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Focus Points
• Scope
• Definitions of key terms
• Recognition
• Classification and presentation of financial
CPA SESSION. instruments
• Classification and measurements of financial
Topic: IFRS 9 and IAS 32- Financial assets and liabilities
Instruments • De-recognition of financial instruments
• Impairment of financial assets

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SCOPE Scope.
This Standard shall be applied by all entities to all types of e) Any forward contract between an acquirer and a selling
financial instruments except: shareholder to buy or sell an acquiree that will result in a business
(a) those interests in subsidiaries, associates and joint ventures combination within the scope of IFRS 3 Business Combinations at a
that are accounted for in accordance with IFRS 10 future acquisition date.
Consolidated Financial Statements , IAS 27 Separate f) Loan commitments.
Financial Statements or IAS 28 Investments in Associates
and Joint Venture. g) Financial instruments, contracts and obligations under share-based
payment transactions to which IFRS 2 Share-based Payment
(b) rights and obligations under leases to which IFRS 16 Leases
applies h) Rights to payments to reimburse the entity for expenditure that it
(c) employers’ rights and obligations under employee benefit is required to make to settle a liability that it recognises as a provision
plans, to which IAS 19 Employee Benefits applies. in accordance with IAS 37
(d) rights and obligations arising under a contract within the i) Rights and obligations within the scope of IFRS 15 Revenue from
scope of IFRS 17 Insurance Contracts , other than an issuer’s Contracts with Customers that are financial instruments, except for
rights and obligations arising under an insurance contract those that IFRS 15 specifies are accounted for in accordance with this
that meets the definition of a financial guarantee contract Standard.
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Definitions Definitions
• Financial instrument. • Financial liability. Any liability that is:
Any contract that gives rise to both a financial asset of one entity and a – a contractual obligation:
financial liability or equity instrument of another entity. • to deliver cash or another financial asset to another entity,
• Financial asset. Any asset that is: or
– cash • to exchange financial instruments with another entity under
– an equity instrument of another entity conditions that are potentially unfavourable.
– a contractual right to receive cash or another financial asset from • a contract that will or may be settled in the entity’s own
another entity; or to exchange financial instruments with another equity instruments and is:
entity under conditions that are potentially favourable to the entity. (i) a non-derivative for which the entity is or may be obliged to
– a contract that will or may be settled in the entity’s own equity deliver a variable number of the entity’s own equity
instruments and is: instruments; or
(i) a non-derivative for which the entity is or may be obliged to receive a (ii) a derivative that will or may be settled other than by the
variable number of the entity’s own equity instruments; or exchange of a fixed amount of cash or another financial asset
for a fixed number of the entity’s own equity instruments
(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 • Equity instrument. Any contract that evidences a residual interest
the entity’s own equity instruments. in the assets of an entity after deducting all of its liabilities.
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Definitions
Definitions IAS 32 makes it clear that the following items are not financial
instruments.
Examples of financial assets include: • Physical assets, eg inventories, property, plant and equipment,
• Trade receivables leased assets and intangible assets (patents, trademarks etc)
• Options • Prepaid expenses, deferred revenue and most warranty obligations
• Shares (when used as an investment) • Liabilities or assets that are not contractual in nature
• Contractual rights/obligations that do not involve transfer of a
Examples of financial liabilities include: financial asset, eg commodity futures contracts, operating leases
• Trade payables
• Debenture loans payable
• Redeemable preference (non-equity) shares
• Forward contracts standing at a loss

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Definitions Recognition.
EXAMPLE 1
Bazoo Inc is an upcoming manufacturer of health products that uses
traditional medicine and methods as its USP (unique selling point). As part of
its local and overseas expansion, it makes several investments.
• An unconditional receivable from one of its clients, LAPSO.
• A forward contract entered into on 12 March 20X6, to purchase 9% bonds
at Tshs10,000 on 12 June 20X6.
• On 5 January 20X6, Bazoo lays down plans for the purchase of the above
mentioned 9% bonds.
• On 2 February 20X6, Basil enters into a firm commitment to purchase a
boiler machine that is designated as a hedged item in a fair value hedge of
the associated foreign currency risk. A hedged item is an asset, liability or a
future transaction that exposes the entity to the risk of changes in future
cash flows.
Required:
CEO of Bazoo has asked you to state with reasons whether these transactions
entered into during the past year would be recognised as financial assets or
financial liabilities under IFRS 9.

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IAS 32:Classification of financial instruments IAS 32:Classification of financial instruments

The issuer of a financial instrument shall classify the instrument, or its
component parts, on initial recognition as a financial liability, a A financial instrument is only an equity instrument if both of the following
financial asset or an equity instrument in accordance with the conditions are met:
substance of the contractual arrangement and the definitions of a Equity instrument
financial liability, a financial asset and an equity instrument.
❑ Debt & equity classification is a complex area and that – The instrument includes no contractual obligation to deliver cash or
contractual terms and conditions are critical to doing the another financial asset to another entity; or to exchange financial
assessment. assets or liabilities with another under conditions that are potentially
❑ A key factor to consider is whether an entity has an unfavourable to the issuer.
unconditional right to avoid payment of cash. – If the instrument will or may be settled in the issuer’s own equity
❑ Under financial liability, there is a contractual obligation to instrument, it is a non-derivative that includes no contractual
deliver cash or another financial asset which the entity cannot
unconditionally avoid. obligation for the issuer to deliver a variable number of its own equity
❑ Under equity, the entity contractually has an unconditional instruments; or it is a derivative that will be settled only by the issuer
right to avoid payment of cash unless in case of liquidation. exchanging a fixed amount of cash or another financial asset for a fixed
number of its own equity shares.

