IAS 32, 39 and IFRS 7

Financial instruments:
classification
 Introduction

Standards on financial instruments

• IAS 32 – Financial Instruments: Presentation;
• IAS 39 – Financial Instruments: Recognition and
Measurement;
• IFRS 7 – Financial Instruments: Disclosures.
IFRS 9 _ Financial Instrument- superseded IAS 39
from January 2013
 Definitions relating to financial
instruments
Financial instruments embrace a broad range of
assets and liabilities. They include:
• Primary financial instruments:
– financial assets such as cash, receivables and
equity securities of another entity;
– financial liabilities such as debt.
• Derivative financial instruments such as financial
options, forwards, swaps and futures.
 Financial Instruments
Definition: Any contract that gives rise to a
financial asset of one entity and a financial
liability or equity instrument of another entity.
financial assets are defined from the perspective
of holder of the instrument whereas financial
liability and equity are from the perspective of
issuer of the instruments.
 Cont…….
• An equity instrument is any contract that
evidences a residual interest in the assets
of an entity after deducting of all its
liabilities…
 Definitions relating to financial
instruments (Continued)
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
favorable to the entity; or
 Definitions relating to financial
instruments (Continued)
(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. For this purpose,
the entity’s own equity instruments do not include
instruments that are themselves contracts for the
future receipt or delivery of the entity’s own
equity instruments.
 Examples of Financial assets
Any asset that is :
a) Cash: cash on hand or right of the depositor to obtain cash from
financial institution with whom it deposited cash
b) An equity instrument of another company: ordinary shares held in
another entity commonly known as share investments
c) A contractual right to
i) To receive cash or another financial asset from another entity_:
accounts receivable, notes receivable, bills receivable
ii) To exchange financial asset or liabilities to another entity under
conditions that are potentially favorable to the entity-an option
contract to purchase the shares at less than market price.
 Financial Liability
Any liability that is:
a) A contractual obligation
i) To deliver cash or another financial asst to
another entity…for example trade accounts
payable, notes payable , loans payable
ii) To exchange financial asset or financial liability
with another company under condition that are
potentially unfavorable to the entity…..an
option written by the issuer to sell shares in a
specified company at less than market price
 Financial Liability
b) A contract that will or may be settled in the entity’s own
equity instrument and is
i) Non derivative for which the entity is or may be
obliged to deliver a variable no of own equity
instrument
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 no of entity’s own equity
instrument
 Derivative instruments
All derivative simply derive their values from
another underlying item such as a share
price or interest rate. It gives a contractual
right to one person to exchange financial
asset or financial liabilities under
conditions that are potentially favorable
while the other party has a contractual
obligation to exchange under potential
unfavorable conditions.
 Financial liability and equity
instrument
a) Equity instruments include no
contractual obligation
i) to deliver cash or other financial asset to
another entity
ii) To exchange financial asset or liabilities
to another entity under conditions that
are potentially favorable to the entity.
b) If the instrument will or may be settled in the
issuer own equity instrument , it is
i) Non derivative that includes no contractual
obligation for which the entity is or may be
obliged to obtain a variable no of entity’s own
equity instruments or
ii) A derivative that will be settled by the issuer
by the exchanging a fixed amount of cash or
another financial assets for a fixed no of
entity's own equity instrument
 Part a-equity , liability test:
Contractual obligation
1) Ordinary shares: Equity………….

2) Non cumulative, non redeemable

preference share…………for
example…Co issued preference share of
100,000 each for taka 1 at a preferred
dividend of 5%
3) Cumulative , redeemable preference
share: …………for example…Co issued
preference share of 100,000 each for taka
1 at a preferred dividend of 5%.
Preference share is cumulative and
redeemable at the option of holder…..
3) Cumulative , redeemable preference
share: …………for example…Co issued
preference share of 100,000 each for taka
1 at a preferred dividend of 5%.
Preference share is cumulative and
redeemable at the option of the
company…..
 Part B: Part a-equity , liability
test: Contractual obligation
i) Non derivative that includes no
contractual obligation for which the entity
is or may be obliged to obtain a variable
no of entity’s own equity instruments or
ii) A derivative that will be settled by the
issuer by the exchanging a fixed
amount of cash or another financial
assets for a fixed no of entity's own
equity instrument
• For example: A co has an obligation to
deliver B co as many as A Co's share as
equal to taka 100,000 no of share will
depend on the price of the share .since
total amount are fixed not no so here it is a
financial liability
For ii part….assume listed co a A issue a
share option to party B that entitles Party
B to buy 100,000 shares in Co A at Taka 1
in 3 months time. This meet the condition
for equity classification under part ii
because it is a derivative that will be
settled by issuing a fixed no of share for a
fixed amount.
Figure 14.1 Classification of financial instruments
 Classification of instruments
• Trading securities
• Held to maturity securities
• Loans and receivables
• Available for sale investments
 Financial assets at fair value
through income statement
A financial asset at fair value through income
statement is a financial asset that meets either of
the following conditions.
(a) It is classified as held for trading.
(b) Upon initial recognition it is designated by the
entity at fair value through the income statement
 Financial assets at fair value
through income statement (Continued)
A financial asset is classified as held for trading if it
is:
(i) acquired or incurred principally for the purpose of
selling or repurchasing it in the near term;
(ii) part of a portfolio of identified financial
instruments that are managed together and for
which there is evidence of a recent actual pattern
of short-term profit taking; or
(iii) a derivative (except for a derivative that is a
financial guarantee contract or a designated and
effective hedging instrument)
 Financial assets at fair value
through income statement (Continued)
Financial assets held for trading include:
• debt and equity securities that are actively traded
by the entity;
• loans and receivables acquired by the entity with
the intention of making a
short-term profit from price or dealer’s margin;
• securities held under repurchase agreements.
 Held-to-maturity investments

