SECTION 11 Basic Financial Instruments

#1 True or False: When accounting for financial instruments, the entity has the choice to use section 11 and 12 of the IFRS for SMEs in full or IAS 39 in full.

False The entity does have a choice of what accounting policy to use but if they decide to use IAS 39, they may do so only with regards to recognition and measurement. As per disclosures, the entity should still use section 11 and 12.

The following are accounted for as basic financial instruments, except: a. A receivable recognized for long-term loans made to another entity. b. Cash purchase of another entity’s ordinary shares. c. Cash purchase of another entity’s convertible preference shares. d. None of the above. #2

C According to section 11.8 and 11.11, investments in convertible preference shares do not fall under the definition of basic financial instruments. This is under Section 12. Other examples include cash, demand deposits, A/R, A/P, N/R, N/P, L/R, L/P, B/P and investments in nonputtable and nonconvertible shares

Which of the following is not a characteristic of a basic debt instrument? a. Its return could be fixed, variable or a mix of both as long as if the rate is variable, it is based on a quoted or observable rate b. It does not contain a contractual provision that could result in the holder losing principal in current or prior periods c. Its contractual provisions to prepay are contingent to future events d. It contains no conditional returns except its variable return or prepayments not contingent to future events. #3

C Aside from C, all are characteristics of a basic debt instrument. C is wrong because contractual provisions to prepay should not be contingent on future events.

The following financial statements will be measured at the transaction price plus transaction costs, except: a. A receivable recognized for goods sold. b. A loan received from a bank. c. Receivable for item sold on a two-year interest free credit. d. Receivable from sale of goods in which is deferred beyond normal business terms. #4

D When payment is deferred beyond normal business transactions, it is considered as a financing transaction. Financing transactions can also be instruments financed at a non- market interest rate. In these cases, initial measurement is the present value of future payments discounted at the market rate of interest for a similar debt instrument.

Which of the following is true? a. The amortized cost of a financial asset is net of the amount at which the financial asset is measured at initial recognition. b. Financial asset that have no stated interest rate are initially measured at an undiscounted amount. c. Effective interest rate method does not include allocation of the interest income or interest expense. d. None of the above. #5

A B is wrong because financial assets and liabilities that have no stated interest are measured at amortized cost if the instrument is noncurrent. The statement becomes true, however, for current assets and liabilities. C on the other hand is wrong because the method is precisely a method of allocating interest income and expense. As you know, amortized cost is computed as the measurement at initial recognition subtracted by loan repayments and impairment and added/subtracted by cumulative amortization.

Which of these statements is true? a. All kinds of debt instruments, whether as a financial asset or liability, are measured at amortized cost. b. All investments in nonputtable and nonconvertible preference/ordinary shares held for trading are measured using FVTPL c. The firm has a choice to measure investments in debt as FVTPL, AFS or HTM according to the purpose of the firm. d. None of the above. #6

B Not all kinds of debt instruments are measured at amortized cost as current debt instruments are measured at its undiscounted carrying cost. Also, investments in debt could not be measured as FVTPL or AFS. Lastly investments in either debt or equity cannot be classified as AFS unless the entity adapts IAS 39 as its accounting policy. This is one of the two main differences between the IFRS for SMEs and the full IFRS.

True or False. For an instrument measured at amortized cost, the impairment loss is the difference between the asset’s carrying amount and the present value of estimated cash flows discounted at the asset’s current effective interest rate. #7

False As we learned in 114, impairment is measured by the estimated cash flows discounted at the asset’s original effective interest rate.

True or False. Reversal of an impairment loss shall result in carrying amount that exceeds what the carrying amount would have been had the impairment not previously been recognized. #8

False Again as we learned in 114, reversal of an impairment result should not exceed what the carrying amount would have been had the impairment not previously been recognized.

For instruments measured at cost less impairment, impairment loss is the difference between the carrying amount and the a. current market value b. best estimated selling price c. present value of contingent cash flows discounted at the current market rate of return for a similar asset d. present value of estimated cash flows discounted at the current market rate of return for a similar asset #9

B In the full IFRS, instruments measured at cost less impairment, impairment loss is the difference between the carrying amount and the present value of estimated cash flows discounted at the current market rate of return for a similar asset. But for IFRS for SMEs, the only requirement is that impairment loss be the difference between the carrying amount and the best estimated selling price.

