topic 2.1(b) section 12 other fin. inst....

© 2011 IFRS Foundation 30 Cannon Street | London EC4M 6XH | UK | www.ifrs.org

1 The IFRS for SMEs

Topic 2.1(b)

Section 12 Other Fin. Inst. Issues

Section 22 Liabilities and Equity

Michael Wells


2 Section 12 – Recognition and measurement

• Initial recognition:

– When entity becomes a party to the

contractual provisions of the instrument

• Initial measurement:

– At FV (normally the transaction price)

– Transaction costs are charged to expense


3 Section 12 – Recognition and measurement

• Subsequent measurement:

– At FVTPL except:

– Equity instrument that is not publicly

traded and cannot get FV reliably, then

measure at cost less impairment

– Also measure a contract linked to such

equity instrument at cost less impairment

– If previously at FVTPL, but now a reliable FV

measure is no longer available, treat most

recent FV measure as „cost‟ going forward.


4 Section 12 – Hedge accounting

• ‘Hedging’ and ‘hedge accounting’ are two

different things

• What is hedging?

– Managing risks by using one financial

instrument („hedging instrument‟) purposely

to offset the variability in FV or cash flows

of a recognised asset or liability, firm

commitment, or future cash flows („hedged

item‟)



• What is hedge accounting?

– Matching the change in FV of the hedging

instrument and the hedged item in the

same income statement

– Hedge accounting is only an issue when

normal accounting would put the two FV

changes in different periods – sometimes

referred to as an „accounting mismatch‟



• Quick illustration:

– Entity has note payable at a fixed rate of interest

due in 3 years. Note measured at amortised cost.

– Buys swap to receive fixed interest and pay

variable. Swap is measured at FVTPL.

– End of year 1, interest rate declines. Therefore

gain on derivative is immediately recognised – but

we will only recognise the higher fixed interest

expense when we pay it in future.

– “Mismatch”



• Hedge accounting matching the gain (loss)

on the derivative with the loss (gain) on the

hedged item.

• Hedge accounting is optional.



• To qualify for hedge accounting:

1. Designate and document hedging

relationship up front

– Clearly identify the hedged risk

2. Hedged risk is listed in ¶12.17

3. Hedging instrument is listed in ¶12.18

4. Entity expects hedging instrument to be

„highly effective‟ in offsetting the

designated hedged risk.



• Hedged risk must be (12.17):

– Interest rate risk in debt measured at cost

– FX or interest rate risk in firm commitment

or highly probable forecast transaction

– Price risk in a commodity owned or to be

acquired in a firm commitment or highly

probable forecast transaction

– FX risk in a net investment in a foreign

operation



• Hedged risk must be (12.17):

– FX risk in debt instrument measured at cost is

not in this list. Why?

– Under ¶30.10 (FX) the debt is translated at

spot rate and FX gain or loss is recognised in

profit or loss

– Change in FV of the swap (hedging

instrument) is also recognised in profit or loss

(measured using forward rate)

– „Natural hedge‟



• Hedging instrument must be (12.18):

– Interest rate swap, FX swap, FX forward,

commodity forward

– Entered into with external party

– Notional amount = principal or notional

amount of hedged item

– Specified maturity not later than maturity or

settlement of hedged item

– Cannot be prepaid or terminated early



• Hedge of fixed interest rate risk or

commodity price risk of commodity held

– Recognise hedging instrument as asset or

liability

– Change in FV of hedging instrument in P&L

– Change in FV of hedged item in P&L and

adjustment of carrying amount of hedged

item – even though hedged item is

otherwise measured at cost

This is called Fair Value Hedge in IAS 39.



