Advanced Financial Accounting and Corporate Reporting (Study Text) Page 22

IFRS 9 (Recognition, Classification and Measurement) – Class notes

RECOGNITION

An entity shall recognize a financial asset or a financial liability in its statement of financial position when
and only when the entity becomes party to the contractual provisions of the instrument. On initial
recognition the entity shall also classify financial asset or financial liability as per guidance discussed later
in this chapter.
Examples:
- Entity B transfers cash to Entity A as a collateral for a borrowing transaction. The cash is not legally
segregated from Entity A’s assets. Therefore, Entity A recognizes the cash as an asset and a payable
to Entity B, while Entity B derecognizes the cash and recognizes a receivable from Entity A.
- Assets to be acquired and liabilities to be incurred as a result of a firm commitment to purchase or
sell goods or services are generally not recognized until at least one of the parties has performed
under the agreement. For example, an entity that receives a firm order does not generally recognize
an asset (and the entity that places the order does not recognize a liability) at the time of the
commitment but, instead, delays recognition until the ordered goods or services have been shipped,
delivered or rendered.
- Planned future transactions, no matter how likely, are not assets and liabilities because the entity has
not become a party to a contract.

CLASSIFICATION OF FINANCIAL ASSETS

Financial assets which are debt instruments of other entity [e.g. investment in debentures]

An entity shall classify financial assets as subsequently measured at:

1) Amortized cost
2) Fair value through other comprehensive income
3) Fair value through profit or loss

1) Amortized cost
A financial asset shall be measured, except for 3(ii) below, at amortized cost if both of the following
conditions are met:
(i) the financial asset is held within a business model whose objective is to hold financial assets in order
to collect contractual cash flows and
(ii) 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.
Amortized cost
The amount at which the financial asset or financial liability is measured at initial recognition minus
the 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, for financial
assets, adjusted for any loss allowance.

2) Fair value through OCI

A financial asset shall be measured, except for 3(ii) below, at fair value through other comprehensive
income if both of the following conditions are met:
(i) the financial asset is held within a business model whose objective is achieved by both collecting
contractual cash flows and selling financial assets and

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 IFRS 9 (Recognition, Classification and Measurement) – Class notes

(ii) 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.

Business model
Any entity’s business model is determined at a level that reflects how groups of financial assets are
managed together to achieve a particular business objective. It does not depend on management’s
intentions for an individual instrument. However, an entity may have more than one business models
for managing its financial instruments. For example, an entity may hold a portfolio of investments that
it manages to collect contractual cash flows and another portfolio of investments that it manages in
order to trade to realize fair value changes.
This assessment is not performed on the basis of scenarios that the entity does not reasonably expect
to occur, such as so-called ‘worst case’ or ‘stress case’ scenarios. For example, if an entity expects that
it will sell a particular portfolio of financial assets only in a stress case scenario, that scenario would not
affect the entity’s assessment of the business model for those assets if the entity reasonably expects
that such a scenario will not occur.
Although the objective of an entity’s business model may be to hold financial assets in order to collect
contractual cash flows, the entity need not hold all of those instruments until maturity. Thus an entity’s
business model can be to hold financial assets to collect contractual cash flows even when sales of
financial assets occur or are expected to occur in the future.

Contractual cashflows comprise of:

Principal Interest
It is the fair value of the financial It consists of consideration for the time value of money, for the
asset at initial recognition. credit risk associated with the principal amount outstanding
during a particular period of time and for other basic lending
risks and costs, as well as a profit margin.

3) Fair value through P&L

A financial asset shall be measured at fair value through profit or loss if either:
(i) it cannot be classified as measured at amortized cost or fair value through OCI; or
(ii) an entity has, at initial recognition, irrevocably designated the financial asset as measured at fair value
through P&L if doing so eliminates or significantly reduces an accounting mismatch.

Financial assets which are equity instruments of other entity [e.g. investment in shares]
An entity shall classify financial assets as subsequently measured at:
1) Fair value through other comprehensive income
2) Fair value through profit or loss

A financial asset shall be measured at fair value through P&L (default method) unless an entity has made
an irrevocable election, at initial recognition, for particular investments in equity instruments if these are
not held for trading to present subsequent changes in fair value in OCI.

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 IFRS 9 (Recognition, Classification and Measurement) – Class notes

CLASSIFICATION OF FINANCIAL LIABILITIES

An entity shall classify all financial liabilities as subsequently measured at amortized cost except for:
(a) Financial liabilities, including derivatives that are liabilities, measured at fair value through P&L
An entity may, at initial recognition, irrevocably designate a financial liability as measured at fair
value through P&L if either:
- It eliminates or significantly reduces an accounting mismatch; or
- A group of financial liabilities is managed and its performance is evaluated on a fair value basis
in accordance with a documented risk management or investment strategy.
(b) Financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or
when the continuing involvement approach applies.
(c) Financial guarantee contracts.
(d) Commitments to provide a loan at a below-market interest rate.
(e) Contingent consideration recognized by an acquirer in a business combination.

INITIAL MEASUREMENT

Financial assets

Financial assets subsequently measured at Financial assets subsequently measured at fair

amortized cost or fair value through OCI: value at P&L:

Fair value of asset + transaction cost Fair value of asset

Financial liabilities

Financial liabilities subsequently measured at Financial liabilities subsequently measured at fair

amortized cost: value at P&L:

Fair value of liability – transaction cost Fair value of liability

Transaction costs
Incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset
or financial liability. An incremental cost is one that would not have been incurred if the entity had not
acquired, issued or disposed of the financial instrument.

Examples of transactions costs:

Include Do not include
• Fees and commission paid to agent, advisers, brokers • Debt premium and discounts
and dealers • Financing costs
• Levies by regulatory agencies and security exchanges • Internal administrative or holding costs
• Transfer taxes and duties

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 IFRS 9 (Recognition, Classification and Measurement) – Class notes

Important for initial measurement:

• Transaction costs for financial asset or financial liability subsequently measured at fair value
through P&L are recognized as expense when incurred.
• Transaction costs expected to be incurred on transfer or disposal of a financial instrument are not
included in the measurement of the financial instrument.
• Initial measurement of trade receivables shall be made in accordance with IFRS 15.
• Generally transaction price (i.e. fair value of consideration given or received) is equal to the fair
value of financial asset or financial liability at initial recognition, however, if transaction price is
different then, the difference on initial measurement shall be charged to P&L.
• Fair value of an interest free long-term loan is measured as the present value of all future cash
receipts discounted using the prevailing market interest rate for a similar instrument. Any additional
amount lent is an expense.

SUBSEQUENT MEASUREMENT [IGNORING IMPAIRMENT]

Financial assets

A financial asset which is an equity instrument of another entity

Types Treatment
(i) Equity investments which - At each reporting date and on de-recognition, the asset shall be
are not held for trading and, measured at fair value.
at initial recognition, entity - Any fair value gain or loss shall be recognized in other
has made irrevocable comprehensive income.
election for this treatment - It is a non-monetary item, therefore, as per IAS 21, its related foreign
[Fair value through OCI] exchange gain or loss shall also be recognized in OCI.
- Cumulative gain or loss recognized in OCI, shall not be reclassified to
profit or loss on de-recognition of the asset. However, it may be
transferred within equity e.g. retained earnings.
- Any dividend income shall be recognized in P&L, unless it clearly
represents a recovery of part of the cost of investment.
(ii) All other equity - At each reporting date and on de-recognition, the asset shall be
investments measured at fair value.
[Fair value through P&L] - Any fair value gain or loss shall be recognized in P&L.
(default measurement)
- It is non-monetary item, therefore, as per IAS 21, its related foreign
exchange gain or loss shall also be recognized in P&L.
- Any dividend income shall be recognized in P&L.

A financial asset which is a financial liability of another entity (e.g. loans)

Types Treatment
(i) If asset is classified as - The asset shall be measured at amortized cost using effective
measured at amortized cost interest rate method.
- Interest income using effective interest rate shall be recognized in
P&L.
- It is a monetary item, therefore, as per IAS 21 its exchange gain or
loss shall be recognized in P&L.
- Any gain or loss on derecognition shall be recognized in P&L.

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 IFRS 9 (Recognition, Classification and Measurement) – Class notes

(ii) If asset is classified as - At each reporting date and on de-recognition, the asset shall be
measured at fair value measured at fair value with any gain or loss recognized in other
through OCI comprehensive income.
- Interest income using effective interest rate shall be recognized in
profit or loss (i.e. same as calculated in amortized cost).
- Any foreign exchange gain/loss on amortized cost measured in
foreign currency shall be recognized in P&L.
- Cumulative fair value gain or loss, previously recognized in OCI, shall
be reclassified to profit or loss on de-recognition of the asset.

(All amounts recognized in P&L would be the same which would have
been recognized had the asset been measured at amortized cost)

(iii) If asset is classified as - At each reporting date and on de-recognition, the asset shall be
measured at fair value measured at fair value with any gain or loss recognized in profit or
through profit or loss loss.
- It is a monetary item, therefore, as per IAS 21 its exchange gain or
loss shall be recognized in P&L.
- Actual interest received is recognized in profit or loss. (Need of
accrual concept is accounted for accordingly)

Financial liabilities

Types Treatment
(i) If liability is classified as - The liability shall be measured at amortized cost using effective
measured at amortized cost interest rate method.
(default measurement) - Interest expense using effective interest rate shall be recognized in
P&L.
- Any gain or loss on derecognition shall be recognized in P&L.
(ii) If liability is classified as - At each reporting date, the liability shall be measured at fair value.
measured at fair value - Any change in fair value attributable to change in own credit risk is
through profit or loss recognized in OCI [Amount presented in OCI shall not be
subsequently transferred to P&L, however, the entity may transfer
the cumulative gain or loss within equity e.g. retained earnings]. The
remaining amount of change in the fair value of the liability shall be
presented in P&L. However, if it creates or enlarges accounting
mismatch, then entire fair value gain or loss shall be recognized in
P&L.
- Actual interest paid is recognized in profit or loss. (Need for accrual
concept is accounted for accordingly)

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 IFRS 9 (Recognition, Classification and Measurement) – Class notes

Estimating change in fair value of liability attributable to change in own credit risk:
Multiple methods can be used to estimate the amount of change in fair value attributable to change in
own credit risk. If the only significant relevant changes in market conditions for a liability are changes
in an observed (benchmark) interest rate, the amount of change in fair value attributable to change in
own credit risk can be estimated in following steps:
1) First find “Instrument-specific component” of IRR of the liability as
= IRR of liability at start of period (i.e. a market rate of return which is calculated using fair value of
liability and the contractual cash flows at the start of the period) LESS observed benchmark interest
rate (e.g. KIBOR) at start of period

2) Calculate the amount of change to be presented in OCI as follows:

Rs.
Fair value of liability at end of the period XXX
Present value of contractual cash flows of liability at end of year discounted at “Year (XXX)
end KIBOR + Instrument-specific component (as calculated in Step 1)”
(Gain)/Loss to be recognized in OCI XXX

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 IFRS 9 (Recognition, Classification and Measurement) – QUESTIONS (1)

PRACTICE QUESTIONS
Question 1
Following independent situations relate to financial assets:
(1) A Limited (AL) holds investments to collect their contractual cash flows. The funding needs of AL are predictable and
the maturity of investments matches to estimated funding needs. However, AL would sell an investment in particular
circumstances, perhaps to fund unanticipated capital expenditure, or because the credit rating of the instrument falls
below that required by AL’s investment policy.
(2) B Limited (BL) purchases portfolios of financial assets such as loans. If payment on the loans is not made on a timely
basis, the entity attempts to realize the contractual cash flows through various follow-up measures. BL’s objective is
to collect the contractual cash flows and it does not manage any of the loans in this portfolio with an objective of
realizing cash by selling them.
(3) C Limited (CL) has a business model with the objective of originating loans to customers and subsequently selling
those loans to a securitisation vehicle. The securitisation vehicle issues instruments to investors. CL controls the
securitisation vehicle and thus consolidates it. The securitisation vehicle collects the contractual cash flows from the
loans and passes them on to its investors. It is assumed for the purposes of this example that the loans continue to
be recognised in the consolidated statement of financial position because they are not derecognised by the
securitisation vehicle.
(4) D Limited (DL) expects to pay a cash outflow in ten years to fund capital expenditure and invests excess cash in short-
term financial assets. When the investments mature, DL reinvests the cash in new short-term financial assets. DL
maintains this strategy until the funds are needed, at which time DL uses the proceeds from the maturing financial
assets to fund the capital expenditure. Only sales that are insignificant in value occur before maturity (unless there is
an increase in credit risk).
(5) E Limited (EL) expects to incur capital expenditure in a few years’ time. EL invests its excess cash in short and long-
term financial assets so that it can fund the expenditure when the need arises. Many of the financial assets have
contractual lives that exceed EL’s anticipated investment period. EL will hold financial assets to collect the contractual
cash flows and, when an opportunity arises, it will sell financial assets to re-invest the cash in financial assets with a
higher return.
(6) F Bank holds financial assets to meet its everyday liquidity needs. The bank actively manages the return on the
portfolio in order to minimize the costs of managing those liquidity needs. That return consists of collecting
contractual payments as well as gains and losses from the sale of financial assets. F Bank holds financial assets to
collect contractual cash flows and sells financial assets to reinvest in higher yielding financial assets or to better match
the duration of its liabilities. In the past, this strategy has resulted in frequent sales activity and such sales have been
significant in value. This activity is expected to continue in the future
Required:
Briefly discuss how each of the above assets should be classified?

Question 2
Following independent situations relate to financial assets (i.e. investments in bonds):
(1) Bond A has a stated maturity date. Payments of principal and interest on the principal amount outstanding are linked
to an inflation index of the currency in which the bond is issued.
(2) Bond B is a variable interest rate instrument with a stated maturity date that permits the borrower to choose the
market interest rate on an ongoing basis. For example, at each interest rate reset date, the borrower can choose to
pay three-month LIBOR for a three-month term or one-month LIBOR for a one-month term.
(3) Bond C has a stated maturity date and pays a variable market interest rate. That variable interest rate is capped.
(4) Bond D is a full recourse loan and is secured by collateral.
(5) Bond E is convertible into fixed number of equity instruments of the issuer.
(6) Bond F is a perpetual bond but the issuer may call the instrument at any point and pay the holder the par amount
plus accrued interest due. It pays a market interest rate but payment of interest cannot be made unless the issuer is
able to remain solvent immediately afterwards. Deferred interest does not accrue additional interest.

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 IFRS 9 (Recognition, Classification and Measurement) – QUESTIONS (2)

Required:
For each of the above assets, briefly discuss whether contractual cashflows solely comprise of principal and interest?

Question 3
On 1 January 2018 Abacus Co purchases a debt instrument for its fair value of Rs. 100,000. The debt instrument is due to
mature on 31 December 2022 at par. The instrument has a face value of Rs. 125,000 and the instrument carries fixed
interest at 4.72% that is paid annually. (The effective interest rate is 10%.)
Required:
Show extracts of Income statement and Balance sheet for each of the five years till December 31, 2022.

Question 4
On May 14, 2018 Zain Limited (ZL) acquired 5,000 shares of a listed company for Rs. 27.50 per share (including Rs. 1.50
per share as broker’s commission). On that date the fair value of share was Rs. 25 per share. ZL had purchased these
shares with the intention of holding in long term. Moreover, it made an irrevocable election for designation as fair value
through other comprehensive income. On June 30, 2018 (i.e. year-end) fair value of shares moved to Rs. 28 per share.
This price further increased to Rs. 33 per share on June 30, 2019. On August 1, 2019 ZL sold 3,000 shares for Rs. 31 per
share. On June 30, 2020 fair value moved to Rs. 37 per share.

Required:

Journalize all of the above transactions.

Question 5
In January 1, 2018 Wolf Limited (WL) purchased 10 million shares of a listed company at a price of Rs. 25 per share
(whereas fair value was Rs. 25.50 per share). WL also paid transaction costs of Rs. 15 million. On November 30, 2018 WL
received a dividend of Rs. 4 per share. WL’s year end is December 31. At December 31, 2018, the shares were trading at
Rs. 28.
Required:
Show the financial statements extracts of WL at December 31, 2018 relating to the investment in shares if:
(i) The shares were bought for short term trading.
(ii) The shares were bought as a source of dividend income and were the subject of an irrevocable election at initial
recognition to recognize them at fair value through other comprehensive income.

Question 6
On January 1, 2018, Tokyo Limited (TL) bought Rs. 100,000 (nominal value) 5% bonds for Rs. 95,000 (fair value), incurring
transactions costs of Rs. 2,000. Interest is received at end of every year. The bonds will be redeemed at a premium of Rs.
5,960 over nominal value on December 31, 2020. The effective rate of interest is 8%. The fair value of the bond was as
follows:

Date Fair value (Rs.)

December 31, 2018 110,000
December 31, 2019 104,000

On January 1, 2020 TL sold this bond for Rs. 105,000.

Required:
Journalize all above transactions over all relevant years if:
(a) TL's business model is to hold bonds until the redemption date and collect contractual cash flows.
(b) TL's business model is to hold bonds until redemption but also to sell them if investments with higher returns become
available.
(c) TL's business model is to buy and sell bonds in the short term to gain from fair value changes.

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 IFRS 9 (Recognition, Classification and Measurement) – QUESTIONS (3)

Question 7
On January 1, 2018, Sialkot Limited (SL) bought 100 Euro-dollar bonds at a price of $ 50 each and incurred transaction
cost of $ 0.5 per bond. The bonds will be redeemed at a premium of 20% over face value of $ 40 each after four years.
Coupon rate is 10%. The effective rate of interest is 6.80%.

The exchange rates and fair value of the bond were as follows:

Date Exchange rate Fair value

(Rs. per $) ($)
01-01-18 150 50
31-12-18 152 51
31-12-19 153 48

Required:
Journalize all transactions for the years ending December 31, 2018 and 2019 if:
(a) SL's business model is to hold bonds until the redemption date and collect contractual cash flows.
(b) SL's business model is to hold bonds until redemption but also to sell them if investments with higher returns become
available.

Question 8
Decent Limited (DL) issued following bonds on January 1, 2019:
1) Face value = Rs. 150,000
Issued at a discount of 5%
Coupon rate = 7%
Redemption after 4 years at a premium of 10%
Effective interest rate = 10.734%
2) Face value = Rs. 80,000
Issued at a premium of 10%
Issue costs = Rs. 2,000
Contractual cash flows:
31-12-19 – Rs. 9,500
31-12-20 – Rs. 41,500
31-12-21 – Rs. 52,700
Effective interest rate = 8.111%
3) Face value = Rs. 100,000
Coupon rate = zero
Issued at a discount of 25%
Redemption after 4 years at par
Effective interest rate = 7.457%
Required:

(a) Prepare complete schedules for amortized cost calculation for each bond.

(b) Journalize all the transactions for the year ending December 31, 2019.

(c) Show extracts of SOFP and SOCI for the year ending December 31, 2019.

Question 9
On January 1, 2018 Engro Limited (EL) issued debentures (nominal value Rs. 50,000) at a premium of 10%. Coupon rate is
10% payable at end of every year. A broker commission of 4% of nominal value was paid on issuance. These debentures
will be redeemed at a premium of 5% after 3 years.

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 IFRS 9 (Recognition, Classification and Measurement) – QUESTIONS (4)

Required:

(a) Calculate effective interest rate to be used for amortized cost calculation.
(b) Journalize all transactions for all three years.

Question 10
On January 1, 2018 Alpha Limited (AL) issued 9% debentures at nominal value of Rs. 80,000 to finance a certain investment
in assets. The management has decided to classify these debentures to be measured at fair value through profit and loss.
AL’s credit rating was also changed in subsequent years due to some factors. These debentures were revalued to fair
values as follows:

Date of fair value Fair value

31-12-18 Rs. 88,000 (Fair value loss of Rs. 3,000 is attributable to change in credit rating of AL)
31-12-19 Rs. 82,000 (Fair value gain of Rs. 7,000 is attributable to change in credit rating of AL)

Required:

(a) Show extracts of Statement of comprehensive income and Statement of financial position for the years ending
December 31, 2018 and 2019.
(b) Journalize above transactions for the years ending December 31, 2018 and 2019.

Question 11
Beta Limited (BL) issued 8% debentures some years ago. These debentures will be redeemed at par (i.e. Rs. 100,000) on
December 31, 2023. On January 1, 2019 the fair value of debentures was Rs. 100,000 showing a market rate of return of
8% (i.e. IRR of fair value and contractual cashflows over remaining life). On that date KIBOR was 5%.

On December 31, 2019 KIBOR moved to 5.75% and fair value of BL’s debentures moved to Rs. 95,972 showing a market
rate of return of 9.25%.

On December 31, 2020 KIBOR moved to 5.50% and fair value of BL’s debentures moved to Rs. 95,026 showing a market
rate of return of 10%.

It is BL’s policy to measure financial liabilities at fair value through P&L.

Required:
Calculate fair value gain/loss to be recognized in OCI and P&L for the years ending December 31, 2019 and 2020.

