College of Business, Hospitality and Tourism Studies

School of Accounting

ACC702: International Corporate Reporting

COURSEBOOK

Revised in SEM 1, 2020.

Maheshwari Chand
Lecturer: Fiji National University, Namaka Campus
 SCHEDULE OF TOPICS, LECTURE AND TUTORIAL GUIDES

WEEK 1 Introduction to IFRS, the IASB, and its Conceptual Framework Topic 1 Alfredson et al. Chapter 1
3rd – 7th Feb

WEEK 2 Revenue Topic 2 Alfredson et al. Chapter 3

10th – 14th Feb
WEEK 3 Related Party Disclosures Topic 3 IAS 24
17th -23rd Feb

WEEK 4 Provisions, Contingent Liabilities and Contingent Assets Topic 4 Alfredson et al. Chapter 4
24th -28th Feb

WEEK 5 Topic 5 Alfredson et al. Chapter 5

2nd -6th Mar Financial Instruments

WEEK 6 Property, Plant, and Equipment Topic 6 Alfredson et al. Chapter 9

th th
9 -13 Mar

WEEK 7 MID SEMESTER EXAMINATION Topics 1-6 20%

16 – 22nd Mar
th

WEEK 8 MID SEMESTER BREAK

23rd -27th Mar

WEEK 9 Intangible Assets Topic 7 Alfredson et al. Chapter 10

30 Mar-3rd Apr
th

WEEK 10 Business Combinations Topic 8 Alfredson et al. Chapter 11

6th -10th Apr
WEEK 11 Impairment of Assets Topic 9 Alfredson et al. Chapter 12
14th -17th Apr
WEEK 12 Employee Benefits Topic 10 Alfredson et al. Chapter 15
20th -24th Apr
WEEK 13 Agriculture Topic 11 Alfredson et al. Chapter 16
27 Apr-1st May
th

WEEK 14 Agriculture Topic 11 Alfredson et al. Chapter 16

4th -8th May
Research Presentations
WEEK 15
11th 15th May
STUDY BREAK
WEEK 16
18th 22nd May
EXAMINATION WEEK
WEEK 17 & 18
25th May- 5thJun
Topic 5: Financial instruments
Learning Objectives
- Evaluate the concept of financial instruments and derivative
- Apply the definitions of the financial assets and financial liabilities
- Contrast between equity instruments and financial liabilities
- Apply the concept of a compound financial instrument.
- Apply the recognition criteria for financial instruments and provide the disclosure requirement of FRS 7.

Relevant Accounting standard to look at:

IAS 32 Financial Instruments: Presentation
IAS 39 Financial Instruments: Recognition and Measurements, IFRS 9 replaces
IFRS 7 Financial Instruments: Disclosures

Introduction to IAS 32, IFRS 7 and IAS 39

• IAS 32 sets out the definitions of financial assets, liabilities and equity instruments
• IFRS 7 contains many of the disclosure requirements of IAS 32 as well as new requirements
• IAS 39 originally based on FASB standard. Includes procedures for the recognition and
measurement of financial instruments.
• IFRS 9 formulated to replace IAS 39 (as yet lacks endorsement by the European parliament)

IAS 32 specifies presentation for financial instruments. For presentation, financial instruments are classified
into financial assets, financial liabilities and equity instruments, however the differentiation between a
financial liability and equity depends on whether an entity has an obligation to deliver cash (or some other
financial asset).

Exceptions apply. When a transaction will be settled in the issuer’s own shares, classification depends on
whether the number of shares to be issued is fixed or variable.

A compound financial instrument- a financial instrument that has the characteristics of both equity (options
to convert into shares) and liability (debt)- such as a convertible bond, is split into equity and liability
components.

IAS 39 establishes principles for recognising and measuring financial assets, financial liabilities and some
contracts to buy or sell non-financial items. It also prescribes principles for derecognising financial
instruments and for hedge accounting. The presentation and the disclosure of financial instruments are the
subjects of IAS 32 and IFRS 7 respectively.