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IAS 32:Classification of financial instruments IAS 32:Classification of financial instruments

❑Classification of preference shares can be assessed based
on the following scenarios: Example 2
Coasters wishes to purchase a new ride for its ‘Animation Galaxy’ theme park
1. One million 5%, non-cumulative, non-redeemable TZS1 but requires extra funding. On 30 September 20X3, Coasters issued the
preference shares. Dividends are at the discretion of the following preference shares:
issuer - this is equity ❑ 1 million preference shares for $3 each. No dividends are payable.
2. One million 2%, cumulative, redeemable TZS1 preference Coasters will redeem the preference shares in three years' time by issuing
shares - this is financial liability. ordinary shares worth $3 million. The exact number of ordinary shares
issuable will be based on their fair value on 30 September 20X6.
3. One million 3%, non-cumulative, redeemable TZS1
preference shares. Redemption is: ❑ 2 million preference shares for $2.80 each. No dividends are payable. The
preference shares will be redeemed in two years' time by issuing 3 million
4. a. Mandatory - this is a financial liability ordinary shares.
b. At the option of the holder -this is a financial liability ❑ 4 million preference shares for $2.50 each. They are not mandatorily
c. At the option of the issuer - this is equity redeemable. A dividend is payable if, and only if, dividends are paid on
ordinary shares.
5. One million 4%, non-cumulative TZS1 preference shares,
convertible into TZS1 million worth of ordinary shares - Required: Discuss whether these financial instruments should be classified as
this is a financial liability financial liabilities or equity in the financial statements of Coasters for the
year ended 30 September 20X3.
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IAS 32:Classification of financial instruments

Answer
1m preference shares IAS 32:Classification of financial instruments
The definition of a financial liability includes any contract that may be
settled in a variable number of the entity’s own equity instruments.
Therefore, a contract that requires the entity to deliver as many of the 4m preference shares
entity’s own equity instruments as are equal in value to a certain A financial liability exists if there is a contractual
amount should be treated as debt. Coasters must redeem the first set
of preference shares by issuing ordinary shares equal to the value of obligation to deliver cash or another financial asset.
$3 million. The $3 million received from the preference share issue There is no obligation for Coasters to repay the
should be classified as a liability on the statement of financial position.
instrument. Dividends are only payable if they are also
2m preference shares paid on ordinary shares. There is no obligation to pay
A contract that will be settled by the entity delivering a fixed number dividends on ordinary shares so there is no obligation to
of its own equity instruments is an equity instrument. Coasters will pay dividends on these preference shares. The instrument
redeem the second preference share issue with a fixed number of is not a financial liability. The proceeds from the
ordinary shares. Therefore, the $5.6 million from the second
preference share issue should be classified as equity in the statement preference share issue should therefore be classified as
of financial position. equity in the statement of financial position.

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IAS 32:Classification of financial instruments IAS 32:Presentation of financial instruments

EXAMPLE 3
Compound Instruments.
During the year, Glad Co issued the following financial
instruments: • A Compound instrument is a financial instrument that has characteristics of
both equity and liabilities, for example debt that can be converted into
• 10,000 9% preference shares redeemable after ten years shares
• Fred bonds paying 5% interest each year which do not have • The issuer of a non-derivative financial instrument shall evaluate the terms
maturity dates assigned to them of the financial instrument to determine whether it contains both a liability
• A call option that allows the holder to purchase a fixed and an equity component. Such components shall be classified separately as
number of ordinary shares from Glad Co for a financial liabilities, financial assets or equity instruments.
predetermined amount of cash • The bondholder has the prospect of acquiring cheap shares in an entity,
• 5,000 5% preference shares redeemable at the option of because the terms of conversion are normally quite generous. Even if the
the shareholder bondholder wants cash rather than shares, the deal may still be good. On
maturity the cash-hungry bondholder will accept the conversion, and
Required: then sell the shares on the market for a tidy profit.
State with reasons whether or not the above items can be • In exchange though, the bondholders normally have to accept a below
classified as financial liabilities. market rate of interest, and will have to wait some time before they get
the shares that form a large part of their return. There is also the risk
that the entity’s shares will under-perform, making the conversion
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IAS 32:Presentation of financial instruments IAS 32:Presentation of financial instruments

EXAMPLE 3
Interest, dividends, losses and gains
On 1January 2001 Denis issued a $50m three-year convertible
• The accounting treatment of interest, dividends, losses and gains
bond at par. There were issue costs of $1.16m. The coupon rate
relating to a financial instrument follows the treatment of the
is 10%, payable annually in arrears on 31st December. The bond
instrument itself.
is redeemable at par on 1January 2004. Bondholders may opt for
conversion. The terms of conversion are two 25-cent equity • For example, dividends paid in respect of preference shares
shares for every $1 owed to each bondholder on 1January 2004. classified as a liability will be charged as a finance expenses through
Bonds issued by similar entities without any conversion rights profit and loss.
currently bear interest at 15%. The effective interest rate • Dividends paid on shares classified as equity will be reported in the
adjusted with issue cost is 16%. Assume that all bondholders opt statement of changes in equity.
for conversion in full.
• Required: How will this be accounted for by Denis?

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Measurement of financial instruments.