True or False. If an entity revises its estimates of payments or receipts, the entity shall adjust the carrying amount of the financial asset or financial liability by discounting cash flows at the current market rate and recognize the adjustment as income or expense in profit or loss at the date or revision. #10

False Even if the asset is not impaired but the entity revises its estimates of payments or receipts, the original effective interest rate should still be used.

The following cases warrant a derecognition of the financial asset, except: a. Contractual rights to cash flow are settled b. The entity transfers to another party only some of the risks and rewards of ownership but control for such was not transferred. c. Entity transfers substantially all of the risks and rewards of ownership. d. None of the above. #11

B As the entity still retains some of the risks and rewards of ownership, the entity should retain the asset as its own. Only when control of such asset to another party has been transferred and the other party has the practical and unilateral ability to sell the asset in its entirety to an unrelated 3 rd party without needing to impose additional restrictions can the entity derecognize the asset but still recognize any separate rights and obligations retained or created in the transfer.

An entity shall disclose the following for financial instrument transfers that does not qualify for derecognition, except: a. The nature of the risks and rewards of ownership to which the entity remains exposed. b. Nature of the assets. c. The carrying amounts of the assets and of any associated liabilities that the entity continues to recognize. d. None of the above #12

D All 3 must be disclosed.

An entity is concerned that one of its customers will not be able to make all principal and interest payments due on a loan in a timely manner because the customer is experiencing financial difficulties. The entity and the customer negotiate a restructuring of the loan. The entity expects that the customer will be able to meet its obligations under the restructured terms. In which of the following restructuring cases will the entity not recognize an impairment loss? #13

a. Customer B will pay the full principal amount of the original loan five years after the original due date, but none of the interest due under the original terms. b. Customer B will pay the full principal amount of the original loan on the original due date but with interest at a lower interest rate than the interest rate inherent in the original loan. c. Customer B will pay the full principal amount of the original loan five years after the original due date and all interest accrued during the original loan term, but no interest for the extended term. d. Customer B will pay the full principal amount of the original loan five years after the original due date and all interest, including interest for both the original term of the loan and the extended term. #13

D An impairment loss should be recognised in cases (a)–(c) as the present value of the future principal and interest payments discounted at the loan’s original effective interest rate will be lower than the carrying amount of the loan. In case (d), even though the timing of payments has changed, the lender will receive interest on interest, and the present value of the future principal and interest payments discounted at the loan’s original effective interest rate will equal the carrying amount of the loan. Therefore, there is no impairment loss.

An entity bought 50 non-puttable ordinary shares in a listed company on the market for cash of $500, and incurred $10 of broker transaction fees. The journal entry on initial recognition of the investment includes? A.Dr. Investment in Equity 510 B.Dr. Investment in Equity 500 C.Dr. Investment in Debt 510 D.Cr. Investment in Debt 500 #14

B Dr Investment in equity instruments 500 Dr Transaction costs 10 Cr Cash 510 The entity initially recognises an investment in equity instruments at the price paid which is $500. For financial instruments that are measured at fair value through profit or loss after initial recognition, transaction costs are recognised as expenses when they are incurred. In other words, transaction costs are not taken into account when determining the amount to recognized initially.

On 15 December 20X1 an entity provided services to a customer and charged the customer $200 with payment due within 60 days. At the entity’s financial year end (31 December 20X1) the customer has not yet paid the amount due. At what amount should the receivable be recognized on Dec 31? a. 0 b. 200 c. 180 d. 100 #15

B The entity initially recognised a trade receivable at $200. The trade receivable is a current asset and there is no hidden financing transaction. Therefore, assuming the customer is expected to pay the full amount shortly after the year-end (and hence there is no impairment), on subsequent measurement at 31 December 20X1 the trade receivable would continue to be measured at the undiscounted amount of the cash expected to be received