When to Recognise or Derecognise

A financial instrument is recognised in the financial statements when the entity becomes a party to the
financial instrument contract. An entity removes a financial liability from its statement of financial position
when its obligation is extinguished. An entity removes a financial asset from its statement of financial
position when its contractual rights to the asset’s cash flows expire; when it has transferred the asset and
substantially all the risks and rewards of ownership; or when it has transferred the asset, and has retained
some substantial risks and rewards of ownership, but the other party may sell the asset. The risks and
rewards retained are recognised as an asset.

Measurement
A financial asset or financial liability is measured initially at fair value. Subsequent measurement depends
on the category of financial instrument. Some categories are measured at amortised cost, and some at fair
value. In limited circumstances other measurement bases apply, for example, certain financial guarantee
contracts.

IFRS 7 requires entities to provide disclosures in their financial statements that enable users to evaluate:

 the significance of financial instruments for the entity’s financial position and performance.
 the nature and extent of risks arising from financial instruments to which the entity is exposed
during the period and at the end of the reporting period, and how the entity manages those risks.
The qualitative disclosures describe management’s objectives, policies and processes for
managing those risks. The quantitative disclosures provide information about the extent to which
the entity is exposed to risk, based on information provided internally to the entity’s key
management personnel. Together, these disclosures provide an overview of the entity’s use of
financial instruments and the exposures to risks they create.

IFRS 9 specifies how an entity should classify and measure financial assets, financial liabilities, and some
contracts to buy or sell non-financial items.

IFRS 9 requires an entity to recognise a financial asset or a financial liability in its statement of financial
position when it becomes party to the contractual provisions of the instrument. At initial recognition, an
entity measures a financial asset or a financial liability at its fair value plus or minus, in the case of a
financial asset or a financial liability not at fair value through profit or loss, transaction costs that are directly
attributable to the acquisition or issue of the financial asset or the financial liability.

One of the most controversial development areas in recent times, especially hedge accounting

What is a financial instrument?

Financial Instrument: “any contract that gives rise to a financial asset of one entity and a financial liability or
equity instrument of another entity”
A two-sided contract. All financial instruments will give rise to a financial asset of one party, with a
corresponding financial liability or equity instrument of another party.
  E.g. – sales contract gives rise to a receivable in the seller’s books and a payable in the
purchaser’s books.
 Definition requires a legal/contractual obligation/right. Non-contractual liabilities are not
financial instruments. E.g. – income taxes arise from a statutory obligation/right.

‘Financial Assets’-means any asset that is (para 11, IAS32):

- Cash
- An equity instrument of another entity
- A contractual right (to receive cash/another financial asset from another entity or
to exchange FA/FL with another entity on conditions favourable to the entity
- A contract settled in the entity’s own equity instruments (derivative settlement or
non-derivative receives)
‘Financial Liability’- means any liability:
- A contractual obligation (to deliver cash/or another FA to an entity, or (to
exchange FA/FL with another entity under conditions favourable to the entity)
- A contract that will/may be settled in the entity’s own equity instruments and this
is:
- non-derivative for which the entity may deliver a # of entity’s own equity
instruments
- derivative – settled on exchange of fixed cash or FA
‘Equity Instrument’- means any contract that evidences a residual interest in the assets of an entity, after
deducting all of its liabilities.

*****Financial Instruments – categorised into two distinct schemes:

1. Primary or Secondary:
Primary instruments - Cash, receivables/ payables, investments/Bonds, loans & borrowings
Secondary (derivative) instruments –Financial options, Forward/Futures exchange contracts,
Swaps, Collaterised debt obligations (CDOs), Letters of credits etc.
2. Simple or Compound
Simple instruments comprise a single FA/ FL or Equity e.g.. accounts receivable or accounts
payable
Compound Instruments -(combination)- convertible debts, Exchangeable debts, Dual currency
bonds.

Does non-financial assets and liabilities constitute financial instrument?

What are * Non-financial assets and liabilities

Contracts to buy or sell non-financial items such as wheat, gold or silver do not satisfy the definition
of a financial instrument where the contract is expected to settled by physical delivery (the
contractual right is to receive/deliver a non-financial asset).
Physical assets such as plant eventually be converted to cash but they are not financial assets
because an entity has no present right to receive cash from another entity.
Prepayments are not a financial instrument because the right is to receive goods/services and not
cash.
What are Derivatives Financial Instruments: para9, IAS39.
Derivative Instruments create rights and obligations that have the effects of transferring one or more of the
financial risks inherent in an underlying primary financial instrument and the value of the contract normally
reflects the changes in the value of the underlying financial instrument.