Held-to-maturity investments are non-derivative

financial assets with fixed or determinable payments
and fixed maturity that an entity has the positive
intention and ability to hold to maturity other than:
(a) those that the entity upon initial recognition
designates as at fair value through income
statement;
(b) those that the entity designates as available for
sale; and
(c) those that meet the definition of loans and
receivables
An entity should assess its intention and ability to hold
its held-to-maturity investments to maturity not only
when those financial assets are initially recognised, but
also at each subsequent balance sheet date. Because
an entity is expected not to change its intent about held-
to-maturity security, the requirement to reassess the
appropriateness of a security’s classification would
necessarily focus on the entity’s ability to hold a security
to maturity. As facts and circumstances may change,
the entity may lose its ability to hold a debt security to
maturity and thus would be forced to reclassify its held-
to-maturity investments to available-for-sale.
 Loans and receivables

Loans and receivables are non-derivative financial

assets with fixed or determinable payments that are
not quoted in an active market other than:
(a) those that an entity intends to sell immediately or
in the near term, which should be classified as
held for trading, and those that the entity upon
initial recognition designates as at fair value
through income statement;
 Loans and receivables (Continued)

(b) those that an entity upon initial recognition

designates as available for sale; or
(c) those for which a holder may not recover
substantially all of its initial investment, other
than because of credit deterioration, which
should be classified as available for sale
(IAS 39 para 9).
 Available-for-sale financial assets

Available-for-sale financial assets are those non-

derivative financial assets that are designated as
available for sale or are not classified as:
(a) loans and receivables;
(b) held-to-maturity investments; or
(c) financial assets at fair value through income
statement (IAS 39 para 9).
 Available for sale investments

That do not fall into other three category

• Initial measurement –Fair value
• Subsequent measurement- Fair value
• Gain or loss: directly in equity unless the
assets are derecognized
 Fair value measurements
• IAS 39 provides the guidelines for
determining fair value for financial
instruments.
a) Active market: Quoted price
Market price is the fair value. If there is no
asking or bidding price then most recent
transaction price is the fair value.
b) No Active market: Valuation technique:
if there is not active market then entity establishes
fair value by using valuation techniques.
Valuation techniques includes:
Recent arms length transactions
Discounted cash flow
Option pricing model
Valuation technique include as many as possible
market input and as less as possible entity
specific input.
c) No active market-equity instrument
Equity instruments which do not have any
active market and fair value can’t be
measured reliably then those instruments
should be measured at cost.
 Impairment
Trading securities: N/A
Held to maturity securities: recognized in
profit or loss
• Loans and receivables: recognized in
profit or loss

• Available for sale investments: recognized

in equity
 Impairment
Difference between the carrying amount and
present value of the assets expected future cash
flows. Carrying amount is reduced either directly
or creating a allowance account. Reversal is
permitted up to to the amortized cost if there was
no impairment.
In case of available for sale instruments
impairment is recognized in equity. but there are
no limit upward reversal since instruments are
measured at fair value. But reversals are
permitted only in case of debt securities.
• Financial Instruments
• Company A purchase a debt instrument on January 1,
2005 with a five year term for its fair value of Taka 1000
and maturity value is 1250, interest is payable yearly.
Investors required an effective interest rate of 10% and
coupon rate is 4.7%.X Co prepares its financial
statement at December 31.At December 31, fair value of
equipment is 1020.
• Held to maturity instrument
• Available for sale financial assets.
• Trading securities.
• During 2007 the issuer of instrument is in financial
difficulties and future cash flow becomes improbable.
The fair value of the instrument is estimated to be 636 at
the end of 2007.no cash flows are received during 2008.
At the end of 2008 the issuer is released from
administration and issuer will be able to pay remaining
obligation Prepare the journal entries regarding this
investment assuming instrument is :
• Held to maturity instrument
• Available for sale financial assets.
• Trading securities.