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 IFRS 9 (Recognition, Classification and Measurement) – SOLUTIONS (1)

SOLUTIONS
Solution No. 1
(1) Although AL may consider, among other information, the financial assets' fair values from a liquidity perspective (i.e.
the cash amount that would be realised if AL needs to sell assets), AL’s objective is to hold the financial assets and
collect the contractual cash flows. Therefore, these assets shall be classified as measured at amortized cost.

(2) The objective of BL’s business model is to hold financial assets to collect contractual cash flows. Therefore, these
assets shall be classified as measured at amortized cost.

(3) The consolidated group originated the loans with the objective of holding them to collect the contractual cash flows.
However, CL has an objective of realising cash flows on the loan portfolio by selling the loans to the securitisation
vehicle, so for the purposes of its separate financial statements it would not be considered to be managing this
portfolio in order to collect the contractual cash flows and thus classified as measured at fair value through OCI.

(4) The objective of DL’s business model is to hold financial assets to collect contractual cash flows. Selling financial
assets is only incidental to DL’s business model. Therefore, these assets shall be classified as measured at amortized
cost.

(5) The objective of the business model is achieved by both collecting contractual cash flows and selling financial assets.
EL decides on an ongoing basis whether collecting contractual cash flows or selling financial assets will maximise the
return on the portfolio until the need arises for the invested cash. Therefore, these assets shall be measured at fair
value through other comprehensive income.

(6) The objective of the business model is to maximise the return on the portfolio to meet everyday liquidity needs and
F Bank achieves that objective by both collecting contractual cash flows and selling financial assets. In other words,
both collecting contractual cash flows and selling financial assets are integral to achieving the business model’s
objective. Therefore, these assets shall be measured at fair value through other comprehensive income.

Solution No. 2
(1) The contractual cash flows are solely payments of principal and interest on the principal amount outstanding. Linking
payments of principal and interest on the principal amount outstanding to an unleveraged inflation index resets the
time value of money to a current level. In other words, the interest rate on the instrument reflects ‘real’ interest.
Thus, the interest amounts are consideration for the time value of money on the principal amount outstanding.
However, if the interest payments were indexed to another variable such as the debtor’s performance (eg the
debtor’s net income) or an equity index, the contractual cash flows are not payments of principal and interest on the
principal amount outstanding.

(2) The contractual cash flows are solely payments of principal and interest on the principal amount outstanding as long
as the interest paid over the life of the instrument reflects consideration for the time value of money, for the credit
risk associated with the instrument and for other basic lending risks and costs, as well as a profit margin. The fact that
the LIBOR interest rate is reset during the life of the instrument does not in itself disqualify the instrument. However,
if the borrower is able to choose to pay a one-month interest rate that is reset every three months, the interest rate
is reset with a frequency that does not match the tenor of the interest rate. Consequently, the time value of money
element is modified. Similarly, if an instrument has a contractual interest rate that is based on a term that can exceed
the instrument’s remaining life (for example, if an instrument with a five-year maturity pays a variable rate that is
reset periodically but always reflects a five-year maturity), the time value of money element is modified. That is
because the interest payable in each period is disconnected from the interest period.

(3) The contractual cash flows of both:

(a) an instrument that has a fixed interest rate; and
(b) an instrument that has a variable interest rate

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 IFRS 9 (Recognition, Classification and Measurement) – SOLUTIONS (2)

are payments of principal and interest on the principal amount outstanding as long as the interest reflects
consideration for the time value of money, for the credit risk associated with the instrument during the term of the
instrument and for other basic lending risks and costs, as well as a profit margin.

(4) The fact that a full recourse loan is collateralized does not in itself affect the analysis of whether the contractual cash
flows are solely payments of principal and interest on the principal amount outstanding.

(5) The holder would analyze the convertible bond in its entirety. The contractual cash flows are not payments of
principal and interest on principal amount outstanding because they reflect a return that is inconsistent with a basic
lending arrangement i.e. the return is linked to the value of the equity of the issuer.

(6) The contractual cashflows are not payments of principal and interest on the principal amount outstanding because
the issuer may be required to defer interest payments and additional interest does not accrue on those deferred
interest amounts. As a result, interest amounts are not consideration for the time value of money on the principal
amount outstanding.

Solution 3
2018 2019 2020 2021 2022
-------------------------------------- Rs. --------------------------------------
Income statement - extracts

Interest income 10,000 10,410 10,861 11,357 11,872

Balance sheet - extracts

Non-current assets
Investment 104,100 108,610 113,571 - -

Current assets
Investment - - - 119,028 -

W-1
Opening Closing
Date Interest Cashflow
balance balance
[A] [B = A x 10%] [C] [A + B - C]

31-12-18 100,000 10,000 5,900 104,100

31-12-19 104,100 10,410 5,900 108,610
31-12-20 108,610 10,861 5,900 113,571
31-12-21 113,571 11,357 5,900 119,028
31-12-22 119,028 11,872 130,900 -

Solution 4
Dr. Cr.
-------- Rs. -------
14-05-18 Investment [5,000 x (25 + 1.50)] 132,500
P&L [5,000 x (27.50 – 25 – 1.50)] 5,000
Cash [5,000 x 27.50] 137,500
[Initial recognition]

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 IFRS 9 (Recognition, Classification and Measurement) – SOLUTIONS (3)

30-06-18 Investment [5,000 x (Rs. 28 - Rs. 26.5)] 7,500

Fair value reserve [OCI] 7,500
[Re-measurement at fair value]

30-06-19 Investment [5,000 x (Rs. 33 - Rs. 28)] 25,000

Fair value reserve [OCI] 25,000
[Re-measurement at fair value]

01-08-19 Fair value reserve [OCI] 6,000

Investment [3,000 x (Rs. 33 – Rs. 31)] 6,000
[Re-measurement at fair value]

01-08-19 Cash [3,000 x Rs. 31] 93,000

Investment 93,000
[Sale of 3,000 shares]

30-06-20 Investment [2,000 x (Rs. 37 - Rs. 33)] 8,000

Fair value reserve [OCI] 8,000
[Re-measurement at fair value]

Solution 5
(i)
Rs. million
SOCI – extracts
Dividend income [10m x Rs. 4] 40.00
Gain on initial recognition [10m x Rs. 0.50] 5.00
Transaction cost (15.00)
Fair value gain [(Rs. 28 – Rs. 25.50) x 10m] 25.00

SOFP – extracts
Non-current assets
Investment [10m x Rs. 28] 280.00

(ii)

SOCI – extracts
Dividend income [10m x Rs. 4] 40.00
Gain on initial recognition 5.00
Other comprehensive income:
Fair value gain [(Rs. 28 x 10m - (Rs. 25.50 x 10m + Rs. 15m)] 10.00

SOFP – extracts
Equity
Fair value reserve 10.00

Non-current assets
Investment [10m x Rs. 28] 280.00

NASIR ABBAS FCA

 IFRS 9 (Recognition, Classification and Measurement) – SOLUTIONS (4)

Solution 6
(a) Asset shall be measured at amortized cost
Dr. Cr.
-------- Rs. -------
01-01-18 Investment [95,000 + 2,000] 97,000
Cash 97,000
[Initial recognition]

31-12-18 Investment 7,760

Investment income (W-1) 7,760
[Investment income for 2018]

31-12-18 Cash [100,000 x 5%] 5,000

Investment 5,000
[Interest received for 2018]

31-12-19 Investment 7,981

Investment income (W-1) 7,981
[Investment income for 2019]

31-12-19 Cash 5,000

Investment 5,000
[Interest received for 2019]

01-01-20 Cash 105,000

Investment (W-1) 102,741
Profit on disposal 2,259
[Sale of investment]

(b) Asset shall be measured at fair value through OCI

01-01-18 Investment [95,000 + 2,000] 97,000
Cash 97,000
[Initial recognition]

31-12-18 Investment 7,760

Investment income (W-1) 7,760
[Investment income for 2018]

31-12-18 Cash 5,000

Investment 5,000
[Interest received for 2018]

31-12-18 Investment (W-1) 10,240

Fair value reserve [OCI] 10,240
[Fair value gain 2018]

31-12-19 Investment 7,981

Investment income (W-1) 7,981
[Investment income for 2019]
31-12-19 Cash 5,000
Investment 5,000
[Interest received for 2019]

NASIR ABBAS FCA

 IFRS 9 (Recognition, Classification and Measurement) – SOLUTIONS (5)

31-12-19 Fair value reserve [OCI] 8,981

Investment (W-1) 8,981
[Fair value loss 2019]

01-01-20 Cash 105,000

Investment 104,000
Profit on disposal 1,000
[Sale of investment]

01-01-20 Fair value reserve [OCI] 1,259

P&L (W-1) 1,259
[Cumulative gain reclassified to P&L]

(c) Asset shall be measured at fair value through P&L

01-01-18 Investment 95,000

P&L (transaction costs) 2,000
Cash 97,000
[Initial recognition]

31-12-18 Investment [110,000 - 95,000] 15,000

P&L 15,000
[Fair value gain for 2018]

31-12-18 Cash 5,000

Investment income 5,000
[Interest received for 2018]

31-12-19 P&L [110,000 - 104,000] 6,000

Investment 6,000
[Fair value loss for 2019]

31-12-19 Cash 5,000

Investment income 5,000
[Interest received for 2019]

01-01-20 Cash 105,000

Investment 104,000
Profit on disposal 1,000
[Sale of investment]

W-1
Opening Closing Fair Fair value
Date Interest Cashflow OCI
balance balance value reserve
[A] [B = A x 8%] [C] [D = A + B - C] [E] [F = E - D] [Change in F]

31-12-18 97,000 7,760 5,000 99,760 110,000 10,240 10,240

31-12-19 99,760 7,981 5,000 102,741 104,000 1,259 (8,981)

NASIR ABBAS FCA

 IFRS 9 (Recognition, Classification and Measurement) – SOLUTIONS (6)

Solution 7
(a) Measured at amortized cost Dr. Cr.
-------- Rs. -------
01-01-18 Investment [(50 + 0.5) x 100 x Rs. 150] 757,500
Cash 757,500
[Initial recognition]

31-12-18 Investment [$343(W-1) x Rs. 152] 52,136

Investment income (W-1) 52,136
[Investment income for 2018]

31-12-18 Cash [$400 x Rs. 152] 60,800

Investment 60,800
[Interest received for 2018]

31-12-19 Investment [$340(W-1) x Rs. 153] 52,020

Investment income (W-1) 52,020
[Investment income for 2019]

31-12-19 Cash [$400 x Rs. 153] 61,200

Investment 61,200
[Interest received for 2019]

(b) Measured at fair value through OCI Dr. Cr.

-------- Rs. -------
01-01-18 Investment [(50 + 0.5) x 100 x Rs. 150] 757,500
Cash 757,500
[Initial recognition]

31-12-18 Investment [$343(W-1) x Rs. 152] 52,136

Investment income (W-1) 52,136
[Investment income for 2018]

31-12-18 Cash [$400 x Rs. 152] 60,800

Investment 60,800
[Interest received for 2018]

31-12-18 Investment (W-1) 26,364

Exchange gain (P&L) (W-2) 10,100
Fair value reserve [OCI] (W-2) 16,264
[Fair value gain & exchange gain 2018]

31-12-19 Investment [$340(W-1) x Rs. 153] 52,020

Investment income (W-1) 52,020
[Investment income for 2019]

31-12-19 Cash [$400 x Rs. 153] 61,200

Investment 61,200
[Interest received for 2019]

NASIR ABBAS FCA

 IFRS 9 (Recognition, Classification and Measurement) – SOLUTIONS (7)

31-12-19 Fair value reserve [OCI] (W-2) 36,613

Investment 31,620
Exchange gain (P&L) (W-2) 4,993
[Fair value loss & exchange gain 2019]

W-1
------------------------ $ Amortized cost ------------------------- Rupees
amortized
Date Opening Closing
Interest Cashflow cost
balance balance (translated)
[A] [B = A x 6.8%] [C] [D = A + B - C] [E]
31-12-18 5,050 343 400 4,993 758,936 [4,993 x 152]
31-12-19 4,993 340 400 4,933 754,749 [4,933 x 153]

W-2
------------------------ Translated values (ignoring FV change) -------------------------
Date Opening Exchange Closing
Interest Cashflow
balance gain/(loss) balance
(balancing figure)
--------------------------------------------- Rs. ------------------------------------------------
31-12-18 757,500 52,136 60,800 10,100 758,936
31-12-19 758,936 52,020 61,200 4,993 754,749

W-3
Amortized Fair value Fair value
Date OCI
cost (translated) reserve
[E] [F] [G = F – E] [Change in G]
--------------------------- Rs. -----------------------------------
31-12-18 758,936 775,200 16,264 16,264
[5,100 x 152]
31-12-19 754,749 734,400 (20,349) (36,613)
[4,800 x 153]

Exam note for students:

If average exchange rate for the period is given then interest income for the year can be required to be translated at
average exchange rate.

Solution 8
(a) ------------------------------- Rs. -----------------------------
Bond - 1
Opening Closing
Date Interest Cashflow
balance balance
[A] [B = A x 10.734%] [C] [A + B - C]

31-12-19 142,500 15,296 10,500 147,296

31-12-20 147,296 15,811 10,500 152,607
31-12-21 152,607 16,381 10,500 158,488
31-12-22 158,488 17,012 175,500 -

NASIR ABBAS FCA

 IFRS 9 (Recognition, Classification and Measurement) – SOLUTIONS (8)

Bond - 2 ------------------------------- Rs. -----------------------------

Opening Closing
Date Interest Cashflow
balance balance
[A] [B = A x 8.111%] [C] [A + B - C]

31-12-19 86,000 6,975 9,500 83,475

31-12-20 83,475 6,771 41,500 48,746
31-12-21 48,746 3,954 52,700 -

Bond - 3
Opening Closing
Date Interest Cashflow
balance balance
[A] [B = A x 7.457%] [C] [A + B - C]

31-12-19 75,000 5,593 - 80,593

31-12-20 80,593 6,010 - 86,603
31-12-21 86,603 6,458 - 93,061
31-12-22 93,061 6,939 100,000 -

(b) Dr. Cr.

Bond - 1 -------- Rs. -------

01-01-19 Cash [150,000 x 95%] 142,500

Bonds 142,500
[Initial recognition]

31-12-19 Finance cost [142,500 x 10.734%] 15,296

Bonds 15,296
[Finance cost for the year]

31-12-19 Bonds [150,000 x 7%] 10,500

Cash 10,500
[Interest payment for the year]

Bond - 2

01-01-19 Cash [80,000 x 1.1 - 2,000] 86,000

Bonds 86,000
[Initial recognition]

31-12-19 Finance cost [86,000 x 8.111%] 6,975

Bonds 6,975
[Finance cost for the year]

31-12-19 Bonds 9,500

Cash 9,500
[Interest payment for the year]

NASIR ABBAS FCA

 IFRS 9 (Recognition, Classification and Measurement) – SOLUTIONS (9)

Bond - 3
Dr. Cr.
-------- Rs. -------
01-01-19 Cash [100,000 x 75%] 75,000
Bonds 75,000
[Initial recognition]

31-12-19 Finance cost [75,000 x 7.457%] 5,593

Bonds 5,593
[Finance cost for the year]

Solution No. 9
(a) ------ 5% ------ -------- 10% -------
Factor PV Factor PV
Initial recognition [50,000 x 1.1 - 50,000 x 4%] (53,000) 1.000 (53,000) 1.000 (53,000)
Year 1 payment [50,000 x 10%] 5,000 0.952 4,760 0.909 4,545
Year 2 payment [50,000 x 10%] 5,000 0.907 4,535 0.826 4,130
Year 3 payment [50,000 x 10% + 50,000 x 1.05] 57,500 0.864 49,680 0.751 43,183
5,975 (1,143)

Effective interest rate = 5% + [5,975/(5,975 + 1,143)] x 5% = 9.20%

(b)
Dr. Cr.
-------- Rs. -------
01-01-18 Cash 53,000
Debentures 53,000
[Initial recognition]

31-12-18 Finance cost 4,875

Debentures 4,875
[Finance cost for the 2018]

31-12-18 Debentures 5,000

Cash 5,000
[Interest payment for the 2018]

31-12-19 Finance cost 4,863

Debentures 4,863
[Finance cost for the 2019]

31-12-19 Debentures 5,000

Cash 5,000
[Interest payment for the 2019]

31-12-20 Finance cost 4,762

Debentures 4,762
[Finance cost for the 2019]

31-12-20 Debentures 57,500

Cash 57,500
[Interest and redemption payment]

NASIR ABBAS FCA

 IFRS 9 (Recognition, Classification and Measurement) – SOLUTIONS (10)

W-1
Date Opening balance Interest Cashflow Closing balance

[A] [B = A x 9.2%] [C] [A + B - C]

31-12-18 53,000 4,875 5,000 52,875

31-12-19 52,875 4,863 5,000 52,738
31-12-20 52,738 4,762 57,500 0

Solution No. 10
(a) 2018 2019
-------------- Rs. ----------------
SOCI – extracts
Interest expense [80,000 x 9%] (7,200) (7,200)
Fair value gain / (loss) [W-1] (5,000) (1,000)
Other comprehensive income:
Fair value gain / (loss) (3,000) 7,000
SOFP - extracts
Equity
Fair value reserve (3,000) 4,000

Non-current liabilities
Debentures 88,000 82,000
(b)
Dr. Cr.
-------- Rs. -------
01-01-18 Cash 80,000
Debentures 80,000
[Initial recognition]

31-12-18 Finance cost [80,000 x 9%] 7,200

Cash 7,200
[Finance cost for the 2018]

31-12-18 P&L 5,000

Fair value reserve [OCI] 3,000
Debentures 8,000
[Fair value loss for 2018]

31-12-19 Finance cost 7,200

Cash 7,200
[Finance cost for the 2019]

31-12-19 P&L 1,000

Debentures 6,000
Fair value reserve [OCI] 7,000
[Fair value gain for 2019]

NASIR ABBAS FCA

 IFRS 9 (Recognition, Classification and Measurement) – SOLUTIONS (11)

W-1 2018 2019

---------- Rs. ----------
FV gain/(loss) to be recognized in:
OCI (3,000) 7,000
P&L (balancing) (5,000) (1,000)
Total [88 - 80] [82 - 88] (8,000) 6,000

Solution No. 11
Calculation for 2019
01-01-19
Market rate for valuation 8%
Cashflows PV
(Rs.) (Rs.)
It is only shown for students
31-12-19 8,000 7,407
knowledge about calculation of
31-12-20 8,000 6,859
market value which is already
31-12-21 8,000 6,351 given in questions
31-12-22 8,000 5,880
31-12-23 108,000 73,503
Market value [A] 100,000

IRR 8.00%
KIBOR 5.00%
Instrument-specific component for 2019 3.00%

31-12-19
Market rate for valuation 9.25%
Cashflows PV
(Rs.) (Rs.) It is only shown for students
31-12-20 8,000 7,323 knowledge about calculation of
31-12-21 8,000 6,703 market value which is already
31-12-22 8,000 6,135 given in questions
31-12-23 108,000 75,812
Market value [B] 95,972

KIBOR 5.75%
Instrument-specific component 3.00%
Discount rate to find OCI portion 8.75%

Present value:
Rate to find OCI portion 8.75%
Cashflows PV
(Rs.) (Rs.)
31-12-20 8,000 7,356
31-12-21 8,000 6,764
31-12-22 8,000 6,220
31-12-23 108,000 77,216
[C] 97,557

NASIR ABBAS FCA

 IFRS 9 (Recognition, Classification and Measurement) – SOLUTIONS (12)

Fair value gain/(loss) for the year 2019 Rs.

Total fair value gain/(loss) [A - B] 4,028
Far value gain/(loss) in OCI [C - B] 1,584
Far value gain/(loss) in P&L (balancing) 2,443

Calculation for 2020

01-01-20
Market value [A] 95,972

IRR 9.25%
KIBOR 5.75%
Instrument-specific component for 2020 3.50%

31-12-20

Market rate for valuation 10.00%

Cashflows PV
It is only shown for students
(Rs.) (Rs.)
knowledge about calculation of
31-12-21 8,000 7,273
market value which is already
31-12-22 8,000 6,612 given in questions
31-12-23 108,000 81,142
Market value [B] 95,026

KIBOR 5.50%
Instrument-specific component 3.50%
Discount rate to find OCI portion 9.00%

Present value:
Rate to find OCI portion 9.00%
Cashflows PV
(Rs.) (Rs.)
31-12-21 8,000 7,339
31-12-22 8,000 6,733
31-12-23 108,000 83,396
[C] 97,469

Fair value gain/(loss) for the year 2019 Rs.

Total fair value gain/(loss) [A - B] 946
Far value gain/(loss) in OCI [C - B] 2,442
Far value gain/(loss) in P&L (balancing) (1,496)

NASIR ABBAS FCA

 IFRS 9 (Regular way transactions and Impairment) – Class notes

REGULAR WAY PURCHASE OR SALE

It is a purchase or sale of a financial asset under a contract whose terms require delivery of the asset
within the time frame established generally by regulation or convention in the marketplace concerned.
(e.g. Pakistan Stock Exchange)

Following two methods are allowed for accounting for regular way purchase or sale of financial assets:
1) Trade date accounting
2) Settlement date accounting

Trade date
The trade date is the date that an entity commits itself to purchase or sell an asset.