Derivatives transfer financial risks of the underlying primary financial instrument

One party acquires a right to exchange a financial asset or liability with another party under potentially
favourable conditions. The other party takes on the right to exchange under potentially unfavourable
conditions. * Parties to derivatives are taking bets on what will happen to it in the future.

Debt/equity distinctions are important – affects gearing and solvency ratios, debt covenants,
treatment of payments as either interest or dividends & capital adequacy requirements

A ‘substance over form’ test in IAS 32 aims to limit attraction to misclassify many as equity instruments

The four common derivative instruments:

• Forward exchange contract- a special type of forward foreign currency contract to avoid risk of
currency loss
• Future contract -an agreement to buy or sell an agreed upon quantity of an underlying asset, at a
specified date, for a stated price. ‘benefits of locking prices’
• Option contract- call option (right to buy) or put option (right to sell) at preset price. ‘strike prices’.

• Swap contract – exchange contracts. A contract where one party exchanges or "swaps" the cash
flows or value of one asset for another, such as:
- interest rate swaps- swapping fixed and floating interest rate obligations
- commodity swaps-exchange of CF, based on the price of underlying commodity
(common in livestock & oil industries)
- cross currency swaps- exchange of principal and interest pmts for loan in one
country with another
- other embedded derivative- hybrid combination a derivative instrument
embedded in another contract (host contract)- e.g
convertible note

Recognition, Measurement and Derecognition- IFRS7, IAS32, & IAS39

The normal recognition criteria as stated in the CF requires ‘asset and liabilities’ to be recognised when and
only when:
(a) it is probable that the future economic benefit will eventuate for the assets or will be
sacrificed in the future for the liability and
(b) the cost or other value can be reliably measured.

According to IAS 39 measurement rules address:

1. Initial measurement
2. Subsequent measurement
3. Fair value measurement consideration
 4. Reclassifications
5. Gain and losses
6. Impairment/Uncollectability.

Measurement- IAS39

1. Initial measurement: all financial assets and financial liabilities should be initially measured at fair
value. ‘FV is defined (para 9, IAS39) the amount for which an asset could be exchanged/liability
settled between knowledgeable, willing parties in an arm’s length transaction.

2. Fair value hierarchy’ determines order of three bases of fair value as:
Active market quoted price – normally the current bid or asking price.
This is the best estimate of fair value
No active market -valuation techniques – e.g. via discounted cash flow analysis
No active market -equity instruments– must be measured at cost

3. Subsequent measurement bases/consideration

IAS39 divides FA into four categories for measurement purposes:
a) Loans and receivables- recognise receivable(sell or service on credit) or recognise loan (when
entity lends money to another entity)
b) Held to maturity investments- where intention and capacity is both to hold investment until
maturity
c) Financial assets at FVTPL- opposite to (b). intention is to trade it when market conditions are
favourable, previously this was known as held for trading.
d) Available for sale financial assets (FA)- catches all the left category…. All FA that does not fit
above three categories..

Summary of FA measurement Requirements as per IAS39:

Financial Assets Measurement Changes in FV
FA at FVTPL FV Recognized in Profit and loss
Held to maturity Amortized cost Not recognized
Available for sale FV Recognized in OCI
Loans and Receivables Amortized costs Not recognized

4. Reclassification of FA
This will only occur in rare circumstances;
• No reversal of any previous recognized gain or loss is allowed
• Loans/receivables (FVTPL) expected to be held to foreseeable future or until maturity
• The fair value at the date of the reclassification becomes the amortized cost going forward.

5. Gain and losses… changes in FV recognized in accounts.

a) gains and losses on financial instrument classified as at fair value through profit or loss are
reported in the profit and loss for the period (comprehensive income).
• b) gain and losses on available for sale securities are recognized in other comprehensive income.
The gain and losses reported in the other comprehensive income remain in equity until the financial
assets is sold or disposed.
 6. Impairment of financial assets (more in IAS36 Impairment of assets)- bankruptcy or disappearance
of the issuer or a significant decline in market price due to a major disaster. Entities should
annually assess the recoverable amount with the carrying amount. Impairment occurs when RA <
CA or when CA > RA.
The impairment loss for FA are carried at amortized cost or reduced the CA of an asset by using
an allowance account (as most entities do for bad and doubtful debts)

What is Hedging
Refers to designating a financial instrument as an offset against the change in FV or cash flows of
a hedged item or group of items with similar characteristics.