IAS 32:Presentation of financial instruments
Initial measurement.
Offsetting a financial asset and a financial liability. • Except for trade receivables within the scope of paragraph 5.1.3, at
• IAS 32 states that a financial asset and a financial liability may only initial recognition, an entity shall measure a financial asset or
be offset in very limited circumstances. The net amount may be financial liability at its fair value plus or minus, in the case of a
reported when the entity: financial asset or financial liability not at fair value through profit or
• Has a legally enforceable right to set off the amount loss, transaction costs that are directly attributable to the
acquisition or issue of the financial asset or financial liability.
• Intends either to settle on a net basis, or to realize the asset and
settle the liability simultaneously. Example
• On 1 October 2015, NMB made an interest free loan to an
employee of TZS 28,800,000. The loan is due for repayment on 30
September 2017 and NMB is confident that the employee will repay
the loan. NMB would normally require an annual rate of return of
10% on business loans.
Required.
What is the initial carrying amount of the loan.
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Classification of financial assets

Measurement of financial instruments.

Subsequent measurement.
• After initial recognition, an entity shall measure a
financial asset at:
a) Amortised cost;
b) fair value through other comprehensive income;
or
c) fair value through profit or loss.
• After initial recognition, an entity shall measure a
financial liability at amortised cost except those
measured at Fair value through Profit o Loss.

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Classification of financial assets Classification of financial assets

An entity shall classify financial assets as subsequently measured at Financial assets at Fair value through other comprehensive income.
amortised cost, fair value through other comprehensive income or A financial asset shall be measured at fair value through other
fair value through profit or loss on the basis of both: comprehensive income if both of the following conditions are met:
a) the entity’s business model for managing the financial assets and • the financial asset is held within a business model whose objective is
achieved by both collecting contractual cash flows and selling financial
b) the contractual cash flow characteristics of the financial asset.
assets and
Financial assets at amortised cost. • the contractual terms of the financial asset give rise on specified dates
A financial asset shall be measured at amortised cost if both of the to cash flows that are solely payments of principal and interest on the
following conditions are met: principal amount outstanding.
• the financial asset is held within a business model whose objective Financial assets at Fair value through Profit or Loss.
is to hold financial assets in order to collect contractual cash flows • A financial asset shall be measured at fair value through profit or loss
and unless it is measured at amortised cost or at fair value through other
• the contractual terms of the financial asset give rise on specified comprehensive income.
dates to cash flows that are solely payments of principal and • an entity may, at initial recognition, irrevocably designate a financial
interest on the principal amount outstanding. asset as measured at fair value through profit or loss if doing so
eliminates or significantly reduces a measurement or recognition
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inconsistency.

Classification of financial assets Classification of financial assets

Example 4
On 1 January 20X1, Tokyo bought a $100,000 5% bond for $95,000, incurring
issue costs of $2,000. Interest is received in arrears. The bond will be
redeemed at a premium of $5,960 over nominal value on 31 December 20X3.
The effective rate of interest is 8%.
The fair value of the bond was as follows:
31/12/X1 $110,000
31/12/X2 $104,000

Required: Explain, with calculations, how the bond will have been accounted
for over all relevant years if:
(a) Tokyo's business model is to hold bonds until the redemption date.
(b) Tokyo's business model is to hold bonds until redemption but also to sell
them if investments with higher returns become available.
(c) Tokyo's business model is to trade bonds in the short-term. Assume that
Tokyo sold this bond for its fair value on 1 January 20X2.

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Classification of financial assets

Classification of financial assets
EXAMPLE 5
ADIE Plc, a CD manufacturing company has entered into the following
• For equity investment normally should be measured at Fair value transactions involving financial instruments:
through Profit or loss. However an entity may make an • ADIE gave a loan to BADU an emerging recording company during the year.
irrevocable election at initial recognition for particular Although BDU owes ADIE money, this transaction does not give rise to a
trade receivable. It is a part of portfolio that the company manages in
investments in equity instruments that would otherwise be order to collect the contractual cash flows.
measured at fair value through profit or loss to present • During the year, ADIE made an investment in 500 equity shares at
subsequent changes in fair value in other comprehensive income. Tshs12,000 per share of Silk Plc quoted in an active market. However, this
investment was not made or held for trading purposes.
• It is possible to designate an equity instrument as fair value • ADIE made an investment in 200 equity shares at TShs10,000 per share of
through other comprehensive income, provided specified Cowell Industries which are not held for trading; do not have a quoted
conditions have been complied with as follows: price and whose fair value cannot be reliably measured.
• ADIE’s investment in debt securities which is not quoted in an active
– The equity instrument cannot be held for trading, and market and is not held for trading.
– There must be an irrevocable choice for this designation upon • During the year, ADIE purchased debt securities of NITE Corp. These debt
instruments were quoted in an active market and ADIE plan on holding on
initial recognition. to them until maturity. However, if market interest rates fall significantly,
ADIE will consider selling the debt securities in order to realise the
associated gain.
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Classification of financial assets Classification of financial assets

• ADIE make a strategic investment in an equity instrument which EXAMPLE 6
they, at the moment, have no intention to sell. Mazimbe Plc incurred the following financial assets and liabilities during the
year 20X7.
• During the year, ADIE made another investment in SUSH Plc which • Purchase of a debt security for Tshs25 million with transaction costs of
was held for trading purposes. Tshs0.2 million. The debt security is held for trading purposes.
Required: • Equity shares purchased for Tshs4 million. The dealer fee paid was Tshs0.75
million. Mazimbe elected to classify these shares as financial assets at fair
ADIE Plc needs you as an accountant, to help them classify these value through profit or loss.
transactions into the appropriate category of financial asset or liability. • During the year, Mazimbe purchased a bond of Tshs10 million at a premium
However, you also need to keep in mind that several transactions can of Tshs0.1 million and classified it as at amortised cost sale. Transaction
costs incurred on the bond were Tshs0.15 million.
fall into more than one category. • Mazimbe issued a bond for Tshs600 million and incurred issuance costs of
Tshs1.2 million. This bond was measured at amortised cost by Mazimbe.
Required:
As their accountant, determine the initial carrying amount of each of the
above financial instruments.