• Example – Assumptions: – Entity borrows 1,000, 3 years, 5% fixed rate,

payable measured at amortised cost

– Hedged with a derivative whose value is linked to

an interest rate index

– End of year 1, market rate = 6%. FV of 50

payable in 1 year at 6% + 1,050 payable 2 years

at 6% = 50 x .943396 + 1,050 x .889996 = 982,

but this 18 „gain‟ is not recognised

– Value of the derivative declines to -20

– Note there is small ineffectiveness = 2



• Balance sheet when loan made:

Cash 1,000

Loan payable 1,000

• Adjust loan end of year 1 to reflect rate change:

Loan payable (hedge acct) 18

P&L (18 gain – 20 loss) 2

Derivative (Liability) 20

• Balance sheet end of year 1:

Cash 1,000


Loan payable 982

Equity (2)



• Conceptual question regarding the

previous example:

– Does the 982 carrying amount of the loan

payable at end of year 1 represent the Fair

Value of the loan?

– Hint: Does the 890 reflect change in credit

risk or prepayment risk?

– If 890 is not Fair Value, what is it?



• Hedge of variable interest rate risk, FX or

commodity price risk in a firm commitment

or highly probable forecast transaction, or

net investment in foreign operation

– Recognise change in FV of hedging

instrument in OCI (assuming it was

effective; ineffectiveness reported in P&L)

– 'Recycle' amount recognised in OCI when

hedged item hits P&L or hedging

relationship ends. Continued…



– If hedged risk was variable interest in debt

measured at cost, recognise in P&L the

periodic net settlements from the interest

rate swap in the period in which the net

settlements occur.

This is called Cash Flow Hedge in IAS 39.



• Example – Assumptions:

– Entity sells goods for 1,000 floating rate 3-

year note receivable

– Interest rate risk managed with a derivative

(interest rate swap)

– End of year 1 interest rates increase – PV

of cumulative cash flows increase by 100

– But FV of swap decreases by 105

– Note: Some hedge ineffectiveness



• Opening balance sheet:

Receivable 1,000

Equity 1,000

• Ineffective portion of hedge:

P&L* 5*

OCI (Equity) 100


*Ineffective portion of hedge

example continued next slide...



• Closing balance sheet:

Receivable 1,000

Equity (OCI)* 100*


Equity 995

*Effective portion of the hedge (loss on

derivative), which will be amortised to P&L as

the higher floating rate interest payments are

earned and recognised in P&L in years 2 & 3



• Disclosures relating to hedge accounting

– For each type of hedge: Description of hedge

(risk, hedged item, instrument)

– Special disclosures for hedge of fixed interest

rate risk and commodity price risk of commodity

held

– Special disclosures for hedge of variable interest

rate risk, FX or commodity price risk of

commodity held, highly probable forecast

transaction, or net investment in foreign operation


22 Section 22 – Liabilities and equity

• Scope of Section 22

– Principles for classifying an instrument as

debt or equity

– Original issuance of shares and other

equity instruments

– Sale of options, rights, warrants

– Bonus issues and share splits

– Issuance of convertible debt

continues...



• Scope of Section 22, continued

– Treasury shares

– Distributions to owners

– Non-controlling interest and transactions in

shares of a consolidated subsidiary



• Principles for classifying an instrument as

debt or equity

– Equity = residual interest in assets minus

liabilities

– Liability is a present obligation (entity does

not have a right to avoid paying cash)



• The following are equity:

– Puttable instrument that entitles holder to

pro rata share of net assets on liquidation

– Instrument that is automatically redeemed if

an uncertain future event occurs or death or

retirement of holder

– Subordinated instrument payable only on

liquidation



• The following are liabilities:

– Instrument is payable on liquidation, but

the amount is subject to a maximum

ceiling

– Entity is obliged to make payments before

liquidation – such as mandatory dividend

– Mandatorily redeemable preference shares



• Members’ shares in a cooperative are

equity only if:

– Coop has unconditional right to refuse

redemption of members‟ shares, or

– Redemption is unconditionally prohibited

by law or entity‟s charter

• Otherwise – liability



• Original issuance of shares and other equity

instruments

– Recognise when equity is issued and subscriber

is obligated to invest

– If equity is issued before the entity gets cash, the

receivable is an offset to equity (not an asset)

