Financial Accounting II Lecture 17

Risks & Disclosure under IAS 32 and 39 Long Term Loans and Advances

Detailed study of IAS 32 and 39 is not included in this course. However, a general understanding of risks discussed in these standards and their disclosures is necessary.

Financial Instrument is an agreement that gives rise to both a Financial Asset of one entity and Financial Liability of another entity. Financial Instruments

Shares (equity instruments) are Financial Assets of the Investor and Financial Liability of the Investee Company. Other examples: Physical Assets TFC, Loan Agreements, Trade Receivables / Payables. Financial Instruments

Following are specifically excluded from Financial Assets Physical Assets Prepaid Expenses Financial Instruments

Types of financial risk are Market risk Credit risk Liquidity risk Cash flow / interest rate risk Financial Instruments

Currency Risk: is the risk that the value of the financial instrument will fluctuate due to changes in foreign exchange rates. Types of Risks - Market Risks

Interest rate risk: is the risk that the value of the financial instrument will fluctuate due to changes in market interest rates. Types of Risks - Market Risks

Price risk: is the risk that the value of the financial instrument will fluctuate due to changes in market prices whether those changes are caused by factors specific to the individual instrument or its issuer or factors affecting all securities traded in the market. Types of Risks - Market Risks

Credit risk: The risk that one party to a financial instrument will fail to discharge an obligation and cause the other party to incur a financial loss. Types of Risks – Credit Risk

Liquidity Risk: The risk that an entity will encounter difficulty in raising funds to meet commitments associated with financial instruments. Liquidity risk may result for an inability to sell a financial asset quickly at close to its fair value. Types of Risks – Liquidity Risk

Cash flow / interest rate risk: The risk that future cash flows of a financial instrument will fluctuate because of changes in market interest rates. In the case of a floating rate debt instrument, for example, such fluctuations result in a change in the effective interest rate of the financial instrument, usually without a corresponding change in its fair value. Types of Risks – Cash Flow Risk

The standard does not prescribe the format or location for disclosure of information. A combination of narrative descriptions and specific quantified data should be given, as appropriate. Financial Instruments

Information must be disclosed about the following: Risk management policies Terms, conditions and accounting policies Different risks involved Fair value of the asset or liability Material items of income, expenses from financial assets and liabilities. Financial Instruments - Disclosure

Sample narrative disclosures Concentration of Credit Risk The credit risk represents the accounting loss that would be recognized at the reporting date if counter parties (parties to the agreement) failed to perform as contracted. Financial Instruments – Sample Disclosures

The company does not have significant exposure to any individual customer. The company believes that it is not exposed to any major credit risk, however, any such possibility is mitigated by the application of credit limits to its customers and also obtaining collaterals. Financial Instruments – Sample Disclosures

Sample narrative disclosures Foreign Exchange Risk Foreign exchange risk arises mainly where receivables and payables exist due to sale and purchase transactions with foreign undertakings. Payables exposed to foreign exchange risks are identified as either "Creditors" or "Bills payable" and receivables exposed to foreign exchange risks are identified as "Trade debts". The transactions are however immaterial and do not pose a major risk. Financial Instruments – Sample Disclosures

Fair Value of Financial Instruments The carrying value of all financial assets and liabilities reflected in the financial statements approximates their fair values. Fair value is determined on the basis of objective evidence at each reporting date. Financial Instruments - Disclosure

Liquidity Risk Management Liquidity risk reflects the company's inability of raising funds to meet commitments. Management closely monitors the company's liquidity and cash flow position. This includes maintenance of balance sheet liquidity ratios, debtors and creditors concentration both in terms of the overall funding mix and avoidance of undue reliance on large individual customers. Financial Instruments - Disclosure

Disclosure Checklist Loans and advances must be shown separately. Distinguish between considered good and bad or doubtful Classification (line items on face) Loans and advances to related parties. Other loans and advances Long Term Loans and Advances

In case of loans and advances to related parties: Name Amount Particulars of collateral / security held In case of CEO, Directors and Executives, the purpose and reconciliation of opening and closing balance. Long Term Loans and Advances

The maximum aggregate amount of loans and advances outstanding (month-end basis) In other loans name of borrower with e repayment terms in case of material loans. Provisions if any. Long Term Loans and Advances