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Classification of financial liabilities.

Classification of financial liabilities.
An entity shall classify all financial liabilities as subsequently measured Example 7
at amortised cost, except for: • Hoy raised finance on 1 January 20X1 by the issue of a two-year
• Financial liabilities at fair value through profit or loss . Such 2% bond with a nominal value of $10,000. It was issued at a
liabilities, including derivatives that are liabilities, shall be discount of 5% and is redeemable at a premium of $1,075. Issue
subsequently measured at fair value. costs can be ignored. The bond has an effective rate of interest
of 10%.
• Financial liabilities that arise when a transfer of a financial asset • Wiggins raised finance by issuing $20,000 6% four-year loan
does not qualify for derecognition or when the continuing notes on 1 January 20X4. The loan notes were issued at a
involvement approach applies. discount of 10%, and will be redeemed after four years at a
• Financial guarantee contracts premium of $1,015. The effective rate of interest is 12%. The
issue costs were $1,000.
• Commitments to provide a loan at a below-market interest rate. • Cavendish raised finance by issuing zero coupon bonds at par on
• Contingent consideration recognised by an acquirer in a business 1 January 20X5 with a nominal value of $10,000. The bonds will
combination to which IFRS 3 applies. Such contingent consideration be redeemed after two years at a premium of $1,449. Issue costs
can be ignored. The effective rate of interest is 7%. The reporting
shall subsequently be measured at fair value with changes date for each entity is 31 December.
recognised in profit or loss.
• Required: Illustrate and explain how these financial instruments
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by each company
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Reclassification De-recognition
• An entity shall reclassifies the financial assets if An entity shall derecognise a financial asset when, and
the business model on managing financial assets only when:
is changed. • the contractual rights to the cash flows from the
• it shall apply the reclassification prospectively financial asset expire, or
from the reclassification date . The entity shall • it transfers the financial asset and the transfer
not restate any previously recognised gains, qualifies for derecognition.
losses (including impairment gains or losses) or
interest.
• Reclassification of financial liabilities is not
permitted.
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De-recognition De-recognition.
EXAMPLE 6
• Ming has two receivables that it has factored to a bank in return for
immediate cash proceeds of less than the face value of the invoices. Both
receivables are due from long standing customers who are expected to
pay in full and on time. Ming has agreed a three-month credit period
with both customers.
• The first receivable is for $200,000 and in return for assigning the
receivable Ming has just received from the factor $180,000. Under the
terms of the factoring arrangement this only money that Ming will
receive regardless of when or even if the customer settles the debt, i.e.
the factoring arrangement is said to be “without recourse”
• Second receivable is for $100,000 and in return for assigning the
receivable Ming has just received from the factor $70,000. Under the
terms of the factoring arrangement if the customer settles the account
on time then a further $5,000 will be paid by the factoring bank to Ming,
but if the customer does not settle the account in accordance with the
agreed terms then the receivable will be reassigned back to Ming who
will then be obliged to refund the factor the original $70,000 plus a
further $10,000. This factoring arrangement is said to be “with recourse”.

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De-recognition. De-recognition.
Required:
• Discuss Ming’s accounting treatment of the monies received under the EXAMPLE 7
terms of the two factoring arrangements.
Solution
Jones bought an investment for $40million plus
• In the first arrangement the $180,000 has been received as a one-off, non associated transaction costs of $ 1million. The asset
refundable sum. This is factoring without recourse for bad debts. The risk was designated upon initial recognition as fair value
of bad debt has clearly passed from Ming to the factoring bank.
Accordingly Ming should derecognize the receivable and there will be an through other comprehensive income. At the reporting
expense of $20,000 recognised. No liability will be recognized. date the fair value of the financial asset had risen to
•
$60million. Shortly after the reporting date the financial
• In the second arrangement the $70,000 is simply a payment on account.
More may be received by Ming implying that Ming retains an element of asset was sold for $70million.
reward. The monies received are refundable in the event of default and as
such represent an obligation. This means that the risk of slow payment Required:
and bad debt remains with Ming who is liable to repay the monies so far
received. As such despite the passage of legal title the asset (i.e • How should this be accounted for
receivable) should remain recognized in the accounts of Ming. In
substance Ming has borrowed $70,000 and this loan should be recognized
• How would the answer have been different if the
immediately. This will increase the gearing of Ming. investment has been classified as at fair value
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through profit and loss?
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De-recognition. De-recognition.
Solution • If Jones had designed the investment as fair value through profit
• On purchase the investment is recorded at the consideration paid including, as the or loss, the transaction costs would have been recognized as an
asset is classified as fair value through other comprehensive income, the associate expense in profit or loss. So on purchase: $m
transaction costs: $m
Dr Asset 41 Dr Asset 40
Cr Cash 41 Cr Cash 40
At the reporting date the asset is re-measured and the gain is recognized in other Dr Expense 1
comprehensive income and taken to equity: $m
Dr Asset 19 Cr Cash 1
Cr Other components of equity 19 Subsequent measurement – at fair value through profit or loss:
On disposal, the asset is derecognized, the gain or loss on disposal is determined by $m
comparing disposal proceeds and carrying value, with the result taken to profit or
loss. $m Dr Asset 20
Dr Cash 70 Cr Profit 20
Cr Asset 60 On disposal the asset is derecognized with the gain taken to income
Cr Profit 10
Note that any gains or losses previously taken to equity are not recycled upon de- Dr Cash 70
recognition, although they may be reclassified within equity. Cr Asset 60
Cr Profit 10
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De-recognition. Review Questions