Settlement date
The settlement date is the date that an asset is delivered to or by an entity.

1) Trade date accounting

Purchase of financial asset

On trade date Financial asset is recognized at the amount as already studied earlier
depending upon the class of asset (i.e. initial measurement) and a
corresponding payable is recognized as payment has not yet been
made.

Dr. Financial asset (i.e. purchased)

Cr. Payable

Fair value changes at year-end Gain/loss on changes in fair value of the financial asset is accounted for
(if it arrives between Trade as studied earlier depending upon the class of asset (i.e. as follows):
date and Settlement date) – Not applicable (for amortized cost class)
– Recognized in OCI (for FV through OCI class)
– Recognized in P&L (for FV through P&L class)

On settlement date (i) Payable is settled

Dr. Payable
Cr. Cash

(ii) Further gain/loss on changes in fair value of the financial asset is

accounted for as studied earlier depending upon the class of asset
(i.e. as follows):
– Not applicable (for amortized cost class)
– Recognized in OCI (for FV through OCI class)
– Recognized in P&L (for FV through P&L class)

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 IFRS 9 (Regular way transactions and Impairment) – Class notes

Sale of financial asset

On trade date Financial asset is de-recognized and a gain or loss on de-recognition is

recognized in P&L/OCI (as studied earlier) and a corresponding
receivable is recognized at sale value (i.e. fair value at trade date).

Dr. Receivable
Cr. Financial asset
Dr. / Cr. OCI (if it would be classified as measured at FV through OCI)
Dr./Cr. P&L (if it would be classified as measured at FV through P&L)

[In case of debt instrument classified at fair value through OCI,

cumulative gain/loss shall be reclassified to P&L as studied earlier]

Fair value changes at year-end No entry as the financial asset is already derecognized.
(if it arrives between Trade
date and Settlement date)

On settlement date Receivable is settled

Dr. Cash
Cr. Receivable

2) Settlement date accounting

Purchase of financial asset

On trade date No accounting

Fair value changes at year-end Though no investment has yet been recognized even then a gain/loss
(if it arrives between Trade on changes in fair value of the financial asset (except where it will be
date and Settlement date) classified as measured at amortized cost) is accounted for as follows (as
studied earlier depending upon the class of asset to be used):

Dr. Receivable
Cr. OCI (if it would be classified as measured at FV through OCI)
Cr. P&L (if it would be classified as measured at FV through P&L

[Above entry is an example of fair value gain. In case of fair value

loss, it is reverse]

On settlement date The financial asset is now recognized as follows:

If asset is classified as measured at amortized cost:

Dr. Financial asset [fair value of trade date]
Cr. Cash [fair value of trade date]

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 IFRS 9 (Regular way transactions and Impairment) – Class notes

If asset is classified as measured at fair value through OCI:

Dr. Financial asset [fair value of settlement date]
Cr. Cash [fair value of trade date]
Cr. Receivable
Dr./Cr. OCI [balancing figure]

If asset is classified as measured at fair value through P&L:

Dr. Financial asset [fair value of settlement date]
Cr. Cash [fair value of trade date]
Cr. Receivable
Dr./Cr. P&L [balancing figure]

Sale of financial asset

On trade date Although the financial asset is not de-recognized but a gain or loss on
changes in fair value of the financial asset is accounted for as follows:
– Not applicable (for amortized cost class)
– Recognized in OCI (for FV through OCI class)
– Recognized in P&L (for FV through P&L class)

Fair value changes at year- No further gain/loss on fair value changes is recognized because the
end (if it arrives between entity’s right to changes in the fair value ceased on trade date.
Trade date and Settlement
date)

On settlement date The financial asset is now de-recognized as follows:

If asset was classified as measured at amortized cost:

Dr. Cash [fair value of trade date]
Cr. Financial asset [Carrying amount]
Dr./Cr. Profit or loss on disposal

If asset was classified as measured at fair value through OCI:

Dr. Cash [fair value of trade date]
Cr. Financial asset [fair value of trade date]

[In case of debt instrument, cumulative gain/loss shall be reclassified

to P&L as studied earlier]

If asset was classified as measured at fair value through P&L:

Dr. Cash [fair value of trade date]
Cr. Financial asset [fair value of trade date]

Nasir Abbas FCA Page 3 | 8

 IFRS 9 (Regular way transactions and Impairment) – Class notes

IMPAIRMENT OF FINANCIAL ASSETS

Impairment does not apply to:

- Financial assets which are equity instruments of other entity
- Financial assets which are debt instruments of other entity and measured at FV through P&L

Following terms should be understood first to discuss the topic of impairment of financial assets:
Key terms
Credit loss
The difference between all contractual cash flows that are due to an entity in accordance with the
contract and all the cash flows that the entity expects to receive (i.e. all cash shortfalls), discounted at
the original effective interest rate (or credit-adjusted effective interest rate for purchased or
originated credit-impaired financial assets).

Expected credit losses

The weighted average of credit losses with the respective risks of a default occurring as the weights.

Lifetime expected credit losses

The expected credit losses that result from all possible default events over the expected life of a
financial instrument.

12-months expected credit losses

The portion of lifetime expected credit losses that represent the expected credit losses that result
from default events on a financial instrument that are possible within the 12 months after the reporting
date.

Credit-impaired financial asset

A financial asset is credit-impaired when one or more events that have a detrimental impact on the
estimated future cash flows of that financial asset have occurred.

Purchased or originated credit-impaired financial asset

Purchased or originated financial asset(s) that are credit-impaired on initial recognition.

Credit-adjusted effective interest rate

The rate that exactly discounts the estimated future cash payments or receipts through the expected
life of the financial asset to the amortized cost of a financial asset that is a purchased or originated
credit-impaired financial asset.

1) Expected credit losses

IAS 36 covers impairment of most of the non-current assets (except for financial assets) and it operates
an incurred loss model. This means that impairment is recognized only when an event has occurred which
has caused a fall in recoverable amount of asset. However, IFRS 9 operates an expected loss model. It is
no longer necessary for a credit event to have occurred before credit losses are recognized. Instead, an
entity always accounts for expected credit losses, and changes in those expected credit losses. The
amount of expected credit losses is updated at each reporting date to reflect changes in credit risk since
initial recognition and, consequently, more timely information is provided about expected credit losses.

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 IFRS 9 (Regular way transactions and Impairment) – Class notes

1.1 – RECOGNITION OF EXPECTED CREDIT LOSSES

(a) General approach

1. An entity shall recognize an allowance for expected losses at an amount equal to 12-months expected
credit losses at initial recognition.

2. An entity shall measure the allowance for expected credit losses at each reporting date:

If the credit risk on that financial instrument If the credit risk on that financial instrument
has increased significantly since initial has NOT increased significantly since initial
recognition: recognition:

At an amount equal to lifetime expected credit At an amount equal to 12-months expected

losses credit losses

Important
o Changes in credit risk can be assessed on an individual or collective basis considering all
reasonable and supportable information.
o When making the assessment of changes in credit risk, an entity shall use the change in the risk
of a default occurring over the expected life instead of the change in the amount of expected
credit losses.
o If reasonable and supportable forward-looking information is available without undue cost or
effort, an entity cannot rely solely on past due information when determining whether credit
risk has increased significantly since initial recognition.
o There is a rebuttable presumption that the credit risk on a financial asset has increased
significantly since initial recognition when contractual payments are more than 30 days past
due. However, ‘30 days past due’ is not a must for assessment of credit risk.

3. If previously a loss allowance has been recognized at lifetime expected credit losses but now the
change in credit risk is not significant since initial recognition, then entity shall measure the loss
allowance at 12-months expected credit losses at current reporting date.

4. Initial recognition of loss allowance as well as any change in the amount of allowance for expected
credit losses (or reversal) shall be recognized in profit or loss as an impairment gain or loss.
In case of financial asset measured at amortized cost:
Dr. Impairment loss (P&L)
Cr. Allowance for expected credit loss (it is a contra asset account)
This “allowance for expected credit loss” is deducted from gross carrying amount of financial asset
so that a net position is presented in statement of financial position.

In case of financial asset (which is a debt instrument of another entity) measured at FV through OCI
Dr. Impairment loss (P&L)
Cr. Allowance for expected credit loss [OCI]
Since loss is credited to OCI, hence no allowance is deducted from gross carrying amount of
financial asset.
Notes: Above entries are given for impairment loss. These should be reversed in case of impairment
gain.

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 IFRS 9 (Regular way transactions and Impairment) – Class notes

(b) Simplified approach for trade receivables, contract assets (IFRS 15) and lease receivables

In case of Trade receivable and contract assets In case of Trade receivable and contract assets
which do not contain a significant financing which contain a significant financing component
component: and Lease receivables:

Simplified approach shall be followed Simplified approach may be followed if the entity
chooses this treatment as an accounting policy.
[Otherwise general approach will be used]

Such policy may be selected for above mentioned

assets independently of each other.

1. An allowance for expected credit losses on initial recognition as well as at each reporting date at an
amount equal to lifetime expected credit loss shall be recognized.

2. Any change in the amount of allowance for expected credit losses (or reversal) shall be recognized in
profit or loss as an impairment gain or loss.

Dr. Impairment loss (P&L)

Cr. Allowance for expected credit loss

This “allowance for expected credit loss” is deducted from gross carrying amount of financial asset
so that a net position is presented in statement of financial position.

Notes: Above entry is given for impairment loss. This should be reversed in case of impairment gain.

1.2 – MEASUREMENT OF EXPECTED CREDIT LOSSES

An entity shall measure expected credit losses of a financial instrument in a way that reflects:
(a) an unbiased and probability-weighted amount that is determined by evaluating a range of possible
outcomes;
(b) the time value of money; and
(c) reasonable and supportable information that is available without undue cost or effort at the reporting
date about past events, current conditions and forecasts of future economic conditions.

2) Credit-impaired asset

Evidence that a financial asset is credit-impaired include observable data about the following events:

(a) significant financial difficulty of the issuer or the borrower;

(b) a breach of contract, such as a default or past due event;
(c) the lender(s) of the borrower, for economic or contractual reasons relating to the borrower’s financial
difficulty, having granted to the borrower a concession(s) that the lender(s) would not otherwise
consider;
(d) it is becoming probable that the borrower will enter bankruptcy or other financial reorganization;

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 IFRS 9 (Regular way transactions and Impairment) – Class notes

(e) the disappearance of an active market for that financial asset because of financial difficulties; or
(f) the purchase or origination of a financial asset at a deep discount that reflects the incurred credit
losses.

It may not be possible to identify a single discrete event—instead, the combined effect of several events
may have caused financial assets to become credit-impaired.

2.1 – FINANCIAL ASSET WHICH SUBSEUQUENTLY BECOMES CREDIT-IMPAIRED

1. Interest revenue shall be calculated by applying the normal effective interest rate to the amortized
cost of the financial asset

Interest income = (Gross carrying amount – Loss allowance) x normal effective interest rate

2. Measurement and accounting for subsequent allowance for impairment loss would be same as
studied earlier for general approach. However, an adjustment would be needed (otherwise amortized
cost table will not by applying effective interest rate to opening balance of loss allowance as follows:

Dr. Financial asset

Cr. Loss allowance [Opening loss allowance x effective interest %]

Exam note:
1 and 2 above are easier to handle if accounted for in a compound entry.

3. If in subsequent reporting periods, the credit risk on the financial instrument improves so that the
financial asset is no longer credit-impaired (e.g. improvement in the borrower’s credit rating) then we
would revert to measuring the interest income by applying the effective interest rate to the gross
carrying amount as before.

2.2 – PURCHASED OR ORIGINATED CREDIT-IMPAIRED FINANCIAL ASSET

1. In some cases, a financial asset is considered credit-impaired at initial recognition because the credit
risk is very high and in a case of purchase it is acquired at a deep discount. Credit-adjusted effective
interest rate is calculated using all contractual cashflows adjusted for initial estimate of the lifetime
expected credit losses.

2. Interest revenue shall be calculated by applying credit-adjusted effective interest rate to the
amortized cost (i.e. net carrying amount) of the financial asset from initial recognition.

3. An entity shall only recognize the cumulative changes in lifetime expected credit losses since initial
recognition as a loss allowance for purchased or originated credit-impaired financial assets. At each
reporting date, an entity shall recognize in profit or loss the amount of the change in lifetime expected
credit losses as an impairment gain or loss. An entity shall recognize favourable changes in lifetime
expected credit losses as an impairment gain, even if the lifetime expected credit losses are less than
the amount of expected credit losses that were included in the estimated cash flows on initial
recognition.

Nasir Abbas FCA Page 7 | 8

 IFRS 9 (Regular way transactions and Impairment) – Class notes

4. If expected credit losses are to be discounted then credit-adjusted effective interest rate determined
at initial recognition shall be used.

Helpful diagram for impairment

Nasir Abbas FCA Page 8 | 8

 IFRS 9 (Regular way transactions and Impairment) – QUESTIONS (1)

PRACTICE QUESTIONS
Question 1
On December 29, 2019 an entity commits itself to purchase a financial asset for Rs. 1,000, which is its fair value on
commitment (trade) date. On December 31, 2019 (i.e. year-end) and on January 4, 2020 (settlement date) the fair value
of the asset is Rs. 1,025 and Rs. 1,038 respectively.
Required:
Journal entries for the above transactions for each of the following cases:
Case – I Financial asset will be measured at amortized cost
Case – II Financial asset will be measured at fair value through OCI
Case – III Financial asset will be measured at fair value through P&L
Under following accounting policies:
(a) Trade date accounting
(b) Settlement date accounting

Question 2
On December 29, 2019 an entity commits itself to sell a financial asset for Rs. 1,010, which is its fair value on commitment
(trade) date. It had been purchased on January 1, 2019 and has a carrying amount of Rs. 1,000 on trade date. On December
31, 2019 (i.e. year-end) and on January 4, 2020 (settlement date) the fair value of the asset is Rs. 1,025 and Rs. 1,030
respectively.
Required:
Journal entries for the above transactions for each of the following cases:
Case – I Financial asset was measured at amortized cost
Case – II Financial asset was measured at fair value through OCI
Case – III Financial asset was measured at fair value through P&L
Under following accounting policies:
(c) Trade date accounting
(d) Settlement date accounting

Question 3
On December 29, 2019 an entity enters into a contract to sell Debenture A, which is measured at amortized cost, in
exchange for Bond B, which will be held for trading and thus will be measured at fair value through P&L. Debenture A had
a carrying amount of Rs. 10,000 on commitment date.
Fair values of both assets were as follows:
Debenture A Bond B
Trade date (i.e. 29-12-19) Rs. 10,100 Rs. 10,100
Year end (i.e. 31-12-19) Rs. 10,120 Rs. 10,090
Settlement date (i.e. 04-01-20) Rs. 10,130 Rs. 10,070

Entity follows settlement date accounting for assets measured at amortized cost and trade date accounting for assets
held for trading.
Required:
Journal entries for the above transactions.

NASIR ABBAS FCA

 IFRS 9 (Regular way transactions and Impairment) – QUESTIONS (2)

Question 4
On January 1, 2018, Nobita Limited (NL) bought Rs. 200,000 (nominal value) 10% bonds, incurring transactions costs of
1% of purchase price. The bonds will be redeemed at a premium of Rs. 25% over nominal value on December 31, 2020.
The effective rate of interest is 16.6386%. The fair value of the bond was as follows:

Date Fair value (Rs.)

December 31, 2018 260,000
December 31, 2019 280,000

The investment was not considered to be credit-impaired at any stage. The relevant expected credit losses, for use in
measuring the loss allowance were as follows:

Date Rs.
January 1, 2018 7,000
December 31, 2018 10,000
December 31, 2019 12,000

Required:
Journalize all above transactions over all relevant years if:
(a) NL's business model is to hold bonds until the redemption date and collect contractual cash flows.
(b) NL's business model is to hold bonds until redemption but also to sell them if investments with higher returns become
available.

Question 5
An entity purchased debentures of Rs. 450,000 on January 1, 2019, on which date they are not considered to be credit-
impaired. The financial asset is classified at amortized cost and has an effective interest rate of 10%. Coupon payment of
Rs. 30,000 was duly received on December 31, 2019 and December 31, 2020. The following additional information is also
available on December 31, 2019:
2019 2020
Lifetime expected credit loss if there is a default (i.e. LGD) 30% 35%
[% of gross carrying amount]
Probability of default occurring within 12-months 10% 11%
Probability of default occurring within lifetime 12% 15%

Required:
Extracts of SOFP and SOCI for the year ending December 31, 2019 and 2020 if risk assessment on each year end shows:
(a) There is no significant increase in credit risk since initial recognition
(b) There is a significant increase in credit risk since initial recognition
(c) The asset has become credit-impaired

Question 6
On January 1, 2019 Happy Limited (HL) invested in 5,000 debentures issued by Sad Limited (SL). Each debenture is
redeemable at par (i.e. Rs. 100) after 4 years. Coupon rate was 9% payable annually. Issue price was Rs. 98 per debenture
(i.e. equal to the fair value). Transaction costs incurred amount to Rs. 2,500. Effective rate of interest was 9.4678%.
HL classified this investment at amortized cost. The investment was not credit-impaired on initial recognition. On initial
recognition HL estimated the lifetime expected credit losses to be Rs. 15,000 and the 12-month expected credit losses to
be Rs. 3,125.

NASIR ABBAS FCA

 IFRS 9 (Regular way transactions and Impairment) – QUESTIONS (3)

On December 31, 2019, due to high debt ratio and declining profit margins, SL issued a warning to its creditors that it is
undergoing a business restructuring process aimed at saving the business from bankruptcy. As a result, the directors of
HL determined that there was a significant increase in credit risk since the initial recognition. On that date, revised
estimates were as follows:
- The lifetime expected credit losses had increased to Rs. 17,500; and
- The 12-months expected credit loss had increased to Rs. 5,000

On December 31, 2020, the credit risk for the investment remained significantly higher than at initial recognition. On that
date, revised estimates were as follows:
- The lifetime expected credit losses had increased to Rs. 20,000; and
- The 12-months expected credit loss had increased to Rs. 8,000

Required:
Journal entries for the year ending December 31, 2019 and 2020 if risk assessment shows:
(a) The asset was not credit-impaired at either December 31, 2019 or December 31, 2020.
(b) The asset became credit-impaired at December 31, 2019 and remained so at December 31, 2020.

Question 7
On December 1, 2019 Good Limited (GL) entered into a contract with a customer for Rs. 500,000. All performance
obligations were satisfied on that date. There is no significant financing component in the contract.
At December 31, 2019 GL does not believe that the increase in credit risk since initial recognition is significant.
If default occurs, GL expects to lose 80% of the gross carrying amount of the receivable. The customer pays in full on
January 15, 2020.

01-12-19 31-12-19
Probability of default over the next 12-months 4% 5%
Probability of default over the lifetime 6% 7%

Required:
Journal entries of above transactions.

Question 8
On December 31, 2019 Mango Limited (ML) has a portfolio of receivables of Rs. 30 million. The trade receivables do not
have a significant financing component in accordance with IFRS 15.
ML has constructed following provision matrix to determine expected credit losses on the portfolio of receivables:

Number of days past due

Current
1-30 31-60 61-90 More than 90
Gross carrying amount (Rs. million) 15.00 7.50 4.00 2.50 1.00
Default rate 0.3% 1.6% 3.6% 6.6% 10.6%
The loss allowance measured at end of 2018 was Rs. 350,000

Required:
Journal entry to record impairment loss on December 31, 2019.

NASIR ABBAS FCA

 IFRS 9 (Regular way transactions and Impairment) – QUESTIONS (4)

Question 9
On January 1, 2019 Almond Limited (AL) purchased 10% debentures (having nominal value of Rs. 60,000) at a price of Rs.
50,000. These bonds are redeemable at par on December 31, 2022. AL’s management had estimated at initial recognition
that only 85% of contractual cashflows would be recovered. As a result of which, the investment was considered as
purchased credit-impaired financial asset and credit-adjusted effective rate was estimated at 10.627%.
On December 31, 2019 Rs. 4,800 was received in respect of coupon payment of 2019 and AL’s revised its estimate of
expected default on contractual cashflows to 20%.
On December 31, 2020 Rs. 4,900 was received in respect of coupon payment of 2020 and AL’s revised its estimate of
expected default on contractual cashflows to 18%.
On December 31, 2021 Rs. 5,300 was received in respect of coupon payment of 2021 and AL’s revised its estimate of
expected default on contractual cashflows to 12%.
Finally on December 31, 2022 the debentures were redeemed at Rs. 58,000.
Required:
All journal entries till December 31, 2022.