*Hedge Accounting
• Hedge arrangements are entered into to protect an entity from risk – e.g. currency or interest rate
risk
• Hedge accounting generally results in a closer matching of the statement of financial position effect
with the profit or loss effect- offsetting
• Protects the statement of profit or loss and other comprehensive income from volatility caused by
fair value changes over time

* What are Hedging Instruments

• A hedging instrument is a financial asset or financial liability whose fair value or cash flows are
expected to offset changes in the fair value or cash flows of a designated hedge item

Hedged item/Instrument
• A hedged item is an asset, liability or anticipated transaction that:
– Exposes the entity to risk of changes in fair value or future cash flows and
– Is designated as being hedged
– A highly probable forecast transaction or
– A net investment in a foreign operation

What are the conditions for hedge accounting?

Five conditions must be met in order for hedge accounting to be applied:

1. Must be formal designation and documentation of the hedge at inception
2. The hedge must be expected to be highly effective (80% - 125%)
3. Where hedge is of forecast transaction, the transaction must be highly probable
4. The effectiveness of the hedge must be able to be reliably measured
5. The hedge must be assessed on an ongoing basis for effectiveness

IAS 39 states three types of hedging contracts/relationships:

1. Fair value hedge-A hedge of the exposure to changes in the FV of an asset, liability or commitment
 2. Cash flow hedge- A hedge of the exposure to the variability in cash flows of a recognised asset or
liability or forecast transaction. Locks in future cash flows

3. Hedge of a net investment in a foreign operation – IAS21 hedge takes the form of a foregin
currency denominated liability to offset the foreign currency denominated asset (investment)

Derecognition of financial assets and financial liabilities

• Derecognizing financial assets: when the contractual right to the cash flows from the financial
assets [Link] when the entity collects cash from receivable or banks collects amounts from
borrowers. Or when the entity transfers the FA as per conditions specified para 18-20 IAS39.

• Derecognizing financial liabilities: when the debtor pays cash or other financial assets to the
creditor and is relieved of its obligation for the liability. Para 39, IAS39 states that a debt is
extinguished when the obligation is discharged or cancelled or expires.

Case Study: This case illustrates the application of the principle for derecognizing of
financial assets Facts During the reporting period, Entity A has sold various financial
assets:
1. Entity A sells a financial asset for $10,000. There are no strings attached to the sale, and
no other rights or obligations are retained by Entity A.

2. Entity A sells an investment in shares for $10,000 but retains a call option to repurchase the shares at
any time at a price equal to their current fair value on the repurchase date.

3. Entity A sells a portfolio of short-term account receivables for $100,000 and promises to pay up to
$3,000 to compensate the buyer if and when any defaults occur. Expected credit losses are significantly
less than $3,000, and there are no other significant risks.

4. Entity A sells a portfolio of receivables for $10,000 but retains the right to service the receivables for a
fixed fee (i.e., to collect payments on the receivables and pass them on to the buyer of the receivables).
The servicing arrangement meets the pass-through conditions.

5. Entity A sells an investment in shares for $10,000 and simultaneously enters into a total return swap with
the buyer under which the buyer will return any increases in value to Entity A and Entity A will pay the buyer
interest plus compensation for any decreases in the value of the investment.

6. Entity A sells a portfolio of receivables for $100,000 and promises to pay up to $3,000 to compensate the
buyer if and when any defaults occur. Expected credit losses significantly exceed $3,000.

Required
Help Entity A by evaluating the extent to which derecognition is appropriate in each of the above cases.

What are the main risks that pertain to financial instruments.