EXAMPLE 8
Matrix Entertainment Software Solutions has entered into the following
transactions involving the sale of several of its financial assets during the
last year.
• Sale of a financial asset for Tshs20 million. There are no conditions
attached to the sale and no other rights and obligations are retained
by Matrix.
• Sale of an investment in shares for Tshs20 million. However, Matrix
retains a call option to repurchase the shares at any time at the
current fair value on the date of the repurchase of the shares.
• Sale of a part of its short-term receivables for Tshs200 million.
According to the terms of the sale, it promises to pay Tshs6 million to
compensate the buyer, Cannon Cable Entertainment, for any defaults
on payment. The expected credit losses on this transaction are
significantly lower than Tshs6 million and there are no significant risks
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Review Questions
• Sale of receivables worth Tshs20 million. According to Impairment of Financial Assets
the terms of the sale, Matrix retains the right to
service the receivables for a fixed fee of Tshs7 million. Scope of the New IFRS 9 Impairment Model
• Matrix enters into a total return swap with  IFRS 9 requires impairment testing of the following instruments:
Evanessence Media Works, the essence of which will ▪ Financial assets that are measured at amortized cost.
return any increases in the fair value of the shares ▪ Debt investments that are measured at FVOCI.
worth Tshs20 million sold to Matrix and compensate ▪ Lease receivables within the scope of IFRS16 Leases.
Evanessence for any decreases in the fair value of the ▪ Trade receivables and contract assets within the scope of IFRS
shares. 15.
▪ Loan commitments that are not measured at FVTPL.
Required: ▪ Financial guarantee contracts within the scope of IFRS 9 that are
You are required to state to what extent derecognition of not measured at FVTPL.
 The impairment requirements of IFRS 9 do not apply to equity
these assets is appropriate in the financial statements in investments or items at FVTPL.
each of the above cases.

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Impairment of Financial Assets

ECL Forecasting IFRS9 Requirements:
Impairment of Financial Assets
1 IFRS9 defines ECL as an unbiased and probability-
Overview of the new impairment model weighted amount determined by evaluating a
• IFRS 9 establishes a three stage impairment model, range of possible outcomes
based on whether there has been a significant increase in An entity should consider reasonable and
the credit risk of a financial asset since its initial
2 supportable information available without undue
recognition. These three stages then determine the cost or effort at the reporting date
amount of impairment to be recognised as expected
credit losses (ECL) (as well as the amount of interest
revenue to be recorded) at each reporting date
3 Incorporate information about past events, current
conditions and forecasts of future economic
conditions that is relevant to the ECLs estimation

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Impairment of Financial Assets Impairment of Financial Assets

STAGES:
A significant increase in credit risk (moving from Stage 1
 Stage 1: As soon as a financial instrument is to Stage 2) can include:
originated or purchased, 12-month expected credit
losses are recognised in profit or loss and a loss • Changes in general economic and/or market conditions
allowance is established. (e.g. expected increase in unemployment rates,
interest rates);
 Stage 2: If the credit risk increases significantly
and the resulting credit quality is not considered to • Significant changes in the operating results or financial
be low credit risk, full lifetime expected credit position of the borrower;
losses are recognised. • Changes in the amount of financial support available to
 Stage 3: If the credit risk of a financial asset an entity (e.g. from its parent);
increases to the point that it is considered credit • Expected or potential breaches of covenants;
impaired, interest revenue is calculated based on • Expected delay in payment (Note: Actual payment
the amortised cost (ie the gross carrying amount delay may not arise until after there has been a
adjusted for the loss allowance). significant increase in credit risk).

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Impairment of Financial Assets. Impairment of Financial Assets

EXAMPLE 8.
Indicators that an asset is credit-impaired( • Bale Co has a portfolio of $50,000 financial assets (debt
instruments) that have two years to maturity and are correctly
move to stage 3) would include observable accounted for at amortised cost. Each asset has a coupon rate of
10% as well as an effective rate of 10%.
data about the following events: • No previous loss allowance has been recognised as the 12 month
ECL was assessed to be nil and there had been no significant
• Actual breach of contract (e.g. default or change in the credit risk since the portfolio had been acquired (this
is Stage 1).
delinquency in payments); • At the year-end (this is Stage 2), information has emerged that the
• Granting of a concession to the borrower due sector in which the borrowers operate is experiencing tough
economic conditions. It is now felt that a proportion of loans will
to the borrower’s financial difficulty; default over the remaining loan period and therefore the credit risk
has increased significantly. After considering a range of possible
• Probable that the borrower will enter outcomes, the overall rate of return from the portfolio is expected to
be approximately 6% per annum for each of the next two years.
bankruptcy or other financial reorganisation. The debt instruments are not, however, considered credit impaired.
Required : Calculate the lifetime expected credit losses and the
loss allowance required.