NASIR ABBAS FCA

 IFRS 9 (Regular way transactions and Impairment) – SOLUTIONS (1)

SOLUTIONS
Solution No. 1
(a) Trade date accounting
Case – I Case – II Case – III
29-12-19

Financial asset 1,000 Financial asset 1,000 Financial asset 1,000

Payable 1,000 Payable 1,000 Payable 1,000

31-12-19

No entry Financial asset 25 Financial asset 25

OCI 25 P&L 25

04-01-20

Payable 1,000 Payable 1,000 Payable 1,000

Cash 1,000 Cash 1,000 Cash 1,000

Financial asset 13 Financial asset 13

OCI 13 P&L 13

(b) Settlement date accounting

Case – I Case – II Case – III
29-12-19

No entry No entry No entry

31-12-19

No entry Receivable 25 Receivable 25

OCI 25 P&L 25

04-01-20

Financial asset 1,000 Financial asset 1,038 Financial asset 1,038

Cash 1,000 Cash 1,000 Cash 1,000
Receivable 25 Receivable 25
OCI 13 P&L 13

Solution No. 2
(a) Trade date accounting
Case – I Case – II Case – III
29-12-19

Receivable 1,010 Receivable 1,010 Receivable 1,010

Financial asset 1,000 Financial asset 1,000 Financial asset 1,000
Profit on disposal 10 Profit on disposal 10 Profit on disposal 10

NASIR ABBAS FCA

 IFRS 9 (Regular way transactions and Impairment) – SOLUTIONS (2)

31-12-19

No entry No entry No entry

04-01-20

Cash 1,010 Cash 1,010 Cash 1,010

Receivable 1,010 Receivable 1,010 Receivable 1,010

(b) Settlement date accounting

Case – I Case – II Case – III
29-12-19

No entry Financial asset 10 Financial asset 10

OCI 10 P&L 10

31-12-19

No entry No entry No entry

04-01-20

Cash 1,010 Cash 1,010 Cash 1,010

Financial asset 1,000 OCI 10 Financial asset 1,010
Profit on disposal 10 Financial asset 1,010
Profit on disposal 10

Solution 3
Dr. Cr.
-------- Rs. -------
29-12-19 Bond B 10,100
Payable 10,100
[initial recognition]

31-12-19 FV loss [P&L] 10

Bond B 10
[FV loss at year end]

04-01-20 Payable 10,100

Debenture A 10,000
Profit on disposal 100
[Derecognition of Debenture A]

04-01-20 FV loss [P&L] 20

Bond B 20
[FV loss at settlement date]

NASIR ABBAS FCA

 IFRS 9 (Regular way transactions and Impairment) – SOLUTIONS (3)

Solution 4
(a) Asset shall be measured at amortized cost Dr. Cr.
-------- Rs. -------
01-01-18 Investment [200,000 x 1.01] 202,000
Cash 202,000
[Initial recognition]

01-01-18 Impairment loss [P&L] 7,000

Loss allowance 7,000
[Initial recognition of ECL]

31-12-18 Investment 33,610

Investment income (W-1) 33,610
[Investment income for 2018]

31-12-18 Cash [200,000 x 10%] 20,000

Investment 20,000
[Interest received for 2018]

31-12-18 Impairment loss [P&L] [10,000 - 7,000] 3,000

Loss allowance 3,000
[Subsequent remeasurement of ECL]

31-12-19 Investment 35,874

Investment income (W-1) 35,874
[Investment income for 2019]

31-12-19 Cash 20,000

Investment 20,000
[Interest received for 2019]

31-12-19 Impairment loss [P&L] [12,000 - 10,000] 2,000

Loss allowance 2,000
[Subsequent remeasurement of ECL]

(b) Asset shall be measured at fair value through OCI Dr. Cr.
-------- Rs. -------
01-01-18 Investment [200,000 x 1.01] 202,000
Cash 202,000
[Initial recognition]

01-01-18 Impairment loss [P&L] 7,000

Loss allowance [OCI] 7,000
[Initial recognition of ECL]

31-12-18 Investment 33,610

Investment income (W-1) 33,610
[Investment income for 2018]

NASIR ABBAS FCA

 IFRS 9 (Regular way transactions and Impairment) – SOLUTIONS (4)

31-12-18 Cash [200,000 x 10%] 20,000

Investment 20,000
[Interest received for 2018]

31-12-18 Impairment loss [P&L] [10,000 - 7,000] 3,000

Loss allowance [OCI] 3,000
[Subsequent remeasurement of ECL]

31-12-18 Investment (W-1) 44,390

Fair value reserve [OCI] 44,390
[Fair value gain 2018]

31-12-19 Investment 35,874

Investment income (W-1) 35,874
[Investment income for 2019]

31-12-19 Cash 20,000

Investment 20,000
[Interest received for 2019]

31-12-19 Impairment loss [P&L] [12,000 - 10,000] 2,000

Loss allowance [OCI] 2,000
[Subsequent remeasurement of ECL]

31-12-19 Investment (W-1) 4,126

Fair value reserve [OCI] 4,126
[Fair value gain 2019]

W-1
Opening Closing Fair Fair value
Date Interest Cashflow OCI
balance balance value reserve
[A] [B = A x 16.6386%] [C] [D = A + B - C] [E] [F = E - D] [Change in F]

31-12-18 202,000 33,610 20,000 215,610 260,000 44,390 44,390

31-12-19 215,610 35,874 20,000 231,484 280,000 48,516 4,126

Solution 5
(a) 2019 2020
----------- Rs. ----------
SOCI - extracts
Interest income (W-1) 45,000 46,500
Expected loss [Change in allowance(W-1)] (13,950) (4,588)

SOFP - extracts
Non-current assets
Investment (W-1) 451,050 462,962

NASIR ABBAS FCA

 IFRS 9 (Regular way transactions and Impairment) – SOLUTIONS (5)

(b)
SOCI - extracts
Interest income (W-1) 45,000 46,500
Expected loss [Change in allowance(W-1)] (16,740) (8,539)

SOFP - extracts
Non-current assets
Investment (W-1) 448,260 456,221

(c)
SOCI - extracts
Interest income (W-1) 45,000 44,826
Expected loss [Change in allowance(W-1)] [25,279 – 16,740 – 1,674] (16,740) (6,865)

SOFP - extracts
Non-current assets
Investment (W-1) 448,260 456,221

W-1 (a) (b) (c)

---------------------- Rs. -------------------
Initial amount [A] 450,000 450,000 450,000
Interest income 45,000 45,000 45,000
[A x 10%] [A x 10%] [A x 10%]
Cashflow (30,000) (30,000) (30,000)
Gross balance 31-12-19 [B] 465,000 465,000 465,000

Loss allowance:
Impairment loss 13,950 16,740 16,740
Balance as at 31-12-19 13,950 16,740 16,740
[B x 30% x 10%] [B x 30% x 12%] [B x 30% x 12%]
[C] 451,050 448,260 448,260

Gross balance 01-01-20 465,000 465,000 465,000

Interest income 46,500 46,500 44,826
[B x 10%] [B x 10%] [C x 10%]
Interest adjustment for allowance [16,740 x 10%] - - 1,674
Cashflow (30,000) (30,000) (30,000)
Gross balance 31-12-20 [D] 481,500 481,500 481,500

Loss allowance:
Balance as at 01-01-20 13,950 16,740 16,740
Interest adjustment - - 1,674
Impairment loss 4,588 8,539 6,865
Balance as at 31-12-20 18,538 25,279 25,279
[D x 35% x 11%] [D x 35% x 15%] [D x 35% x 15%]
462,962 456,221 456,221

NASIR ABBAS FCA

 IFRS 9 (Regular way transactions and Impairment) – SOLUTIONS (6)

Solution 6
(a) Dr. Cr.
-------- Rs. -------
01-01-19 Investment [5,000 x 98 + 2,500] 492,500
Cash 492,500
[Initial recognition]

01-01-19 Impairment loss [P&L] 3,125

Loss allowance 3,125
[Initial recognition of ECL]

31-12-19 Investment 46,629

Investment income (W-1) 46,629
[Investment income for 2019]

31-12-19 Cash 45,000

Investment 45,000
[Interest received for 2019]

31-12-19 Impairment loss [P&L] (W-1) 14,375

Loss allowance 14,375
[Subsequent remeasurement of ECL]

31-12-20 Investment 46,783

Investment income (W-1) 46,783
[Investment income for 2020]

31-12-20 Cash 45,000

Investment 45,000
[Interest received for 2020]

31-12-20 Impairment loss [P&L] (W-1) 2,500

Loss allowance 2,500
[Subsequent remeasurement of ECL]

(b) Dr. Cr.

-------- Rs. -------
01-01-19 Investment [5,000 x 98 + 2,500] 492,500
Cash 492,500
[Initial recognition]

01-01-19 Impairment loss [P&L] 3,125

Loss allowance 3,125
[Initial recognition of ECL]

31-12-19 Investment 46,629

Investment income (W-1) 46,629
[Investment income for 2019]

NASIR ABBAS FCA

 IFRS 9 (Regular way transactions and Impairment) – SOLUTIONS (7)

31-12-19 Cash 45,000

Investment 45,000
[Interest received for 2019]

31-12-19 Impairment loss [P&L] (W-1) 14,375

Loss allowance 14,375
[Subsequent remeasurement of ECL]

31-12-20 Investment 46,783

Loss allowance (W-1) 1,657
Investment income (W-1) 45,126
[Investment income for 2020]

31-12-20 Cash 45,000

Investment 45,000
[Interest received for 2020]

31-12-20 Impairment loss [P&L] (W-1) 843

Loss allowance 843
[Subsequent remeasurement of ECL]

W-1 (a) (b)

-------------- Rs. --------------
Initial amount [5,000 x 98 + 2,500] [A] 492,500 492,500
Interest income 46,629 46,629
[A x 9.4678%] [A x 9.4678%]
Cashflow [5,000 x 100 x 9%] (45,000) (45,000)
Gross balance 31-12-19 [B] 494,129 494,129

Loss allowance:
Initial amount 3,125 3,125
Impairment loss at year end 14,375 14,375
Balance as at 31-12-19 17,500 17,500
[C] 476,629 476,629

Gross balance 01-01-20 494,129 494,129

Interest income 46,783 45,126
[B x 9.4678%] [C x 9.4678%]
Interest adjustment for allowance [17,500 x 9.4678%] - 1,657
Cashflow (45,000) (45,000)
Gross balance 31-12-20 [D] 495,912 495,912

Loss allowance:
Balance as at 01-01-20 17,500 17,500
Interest adjustment - 1,657
Impairment loss 2,500 843
Balance as at 31-12-20 20,000 20,000
475,912 475,912

NASIR ABBAS FCA

 IFRS 9 (Regular way transactions and Impairment) – SOLUTIONS (8)

Solution 7 Dr. Cr.

-------- Rs. -------
01-12-19 Trade receivables 500,000
Sales 500,000
[Initial recognition]

01-12-19 Impairment loss [P&L] [500,000 x 80% x 6%] 24,000

Loss allowance 24,000
[Initial recognition of ECL]

31-12-19 Impairment loss [P&L] [500,000 x 80% x 7% - 2 4,000] 4,000

Loss allowance 4,000
[Subsequent remeasurement of ECL]

15-01-20 Cash 500,000

Trade receivable 500,000
[Cash received from customer]

15-01-20 Loss allowance 28,000

Impairment loss [P&L] 28,000
[Loss allowance reversed on cash recovery]

Solution 8
Dr. Cr.
-------- Rs. million -------
31-12-19 Impairment loss [P&L] 0.23
Loss allowance 0.23
[Impairment loss for 2019]

W-1
Gross
Default rate Allowance
amount
(Rs. million) (Rs. million)
Current 15.00 0.30% 0.05
1-30 days 7.50 1.60% 0.12
31-60 days 4.00 3.60% 0.14
61-90 days 2.50 6.60% 0.17
More than 90 days 1.00 10.60% 0.11
0.58
Opening balance 0.35
0.23

Solution 9
Dr. Cr.
-------- Rs. -------
01-01-19 Investment 50,000
Cash 50,000
[Initial recognition]

NASIR ABBAS FCA

 IFRS 9 (Regular way transactions and Impairment) – SOLUTIONS (9)

31-12-19 Investment 5,314

Investment income (W-1) 5,314
[Investment income for 2019]

31-12-19 Cash 4,800

P&L 300
Investment (W-1) 5,100
[Interest received for 2019]

31-12-19 Impairment loss [P&L] (W-1) 2,992

Loss allowance 2,992
[Measurement of ECL]

31-12-20 Investment 5,336

Loss allowance (W-1) 318
Investment income (W-1) 5,018
[Investment income for 2020]

31-12-20 Cash 4,900

P&L 200
Investment (W-1) 5,100
[Interest received for 2020]

31-12-20 Loss allowance (W-1) 1,451

Impairment gain [P&L] 1,451
[Measurement of ECL]

31-12-21 Investment 5,361

Loss allowance 198
Investment income (W-1) 5,164
[Investment income for 2021]

31-12-21 Cash 5,300

P&L 200
Investment (W-1) 5,100
[Interest received for 2021]

31-12-21 Loss allowance (W-1) 3,722

Impairment gain [P&L] 3,722
[Measurement of ECL]

31-12-22 Investment 5,389

Loss allowance (W-1) 177
Investment income (W-1) 5,566
[Investment income for 2022]

NASIR ABBAS FCA

 IFRS 9 (Regular way transactions and Impairment) – SOLUTIONS (10)

31-12-22 Cash 58,000

P&L 58
Loss allowance (W-1) 1,842
Investment (W-1) 56,100
[Redemption amount received]

W-1 Rs.
Initial amount 50,000
Interest income [50,000 x 10.627%(W-2)] 5,314
Cashflow (W-2) (5,100)
Gross balance 31-12-19 50,214

Loss allowance:
Impairment loss 2,992
Balance 31-12-19 (W-2.1) 2,992
47,221

Gross balance 01-01-20 50,214

Interest income [47,221 x 10.627%] 5,018
Interest adjustment for allowance [2,992 x 10.627%] 318
Cashflow (W-2) (5,100)
Gross balance 31-12-20 50,450

Loss allowance:
Balance 01-01-20 2,992
Interest adjustment 318
Impairment loss (1,451)
Balance 31-12-20 (W-.2.2) 1,859
48,590

Gross balance 01-01-21 50,450

Interest income [48,590 x 10.627%] 5,164
Interest adjustment for allowance [1,859 x 10.627%] 198
Cashflow (W-2) (5,100)
Gross balance 31-12-21 50,711

Loss allowance:
Balance 01-01-21 1,859
Interest adjustment 198
Impairment loss (3,722)
Balance 31-12-21 (W-.2.2) (1,665)
52,376

Gross balance 01-01-22 50,711

Interest income [52,376 x 10.627%] 5,566
Interest adjustment for allowance [1,665 x 10.627%] (177)
Cashflow (W-2) (56,100)
Gross balance 31-12-22 -

NASIR ABBAS FCA

 IFRS 9 (Regular way transactions and Impairment) – SOLUTIONS (11)

Loss allowance:
Balance 01-01-22 (1,665)
Interest adjustment (177)
Impairment loss 1,842
Balance 31-12-22 -
-

W-2
Contractual Recovery Expected
Credit-adjusted effective rate cashflows expected cashflows
Transaction price (50,000) (50,000)
31-12-19 6,000 85% 5,100
31-12-20 6,000 85% 5,100
31-12-21 6,000 85% 5,100
31-12-22 66,000 85% 56,100
Credit-adjusted effective rate 10.627%

Initial estimate of expected credit loss Rs.

PV of contractual cash flows at credit-impaired effective rate 58,824
PV of expected cash flows at credit-impaired effective rate 50,000
8,824
W-2.1
31-12-19
Contractual Expected
Default PV of loss
Expected credit loss cash flows credit loss
31-12-20 6,000 20% 1,200 1,085
31-12-21 6,000 20% 1,200 981
31-12-22 66,000 20% 13,200 9,750
11,816
Initial estimate of credit loss 8,824
Change in expected credit loss 2,992
W-2.2
31-12-20
Contractual Expected
Default PV of loss
Expected credit loss cash flows credit loss
31-12-21 6,000 18% 1,080 976
31-12-22 66,000 18% 11,880 9,707
10,683
Initial estimate of credit loss 8,824
Change in expected credit loss 1,859
W-2.3
31-12-21
Contractual Expected
Default PV of loss
Expected credit loss cash flows credit loss
31-12-22 66,000 12% 7,920 7,159
7,159
Initial estimate of credit loss 8,824
Change in expected credit loss (1,665)

NASIR ABBAS FCA

 IFRS 9 (Re-classification, De-recognition and Modification) – Class notes

RE-CLASSIFICATION

Financial assets

1. When and only when an entity changes it business model for managing financial assets, it shall
reclassify all affected financial assets. Such changes are expected to be very infrequent. A change in
entity’s business model will occur only when an entity either begins or ceases to perform an activity
that is significant to its operations.
Examples:
- An entity has a portfolio of commercial loans that it holds to sell in the short term. The entity
acquires a company that manages commercial loans and has a business model that holds the loans
in order to collect the contractual cash flows. The portfolio of commercial loans is no longer for
sale, and the portfolio is now managed together with the acquired commercial loans and all are
held to collect the contractual cash flows.
- A financial services firm decides to shut down its retail mortgage business. That business no longer
accepts new business and the financial services firm is actively marketing its mortgage loan
portfolio for sale.
Exam note
Since reclassification is applied to “change in business model” only, therefore technically it is not
allowed for:
- Equity investments.
- Investments in debt instruments for which fair value through P&L class was elected irrevocably
on initial recognition.

2. The following are not changes in business model:

- A change in intention related to particular financial asset
- The temporary disappear of a particular market for financial assets
- A transfer of financial assets between parts of the entity with different business models.

3. The reclassification shall be applied prospectively from the reclassification date. The entity shall not
restate any previously recognized gains, losses (including impairment gains or losses) or interest.
Reclassification date
The first day of the first reporting period following the change in business model that results in an
entity reclassifying financial assets.

If a financial asset is reclassified out of AMORTIZED COST measurement:

Reclassified to: Treatment
Fair value through P&L - Loss allowance is derecognized and adjusted against financial asset.
- The asset shall be measured at fair value on reclassification date.
- Any resulting fair value gain or loss shall be recognized in P&L.

Fair value through OCI - The asset shall be measured at fair value on reclassification date.
- Any resulting fair value gain or loss shall be recognized in OCI.
- The effective interest rate and the measurement of expected credit
losses shall not be adjusted as a result of the reclassification.

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 IFRS 9 (Re-classification, De-recognition and Modification) – Class notes

- The loss allowance, which is currently shown as a contra asset

account, would be de-recognized and recognized as a loss
allowance[OCI].

If a financial asset is reclassified out of FAIR VALUE through P&L measurement:

Reclassified to: Treatment
Fair value through OCI - The asset shall continue to be measured at fair value.
- The effective interest rate is calculated based on the fair value of the
asset at reclassification date.
- For the purpose of initial recognition of loss allowance,
reclassification date is treated as the date of initial recognition.

Amortized cost - The asset shall be measured at fair value on reclassification date.
- Any resulting fair value gain or loss shall be recognized in P&L.
- The fair value at reclassification date becomes its new gross carrying
amount.
- The effective interest rate is calculated based on the fair value of the
asset at reclassification date.
- For the purpose of initial recognition of loss allowance,
reclassification date is treated as the date of initial recognition.

If a financial asset is reclassified out of FAIR VALUE through OCI measurement:

Reclassified to: Treatment
Fair value through P&L - The asset shall continue to be measured at fair value.
- The cumulative gain or loss (including loss allowance) previously
recognized in OCI shall be reclassified to P&L.

Amortized cost - The asset shall be measured at fair value on reclassification date.
- The cumulative gain or loss previously recognized in OCI shall be
removed from equity and adjusted against the asset.

Dr. Fair value reserve [it is shown in SOCIE]

Cr. Financial asset

- The effective interest rate and the measurement of expected credit

losses shall not be adjusted as a result of the reclassification.
- A loss allowance[OCI] would be de-recognized and recognized as a
loss allowance which would be shown as contra asset account from
the reclassification date.

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 IFRS 9 (Re-classification, De-recognition and Modification) – Class notes

Financial liabilities

An entity shall not reclassify any financial liability.

DE-RECOGNITION OF FINANCIAL ASSET

If a part of a financial asset is transferred, then following de-recognition rules should be applied to the
part only if any one of the following conditions are met:
(i) The part comprises only specifically identified cash flows from an asset (e.g. when an entity enters
into an interest rate stirp whereby the counterparty obtains the right to the interest cash flows but
not the principal cash flows from a debt instrument, the de-recognition rules are applied to interest
cashflows);
(ii) The part comprises only a fully proportionate share of the cash flows from an asset (e.g. when an
entity enters into an arrangement whereby the counterparties obtain the rights to 90% share of all
cashflows of a debt instrument, the de-recognition rules are applied to 90% of those cashflows); OR
(iii) The part comprises only a fully proportionate share of specifically identified cashflows from an asset
(e.g. when an entity enters into an arrangement whereby the counterparties obtain the rights to
90% share of interest cashflows of a debt instrument, the de-recognition rules are applied to 90%
of those interest cashflows).

In all other cases de-recognition rules should be applied to the financial asset in its entirety.