Usually The Market risk is comprised of:

(1) currency risk – the risk that the value of a financial instrument will fluctuate because of changes in
foreign exchange rates;

(2) interest rate risk – the risk that the value of a financial instrument will fluctuate because of changes in
market interest rates;

(3) other price risk – the risk that the value of a financial instrument will fluctuate as a result of changes in
market prices. Market risk embodies the potential for both loss and gain.
• Credit risk is the risk that one party to a financial instrument will fail to discharge an obligation and
cause the other party to incur a financial loss.
• Liquidity risk is the risk that an entity will encounter difficulty in meeting obligations associated with
financial liabilities. This is also known as funding risk.

Presentation & Disclosure issues

The purpose of disclosures prescribed by IFRS 7 is to:
aid understanding of entity’s financial position/ performance/cash flows, and assess amounts, timing and
certainty of future cash flows

*Statement of financial position & performance requires disclosures

-Categories of financial assets and liabilities- Carrying value for each of the 4 categories of financial assets
and the 2 categories of financial liabilities.

- Financial assets or financial liabilities at fair value through profit and loss – requires specific disclosures
about any loan or receivables that an entity has designated at fair value through profit and loss.

Any Reclassification- disclosure of the amount reclassified together with the reasons for the reclassification.

Any Derecognition- disclosure of assets that was dercognised during the year.

*Statement of comprehensive income & equity disclosures

Disclosure in respect to:
 Net gain and losses on
 - financial assets or liabilities at fair value through statement of comprehensive income
- Available for sale financial assets (AFS)
-Held to maturity investment
-Loans and receivables
-Financial liabilities measured at amortized cost.
- Total interest income and total interest expenses
- Fee Income and expenses
- Interest income on impaired financial assets
- The amount of impairment loss for each class of financial assets.

 Other Disclosures: para 20-30

- Accounting policies (measurement methods)
- Hedge accounting disclosures
* description of each type of hedge
*details of hedging instruments
*nature of risks being hedged
* substantial details about cash flow hedges and changes in FV hedges
- FV disclosures (methods & significant assumptions, value techniques, etc).

Reading Resource Materials

• IAS 32 Financial Instruments; Presentation refer to the website < http: // [Link]/
standard/ [Link]> (Accessed January 2015)

• IFRS 7 Financial Instruments, Disclosure refer to website < http: // [Link]/ standard/
[Link]> (Accessed January 2015)

• IAS 39 Financial Instruments:; Recognition and Measurement refer to the website < http: //
[Link]/ standard/ [Link]> (Accessed January 2015)

• McClintock, B. (1996) ‘International Financial instability and the financial derivatives market’,
Journal of Economic Issues, Vol.30, no.1, pp. 13-18, 5p.

• Strand, C M. & Elliott, J.A. (1998) ‘Risk and financial reporting: A summary of the discussion at the
1997 AAA/FASB conference’, Accounting Horizon, vol. 12, no.3 pp. 271 – 275, 5p.

• Moore, R. (2002) Accounting for financial instruments under IAS: The European dimension,
Balance Sheet, Volume: 10 Issue: 1, 1p.
 Discussion question

This questions illustrates how to apply the definition of a financial instrument and the
scope of IAS 32.

Facts: Company A is evaluating whether each of these items is a financial instrument and whether it should
be accounted for under IAS 32:
1. Cash deposited in banks
2. Forward contract to sell gold bullion- receipt/ delivery of gold bullion
3. Trade accounts receivable
4. Investments in debt instruments
5. Investment in subsidiary
6. Investments in equity instruments, where Company A does not have significant influence
over the investee
7. Investments in equity instruments, where Company A has significant influence over the investee
8. Prepaid expenses
9. Finance lease receivables or payables
10. Deferred revenue
11. Statutory tax liabilities
12. Provision for estimated litigation losses
13. An electricity purchase contract that can be net settled in cash
14. Issued debt instruments
15. Issued equity instruments

Required
Help Company A to determine (1) which of the above items meet the definition of a financial instrument and
(2) which of the above items fall within the scope of IAS 32.

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Discussion Question

Company A issues redeemable preference shares. The shares are redeemable for cash at the option of the
issuer. The shares carry a cumulative 6% dividend. In addition, the preference share dividend can be paid
only if a dividend on ordinary shares is paid for the relevant period. Company A is highly profitable and has
a history of paying ordinary dividends at a yield of about 4% annually without fail for the past 25 years.
Company A issued the preference shares after considering various options to raise finance for building a
new factory. The market interest rate for long-term debt at the time the preference shares were issued was
7%.