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Impairment of Financial Assets Impairment of Financial Assets

Answer EXAMPLE 9
• The lender was expecting an annual return of On 1 January 20X1, Napa purchased a bond for $1 m which is measured
at amortised cost. Interest of 10% is payable in arrears. Repayment is
$5,000 a year ($50,000 × 10%) but is now only due on 31 December 20X3. The effective rate of interest is 10%.
expecting an annual return of $3,000 a year On 31 December 20X1, Napa received interest of $100,000. It estimated
($50,000 × 6%). There is therefore a cash shortfall that the probability of default on the bond within the next 12 months
– ie an ECL of $2,000 per year. A loss allowance would be 0.5%. If default occurs within the next 12 months then Napa
estimated that no further interest will be received and that only 50% of
should be calculated at the present value of the the capital will be repaid on 31 December 20X3.
shortfalls over the remaining life of the asset. The asset’s credit risk at 31 December 20X1 is low.
• The discount rate used should be the effective Required:
discount rate ie 10%. Discuss the accounting treatment of the financial asset at 31 December
20X1.

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Impairment of Financial Assets Impairment of Financial Assets

ANSWER • The net carrying amount of the financial asset on the statement of
• The credit risk on the financial asset has not significantly financial position is $997,066 ($1,000,000 – $2,934).
increased. Therefore, a loss allowance should be made • Note: Interest in future periods will continue to be charged on the
equal to 12-month expected credit losses. The loss asset’s gross carrying amount of $1,000,000.
allowance should factor in a range of possible outcomes, as
well as the time value of money.
• The credit loss on the asset is $586,777 (W1). This Date Expected cash Discount PV
represents the present value of the difference between the shortfall rate
contractual cash flows and the expected receipts if a default $ $
occurs.
31/12/X2 100,000 1/1.1 90,909
• The expected credit loss is $2,934 ($586,777 credit loss ×
0.5% probability of occurrence). A loss allowance of $2,934 31/12/X3 100,000 1/1.12 82,645
will be created and an impairment loss of $2,934 will be 31/12/X3 500,000 1/1.12 413,223
charged to profit or loss in the year ended 31 December –––––––
20X1. 586,777
–––––––
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Impairment of Financial Assets Impairment of Financial Assets

EXAMPLE 10 ANSWER
On 1 February 20X6, Eve made a four-year loan of $10,000 to Evidence about the significant financial difficulties of Fern
Fern. The coupon rate on the loan is 6%, the same as the mean that the asset is now credit impaired.
effective rate of interest. Interest is received at the end of each Expected losses on credit impaired assets are calculated as the
year. difference between the asset's gross carrying amount and the
On 1 February 20X9, Fern tells Eve that it is in significant present value of the expected future cash flows discounted
financial difficulties. At this time the current market interest using the original effective rate of interest.
rate is 8%.
Eve estimates that it will receive no more interest from Fern. It Because the coupon and the effective interest rate are the
also estimates that only $6,000 of the capital will be repaid on same, the carrying amount of the asset will remain constant at
the redemption date. $10,000.
Eve has already recognised a loss allowance of $1,000 in The present value of the future cash flows discounted using
respect of its loan to Fern. the original effective rate is $5,660 ($6,000 × 1/1.06).
Required: How should this be accounted for?

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Impairment of Financial Assets.

Impairment of Financial Assets EXAMPLE 11.
On 31 December 20X1, the gross carrying amount of the
The expected losses are therefore $4,340 ($10,000 – asset was TZS 100m;
$5,660) and so a loss allowance should be recognised for – Effective Interest rate is 10%;
this amount. Therefore, the existing loss allowance must
be increased by $3,340 ($4,340 – $1,000) with an – Asset becomes credit-impaired and the loss allowance
expense charged to profit or loss. is TZS 60M;
The asset is credit impaired and so interest income will – Asset’s amortised cost is therefore TZS 40m;
now be calculated on the net carrying amount of $5,660 On 31 December 20X2, no cash has been received and
(the gross amount of $10,000 less the loss allowance of
$4,340). Consequently, in the last year of the loan, there is no change to the expected cash flows;
interest income of $340 (5,660 × 6%) will be recognised in – Interest revenue recognised is TZS 4m (TZS 40m x
profit or loss. 10%);
– Amortised cost is TZS 44m = TZS 40m + (TZS 40m
×10%)
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Review Questions
Question 1
Impairment of Financial Assets a) One of the matters addressed in IFRS 9 – Financial Instruments is the
initial and subsequent measurement of financial assets. IFRS 9 requires
that financial assets are initially measured at their fair value at the date of
Trade receivables and contract assets without initial recognition. However, subsequent measurement of financial assets
significant financing component. depends on their classification for which IFRS 9 identifies three possible
alternatives.
 For trade receivables and contract assets that do not contain Required:
a significant financing component in accordance with IFRS 15 Explain the three classifications which IFRS 9 identifies for financial assets and
(so generally trade receivables and contract assets with a the basis of measurement which is appropriate for each classification. You
maturity of 12 months or less), ‘lifetime expected credit should also identify any exceptions to the normal classifications which may
apply in specific circumstances.
losses’ are recognised. Because the maturities will typically be b) Kappa prepares financial statements to 30 September each year. During
12 months or less, the credit loss for 12-month and lifetime the year ended 30 September 2016 Kappa entered into the following
expected credit losses would be the same. transactions:
i. On 1 October 2015, Kappa made an interest free loan to an employee of
 The new impairment model allows entities to calculate $800,000. The loan is due for repayment on 30 September 2017 and
expected credit losses on trade receivables using a provision Kappa is confident that the employee will repay the loan. Kappa would
matrix. normally require an annual rate of return of 10% on business loans