In following guidance, term “financial asset” refers to either a part of a financial asset (as identified above)
or a financial asset in its entirety.

1. An entity shall derecognize a financial asset when, and only when:

(a) the contractual rights to the cash flows from the financial asset expire, or
(b) it transfers the financial asset and the transfer qualifies for derecognition.

2. An entity transfers a financial asset if, and only if, it either:

(a) transfers the contractual rights to receive the cash flows of the financial asset, or
(b) retains the contractual rights to receive the cash flows of the financial asset (i.e. the original asset),
but assumes a contractual obligation to pay the cash flows to one or more recipients in an
arrangement that meets all of the following conditions:
Conditions
(i) The entity has no obligation to pay amounts to the eventual recipients unless it collects
equivalent amounts from the original asset. Short-term advances by the entity with the right
of full recovery of the amount lent plus accrued interest at market rates do not violate this
condition.
(ii) The entity is prohibited by the terms of the transfer contract from selling or pledging the
original asset other than as security to the eventual recipients for the obligation to pay them
cash flows.
(iii) The entity has an obligation to remit any cash flows it collects on behalf of the eventual
recipients without material delay. In addition, the entity is not entitled to reinvest such cash
flows, except for investments in cash or cash equivalents during the short settlement period
from the collection date to the date of required remittance to the eventual recipients, and
interest earned on such investments is passed to the eventual recipients.

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 IFRS 9 (Re-classification, De-recognition and Modification) – Class notes

3. When an entity transfers a financial asset:

(a) if the entity transfers substantially all the risks and rewards of ownership
The entity shall derecognize the financial asset and recognize separately as assets or liabilities any
rights and obligations created or retained in the transfer.
Examples
(a) an unconditional sale of a financial asset;
(b) a sale of a financial asset together with an option to repurchase the financial asset at its fair
value at the time of repurchase; and
(c) a sale of a financial asset together with a put or call option that is deeply out of the money

(b) if the entity retains substantially all the risks and rewards of ownership
The entity shall continue to recognize the financial asset and 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 liability.
Examples
(a) a sale and repurchase transaction where the repurchase price is a fixed price or the sale
price plus a lender’s return;
(b) a securities lending agreement;
(c) a sale of a financial asset together with a total return swap that transfers the market risk
exposure back to the entity;
(d) a sale of a financial asset together with a deep in-the-money put or call option; and
(e) a sale of short-term receivables in which the entity guarantees to compensate the
transferee for credit losses that are likely to occur.

(c) if the entity neither transfers nor retains substantially all the risks and rewards of ownership
[For example sale and repurchase transactions (i.e. repo transactions)]
The entity shall determine whether it has retained control of the financial asset.
(i) if the entity has not retained control (i.e. the transferee has the practical ability to sell the
financial asset), it shall derecognize the financial asset and recognize separately as assets or
liabilities any rights and obligations created or retained in the transfer.
(ii) if the entity has retained control (i.e. the transferee does not have the practical ability to sell
the financial asset), it shall continue to recognize the financial asset to the extent of its
continuing involvement in the financial asset. It also recognizes an associated liability.

Extent of continuing involvement

It is the extent to which entity is exposed to changes in value of the transferred asset. When
the entity’s continuing involvement takes the form of guaranteeing the transferred asset,
the transferred asset at the date of transfer is measured at lower of (i) carrying amount of
the asset and (ii) the maximum amount of consideration received that the entity could be
required to repay (i.e. the guarantee amount). The associated liability is initially measured
at the guarantee amount. Subsequently the liability is recognized in P&L when the
obligation is satisfied.

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 IFRS 9 (Re-classification, De-recognition and Modification) – Class notes

4. On de-recognition of a financial asset in its entirety, the difference between:

(a) The carrying amount (measured at date of de-recognition); and
(b) The consideration received (including any new asset obtained less any new liability)
Shall be recognized in P&L.

5. On de-recognition of a part of an asset, the previous carrying amount of the larger financial asset shall
be allocated between the part that continues to be recognized and the part that is de-recognized, on
the basis of the relative fair values of parts on the date of transfer. The difference between:
(a) The carrying amount (measured at date of de-recognition) allocated to the part derecognized;
and
(b) The consideration received for the part derecognized (including any new asset obtained less any
new liability)
Shall be recognized in P&L.

Measurement at date of de-recognition

Before making above entries for de-recognition, the carrying amount is measured at the date of de-
recognition using the same rules as studied earlier for “subsequent measurement”.

Re-classification of cumulative gain/loss on debt investment measured at FV through OCI

It has already been discussed earlier in subsequent measurement that cumulative value fair gain/loss
previously recognized in OCI shall be reclassified to P&L on de-recognition.

If the asset, which is being partially de-recognized, has cumulative gain/loss in OCI, then the balance in
OCI will also be allocated based on the relative fair values of parts on the date of transfer.

Some important transactions for exams:

Repo transaction
Under repo transaction (i.e. sale and repurchase agreement) an entity sells an asset with a condition
that same asset will be repurchased after some agreed time.
Sale of asset – If terms of sale suggest that substantially all the risks and rewards are transferred then
asset is derecognized (e.g. when repurchase price is based on fair value on repurchase date)
Secured loan – If terms of sale suggest that substantially all the risks and rewards are not transferred
(e.g. when repurchase is either at a fixed price or sale price plus lender’s rate of return). This transaction
is a secured loan in substance. Entity shall not de-recognize the asset rather it shall recognize a loan
and account for accordingly.

Factoring
Factoring means sale of receivables to another party called “factor”. Factor provides debt collection
services and also provide a certain portion as advance. Factor service may be “with recourse” or
“without recourse”.
With recourse – Since bad debt risk is borne by the entity, therefore, any advance received is considered
as a loan and receivables are not derecognized.
Without recourse – Since bad debt risk is borne by the factor, therefore, receivables are derecognized.

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 IFRS 9 (Re-classification, De-recognition and Modification) – Class notes

Write-off
An entity shall directly reduce the gross carrying amount of a financial asset when the entity has no
reasonable expectations of recovering a financial asset in its entirety or a portion thereof. A write-off
constitutes a de-recognition event.
For example, an entity plans to enforce the collateral on a financial asset and expects to recover no
more than 30 per cent of the financial asset from the collateral. If the entity has no reasonable
prospects of recovering any further cash flows from the financial asset, it should write off the remaining
70 per cent of the financial asset.

DE-RECOGNITION OF FINANCIAL LIABILITIES

1. An entity shall remove a financial liability (or a part of a financial liability) from its statement of
financial position when, and only when, it is extinguished—i.e. when the obligation specified in the
contract is discharged (e.g. payment) or cancelled or expires (i.e. legally released from primary
responsibility for the liability).

2. An exchange between an existing borrower and lender of debt instruments with substantially
different terms shall be accounted for as an extinguishment of the original financial liability and the
recognition of a new financial liability. Similarly, a substantial modification of the terms of an existing
financial liability or a part of it (whether or not attributable to the financial difficulty of the debtor)
shall be accounted for as an extinguishment of the original financial liability and the recognition of a
new financial liability.
Substantial change
The terms are substantially different if the discounted present value of the cash flows under the
new terms, including any fees paid net of any fees received (only fees paid or received between the
borrower and lender) and discounted using the original effective interest rate, is at least 10 per cent
different from the discounted present value of the remaining cash flows of the original financial
liability.

3. The difference between:

(a) the carrying amount of a financial liability (or part of a financial liability) extinguished or
transferred to another party; and
(b) the consideration paid, including any non-cash assets transferred or liabilities assumed
shall be recognized in profit or loss.

4. If an exchange of debt instruments or modification of terms is accounted for as an extinguishment,

any costs or fees incurred are recognized as part of the gain or loss on the extinguishment. If the
exchange or modification is not accounted for as an extinguishment, any costs or fees incurred adjust
the carrying amount of the liability and are amortized over the remaining term of the modified liability
(i.e. using revised effective interest rate).

IFRIC 19 – Extinguishing financial liabilities with equity instruments

Background
A debtor and creditor might renegotiate the terms of a financial liability with the result that the debtor
extinguishes the liability fully or partially by issuing equity instruments to the creditor. These
transactions are sometimes referred to as ‘debt for equity swaps’.

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 IFRS 9 (Re-classification, De-recognition and Modification) – Class notes

Scope
An entity shall not apply this Interpretation to transactions in situations where:
(a) the creditor is also a direct or indirect shareholder and is acting in its capacity as a direct or indirect
existing shareholder.
(b) the creditor and the entity are controlled by the same party or parties before and after the
transaction and the substance of the transaction includes an equity distribution by, or contribution
to, the entity.
(c) extinguishing the financial liability by issuing equity shares is in accordance with the original terms
of the financial liability. (e.g. convertibles)

Consensus
1. When equity instruments issued to a creditor as a consideration paid to extinguish all or part of a
financial liability are recognized initially, an entity shall measure them at:
(a) the fair value of the equity instruments issued, unless that fair value cannot be reliably
measured.
(b) If the fair value of the equity instruments issued cannot be reliably measured then the equity
instruments shall be measured to reflect the fair value of the financial liability extinguished.

2. The difference between:

(i) The carrying amount of the financial liability extinguished; and
(ii) The consideration paid (i.e. amount of equity instruments issued)
Shall be recognized in profit and loss.

3. If only a part of financial liability is extinguished and part of the consideration also relates to the
modification of the remaining portion, then the consideration paid shall be allocated between the
part extinguished and part retained.

MODIFICATION OF FINANCIAL ASSET (Measured at Amortized cost)

Case – I Modification does not result in de-recognition of financial asset:

1. An entity shall recalculate the gross carrying amount of the financial asset and shall recognize a
modification gain or loss in profit or loss.
2. The gross carrying amount of the financial asset shall be recalculated as the present value of the
renegotiated or modified contractual cash flows that are discounted at the financial asset’s original
effective interest rate (or credit-adjusted effective interest rate for purchased or originated credit-
impaired financial assets).

3. Any costs or fees incurred adjust the carrying amount of the modified financial asset and are
amortized over the remaining term of the modified financial asset.

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 IFRS 9 (Re-classification, De-recognition and Modification) – Class notes

4. An entity shall assess whether there has been a significant increase in the credit risk of the financial
instrument by comparing:
(a) the risk of a default occurring at the reporting date (based on the modified contractual terms);
and
(b) the risk of a default occurring at initial recognition (based on the original, unmodified contractual
terms).

5. If the contractual cash flows on a financial asset have been renegotiated or otherwise modified, but
the financial asset is not derecognized, that financial asset is not automatically considered to have
lower credit risk. An entity shall assess whether there has been a significant increase in credit risk
since initial recognition on the basis of all reasonable and supportable information that is available
without undue cost or effort.

Case – II Modification results in de-recognition of financial asset:

1. The modified asset is considered a ‘new’ financial asset. Accordingly, the date of the modification shall
be treated as the date of initial recognition of that financial asset when applying the impairment
requirements to the modified financial asset. This typically means measuring the loss allowance at an
amount equal to 12-month expected credit losses until the credit risk is significantly increased
afterwards.

2. However, in some unusual circumstances following a modification that results in derecognition of the
original financial asset, there may be evidence that the modified financial asset is credit-impaired at
initial recognition, and thus, the financial asset should be recognized as an originated credit-impaired
financial asset.

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 IFRS 9 (Re-classification, De-recognition and Modification) – QUESTIONS (1)

PRACTICE QUESTIONS
Question 1
On January 1, 2017, Tokyo Limited (TL) invested Rs. 500,000 (i.e. equal to face value) in 8% debentures. These debentures
would be redeemed at a premium of 10%. The effective interest was 8.6687%.
Initially these debentures were classified as measured at amortized cost. However, on June 30, 2019 management of TL
changed its business model and decided to re-classify these bonds as measured at fair value through P&L.
The fair values of the debentures were as follows:

Date Fair value (Rs.)

June 30, 2019 540,000
January 1, 2020 510,000
December 31, 2020 545,000

The debentures have never been credit-impaired and there have been no significant increase in credit risk since initial
recognition. The expected credit losses were determined as follows:

Date 12-month credit losses Lifetime credit losses

(Rs.) (Rs.)
January 1, 2017 5,000 12,500
December 31, 2017 7,000 15,000
December 31, 2018 8,000 16,700
December 31, 2019 9,200 17,000

Required:
Journal entries for the years ending December 31, 2019 and 2020.

Question 2
Sigma Limited (SL) purchased bonds in a company some years ago. The bonds were classified at fair value through profit
or loss since they were held for trading. The bonds have a face value of Rs. 500,000 and coupon rate of 10% per annum.
The bonds would be redeemed at a premium of 20% on December 31, 2025.
On August 1, 2019, SL decided to change the classification from fair value through P&L to amortized cost.
The fair values of the bonds were as follows:

Date Fair value (Rs.)

December 31, 2018 545,000
August 1, 2019 570,000
January 1, 2020 590,000

The debentures have never been credit-impaired and there have been no significant increase in credit risk since initial
recognition. The expected credit losses were determined as follows:

Date 12-month credit losses Lifetime credit losses

(Rs.) (Rs.)
January 1, 2018 5,000 12,500
January 1, 2019 7,000 15,000
January 1, 2020 8,000 16,700
December 31, 2020 9,200 17,000

Required:
Journal entries for the years ending December 31, 2019 and 2020.

NASIR ABBAS FCA

 IFRS 9 (Re-classification, De-recognition and Modification) – QUESTIONS (2)

Question 3
Mango Limited (ML) purchased debentures of a company on January 1, 2018 for Rs. 147,408 (i.e. fair value). The face
value of debentures was Rs. 100,000 and coupon rate was 20% per annum. These would be redeemed at a premium of
23% on December 31, 2021. Effective interest rate was 10%.
On August 1, 2019, ML decided to change the classification from fair value through OCI to amortized cost.
The fair values of the debentures were as follows:

Date Fair value (Rs.)

December 31, 2018 145,350
August 1, 2019 147,500
December 31, 2019 148,850
December 31, 2020 142,000

The debentures have never been credit-impaired and there have been no significant increase in credit risk since initial
recognition. The expected credit losses were determined as follows:

Date 12-month credit losses Lifetime credit losses

(Rs.) (Rs.)
January 1, 2018 5,000 12,500
December 31, 2018 7,000 15,000
December 31, 2019 8,000 16,700
December 31, 2020 9,200 17,000

Required:
Journal entries for the years ending December 31, 2019 and 2020.

Question 4
On April 30, 2020 Alpha Limited (AL) sold 3,000 shares of a company at a price of Rs. 65 per share (fair value of share on
that date was Rs. 68). AL also incurred a transaction cost of Rs. 0.70 per share in sale transaction.

These shares had been purchased last year and were re-measured on December 31, 2019 to Rs. 62 per share.

Required:
Journal entries to record sale of shares on April 30, 2020 if AL measures its investments in shares at:
(a) Fair value through P&L
(b) Fair value through OCI

Question 5
On April 30, 2020 Beta Limited (BL) sold 2,000 debentures of a company at a price of Rs. 115 per debenture (fair value of
debenture on that date was Rs. 118). BL also incurred a transaction cost of Rs. 2.50 per debenture.
These debentures had been purchased on January 1, 2018 for Rs. 105 per debenture and also incurred transaction costs
of Rs. 6,000. The effective rate was 12% whereas annual coupon payment was Rs. 15 per debenture.
The fair values of the debentures were as follows:
Date Fair value (Rs.)
December 31, 2018 220,000
December 31, 2019 226,000
Required:
Journal entries to record sale of debentures on April 30, 2020 if BL measures its investments in debentures at:
(a) Amortized cost
(b) Fair value through OCI

NASIR ABBAS FCA

 IFRS 9 (Re-classification, De-recognition and Modification) – QUESTIONS (3)

Question 6
On January 1, 2020 an entity has a portfolio of loans whose coupon and effective interest rate is 10% and whose principal
amount and amortized cost is Rs. 10,000. On that date, it enters into a transaction in which, in return for a payment of Rs.
9,115, the transferee obtains the right to Rs. 9,000 of any collections of principal plus interest thereon at 9.5%. The entity
retains rights to Rs. 1,000 of any collections of principal plus interest thereon at 10%, plus the excess spread of 0.5% on
the remaining Rs. 9,000 of principal.
Collections are to be allocated between the entity and the transferee proportionately in the ratio of 1:9, but any defaults
are to be deducted from the entity’s interest of Rs. 1,000 until that interest is exhausted. The fair value of the loans at the
date of the transaction is Rs. 10,100 and the fair value of the excess spread of 0.5% is Rs. 40.

Required:
Explain the accounting treatment along with journal entry at the date of transfer.

Question 7
On January 1, 2019 Zee Limited (ZL) sold 2,000 debentures of a company at a price of Rs. 120 per debenture (equal to fair
value of debenture on that date) to Hexa Finance (HF) in a sale and repurchase agreement. Following terms were agreed
in repo agreement:
- ZL will purchase the debentures on December 31, 2020 at a price of Rs. 132 per debenture (irrespective of fair value)
- Coupon payments for 2019 and 2020 will be received by HF being legal owner of debentures
[It gives an effective rate of return of HF equal to 17.106%]

These debentures had been purchased on January 1, 2018 for Rs. 105 per debenture and ZL also incurred transaction
costs of Rs. 6,000. The effective rate was 12% whereas annual coupon payment was Rs. 15 per debenture.

Required:
Journal entries for the years ending December 31, 2019 and 2020.

Question 8
On December 1, 2019 Wee Limited (WL) sold its receivable to factors as follows:
- Receivables amounting to Rs. 800,000 were sold to Factor Aay and receives an advance of 70% immediately at an
interest of 1% per month. The factor also charged a fee of Rs. 8,000 for the service. Factor Aay will pay the balance
amount, after deducting interest and service fees, on debt settlement by customer (i.e. on December 31, 2019). The
debts are factored with recourse.
- Receivables amounting to Rs. 500,000 were sold to a Factor Bee for an immediate payment of Rs. 400,000 and
remaining Rs. 70,000 will be paid on December 31, 2019. The debts are factored without recourse.

Required:
Journal entries for above transactions assuming that debtors settled their accounts on December 31, 2019.

Question 9
Zalmi Limited (ZL) took a loan from Dolphin Bank amounting to Rs. 800,000 on January 1, 2017 at 10% interest payable
annually. Final maturity of loan is on December 31, 2021. ZL also paid processing and legal charges of Rs. 30,000. As a
result its effective interest rate was 11.015%.
During 2018, ZL faced certain financial difficulties and the bank agreed to modify the existing loan. On January 1, 2019,
new terms were agreed as follows:
o ZL will not pay interest for the years 2019 and 2020
o From 2021 onwards annual interest rate will be charged at 12% (i.e. market interest rate)
o Final maturity date will be extended to December 31, 2023
o Fair value of new loan on that date was Rs. 637,755 and effective interest rate was 12%.

ZL paid Rs. 25,000 on January 1, 2019 relating to modification of the loan contract.
Required:
Journal entries for the year ending December 31, 2019.

NASIR ABBAS FCA

 IFRS 9 (Re-classification, De-recognition and Modification) – QUESTIONS (4)

Question 10
Kings Limited (KL) took a loan from Sultan Bank amounting to Rs. 800,000 on January 1, 2017 at 10% interest payable
annually. Final maturity of loan is on December 31, 2021. ZL also paid processing and legal charges of Rs. 30,000. As a
result its effective interest rate was 11.015%.
During 2018, ZL faced certain financial difficulties and the bank agreed to modify the existing loan. On January 1, 2019,
new terms were agreed as follows:
o ZL will not pay interest for the years 2019 and 2020
o From 2021 onwards annual interest rate will be charged at 13% (i.e. market interest rate)
o Final maturity date will be extended to December 31, 2023

ZL paid Rs. 40,000 on January 1, 2019 relating to modification of the loan contract.

Required:
Journal entries for the year ending December 31, 2019.

Question 11
On January 1, 2017, Sidney Limited (SL) purchased 1 million 5 years debentures issued by Oval Limited (OL) at a premium
of Rs. 5 per debenture. SL also incurred transaction costs of Rs. 1.50 per debenture. Coupon rate was 6% payable annually.
The debentures would be redeemed at par value of Rs. 100 each on December 31, 2021. The effective interest rate was
4.5186%.
Due to certain financial and liquidity issues, OL re-structured the payment plan with effect from January 1, 2020 after due
consultation with debenture holders. Under the revised plan the maturity date was extended by one year. further the
coupon rate was increased to 6.25% for 2020 and 2021 and 6.50% for 2022.

Required:
Journal entries for the year ending December 31, 2020.

Question 12
On January 1, 2018, Mosco Limited (ML) issued 1 million debentures at par (i.e. Rs. 100 each) against purchase of a
building. Coupon rate was 12% per annum whereas effective interest was 14.5%.
On January 1, 2020 it was agreed with the creditor to settle the entire remaining liability by issue of ordinary shares of
ML (having face value of Rs. 10 each) and a result 1.8 million shares were issued. The market price of ML’s shares on
that date was Rs. 65 per share.

Required:
Journal entry to record the issue of shares.

