 = 69 Interest Revenue 69

Section 11 Recognition and measurement 17 Subsequent measurement: Debt instruments in the scope of Section 11 (even if publicly traded): Amortised cost using the effective interest method Equity instruments in scope of Section 11: If publicly traded or FV can be measured reliably: FVTPL All others: cost less impairment

Section 11 Recognition and measurement 18 What is amortised cost? Amount measured at initial recognition Minus repayments of principal Plus or minus cumulative amortisation of any difference between initial measurement and maturity amount (using effective interest method) Minus (for assets) reduction for impairment or uncollectibility

Section 11 Recognition and measurement 19 What is effective interest method? Effective interest is rate that exactly discounts future cash payments (receipts) to the carrying amount Also called Internal Rate of Return Amortised cost = PV of future cash receipts (payments) discounted at effective interest rate Interest expense (income) = carrying amount at beginning of period x effective interest rate

Section 11 Effective interest example 20 1/1/X0 buy 5-year bond for 900, transaction cost = 50, cash interest = 40/year, mandatory redemption at 1,100 at 31/12/X4. Year Carrying amount beginning Int. income at 6.9583%* Cash inflow Carrying amt ending X0 950.00 66.10 (40) 976.11 X1 976.11 67.92 (40) 1,004.03 X2 1,004.03 69.86 (40) 1,033.89 X3 1,033.89 71.94 (40) 1,065.83 X4 1,065.83 74.16 (40) 1,100.00 *6.9583% is the rate that exactly discounts the cash flows to 950.00

Section 11 Recognition and measurement 21 What is fair value? Amount for which FI could be sold or settled in an arm s length transaction Best: Quoted market price in an active market (bid price) Next: Price in a recent transaction for identical asset (unless circumstances have changed) Estimate using a valuation technique (a model)

Section 11 Impairment 22 Impairment only applies to FI measured at cost or amortised cost At each reporting date, look for evidence that FV is below carrying amount Significant financial difficulty of issuer Default or delinquency Abnormal concession granted to debtor by creditor Probable debtor bankruptcy or reorg.

Section 11 Impairment 23 Impairment assessment: Individually for all equity instruments Individually for debt instruments that are individually significant For other debt instruments, either individually or grouped based on similar risk characteristics Impairment recognition: Write-down is recognised in P&L

Section 11 Impairment Measurement of the impairment loss: Debt instruments: Difference between carrying amount and current PV of estimated cash flows discounted at asset s original effective interest rate. (Use current rate if variable.) Equity instruments: Difference between carrying amount and best estimate (approximation) of the amount (might be zero) that entity would receive if asset were sold at reporting date. 24

Section 11 Impairment Reversal of an impairment loss: Required if the problem causing the original impairment reduces Write up but not to more than what carrying amount would have been had no impairment been recognised (ie not to FV but to new amortised cost ) Reversal recognised in P&L 25

Section 11 Derecognition Derecognition of a financial asset: Derecognition = remove from balance sheet Only when: a. Rights to cash flows expire or settled b. Substantially all risks and rewards (cash flows) transferred to other entity c. Transferred some but not substantially all risks and rewards, and physical control of asset transferred to another party who has the right to sell the asset to an unrelated third party. 26

Section 11 Derecognition 27 Derecognition of a financial asset: In case (c) above: Derecognise old asset entirely, and Recognise separately any rights and obligations retained or created in the transfer (measure at fair value) If transfer does not result in derecognition, keep transferred asset on books and recognise financial liability for the consideration received Do not offset

Section 11 Derecognition Derecognition of a financial asset: Transferor gives noncash collateral: If transferee can sell or repledge the collateral: Transferor must show the collateral asset separately in its balance sheet If transferee sells: It must recognise a liability to return the collateral If transferor defaults: It derecognises the collateral, and transferee recognise it at FV (or if it has already sold it, derecognise the liability) 28

Section 11 Derecognition Derecog. of financial asset examples: Must derecognise: Sell receivables to bank but we continue to collect and remit, for a handling fee. Bank assumes credit risk. May not derecognise: Same facts except entity agrees to buy back any receivables in arrears for more than 120 days. Entity continues to recognise the receivables until collected or writeoff as uncollectible. 29

Section 11 Derecognition Derecognition of a financial liability: Only when extinguished, that is: a. Discharged b. Cancelled c. Expired If existing debt is replaced with new one with substantially different terms (or there is a significant modification of terms): Treat as new liability and extinguishment of original liability 30

Section 11 Presentation and Disclosure Disclose accounting policies for FI Disclose financial assets and liabilities by categories in the balance sheet: Equity or debt at FVTPL Debt at amortised cost Equity measured at cost less impairment Liabilities at FVTPL Liabilities at amortised cost 31

Section 11 Disclosure Terms, conditions, and restrictions of financial assets and liability For those at FVTPL, details of how FV was determined Details of transfer of financial asset that did not qualify for derecognition Details of financial assets pledged as collateral Details of defaults and breaches on loans payable continued next slide... 32

Section 11 Disclosure Items of income, expense, gains and losses: Changes in FV for instruments measured at FVTPL Total interest income and total interest expense on FI not measured at FVTPL Impairment loss by class of financial asset 33

Questions or comments? 34 Expressions of individual views by members of the IASB and its staff are encouraged. The views expressed in this presentation are those of the presenter. Official positions of the IASB on accounting matters are determined only after extensive due process and deliberation.

35 This presentation may be modified from time to time. The latest version may be downloaded from: http://www.ifrs.org/conferences+and+workshops/ifrs+for+smes+train +the+trainer+workshops.htm The accounting requirements applicable to small and medium sized entities (SMEs) are set out in the International Financial Reporting Standard (IFRS) for SMEs, which was issued by the IASB in July 2009. The IFRS Foundation, the authors, the presenters and the publishers do not accept responsibility for loss caused to any person who acts or refrains from acting in reliance on the material in this PowerPoint presentation, whether such loss is caused by negligence or otherwise.