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ii. On 1 October 2015, Kappa made a three-year loan of $10 million to Solution
entity X. The rate of interest payable on the loan was 8% per annum, (a) The classification and measurement of financial assets is largely based
payable in arrears. On 30 September 2018, Kappa will receive a fixed on: The business model for managing the asset – specifically whether or
number of shares in entity X in full settlement of the loan. Entity X paid not the objective is to hold the financial asset in order to collect the
the interest due of $800,000 on 30 September 2016 and entity X has no contractual cash flows.
liquidity problems. Following payment of this interest, the fair value of Whether or not the contractual cash flows are solely payments of principal
this loan asset at 30 September 2016 was estimated to be $10·5 million. and interest on the principal amount outstanding.
Where the business model for managing the asset is to hold the financial
iii. On 1 October 2015, Kappa purchased an equity investment in entity Y asset in order to collect the contractual cash flows and the contractual cash
for $12 million. The investment did not give Kappa control or significant flows are solely payments of principal and interest on the principal amount
influence over entity Y but the investment is seen as a long-term one. outstanding, then the financial asset is normally measured at amortised cost.
On 30 September 2016, the fair value of Kappa’s investment in entity Y Where the business model for managing the asset is to both hold the
was estimated to be $13 million. financial asset in order to collect the contractual cash flows and to sell the
Required: financial asset and the contractual cash flows are solely payments of principal
Explain and show how the above transactions would be reported in the and interest on the principal amount outstanding, then the financial asset is
financial statements of Kappa for the year ended 30 September 2016. normally measured at fair value through other comprehensive income.
Interest income on such assets is recognised in the same way as if the asset
were measured at amortised cost.

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In other circumstances, financial assets are normally measured at fair value (ii) Since the loan is at normal commercial rates, the loan would initially be
through profit or loss. recognised at $10 million – the amount advanced.
Notwithstanding the above, where equity investments are not held for The interest received and receivable of $800,000 would be credited to profit or loss
trading, an entity may make an irrevocable election to measure such as finance income. 1 In this case, the contractual cash flows are not solely payments
investments at fair value through other comprehensive income. 1 Finally an of principal and interest on the principal amount outstanding. Therefore the asset
entity may, at initial recognition, irrevocably designate a financial asset as would be measured at fair value through profit or loss.
measured at fair value through profit or loss if to do so eliminates or A fair value gain of $500,000 ($10·5 million – $10 million would be recognised in
significantly reduces an accounting mismatch. profit or loss. 1 The loan asset of $10·5 million would be shown as a non-current
asset.
(b) (i) The loan is a financial asset which would initially be recognised at its
fair value on 1 October 2015. (iii) The equity investment would be initially recognised at its cost of purchase – $12
million.
Given the fact that Kappa normally requires a return of 10% per annum on The contractual cash flows relating to an equity investment are not solely payments
business loans of this type, the loan asset should be initially recognised at of principal and interest on the principal amount outstanding. Therefore the asset
$661,157 ($800,000/(1·10)2). 1 An amount of $138,843 ($800,000 – would normally be measured at fair value through profit or loss. This would result in
$661,157) would be charged to profit or loss at 1 October 2015. a gain on remeasurement to fair value of $1 million ($13 million – $12 million) being
Because of the business model and the contractual cash flows, this loan asset recognised in profit or loss.
will subsequently be measured at amortised cost. Since the equity investment is being held for the long term, rather than as part of a
Therefore $66,116 ($661,157 x 10%) will be recognised as finance income in trading portfolio, it is possible to make an irrevocable election on 1 October 2015 to
classify the asset as fair value through other comprehensive income. In such
the year ended 30 September 2016. The closing loan asset $727,273 will be circumstances, the remeasurement gain of $1 million would be recognised in other
($661,157 + $66,116). This will be shown as a current asset since repayment comprehensive income rather than profit or loss.
is due on 30 September 2017.
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Review Questions
Review Questions
Question 2
IFRS 9 - Financial Instruments sets out the principles and rules for the
appropriate accounting treatment of most financial instruments. In particular,
it deals with loans between entities, both from the perspective of the lender The ’Rathangan’ bond was bought at a deep discount, and the aim is to
and the borrower. wait until the market value increases, and then sell it on at a profit. At
Tamsin Plc invests in bonds. Sometimes, it trades these bonds by flipping 31 July 2019, the ‘Rathangan’ bond had a fair value of €27.5 million.
them quickly for profit. Others are held for the long term. In both cases, the coupon is payable on 31 July each year, and has
Details of two particular bonds purchased on 1 August 2018 are as follows: been paid as promised.
‘Athy’ ‘Rathangan’
Nominal value of bond €45 million €30 million REQUIREMENT:
Coupon interest rate 4% 5% a) Discuss the accounting treatment required by IFRS 9 for
Purchase price of bond €38.5 million €28 million recognition and measurement of financial assets such as bonds,
paying particular attention to the tests required to decide
Effective yield to maturity 6.75% 7.8% between alternative treatments.
The ‘Athy’ bond was purchased with a view to holding it for the long term, b) In the case of each bond above, outline the accounting treatment
drawing the interest and principal as it becomes payable. required by IFRS 9 for year ended 31 July 2019. Show all workings
clearly.