NASIR ABBAS FCA

 IFRS 9 (Re-classification, De-recognition and Modification) – SOLUTIONS (1)

SOLUTIONS
Solution No. 1
Dr. Cr.
------------ Rs. -----------
31-12-19 Investment (AC) 43,948
Interest income 43,948
[Investment income for 2019]

31-12-19 Cash 40,000

Investment (AC) 40,000
[Contractual cashflow for 2019]

31-12-19 Impairment loss [9,200 - 8,000] 1,200

Loss allowance 1,200
[Impairment loss for 2019]

01-01-20 Loss allowance 9,200

Investment (FVPL) 510,000
Investment (AC) 510,925
FV gain [P&L] (W-2) 8,275
[Reclassification adjustment]

31-12-20 Cash 40,000

Interest income 40,000
[Contractual cashflow for 2020]

31-12-20 Investment (FVPL) [545,000 - 510,000] 35,000

FV gain [P&L] 35,000
[Fair value gain for 2020]

W-1
Opening Closing
Date Interest Payment
balance balance
[A] [B = A x 8.6687%] [C] [A + B - C]
31-12-17 500,000 43,344 40,000 503,344
31-12-18 503,344 43,633 40,000 506,977
31-12-19 506,977 43,948 40,000 510,925

W-2 Rs.
Gross carrying amount 510,925
Loss allowance (9,200)
501,725
Fair value 510,000
Fair value gain 8,275

NASIR ABBAS FCA

 IFRS 9 (Re-classification, De-recognition and Modification) – SOLUTIONS (2)

Solution 2
Dr. Cr.
------------ Rs. -----------
31-12-19 Investment (FVPL) [590,000 - 545,000] 45,000
Fair value gain [P&L] 45,000
[Fair value gain for 2019]

31-12-19 Cash [500,000 x 10%] 50,000

Interest income 50,000
[Contractual cashflow for 2019]

01-01-20 Investment (AC) 590,000

Investment (FVPL) 590,000
[Reclassification adjustment]

01-01-20 Impairment loss 8,000

Loss allowance 8,000
[Initial recognition of loss allowance]

31-12-20 Investment (AC) [590,000 x 8.833%(W-1)] 52,115

Interest income 52,115
[Investment income for 2020]

31-12-20 Cash 50,000

Investment (AC) 50,000
[Contractual cashflow for 2020]

31-12-20 Impairment loss [9,200 - 8,000] 1,200

Loss allowance 1,200
[Measurement of loss allowance]

W-1 ---------- 5% -------- --------- 10% -------

Cashflows Factor PV Factor PV
FV at reclassification (590,000) 1.000 (590,000) 1.000 (590,000)
Year 1 payment 50,000 0.952 47,600 0.909 45,450
Year 2 payment 50,000 0.907 45,350 0.826 41,300
Year 3 payment 50,000 0.864 43,200 0.751 37,550
Year 4 payment 50,000 0.823 41,150 0.683 34,150
Year 5 payment 50,000 0.784 39,200 0.621 31,050
Year 6 payment 650,000 0.746 484,900 0.564 366,600
111,400 (33,900)

Effective interest rate = 5% + [111,400/(111,400 + 33,900)] x 5% = 8.833%

NASIR ABBAS FCA

 IFRS 9 (Re-classification, De-recognition and Modification) – SOLUTIONS (3)

Solution 3
Dr. Cr.
------------ Rs. -----------
31-12-19 Investment (FVOCI) (W-1) 14,215
Interest income 14,215
[Investment income for 2019]

31-12-19 Cash 20,000

Investment (FVOCI) 20,000
[Contractual cashflow for 2019]

31-12-19 Investment (FVOCI) (W-1) 9,285

FV reserve [OCI] 9,285
[Fair value gain for 2019]

31-12-19 Impairment loss [8,000 - 7,000] 1,000

Loss allowance [OCI] 1,000
[Impairment loss for 2019]

01-01-20 Loss allowance [OCI] 8,000

Loss allowance 8,000
[Reclassification adjustment]

01-01-20 Fair value reserve 12,486

Investment (FVOCI) 12,486
[Reclassification adjustment]

01-01-20 Investment (AC) 136,364

Investment (FVOCI) 136,364
[Reclassification adjustment]

31-12-20 Cash 20,000

Interest income 20,000
[Contractual cashflow for 2020]

31-12-20 Investment (AC) (W-1) 13,636

Interest income 13,636
[Investment income for 2020]

31-12-20 Impairment loss [9,200 - 8,000] 1,200

Loss allowance 1,200
[Impairment loss for 2020]

W-1
Opening Closing Fair value
Date Interest Payment Fair value OCI
balance balance reserve
[A] [B = A x 10%] [C] [A + B - C] [E] [F = E - D] [Change in F]
31-12-18 147,408 14,741 20,000 142,149 145,350 3,201 3,201
31-12-19 142,149 14,215 20,000 136,364 148,850 12,486 9,285
31-12-20 136,364 13,636 20,000 130,000 - - -

NASIR ABBAS FCA

 IFRS 9 (Re-classification, De-recognition and Modification) – SOLUTIONS (4)

Solution 4
Dr. Cr.
(a) ------------ Rs. -----------
30-04-20 Investment [3,000 x (68 – 62)] 18,000
Fair value gain [P&L] 18,000
[Remeasurement on the date of de-recognition]

30-04-20 Cash [3,000 x (65 – 0.70)] 192,900

Loss on disposal (P&L) 11,100
Investment [3,000 x 68] 204,000
[Sale of investment]

Dr. Cr.
(b) ------------ Rs. -----------
30-04-20 Investment [3,000 x (68 – 62)] 18,000
Fair value reserve [OCI] 18,000
[Remeasurement on the date of de-recognition]

30-04-20 Cash [3,000 x (65 – 0.70)] 192,900

Loss on disposal (P&L) 11,100
Investment [3,000 x 68] 204,000
[Sale of investment]

Solution 5
Dr. Cr.
(a) ------------ Rs. -----------
30-04-20 Investment (W-1) 8,294
Interest income 8,294
[Investment income for 4 months]

30-04-20 Cash [2,000 x (115 - 2.50)] 225,000

Gain on disposal 9,356
Investment (W-1) 215,644
[Sale of investment]
Dr. Cr.
(b) ------------ Rs. -----------
30-04-20 Investment (W-1) 8,294
Interest income 8,294
[Investment income for 4 months]

30-04-20 Investment (W-1) 1,706

Fair value reserve [OCI] 1,706
[Remeasurement on the date of de-recognition]

30-04-20 Cash [2,000 x (115 - 2.50)] 225,000

Loss on disposal [P&L] 11,000
Investment (W-1) 236,000
[Sale of investment]

NASIR ABBAS FCA

 IFRS 9 (Re-classification, De-recognition and Modification) – SOLUTIONS (5)

30-04-20 Fair value reserve [OCI] 20,356

Gain on disposal [P&L] 20,356
[Reclassification of cumulative gain on de-recognition]

W-1
Opening Closing Fair value
Date Interest Payment Fair value OCI
balance balance reserve
[A] [B = A x 12%] [C] [A + B - C] [E] [F = E - D] [Change in F]
31-12-18 216,000 25,920 30,000 211,920 220,000 8,080 8,080
31-12-19 211,920 25,430 30,000 207,350 226,000 18,650 10,570
30-04-20 207,350 8,294 - 215,644 236,000 20,356 1,706
[207,350 x 12% x 4/12]

* Initial recognition = 105 x 2000 + 6,000 = Rs. 216,000

Solution 6
The entity calculates that Rs. 9,090 (90% × Rs. 10,100) of the consideration received of Rs. 9,115 represents the
consideration for a fully proportionate 90%. The remainder of the consideration received (Rs. 25) represents consideration
received for subordinating its retained interest to provide credit enhancement to the transferee for credit losses. In
addition, the excess spread of 0.5% represents consideration received for the credit enhancement. Accordingly, the total
consideration received for the credit enhancement is Rs. 65 (Rs. 25 + Rs. 40).

For allocation of carrying amount to portion of asset de-recognized and portion retained, it is assumed that fair values of
both portions also have a ratio of 1:9 as follows:
Allocation of carrying amount Fair value Portion Carrying amount
Rs. Rs.
Portion transferred 9,090 90% 9,000
Portion retained 1,010 10% 1,000
10,100 10,000

Dr. Cr.
-------- Rs. -------
01-01-20 Cash 9,115
Continuing involvement [1,000 + 40] 1,040
Liability [1,040 + 25] 1,065
Financial asset (W-1) 9,000
Profit on transfer (balancing) 90
[Recognition of transfer]

Solution 7
Dr. Cr.
------------ Rs. -----------
01-01-19 Cash [120 x 2,000] 240,000
Financial liability - repo 240,000
[sale of debentures]

31-12-19 Financial liability - repo [2,000 x 15] 30,000

Investment 30,000
[Contractual cashflow for 2019]

NASIR ABBAS FCA

 IFRS 9 (Re-classification, De-recognition and Modification) – SOLUTIONS (6)

31-12-19 Interest expense [240,000 x 17.106%] 41,055

Financial liability - repo 41,055
[Interest expense for 2019]

31-12-19 Investment (W-1) 25,430

Interest income 25,430
[Interest income for 2019]

31-12-20 Financial liability - repo [2,000 x 15] 30,000

Investment 30,000
[Contractual cashflow for 2020]

31-12-20 Interest expense [(240,000 + 41,055 - 30,000) x 17.106%] 42,945

Financial liability - repo 42,945
[Interest expense for 2020]

31-12-20 Investment (W-1) 24,882

Interest income 24,882
[Interest income for 2020]

31-12-20 Financial liability - repo 264,000

Cash [132 x 2,000] 264,000
[Repurchase of debentures]

W-1
Opening Closing
Date Interest Payment
balance balance
[A] [B = A x 12%] [C] [A + B - C]
31-12-18 216,000 25,920 30,000 211,920
31-12-19 211,920 25,430 30,000 207,350
31-12-20 207,350 24,882 30,000 202,232

Solution 8
Dr. Cr.
(a) Factor with recourse ------------ Rs. -----------
01-12-19 Cash [800,000 x 70%] 560,000
Financial liability (Factor) 560,000
[70% advance received]

31-12-19 Cash 226,400

Financial liability (Factor) 560,000
Factor finance cost [560,000 x 1%] 5,600
Factor fees [P&L] 8,000
Receivables 800,000
[Cash settlement of receivables]

NASIR ABBAS FCA

 IFRS 9 (Re-classification, De-recognition and Modification) – SOLUTIONS (7)

(b) Factor without recourse ------------ Rs. -----------

01-12-19 Cash 400,000
Financial asset (Factor) 70,000
Loss on sale of receivables 30,000
Receivables 500,000
[Receivables derecognized

31-12-19 Cash 70,000

Financial asset (Factor) 70,000
[Final settlement from factor]

Solution 9
Dr. Cr.
------------ Rs. -----------
01-01-19 Bank loan (existing) (W-1) 780,161
Gain on extinguishment 117,406
Cash 25,000
Bank loan (New) 637,755
[Restructuring of loan]

31-12-19 Interest expense (W-3) 76,531

Bank loan (New) 76,531
[Interest expense for 2019]

W-1 Original loan schedule

Opening Closing
Date Interest Cashflow
balance balance
[A] [B = A x 11.015%] [C] [A + B - C]
31-12-17 770,000 84,816 80,000 774,816
31-12-18 774,816 85,346 80,000 780,161
31-12-19 780,161 85,935 80,000 786,096
31-12-20 786,096 86,588 80,000 792,685
31-12-21 792,685 87,315 880,000 -

W-2 Testing of 10% rule

Cashflow Factor PV
[11.015%]
01-01-19 25,000 1.000 25,000
31-12-19 - 0.901 -
31-12-20 - 0.811 -
31-12-21 96,000 0.731 70,176
31-12-22 96,000 0.658 63,168
31-12-23 896,000 0.593 531,328
PV of new terms at original effective rate 689,672
PV of original terms 780,161
Difference 90,489
11.60%

Since it is more than 10% therefore existing loan is derecognized

NASIR ABBAS FCA

 IFRS 9 (Re-classification, De-recognition and Modification) – SOLUTIONS (8)

W-3 Revised loan schedule

Opening Closing
Date Interest Payment
balance balance
[A] [B = A x 12%] [C] [A + B - C]
31-12-19 637,755 76,531 - 714,286
31-12-20 714,286 85,714 - 800,000
31-12-21 800,000 96,000 96,000 800,000
31-12-22 800,000 96,000 96,000 800,000
31-12-23 800,000 96,000 896,000 -

Solution 10
Dr. Cr.
------------ Rs. -----------
01-01-19 Bank loan (existing) (W-1) 40,000
Cash 40,000
[Restructuring cost of loan]

31-12-19 Interest expense (W-3) 66,931

Bank loan (Existing) 66,931
[Interest expense for 2019]

W-1 Original loan schedule

Opening Closing
Date Interest Cashflow
balance balance
[A] [B = A x 11.015%] [C] [A + B - C]
31-12-17 770,000 84,816 80,000 774,816
31-12-18 774,816 85,346 80,000 780,161
31-12-19 780,161 85,935 80,000 786,096
31-12-20 786,096 86,588 80,000 792,685
31-12-21 792,685 87,315 880,000 -

W-2 Testing of 10% rule

Cashflow Factor PV
[11.015%]
01-01-19 40,000 1.000 40,000
31-12-19 - 0.901 -
31-12-20 - 0.811 -
31-12-21 104,000 0.731 76,024
31-12-22 104,000 0.658 68,432
31-12-23 904,000 0.593 536,072
PV of new terms at original effective rate 720,528
PV of original terms 780,161
Difference 59,633
7.64%

Since it is less than 10% therefore existing loan is not derecognized

NASIR ABBAS FCA

 IFRS 9 (Re-classification, De-recognition and Modification) – SOLUTIONS (9)

W-3 Revised loan schedule

Opening Closing
Date Interest (W-4) Payment
balance balance
[A] [B = A x 9.0427%] [C] [A + B - C]
01-01-19 780,161 - 40,000 740,161
31-12-19 740,161 66,931 - 807,092
31-12-20 807,092 72,983 - 880,075
31-12-21 880,075 79,583 104,000 855,657
31-12-22 855,657 77,375 104,000 829,032
31-12-23 829,032 74,968 904,000 -

W-4 Calculation of revised effective rate

Cashflow
01-01-19 (740,161)
31-12-19 -
31-12-20 -
31-12-21 104,000
31-12-22 104,000
31-12-23 904,000

IRR = 9.0427%

Solution 11
Dr. Cr.
--------- Rs. million --------
01-01-20 Investment (W-2) 2.22
Modification gain [P&L] 2.22
[Modification gain recognized]

31-12-20 Investment 4.74

Interest income (W-1) 4.74
[Interest income for 2020]

31-12-20 Cash 6.25

Investment 6.25
[Contractual cashflow for 2020]

W-1
Opening Closing
Date Modification Interest Cashflow
balance balance
[A] [B] [C = (A + B) x 4.5186%] [D] [A + B + C - D]

31-12-17 106.50 - 4.81 6.00 105.31

31-12-18 105.31 - 4.76 6.00 104.07
31-12-19 104.07 - 4.70 6.00 102.77
31-12-20 102.77 2.22 4.74 6.25 103.49
31-12-21 103.49 - 4.68 6.25 101.91
31-12-22 101.91 - 4.59 106.50 -

NASIR ABBAS FCA

 IFRS 9 (Re-classification, De-recognition and Modification) – SOLUTIONS (10)

W-2 Modification gain/loss

Cashflow Factor PV
[4.5186%]
31-12-20 6.25 0.957 5.98
31-12-21 6.25 0.915 5.72
31-12-22 106.50 0.876 93.29
PV of modified cashflows at original effective rate 104.99
PV of original cashflows 102.77
Modification gain 2.22

Solution 12
Dr. Cr.
------------ Rs. million ----------
-
01-01-20 Debentures (W-1) 105.36
Loss on extinguishment 11.64
Share capital [1.8 x Rs. 10] 18.00
Share premium [1.8 x Rs. 55] 99.00
[Extinguishment of financial liability]

W-1
Opening Closing
Date Interest Payment
balance balance
[A] [B = A x 14.5%] [C] [A + B - C]
31-12-18 100.00 14.50 12.00 102.50
31-12-19 102.50 14.86 12.00 105.36

NASIR ABBAS FCA

 IAS 32 – Class notes

DEFINITIONS

A financial instrument is any contract that gives rise to a financial asset of one entity and a financial
liability or equity instrument of another entity.

A 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 liabilities with another entity under conditions that are
potentially favourable to the entity; or
(d) a contract that will or may be settled in the entity’s own equity 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.
Examples
Financial assets Non-financial assets
o cash o PPE
o cash at bank o Right of use asset
o trade receivables o Intangible assets
o Notes receivables o Inventory
o Loans receivables o Prepaid expenses
o Bonds receivables
o Perpetual bond (For investor)

A 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 liabilities with another entity under conditions that are
potentially unfavourable to the entity; or
(b) a contract that will or may be settled in the entity’s own equity 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 sset for a fixed number of the entity’s own equity instruments.
Examples
Financial liabilities Non-financial liabilities
o trade payables o Deferred revenue
o Notes payables o Income tax payable
o Loans payables o Provisions arising out of constructive
o Bonds payables obligation (IAS 37)
o Perpetual bond (For issuer)

An equity instrument is any contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities.

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 IAS 32 – Class notes

PRESENTATION

Liability and Equity

1. The issuer of the financial instrument shall classify the instrument (or its component parts) on initial
recognition as a financial liability or an equity instrument in accordance with the substance of the
contractual agreement and the definitions.

2. A critical feature in differentiating a financial liability from an equity instrument is the existence of a
contractual obligation of one party to the financial instrument (the issuer) either to deliver cash or
another financial asset to the other party (the holder) or to exchange financial assets or financial
liabilities with the holder under conditions that are potentially unfavourable to the issuer. Although
the holder of an equity instrument may be entitled to receive a pro rata share of any dividends or
other distributions of equity, the issuer does not have a contractual obligation to make such
distributions because it cannot be required to deliver cash or another financial asset to another party.

3. A contract is not an equity instrument solely because it may result in the receipt or delivery of the
entity’s own equity instruments. Two examples are (a) a contract to deliver as many of the entity’s
own equity instruments as are equal in value to Rs. 100, and (b) a contract to deliver as many of the
entity’s own equity instruments as are equal in value to the value of 100 ounces of gold. Such a
contract is a financial liability of the entity even though the entity must or can settle it by delivering
its own equity instruments.

4. 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.

Compound financial instruments

1. An entity recognizes separately the components of a financial instrument that:
(a) creates a financial liability of the entity; and
(b) grants an option to the holder of the instrument to convert it into an equity instrument of the
entity.

For example, a bond or similar instrument convertible by the holder into a fixed number of ordinary
shares of the entity is a compound financial instrument. From the perspective of the entity, such an
instrument comprises two components: a financial liability (a contractual arrangement to deliver cash
or another financial asset) and an equity instrument (a call option granting the holder the right, for a
specified period of time, to convert it into a fixed number of ordinary shares of the entity). The
economic effect of issuing such an instrument is substantially the same as issuing simultaneously a
debt instrument with an early settlement provision and warrants to purchase ordinary shares, or
issuing a debt instrument with detachable share purchase warrants. Accordingly, in all cases, the
entity presents the liability and equity components separately in its statement of financial position.

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 IAS 32 – Class notes

2. Classification of the liability and equity components of a convertible instrument is not revised as a
result of a change in the likelihood that a conversion option will be exercised, even when exercise of
the option may appear to have become economically advantageous to some holders.
3. The initial carrying amount of a compound financial instrument is allocated to its equity and liability
components as follows:
Fair value of the instrument as a whole X
Less: Financial liability component [i.e. calculated as PV of contractual cashflows (X)
(ignoring conversion option) discounted at the market rate of interest on similar
debt instruments without conversion options]
Equity component X

4. Transaction costs that relate to the issue of compound financial instrument are allocated to the
liability and equity components of the instrument in proportion to above allocation.
Transaction cost relating to:

Equity: Financial liability:

Shall be accounted for as deduction from Shall be accounted for as already studied for initial
equity. measurement of financial liability.
Dr. Equity component Dr. Financial liability (i.e. amortized cost)
Cr. Cash OR
Dr. P&L (i.e. FV through P&L)
Cr. Cash
5. Subsequently:
- Financial liability component shall be measured as already studied earlier. If amortized cost
method is followed, the effective interest rate is calculated. However, in absence of any
transaction cost, the market interest rate used in point (3) above will be used as effective interest
rate.
- Equity component shall not be remeasured.