– If entity gets (nonrefundable) cash before equity

is issued, equity is increased

– No increase in equity is recognised for subscribed

shares that have not been issued and entity has

not received cash



• Sale of options, rights, warrants

– Same principles as for original issuance of

shares (previous slide)

• Transaction costs in issuing equity

instruments

– Accounted for as a reduction of equity (not

an expense)



• Bonus issues (stock dividends) and share

splits

– These do not change equity

– Accounted for as reclassification of

amounts within equity (out of retained

earnings and into permanent capital)

– Amounts reclassified should be based on

local laws



• Issuance of convertible debt

– Must account separately for debt component and

equity component (conversion right)

– Debt proceeds = FV of similar risk debt without

conversion feature (PV calculation)

– Equity proceeds are the residual

– Recorded at issuance; not subsequently revised

– Subsequently, debt discount = additional interest

expense (effective interest method)



• Issuance of convertible debt - Example

– 1/1/X1 issue at par a 4% convertible bond, par and

maturity amount = 50,000, maturity in 5 years

– If no conversion feature, would have paid 6%

– Calculate present value of cash flows at 6%:

– PV 50,000 due in 5 years @ 6% = 37,363

– PV annuity 2,000/year 5 years @ 6% = 8,425

– Total PV = 45,788

Debit cash 50,000

Credit financial liability 45,788

Credit equity (conversion right) 4,212

© 2011 IFRS Foundation 30 Cannon Street | London EC4M 6XH | UK | www.ifrs.org © 2011 IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK | www.ifrs.org


Date Inter-

est

paid

Interest

expense

@ 6%

Amort. of

discount

Bond

dis-

count

Net bond

liability

1/1/X1 4,212 45,788

31/12/X1 2,000 2,747 747 3,465 46,535

31/12/X2 2,000 2,792 792 2,673 47,327

31/12/X3 2,000 2,840 840 1,833 48,167

31/12/X4 2,000 2,890 890 943 49,057

31/12/X5 2,000 2,943 943 0 50,000

31/12/X1: Debit interest expense 2,747

Credit financial liability 747

Credit cash 2,000



• Treasury shares

– Equity instruments entity has issued and

later reacquired

– Measure at cash paid or FV of other

consideration given to acquire \

– Present as deduction from equity (not

asset)

– No gain or loss recognised on purchase,

sale, or cancellation



• Distributions to owners

– If cash – measurement = cash paid

– If non-cash – measurement = FV of assets

distributed

– Amount reduces equity

– If entity gets tax deduction for dividend, tax

benefit is adjustment of equity

– Not reduction of income tax expense

– If entity pays withholding tax on dividends

paid, tax reduces equity as part of dividend



• Non-controlling interest (NCI) and

transactions in shares of a consolidated

subsidiary

– In consolidated balance sheet NCI is part of

equity (not liability or „in between‟)

– Change in parent‟s controlling interest that does

not result in loss of control is a transaction with

owners

– Equity adjustment, not through P&L

– No adjustment of carrying amounts of assets

or goodwill


37 Questions or comments?

Expressions of individual views by

members of the IASB and its staff

are encouraged.

The views expressed in this

presentation are those of the

presenter.

Official positions of the IASB on

accounting matters are determined

only after extensive due process

and deliberation.


38

This presentation may be modified from time to time. The latest version may be downloaded from:

http://www.ifrs.org/IFRS+for+SMEs/SME+Workshops.htm

The accounting requirements applicable to small and medium-sized entities (SMEs) are set out in the International Financial Reporting Standard (IFRS) for SMEs, which was issued by the IASB in July 2009.

The IFRS Foundation, the authors, the presenters and the publishers do not accept responsibility for loss caused to any person who acts or refrains from acting in reliance on the material in this PowerPoint presentation, whether such loss is caused by negligence or otherwise.

http://www.ifrs.org/IFRS+for+SMEs/SME+Workshops.htm

topic 2.1(b) section 12 other fin. inst....

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