Required
• Determine whether this financial instrument should be classified as a financial liability or equity
instrument of company A. Give reasons for your answer.
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On October 31, 20X5, Entity A issues convertible bonds with a maturity of five years. The issue is for a total
of 1,000 convertible bonds. Each bond has a par value of $100,000, a stated interest rate is 5% per year,
and is convertible into 5,000 ordinary shares of Entity A. The convertible bonds are issued at par. The per-
share price for an Entity A share is $15. Quotes for similar bonds issued by Entity A without a conversion
option (i.e., bonds with similar principal and interest cash flows) suggest that they can be sold for $90,000.

Required
Indicate how Entity A should account for the compound instrument on initial recognition.
Determine whether the effective interest rate will be higher, lower, or equal to 5%.
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Entity A enters into a contract to purchase 5 million pounds of copper for a fixed price at a future date.
Copper is actively traded on the metals exchange and is readily convertible to cash.

Required : Discuss whether this contract falls within the scope of IAS 39.

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Explain the following terms with examples

a) highly probable
b) Financial Instrument
c) Fair value hedge
d) Cash flow hedge
e) Equity risk
f) Hedged item
g) Hedging instruments
h) Derivatives
i) Hedge accounting

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Tutorial Questions for Week 6

1. Discuss the concept of ‘equity risk’ and how it is useful in determining whether a financial instrument is a
financial liability or an equity instrument of the issuer.

2. What is the purpose of IFRS 7’s disclosure requirements?

3. Explain what an economic hedge is. Will hedge accounting always result in the same outcome as an
economic hedge?

4. Distinguish, explain and discuss the meaning of ‘highly effective’ and ‘highly probable’ in the context of
the hedge accounting rules in IAS 39.

5. Classify the following items as statement of comprehensive income/statement of changes in equity.

(a) Dividends paid on non-redeemable preference shares

(b) Dividends paid on preference shares redeemable at the holder’s option

(c) Interest paid on a five-year, fixed interest note

(d) Interest paid on a convertible note classified as a compound instrument

6. Which of the following is a financial instrument (i.e. a financial asset, financial liability, or equity
instrument in another entity) within the scope of IAS 32? Give reasons for your answer.
(a) Cash
(b) Investment in a debt instrument
(c) Investment in a subsidiary
(d) Provision for restoration of a mine site
(e) Buildings owned by the reporting entity
(f) Forward contract entered into by a bread manufacturer to buy wheat
(g) Forward contract entered into by a gold producer to hedge the future sales of gold
(h) General sales tax payable

7. Company A issues 100000 $1 convertible notes. The notes pay interest at 7%. The market rate for
similar debt without the conversion option is 9%. The note is not redeemable, but it converts at the option of
the holder into however many shares that will have a value of exactly $100000.

Required
Determine whether this financial instrument should be classified as a financial liability or equity instrument
of Company A. Give reasons for your answer.
8. Categorise each of the following common financial instruments as financial assets, financial liabilities or
equity instruments - of the issuer or the holder, as specified.

(a) Loans receivable (holder)

(b) Loans payable (issuer)
(c) Ordinary shares of the issuer
(d) The holder’s investment in the ordinary shares in part (c)
(e) Redeemable preference shares of the issuer, redeemable at any time at the option of the holder
(f) The holder’s investment in the preference shares in part (e)

9. Company A issues 100000 $1 redeemable convertible notes. The notes pay interest at 5%. They convert
at anytime at the option of the holder into 100000 ordinary shares.
The notes are redeemable at the option of the issuer for cash after 5 years. If after 5 years the note have
not been redeemed or converted, they cease to carry interest. Market rates for similar notes without the
conversion option are 7%.

Determine whether this financial instrument should be classified as a financial liability or equity instrument
of company A. Give reasons for your answer.

Research Question:

‘Financial Instruments are most controversial development areas in

recent times’
Research the above statement and discuss the expected future
developments on accounting for financial instruments and enlighten
the concept of hedge accounting (apply the rules to simple common
cash flow and fair value hedges). (Support your research findings with
SPSE’s listed entities)

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THE END