6. On redemption date of instrument:

If holder opts for redemption: If holder opts for conversion:

(i) Cash redemption: (i) Conversion of instrument:
Dr. Financial liability (carrying amount) Dr. Financial liability (carrying amount)
Cr. Cash (redemption amount) Cr. Share capital (face value of shares issued)
Cr. Share premium (balancing)
(ii) Transfer of equity component: (ii) Transfer of equity component:
Dr. Equity component (carrying amount) Dr. Equity component (carrying amount)
Cr. Retained earnings Cr. Retained earnings
ALTERNATIVELY
Conversion of instrument
Dr. Financial liability (carrying amount)
Dr. Equity component (carrying amount)
Cr. Share capital (face value of shares issued)
Cr. Share premium (balancing)

Nasir Abbas FCA Page 3 | 6

 IAS 32 – Class notes

7. When an entity extinguishes a convertible instrument before maturity through an early redemption
or repurchase in which the original conversion privileges are unchanged:
(a) the entity allocates the consideration paid for the repurchase or redemption to the liability and
equity components of the instrument at the date of the transaction and account for as follows:

Fair value of the liability component on repurchase date [A] X

[i.e. PV of remaining contractual cashflows (ignoring conversion option)
discounted at the market rate of interest on similar debt instruments
without conversion options on repurchase date]
Less: Carrying amount of liability component (X)
(Gain)/Loss on repurchase of liability component (charged to P&L) X

Total consideration paid X

Less: Consideration for liability component [A] (X)
Consideration for equity component [B] X

Dr. Financial liability [Carrying amount]

Dr/Cr. Loss or gain on repurchase of liability component [P&L]
Dr. Equity component [Consideration for equity component i.e. B]
Cr. Cash [Total consideration paid]

(b) Any transaction cost paid is allocated to liability component and equity component in ratio of [A]
and [B] above mentioned in point [7(a)]. This allocated transaction cost is then accounted for as
follows:

Dr. P&L [Portion allocated to liability component]

Dr. Equity component [Portion allocated to equity component]
Cr. Cash [Total transaction cost paid]

(c) Any remaining balance in equity component may be transferred to another line item in equity e.g.
retained earnings.

8. An entity may amend the terms of a convertible instrument to induce early conversion, for example
by offering a more favourable conversion ratio or paying other additional consideration in the event
of conversion before a specified date. The difference, at the date the terms are amended, between
the fair value of the consideration the holder receives on conversion of the instrument under the
revised terms and the fair value of the consideration the holder would have received under the
original terms is recognised as a loss in profit or loss.

Treasury shares

If an entity reacquires its own equity instruments, those instruments (‘treasury shares’) shall be deducted
from equity. No gain or loss shall be recognized in profit or loss on the purchase, sale, issue or cancellation
of an entity’s own equity instruments. Such treasury shares may be acquired and held by the entity or by
other members of the consolidated group.

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 IAS 32 – Class notes

However, when an entity holds its own equity on behalf of others, e.g. a financial institution holding its
own equity on behalf of a client, there is an agency relationship and as a result those holdings are not
included in the entity’s statement of financial position.

Interest, dividends, losses and gains

Interest, dividends, losses and gains relating to a financial instrument or a component that is a financial
liability shall be recognized as income or expense in profit or loss. Distributions to holders of an equity
instrument shall be recognized by the entity directly in equity. Transaction costs of an equity transaction
shall be accounted for as a deduction from equity.

Offsetting a financial asset and a financial liability

1. A financial asset and a financial liability shall be offset and the net amount presented in the statement
of financial position when, and only when, an entity:
(a) currently has a legally enforceable right to set off the recognized amounts; and
(b) intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.

2. An entity currently has a legally enforceable right of set‑off if the right of set‑off:
(a) is not contingent on a future event; and
(b) is legally enforceable in all of the following circumstances:
(i) the normal course of business;
(ii) the event of default; and
(iii) the event of insolvency or bankruptcy of the entity and all of the counterparties.

3. Offsetting a recognized financial asset and a recognized financial liability and presenting the net
amount differs from the derecognition of a financial asset or a financial liability. Although offsetting
does not give rise to recognition of a gain or loss, the derecognition of a financial instrument not only
results in the removal of the previously recognized item from the statement of financial position but
also may result in recognition of a gain or loss.

Preference shares

Preference shares may be issued with various rights. In determining whether a preference share is a
financial liability or an equity instrument, an issuer assesses the particular rights attaching to the share to
determine whether it exhibits the fundamental characteristic of a financial liability.

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 IAS 32 – Class notes

A summary of various terms relating to preference shares and the resulting accounting treatment is
outlined in the table below:
Preference shares Preference dividend Preference dividend
(Mandatory) (Discretionary)
Redeemable: It is considered as financial It is considered as compound
- Mandatory; OR liability instrument
- At the option of holder
Liability is initially measured at Liability is initially measured at
fair value i.e. present value of PV of the redemption amount
future contractual cashflows only.
Equity is initially measured as
residual.

Unwinding of Preference Preference dividend will be

dividend as well as redemption recognized as a distribution of
amount will be recognized as equity (in SOCIE).
Interest expense in P&L using Unwinding of redemption
effective interest rate method. amount will be recognized as
interest expense in P&L using
effective interest rate method.

Redeemable: It is considered as compound It is considered as equity

- At the option of issuer instrument

Liability is initially measured at Equity is initially measured at

PV of the dividends only. the entire proceeds
Equity is initially measured as
residual.

Unwinding of Preference Preference dividend will be

dividend will be recognized as recognized as a distribution of
Interest expense in P&L using equity (in SOCIE).
effective interest rate method.
Non-redeemable It is considered as compound It is considered as equity
instrument

Liability is initially measured at Equity is initially measured at

PV of the dividends only. the entire proceeds
Equity is initially measured as
residual.

Unwinding of preference Preference dividend will be

dividend will be recognized as recognized as a distribution of
Interest expense in P&L using equity (in SOCIE).
effective interest rate method.

Nasir Abbas FCA Page 6 | 6

 IAS 32 – QUESTIONS (1)

PRACTICE QUESTIONS

Question 1
An entity issued 2,000 convertible bonds on January 1, 2020. 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 but the fair value was Rs. 1,980,000. Interest
is payable annually in arrears at a nominal annual interest rate of 6 per cent. Each bond is convertible at any time up to
maturity into 250 ordinary shares. When the bonds are issued, the prevailing market interest rate for similar debt without
conversion options is 9 per cent.
Required:
Journal entry at initial recognition of bonds.

Question 2
A Pakistani company issued 100 5% FCCBs at a nominal value of $ 5 each on January 1, 2019. These bonds can be redeemed
at par or converted into 25 ordinary shares per bond after 3 years. On the date of issuance, market rate of return for
similar bonds without conversion option was 9%. Exchange rates are as follows:

Date Rs./$
01-01-19 150
31-12-19 152
31-12-20 156
31-12-21 160

Required:
All journal entries till maturity if on maturity:
(a) Investor opts for cash redemption.
(b) Investor opts for conversion (Assume face value of each share is Rs. 10).

Question 3
An entity issued 1,000 convertible bonds on January 1, 2011. The bonds had a 10-year term, and were issued at par with
a face value of Rs. 1,000 per bond, giving total proceeds of Rs. 1,000,000. Interest is payable in arrears at a nominal annual
interest rate of 10% payable every 6-months. Each bond is convertible on maturity into ordinary shares at a conversion
price of Rs. 25 per share. When the bonds were issued, the prevailing market interest rate for similar debt without
conversion options was 11%.
On January 1, 2016 the entity repurchased the bonds at a price of Rs. 1,700 each. On that date market interest rate of
similar non-convertible bonds was 8%.
Required:
Journal entries to record repurchase of bonds.

Question 4
An entity issued 1,000 convertible bonds on January 1, 2011. The bonds had a 10-year term, and were issued at par with
a face value of Rs. 1,000 per bond, giving total proceeds of Rs. 1,000,000. Interest is payable in arrears at a nominal annual
interest rate of 10% payable every 6-months. Each bond is convertible on maturity into ordinary shares at a conversion
price of Rs. 25 per share. When the bonds were issued, the prevailing market interest rate for similar debt without
conversion options was 11%.
On January 1, 2012, to induce the holder to convert the convertible debenture, the entity reduced the conversion price
to Rs. 20. Assume the market price of entity’s ordinary shares on the date of amendment is Rs. 40 per share.
Required:
Journal entry on January 1, 2012 to record the effect of amendment.

NASIR ABBAS FCA

 IAS 32 – QUESTIONS (2)

Question 5
Following transactions relate to Aron Limited (AL):
(a) AL issued one million convertible bonds on January 1, 2018. The bonds had a term of three years and were issued
with a total fair value of Rs. 100 million which is also the par value. Interest is paid annually in arrears at a rate of 6%
per annum and bonds, without the conversion option, attracted an interest rate of 9% per annum on January 1, 2018.
The company incurred issue costs of Rs. 1 million. If the investor did not convert to shares they would have been
redeemed at par. At maturity all of the bonds were converted into 2.5 million ordinary shares of Rs. 10 each of AL.
No bonds could be converted before that date. The directors have been told that the impact of the issue costs is to
increase the effective interest rate to 9.38%.

(b) AL held a 3% holding of the shares in Smart, a public limited company, The investment was classified as an investment
in equity instruments and at December 31, 2020 had a carrying value of Rs. 5 million (brought forward from the
previous period). As permitted by IFRS 9 Financial instruments, AL had made an irrevocable election to recognize all
changes in fair value in other comprehensive income. The cumulative gain to December 31, 2019 recognized in other
comprehensive income relating to the investment was Rs. 400,000. On December 31, 2020, the whole of the share
capital of Smart was acquired by Given, a public limited company, and as a result, AL received shares in Given with a
fair value of Rs. 5.5 million in exchange for its holding in Smart.

(c) AL granted interest free loans to its employees on January 1, 2020 of Rs. 10 million. The loans will be paid back on
December 31, 2021 as a single payment by the employees. The market rate of interest for a two year loan on both of
the above dates is 6% per annum.

Required:
Journal entries for the year ending December 31, 2020.

NASIR ABBAS FCA

 IAS 32 – SOLUTIONS (1)

SOLUTIONS
Solution No. 1 Dr. Cr.
------------ Rs. -----------
01-01-20 Cash 2,000,000
Gain on initial recognition [P&L] 20,000
Financial liability (W-1) 1,848,122
Equity component (W-1) 131,878
[Initial recognition of bonds]

W-1 Rs.
Total fair value of financial instrument 1,980,000
Liability component 1,848,122
[120,000 x annuity factor at 9% + 2,000,000 x discount factor at 9%]
Equity component 131,878

Solution No. 2 Dr. Cr.

-------- Rs. -------
01-01-19 Cash 75,000
Financial liability [449.37(W-1) x 150] 67,406
Equity component [50.63(W-1) x 150] 7,594
[Initial recognition]

31-12-19 Interest expense [40.44(W-2) x 152] 6,147

Financial liability 6,147
[Investment expense for 2019]

31-12-19 Financial liability [25(W-2) x 152] 3,800

Cash 3,800
[Coupon paid for 2019]

31-12-19 Exchange loss (W-2) 899

Financial liability 899
[Exchange loss at year end]

31-12-20 Interest expense [41.83(W-2) x 156] 6,525

Financial liability 6,525
[Investment expense for 2020]

31-12-20 Financial liability [25(W-2) x 156] 3,900

Cash 3,900
[Coupon paid for 2020]

31-12-20 Exchange loss (W-2) 1,859

Financial liability 1,859
[Exchange loss at year end]

31-12-21 Interest expense [43.36(W-2) x 160] 6,937

Financial liability 6,937
[Investment expense for 2021]

NASIR ABBAS FCA

 IAS 32 – SOLUTIONS (2)

31-12-21 Exchange loss (W-2) 1,927

Financial liability 1,927
[Exchange loss at settlement]

(a) Redemption
31-12-21 Financial liability [525(W-2) x 160] 84,000
Equity component 7,594
Retained earnings 7,594
Cash 84,000
[Redemption of bonds]

(b) Conversion
31-12-21 Financial liability [525(W-2) x 160] 84,000
Equity component 7,594
Share capital [100 x 25 x RS. 10] 25,000
Share premium (balancing) 66,594
[Conversion of bonds into ordinary shares]

W-1 $
Total fair value of financial instrument [$ 5 x 100] 500.00
Liability component [$500 x 5% x annuity factor at 9% + $500 x discount factor at 9%] 449.37
Equity component 50.63

W-2
------------------------ $ Amortized cost ------------------------- Rupees
amortized
Date Opening Closing
Interest Cashflow cost
balance balance (translated)
[A] [B = A x 9%] [C] [D = A + B - C] [E]
31-12-19 449.37 40.44 25.00 464.81 70,652 [464.81 x 152]
31-12-20 464.81 41.83 25.00 481.64 75,136 [481.64 x 153]
31-12-21 481.64 43.36 525.00 - -

------------------------ Rs. Amortized cost -------------------------

Date Opening Exchange Closing
Interest Cashflow
balance loss balance
[F] [G] [H] [bal. figure] [E]
31-12-19 67,406 6,147 3,800 899 70,652
31-12-20 70,652 6,525 3,900 1,859 75,136
31-12-21 75,136 6,937 84,000 1,927 -

Solution No. 3 Dr. Cr.

------------ Rs. -----------
01-01-16 Financial liability (W-2) 962,312
Loss on redemption of liability [P&L] (W-2) 118,797
Equity component (W-2) 618,891
Cash 1,700,000
[Repurchase of convertible bonds]

NASIR ABBAS FCA

 IAS 32 – SOLUTIONS (3)

01-01-16 Retained earnings 559,139

Equity component [618,891 – 59,752] 559,139
[Transfer of remaining balance in equity component]

W-1 Rs.
Initial measurement:
Total value of financial instrument 1,000,000
Liability component 940,248
[50,000 x annuity factor at 5.5%* + 1,000,000 x discount factor at 5.5%]
Equity component 59,752
* 11% x 6/12 = 5.5%

W-2
Loss on repurchase of liability:
PV of remaining contractual cashflows at 8% 1,081,109
[50,000 x annuity factor at 4% + 1,000,000 x discount factor at 4%]

Carrying amount of liability component 962,312

[50,000 x annuity factor at 5.5% + 1,000,000 x discount factor at 5.5%]
Loss on repurchase of liability component 118,797

Consideration for equity:

Total consideration paid 1,700,000
Consideration for liability component 1,081,109
Consideration for equity component 618,891

Solution No. 4
Dr. Cr.
------------ Rs. -----------
01-01-12 Loss on amendment 400,000
Equity component (W-1) 400,000
[Loss on amendment of conversion ratio]

W-1 Rs.
Fair value of shares under amended terms [Rs. 1m ÷ Rs. 20 x Rs. 40] 2,000,000
Fair value of shares under original terms [Rs. 1m ÷ Rs. 25 x Rs. 40] 1,600,000
Loss on amendment 400,000

Solution No. 5
Dr. Cr.
------------ Rs. million ----------
(a) -
31-12-20 Interest expense (W-2) 9.11
Financial liability 9.11
[Interest expense for 2020]

31-12-20 Financial liability 6.00

Cash 6.00
[Coupon payment for 2020]

NASIR ABBAS FCA

 IAS 32 – SOLUTIONS (4)

31-12-20 Financial liability (W-2) 100.00

Equity component [7.59 - 0.08](W-1) 7.52
Share capital [2.5m x 10] 25.00
Share premium (balancing) 82.52
[Conversion of bonds into shares]

(b)
31-12-20 Investment (Smart) [5.50 - 5] 0.50
FV reserve [OCI] 0.50
[Remeasurement gain on de-recognition]

31-12-20 Investment (Given) 5.50

Investment (Smart) 5.50
[Exchange of shares]

(c)
01-01-20 Financial asset (Loan) [10m x 1.06-2] 8.90
Employee cost (balancing) 1.10
Cash 10.00
[Initial recognition of loan]

31-12-20 Financial asset (Loan) [8.90 x 6%] 0.53

Interest income 0.53
[Interest income for 2020]

W-1 Rs. million

Initial measurement
Total value of financial instrument 100.00
Liability component 92.41
[6m x 3-year annuity factor at 9% + 100m x discount factor at 9%]
Equity component 7.59

Allocation of transaction cost:

Financial liability component [1m x 92.41/100] 0.92
Equity component [1m x 7.59/100] 0.08
1.00

W-2
Opening Closing
Date Interest Payment
balance balance
[A] [B = A x 9.38%] [C] [A + B - C]
31-12-18 91.48 8.58 6.00 94.06
31-12-19 94.06 8.82 6.00 96.89
31-12-20 96.89 9.11 6.00 100.00

NASIR ABBAS FCA

 IFRS 9 (Hedging) – Class notes

DERIVATIVES
A financial instrument or other contract with all three of the following characteristics:
(a) 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, credit rating or credit index, or other
variable (called the ‘underlying’).
(b) 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.
(c) it is settled at a future date.

Examples:
Forward – a forward contract is a binding contract to buy or sell a specified amount of a specified item
(e.g. currency, oil, gold etc.) on a specified date. Normally a commission is paid at the time of contract.
Future – a future contract is a contract to buy or sell standard amount of a particular item (e.g. currency,
copper, shares etc.) on a standard date at a price determined in market. Futures are traded in an organized
market where these contracts are mostly settled by closing out by taking opposite position (e.g. sell now
and buy later) and net gain/loss is settled.
Option – an option contract is a right to its holder to buy or sell a particular item (e.g. shares, currency, oil
etc.) at a specified price on a specified date. Holder is not obligated to exercise the option rather it may
exercise the option only when beneficial. A premium (i.e. charges for option) is paid at the time of contract
irrespective of whether the option is eventually exercised or not.
Swap – a swap is an agreement between parties to exchange a series of cashflow at an agreed rate. Most
commonly used type of swap arrangement is an interest rate swap where two parties agree to exchange
interest payments calculated on a notional principal. Sometimes a fee is also paid to a bank that arranges
the swap and the said fee is also generally agreed as a % of notional principal.

Use of derivatives:
- Speculation
- Hedging

Measurement:
If used for speculation, derivates are termed as “held for trading” and measured at fair value through P&L.

Embedded derivatives
An embedded derivative is a component of a hybrid contract that also includes 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.
If the host contract is not a financial asset as per IFRS 9, then an embedded derivative shall be separated
from the host and accounted for as a derivative (i.e. measured at fair value through P&L) [e.g. purchase
of convertible debenture].
However, if the host contract is a financial asset as per IFRS 9, then whole contract is accounted for as
per IFRS 9 and derivative is not separated. [e.g. purchase of a car with share warrant]

Nasir Abbas FCA Page 1 | 4

 IFRS 9 (Hedging) – Class notes

HEDGING
Hedging refers to an entity’s risk management activities that use financial instruments to manage
exposures arising from particular risks that could affect profit or loss or OCI.

Hedged item
A hedged item is a recognized asset or liability, an unrecognized firm commitment (e.g. purchase order),
highly probable forecast transaction or net investment in a foreign operation that (a) exposes the entity
to risk of changes in fair value or future cash flows and (b) is designated as being hedged.

Hedging instrument
A hedging instrument is a designated derivative or (for a hedge of the risk of changes in foreign currency
exchange rates only a designated non-derivative financial asset or non-derivative financial liability) whose
fair value or cash flows are expected to offset changes in the fair value or cash flows of a designated
hedged item.

Hedge effectiveness
Hedge effectiveness is the degree to which changes in the fair value or cash flows of the hedged item that
are attributable to a hedged risk are offset by changes in the fair value or cash flows of the hedging
instrument.

Hedge ratio
Hedge ratio is the relationship between the quantity of the hedging instrument and the quantity of the
hedged item in terms of their relative weighting.

HEDGING ACCOUNTING

A hedging relationship qualifies for hedge accounting only if all of the following criteria are met:
(a) the hedging relationship consists only of eligible hedging instruments and eligible hedged items.

(b) at the inception of the hedging relationship there is formal designation and documentation of the
hedging relationship and the entity’s risk management objective and strategy for undertaking the
hedge. That documentation shall include identification of the hedging instrument, the hedged item,
the nature of the risk being hedged and how the entity will assess whether the hedging relationship
meets the hedge effectiveness requirements (including its analysis of the sources of hedge
ineffectiveness and how it determines the hedge ratio).

(c) the hedging relationship meets all of the following hedge effectiveness requirements:
(i) there is an economic relationship between the hedged item and the hedging instrument (i.e. the
hedging instrument and the hedged item have values that generally move in the opposite
direction because of the same risk, which is the hedged risk).
(ii) the effect of credit risk does not dominate the value changes that result from that economic
relationship (i.e. the gain or loss from credit risk does not frustrate the effect of changes in the
underlying on the value of the hedged item or hedging instrument); and
(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.

Nasir Abbas FCA Page 2 | 4

 IFRS 9 (Hedging) – Class notes

An entity shall discontinue hedge accounting prospectively only when the hedging relationship (or a part
of a hedging relationship) ceases to meet the qualifying criteria. This includes instances when the hedging
instrument expires or is sold, terminated or exercised.
There are three types of hedging relationships:
1) fair value hedge
2) cash flow hedge
3) hedge of a net investment in a foreign operation (IAS 21)

Exam tips for selecting between fair value hedge and cashflow hedge:
Examples of items Hedge
Fixed rate debt (asset/liability) Fair value hedge
Floating rate debt (asset/liability) Cashflow hedge
Highly probable forecast transaction Cashflow hedge
Foreign currency firm commitment Entity has choice of either of the two hedges
Foreign currency receivables/payables Cashflow hedge
Recognized assets whose value changes are a Fair value hedge
concern for entity (e.g. inventory, investment in
shares)

However, exam question may specify any hedge to be used different from above tips.