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Solution Subsequent measurement of financial assets
(a)Classification of financial assets Financial assets are remeasured at each reporting date in accordance with the
classification method adopted.
There are three sub-classifications used for financial assets. These are:
Amortised Cost:
• Amortised cost;
• If classified as “amortised cost”, the effective interest rate method is applied in
• Fair value through profit or loss; or arriving at an updated valuation at each reporting date. Amortised cost is the
• Fair value through other comprehensive income. amount at which a financial asset or liability is measured at initial recognition, plus
Amortised cost is used for an asset if BOTH the following two tests are satisfied: or minus the cumulative amortization (using the effective interest rate) of any
• Cash Flow Test - The contractual cash flows are solely payments of principal and difference between the initially recognized amount and the maturity amount,
interest on the principal amount outstanding; AND allowing for any payments in the intervening period.
• Business Model Test - the asset is being held with the intention of drawing the • The effective interest rate is that rate that exactly discounts the estimated future
contractually agreed cash flows for its life, cash payments or receipts for the life of the instrument to the net carrying value of
the instrument.
If BOTH tests are met, then the amortised cost classification is required. Otherwise (if
EITHER one fails) fair value should be used. This normally applies to debt instruments
expected to be held to maturity. Fair Value:
Fair value through other comprehensive income is used for a debt asset if BOTH the • If classified as “fair value”, the asset or liability is revalued to fair value at each
following two tests are satisfied: reporting date. Gains and losses are normally taken to profit or loss but there are
• Cash Flow Test - The contractual cash flows are solely payments of principal and important exceptions:
interest on the principal amount outstanding; AND • An irrevocable election was made (in the case of an equity investment not held for
• Business Model Test - the asset is being held within a business model which seeks trading) to take fair value gains and losses to OCI;
to both collect contractual cash flows and sell financial assets. • The asset is a debt instrument required to be carried at fair value through other
Fair value through profit or loss is Compiled
used for all other
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comprehensive income due to Compiled
the business model adopted;
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(b) Athy Finally, the interest payment was paid at 31 July 2019 as promised.
As the bond was purchased with a view to holding it for the long term, the business
This should be 4% of the par value €45 million, or €1.8 million. This
model test is met. As the bond’s cash flows consist solely of interest and principal
is treated as a reduction to the financial asset.
payments, the cash flow test is met. Hence, this bond should be accounted for using € million € million
the amortised cost method. Dr Cash 1.8
The bond is recorded at its cost, plus any costs to purchase (not relevant here). Cr Financial assets 1.8
€ million € million
Dr Financial assets 38.5 Rathangan
Cr Cash 38.5 As this bond was purchased with a view to sell it on, the business
Subsequently, the effective yield to maturity should be used to amortise the bond model test fails. Hence, amortised cost cannot be used to measure
over the year. This is applied to the opening balance to determine the finance cost the bond. It must be remeasured to fair value at the reporting date.
(6.75% * 38.5m = 2.59875 million or €2.6 million) The bond is recorded at cost, but any costs of purchase would be
€ million € million expenses in this scenario.
Dr Financial assets 2.6 € million € million
Cr Profit or loss (finance income) 2.6 Dr Financial asset 28
Cr Cash 28
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At 31 July 2019, the scheduled interest is paid, at 5% of Question 3.
par value €30 million, or €1.5 million. This is taken to a) Evaluate whether each of the listed items (i) to (v) is a
finance income. financial instrument and whether it should be accounted
€ million € million for under IAS 32. Financial Instrument Presentation
Dr Cash 1.5 i. Cash deposited in banks
Cr Finance Income 1.5
ii. Prepaid expenses
Finally, at the reporting date, the bond is remeasured to
fair value, €27.5 million. This shows a loss of €0.5 million iii. Gold bullion deposited in banks
which should be taken to profit or loss. iv. Finance lease receivables or payables
€ million € million v. Trade accounts receivable
Dr Profit or loss (finance costs) 0.5
Cr Financial Assets 0.5

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b) Extract from the trial balance on GOME as at 30 th June 2015 are as follows.
Note 1
• The financial assets measured at amortized cost represent an
Dr Cr investment in loan notes of another entity. GOME invested TZS
50,000 million, their nominal value, in 10% loan notes will be repaid
TZS TZS millions at premium on 30th July 2013. Transaction costs of TZS 2,000 million
millions were incurred. The loan notes will be repair at premium on 30th July
2017. Their effective interest rate is 12%. The interest due as
Financial assets at amortized cost 53,240 receivable in the year and credited to investment income
Financial assets of FVTOCI 35,400 Note 2
• The FVTOCI investments are recorded in the trial balance at their
Financial assets at FVTPL 73,200 fair value as at 30th June 2014. During the year, an investment which
had original cost of TZS 3,000 million was sold for cash proceeds of
Investment income 5,000 TZS 8,000 million. Only the cash proceeds have been recorded in
the above trial balance. Its fair value as at 30th June 2014 was TZS
Proceeds from disposal of financial 8,000 6,500 million. The fair value of the remaining investments at 30th
assets June 2015 was measured at TZS 36,700 million.
Retained earnings 125,500
FVTOCI Reserve 30,800
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Review Questions
Note 3 IFRS 9 & IAS 32.
• The FVTPL financial assets are recorded in the trial
balance at their fair value as at 30th June 2014 plus the
cost of financial assets purchased in the year. Financial
assets were purchased during the year at a cost of TZS
12,500 million plus transaction costs of TZS 1,500
million which have also been capitalized.
• The fair value of all these investments at 30th June was
TZS 84,700 million THE END!!!!
REQUIRED:
• Prepare the extracts of the following GOME’s financial
statements for the year ended 30th June 2015.
• Statement of Profit or Loss and other comprehensive
income Statement of financial position

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