1) Fair value hedge

It is a hedge of the exposure to changes in fair value of a recognized asset or liability or an unrecognized
firm commitment, or a component of any such item, that is attributable to a particular risk and could
affect profit or loss.

Accounting for fair value hedge:

(a) the hedging gain or loss on the hedged item and the gain or loss on hedging instrument both shall
be:

If the hedged item is an investment in equity In all other cases:

instruments measured fair value through OCI:

Recognized in OCI Recognized in P&L

(b) the hedging gain or loss on the hedged item shall adjust the carrying amount of the hedged item. If
the measurement of hedged item involves amortized calculation, then this adjustment in carrying
amount is taken to P&L [as mentioned in (a) above] through revised effective interest rate.
When a hedged item is an unrecognized firm commitment, the cumulative change in the fair value of
the hedged item subsequent to its designation is recognized as a firm commitment asset or a firm
commitment liability. If this commitment was to acquire an asset or assume a liability, then such firm
commitment asset or firm commitment liability shall be closed against initial carrying amount of the
asset or liability on eventual recognition.

Nasir Abbas FCA Page 3 | 4

 IFRS 9 (Hedging) – Class notes

2) Cash flow hedge

It is a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated
with all, or a component of, a recognized asset or liability (such as all or some future interest payments
on variable-rate debt) or a highly probable forecast transaction, and could affect profit or loss.
Accounting for cash flow hedge:
(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): [+/– sign of (i) will be used]
(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 (i.e. the present value of
the cumulative change in the hedged expected future cash flows) from inception of the hedge.
(b) the gain or loss on the hedging instrument is accounted for as follows:
(i) the portion of the gain or loss that is determined to be an effective hedge [i.e. 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.
(ii) 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.
(c) 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
and hence it does not affect other comprehensive income.
(ii) for cash flow hedges other than those covered by (i) [e.g. financial assets], that amount shall be
reclassified from the cash flow hedge reserve to profit or loss as a reclassification adjustment 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 recognized 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.

3) Hedges of a net investment in a foreign operation

It shall be accounted for similarly to cash flow hedges as follows:

(a) the portion of the gain or loss on hedging instrument that is determined to be an effective hedge shall
be recognized in OCI; and
(b) the ineffective portion shall be recognized in P&L.

The cumulative gain or loss that has been accumulated in foreign currency translation reserve shall be
reclassified from equity to P&L as a reclassification adjustment on the disposal of the foreign operation.

Nasir Abbas FCA Page 4 | 4

 IFRS 9 (Hedging) – QUESTIONS (1)

PRACTICE QUESTIONS
Question 1
Journalize each of the following independent derivative transactions, entered into for speculation purposes:
(a) On May 1, 2020 A limited entered into a forward contract with Bank XYZ to purchase $ 50,000 on July 31, 2020 at an
agreed rate of Rs/$ 160. A forward commission of Rs. 0.1 per USD was paid at the time of contract. Following exchange
rates are available:
Date Forward rate (Rs/$) Spot rate (Rs/$)
01-05-20 160 (3-month forward) 158.20
30-06-20 (year-end) 162.25 (1 month forward) 161.30
31-07-20 - 163.50

(b) On June 1, 2020 B limited purchased 2000 call options on shares of ML, a listed company, on following terms:
Exercise price Rs. 45 per share
Exercise date August 31, 2020
Premium Rs. 2 per share (it is also considered as fair value of option on that date)

Fair value of option and shares of M limited are as follows:

Date Option Share of ML
(Rs/share) (Rs/share)
01-06-20 2.00 38
30-06-20 (year-end) 5.50 43
31-08-20 12.00 57

(c) On June 1, 2020 C limited bought 12 crude oil future contracts, with a contract size of 150 barrels, having 30 th
September maturity. Following are the future prices quoted in future market for 30th September crude oil futures:
Date Future price
(Rs/barrel)
01-06-20 10,000
30-06-20 (year-end) 9,800
30-09-20 9,450

(d) Company A has a loan of Rs. 2 million with a fixed rate of 10%. Company B has a loan of Rs. 2 million with a variable
rate of KIBOR which is revised annually. On January 1, 2019 both companies agreed to swap their interest rates for
three years. KIBOR was revised as follows:
Date KIBOR
01-01-19 10%
01-01-20 8%
01-01-21 13%
Journalize all transactions in books of Company A for three years.

Question 2
On December 1, 2019 A limited acquired 10,000 ounces of a Material XYZ, at a cost of Rs. 220 per ounce, which it held in
its inventories. A limited was concerned that the price of XYZ would fall, so on December 1, 2019 it sold 10,000 ounces in
future market at a price of Rs. 215 per ounce with a maturity date of March 31, 2020.
At December 31, 2019 (i.e. accounting year-end) the fair value of XYZ was Rs. 200 per ounce while the future price moved
to Rs. 198 per ounce. On March 1, 2020 A limited sold entire stock of XYZ at market price of Rs. 195 per ounce whereas
future price of 31st March XYZ future at date was Rs. 192.

Required:
All journal entries for above transactions.

NASIR ABBAS FCA

 IFRS 9 (Hedging) – QUESTIONS (2)

Question 3
B limited has a firm commitment to buy a machine for $ 2 million on March 31, 2020. The directors are worried about
exchange rate fluctuations. On October 1, 2019, when exchange rate was Rs/$ 150, B limited entered into a future contract
to buy $ 2 million with a maturity date of March 31, 2020 at a price of Rs. 152 per $.
At December 31, 2019 (i.e. accounting year-end) spot exchange rate moved to Rs/$ 154.50. On that date future price of
31st March $ future moved to Rs. 157 per $. Finally on 31st March 2020 spot exchange rate moved to Rs./$ 160. Useful life
of machine is 10 years.

Required:
Journal entries in respect of above information for the years ending December 31, 2019 and 2020 if on October 1, 2019
the future contract was designated as a fair value hedge for the firm commitment of purchase of machine.

Question 4
OneAir is a successful international airline. A key factor affecting OneAir’s cashflows and profits is the price of jet fuel. On
October 1, 2019, OneAir entered into a forward contract to hedge its expected fuel requirements for the second quarter
of 2020 for delivery of 28m gallons of jet fuel on March 31, 2020 at a price of Rs. 204 per gallon. The spot price on October
1, 2029 of jet fuel was Rs. 190 per gallon.
The airline intended to settle the contract net in cash and purchase the actual required quantity of jet fuel in the open
market on March 31, 2020.
At the company’s year end (i.e. December 31, 2019) the forward price for delivery on March 31, 2020 had risen to Rs. 216
per gallon of
ereas spot price on that day was Rs. 200 per gallon.
All necessary documentation was set up at inception for the contract to be accounted for as a hedge. On March 31, 2020
the company settled the forward contract net in cash and purchased 30m gallons of jet fuel at the spot price on that day
of Rs. 219 per gallon.
Required:
Journal entries for above transactions.

Question 5
Beta limited has approved a capital budget in its board meeting on October 1, 2019 to purchase a machine on September
30, 2020 from Ceta limited for £8 million. Beta limited hedged this highly probable forecast transaction by entering into a
forward contract to buy £8 million at an agreed rate of Rs/£ 200. Spot and forward exchange rates were as follows:

Date Forward rate (Rs/£) Spot rate (Rs/£)

01-10-19 200 (1-year forward) 180
31-12-19 (year-end) 214 (9-months forward) 190
30-09-20 - 222

On September 30, 2020 the machine was purchased as per plan and accordingly brought into use. Its useful life was
estimated at 10 years.

Required:
Journal entries for the years ending December 31, 2019 and 2020.

Question 6
Delta Limited (DL) planned to purchase an asset in July 2021. In this respect a quotation was received from a supplier in
US for $ 50,000. A forward contract was taken out to hedge currency fluctuation on March 1, 2021 with an expiry date of
August 31, 2021. On April 15, 2021 it accepted the quotation and issued purchase order for the asset to be delivered on
July 20, 2021. Full purchase amount to be settled on August 31, 2021.

NASIR ABBAS FCA

 IFRS 9 (Hedging) – QUESTIONS (3)

Spot and exchange rates were as follows:

Date Forward rate (Rs/$) Spot rate (Rs/$)

01-03-21 158 (6-month forward) 150
15-04-21 160 (4.5-month forward) 153
30-06-21 (year-end) 163 (2-month forward) 158
20-07-21 167 (6-month forward) 162
31-08-21 - 170

Forward hedge was designated as:

Hedge for firm commitment – Fair value hedge
Hedge for recognized asset/liability – fair value hedge

40% of this asset was sold on September 27, 2021 and 60% was sold on October 31, 2021.
Required:
All relevant journal entries assuming that:
(a) Purchased asset was inventory.
(b) Purchased asset was an Investment.

NASIR ABBAS FCA

 IFRS 9 (Hedging) – SOLUTIONS (1)

SOLUTIONS
Solution No. 1
Dr. Cr.
(a) ------------ Rs. -----------
01-05-20 P&L [0.1 x $ 50,000] 5,000
Cash 5,000
[Transaction cost paid]

30-06-20 Financial asset [(162.25 - 160) x $ 50,000] 112,500

P&L 112,500
[Fair value gain at year end]

31-07-20 Financial asset [(163.50 - 162.25) x $ 50,000] 62,500

P&L 62,500
[Fair value gain on settlement date]

31-07-20 Cash [(163.50 - 160) x $ 50,000] 175,000

Financial asset 175,000
[Forward contract settled]

(b)
01-06-20 Financial asset [2 x 2000] 4,000
Cash 4,000
[Initial recognition of option contract]

30-06-20 Financial asset [(5.50 - 2) x 2,000] 7,000

P&L 7,000
[Fair value gain at year end]

31-08-20 Financial asset [(12 - 5.50) x 2,000] 13,000

P&L 13,000
[Fair value gain on settlement date]

31-08-20 Cash [(57 - 45) x 2,000] 24,000

Financial asset 24,000
[Gain on exercise of call options]

(c)
01-06-20 No entry

30-06-20 P&L (W-1) 360,000

Financial liability 360,000
[Fair value loss at year end]

30-09-20 P&L (W-1) 630,000

Financial liability 630,000
[Fair value loss on settlement date]

NASIR ABBAS FCA

 IFRS 9 (Hedging) – SOLUTIONS (2)

30-09-20 Financial liability (W-1) 990,000

Cash 990,000
[Loss settlement on future close out]

W-1
30-06-20 Rs.
Buy 10,000
Sell 9,800
Loss (200)
Total loss [200 x 150 x 12] (360,000)

30-09-20 Rs.
Buy 10,000
Sell 9,450
Loss (550)
Total loss [550 x 150 x 12] (990,000)
Total loss previously recognized (360,000)
(630,000)

(d)
31-12-19 Finance cost [2m x 10%] 200,000
Bank 200,000
[Interest on loan for 2019]

31-12-20 Finance cost [2m x 10%] 200,000

Bank 200,000
[Interest on loan for 2020]

31-12-20 Bank [2m x 2%(W-1)] 40,000

Finance cost 40,000
[Net receipt under swap agreement]

31-12-21 Finance cost [2m x 10%] 200,000

Bank 200,000
[Interest on loan for 2021]

31-12-21 Finance cost 60,000

Bank [2m x 3%(W-1)] 60,000
[Net payment under swap agreement]

W-1
2020 %
A receives from B 10%
A pays to B 8%
Net receipt 2%

2021 %
A receives from B 10%
A pays to B 13%
Net payment -3%

NASIR ABBAS FCA

 IFRS 9 (Hedging) – SOLUTIONS (3)

Solution No. 2
Dr. Cr.
------------ Rs. -----------
01-12-19 Inventory [10,000 x 220] 2,200,000
Cash 2,200,000
[Purchase of 10,000 ounces of XYZ]

31-12-19 P&L [(220 - 200) x 10,000] 200,000

Inventory 200,000
[Fair value loss on inventory at year end]

31-12-19 Financial asset 170,000

P&L (W-1) 170,000
[Fair value gain on future at year end]

01-03-20 P&L [(200 - 195) x 10,000] 50,000

Inventory 50,000
[Fair value loss on inventory on sale date]

01-03-20 Financial asset 60,000

P&L (W-1) 60,000
[Fair value gain on future on sale date]

01-03-20 Cash [195 x 10,000] 1,950,000

Cost of sales 1,950,000
Inventory 1,950,000
Sales 1,950,000
[Sale of goods]

01-03-20 Cash (W-1) 230,000

Financial asset 230,000
[Gain settlement on future close out]

W-1
31-12-19 Rs.
Sell 215
Buy 198
Gain 17
Total gain [17 x 10,000] 170,000

01-03-20 Rs.
Sell 215
Buy 192
Gain 23
Total gain [23 x 10,000] 230,000
Total gain previously recognized 170,000
60,000

NASIR ABBAS FCA

 IFRS 9 (Hedging) – SOLUTIONS (4)

Solution No. 3
Dr. Cr.
------------ Rs. -----------
01-10-19 No entry

31-12-19 Financial asset 10,000,000

P&L (W-1) 10,000,000
[Fair value gain at year end]

31-12-19 P&L [$2m x (Rs. 154.50 - Rs. 150)] 9,000,000

Firm commitment liability 9,000,000
[Loss on commitment based on spot]

31-03-20 Financial asset 6,000,000

P&L (W-1) 6,000,000
[Fair value gain on close out]

31-03-20 Cash (W-1) 16,000,000

Financial asset 16,000,000
[Gain settlement on future close out]

31-03-20 P&L [$2m x (Rs. 160 - Rs. 154.50)] 11,000,000

Firm commitment liability 11,000,000
[Loss on commitment based on spot]

31-03-20 Plant & machinery (balancing) 300,000,000

Firm commitment liability 20,000,000
Cash [$2m x Rs. 160] 320,000,000
[Purchase of plant]

31-12-20 Depreciation [Rs. 300m ÷ 10 x 9/12] 22,500,000

Accumulated depreciation 22,500,000
[Dep. for the year 2020]

W-1
31-12-19 Rs.
Buy 152
Sell 157
Gain 5

Total gain [$2m x Rs. 5] 10,000,000

31-03-20 Rs.
Buy 152
Sell 160
Gain 8

NASIR ABBAS FCA

 IFRS 9 (Hedging) – SOLUTIONS (5)

Total gain [$2m x Rs. 8] 16,000,000

Total gain previously recognized 10,000,000
6,000,000

Solution No. 4
Dr. Cr.
------------ Rs. million --------
01-10-19 No entry

31-12-19 Financial asset (W-1) 336.00

Cashflow hedge reserve [OCI] (W-1) 280.00
P&L (balancing) 56.00
[Gain on hedging instrument]

31-03-20 P&L (Fuel cost) [30m x 219] 6,570.00

Cash 6,570.00
[Purchase of jet fuel from spot market]

31-03-20 Cashflow hedge reserve 280.00

Cash [(219 - 204) x 28m] 420.00
Financial asset 336.00
P&L (balancing) 364.00
[Net settlement of forward and OCI reclassified to P&L]

W-1
31-12-19 Rs. million
Cumulative loss on hedged item [(200 - 190) x 28m] (280.00)
Cumulative gain on hedging instrument [(216 - 204) x 28m] 336.00
Cash flow hedge reserve [i.e. lower of above] 280.00

Solution No. 5
Dr. Cr.
------------ Rs. million --------
01-10-19 No entry

31-12-19 Financial asset (W-1) 112.00

Cashflow hedge reserve [OCI] (W-1) 80.00
P&L (balancing) 32.00
[Gain on hedging instrument at year-end]

30-09-20 Financial asset (W-2) 64.00

P&L (balancing) 32.00
Cashflow hedge reserve [OCI] (W-2) 96.00
[Gain on hedging instrument on settlement date]

NASIR ABBAS FCA

 IFRS 9 (Hedging) – SOLUTIONS (6)

30-09-20 Machine [£8m x 222] 1,776.00

Financial asset (W-2) 176.00
Cash [£8m x 200] 1,600.00
[Purchase of machine and payment through forward]

30-09-20 Cashflow hedge reserve [directly in equity] (W-2) 176.00

Machine 176.00
[Transfer of cash flow hedge reserve to cost of Machine]

31-12-20 Depreciation [(1,776 - 176) ÷ 10 x 3/12] 40.00

Accumulated depreciation 40.00
[Depreciation for 2020]

W-1
31-12-19 Rs. million
Cumulative loss on hedged item [(190 - 180) x £8m] (80.00)
Cumulative gain on hedging instrument [(214 - 200) x £8m] 112.00
Cash flow hedge reserve [i.e. lower of above] 80.00

W-2
30-09-20 Rs. million
Cumulative loss on hedged item [(222 - 180) x £8m] (336.00)
Cumulative gain on hedging instrument [(222 - 200) x £8m] 176.00
Cash flow hedge reserve [i.e. lower of above] 176.00

Additional gain on hedging instrument [176 - 112] 64.00

Change in cash flow hedge reserve [176 - 80] 96.00
Solution No. 6
(a) Dr. Cr.
------------ Rs. 000 --------
01-03-21 No entry

15-04-21 Financial asset (W-1) 100.00

Cashflow hedge reserve [OCI] (W-1) 100.00
[Gain on hedging instrument]

15-04-21 Cashflow hedge reserve [directly in equity] 100.00

Firm commitment liability 100.00
[Direct transfer from cashflow reserve]

30-06-21 P&L (W-2) 300.00

Firm commitment liability 300.00
[Forex loss on commitment at year end]

30-06-21 Financial asset [(163 - 160) x $50,000] 150.00

Forex gain 150.00
[Forex gain on forward at year end]

NASIR ABBAS FCA

 IFRS 9 (Hedging) – SOLUTIONS (7)

20-07-21 P&L [(162 - 158) x $50,000] 200.00

Firm commitment liability 200.00
[Forex loss on commitment on transaction date]

20-07-21 Inventory (balancing) 7,500.00

Firm commitment liability 600.00
Creditors [$50,000 x 162] 8,100.00
[Recognition of inventory and payables]

31-08-21 Financial asset [(170 - 163) x $50,000] 350.00

Forex gain 350.00
[Forex gain on forward at settlement]

31-08-21 Forex loss 400.00

Creditors [$50,000 x (170 - 162)] 400.00
[Forex loss on creditors at settlement]

31-08-21 Creditors 8,500.00

Financial asset 600.00
Cash [$50,000 x 158] 7,900.00
[Final payment to creditors]

27-09-21 Cost of sales [7,500 x 40%] 3,000.00

Inventory 3,000.00
[sale of 40% inventory]

31-10-21 Cost of sales [7,500 x 60%] 4,500.00

Inventory 4,500.00
[sale of 60% inventory]

W-1
15-04-21 Rs. 000
Cumulative loss on hedged item [(153 - 150) x $50,000] (150.00)
Cumulative gain on hedging instrument [(160 - 158) x $50,000] 100.00
Cash flow hedge reserve [i.e. lower of above] 100.00

W-2
30-06-21 Rs. 000
Initial recognition in firm commitment 100.00
Revised value of commitment [(158 - 150) x $50,000] 400.00
Forex loss 300.00

(b) Dr. Cr.

------------ Rs. 000 --------
01-03-21 No entry

NASIR ABBAS FCA

 IFRS 9 (Hedging) – SOLUTIONS (8)

15-04-21 Financial asset (W-1) 100.00

Cashflow hedge reserve [OCI] (W-1) 100.00
[Gain on hedging instrument]

30-06-21 P&L (W-2) 400.00

Firm commitment liability 400.00
[Forex loss on commitment at year end]

30-06-21 Financial asset [(163 - 160) x $50,000] 150.00

Forex gain 150.00
[Forex gain on forward at year end]

20-07-21 P&L [(162 - 158) x $50,000] 200.00

Firm commitment liability 200.00
[Forex loss on commitment on transaction date]

20-07-21 Investment (balancing) 7,500.00

Firm commitment liability 600.00
Creditors [$50,000 x 162] 8,100.00
[Recognition of inventory and payables]

31-08-21 Financial asset [(170 - 163) x $50,000] 350.00

Forex gain 350.00
[Forex gain on forward at settlement]

31-08-21 Forex loss 400.00

Creditors [$50,000 x (170 - 162)] 400.00
[Forex loss on creditors at settlement]

31-08-21 Creditors 8,500.00

Financial asset 600.00
Cash [$50,000 x 158] 7,900.00
[Final payment to creditors]

27-09-21 P&L [7,500 x 40%] 3,000.00

Investment 3,000.00
[sale of 40% investment]

27-09-21 Cashflow hedge reserve [OCI] 40.00

P&L [100 x 40%] 40.00
[Transfer from hedge reserve]

31-10-21 Cost of sales [7,500 x 60%] 4,500.00

Inventory 4,500.00
[sale of 60% inventory]

31-10-21 Cashflow hedge reserve [OCI] 60.00

P&L [100 x 60%] 60.00
[Transfer from hedge reserve]

NASIR ABBAS FCA