1. FINANCIAL INSTRUMENTS
IFRS 7
IAS 32
IAS 39 by
Dr.Anjali Bhave

2. Financial instruments background
Increased complexity of financial instruments
Harmonised global markets
Concept of fair value

3. Financial instruments background
Need for better disclosures and assessment of risks
Unprecedented global financial crisis
Governance issues

4. What is included in the standards?
IAS 39
Recognition and derecognition of financial instruments
Measurement of financial instruments
Derivatives and hedge accounting

5. What is included in the standards?
IAS 32
Presentation of financial instruments - Debt and Equity classification
IFRS 7
Financial instruments disclosures

6. What is a Financial instrument?
Contract giving rise to
Financial asset of one entity
and
Financial liability / equity of another entity

7. Financial asset Any asset that is (a) Cash;
(b) An equity instrument of another entity;
(c) A contractual right to receive cash or another financial asset from another entity or to exchange financial assets or financial liabilities with another entity under conditions that are potentially favorable to the entity or

8. Financial asset
(d) A contract that may or will be settled in the entity’s own equity instrument and is
1) a derivative which will or may be settled other than by exchange of a fixed amount of cash or another financial asset for a fixed number of entity’s own equity instruments
2) non derivative for which the entity is or may be obliged to receive a variable number of the entity’s own equity instruments or

9. Financial liability Any liability that is a) A contractual obligation
1) to deliver cash or another financial asset to another entity or
2) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavorable to the entity

10. Financial liability
b) A contract that will or may be settled in the entity’s own equity instruments
1) a derivative which will or may be settled other than by exchange of a fixed amount of cash or another financial asset for a fixed number of entity’s own equity instruments
1) non derivative for which the entity is or may be obliged to receive a variable number of the entity’s own equity instruments or

11. Examples Financial assets Financial liabilities Cash
Investment in shares
Receivables
Loans to other entities
Investments in bonds and other debt instruments
Financial liabilities
Trade payables
Loans from other entities
Bonds and other debt instruments issued

12. Categories of Financial assets – IAS 39
Financial assets held for trading
Held-to-maturity investments
Loans and receivables
Available-for-sale financial assets

13. Categories of Financial assets – IAS 39
Financial assets at fair value through profit or loss
Designated as such upon initial recognition
Those classified as held for trading
Derivatives not accounted for as hedges

14. Classification as held for trading
Acquired or incurred principally for the purpose of selling or repurchasing it in the near term
Part of a portfolio of identified financial instruments with evidence of a recent actual pattern of short-term profit-taking

15. Classification as held for trading
A non hedging derivative
An entity may also designate an entire hybrid contract at fair value through profit or loss if the contract contains one or more embedded derivatives

16. Categories of Financial assets – IAS 39
Held-to-maturity investments - financial assets
With fixed or determinable payments and fixed maturity (eg, debt securities and redeemable preference shares)
That an entity has the positive intent and ability to hold to maturity.

17. Categories of Financial assets – IAS 39
Loans and receivables
Non-derivative financial assets with fixed or determinable payments not quoted in an active market
Arise when entity provides money, goods or services directly to a debtor with no intention of trading the receivables .

18. Categories of Financial assets – IAS 39
Available-for-sale financial assets
Residual category –
assets that are not classified in another category

19. FINANCIAL INSTRUMENTS – DECISION TREE FOR CATEGORIES
Asset is acquired/held to generate profit? Or originated to be sold in the short-term?
YES NO
Part of portfolio with a pattern of profit taking?
YES NO
Is it a derivative?
Is its designated & effective hedge
YES NO NO
YES
Are there: -fixed and determinable payments -fixed maturity - intent & ability to hold maturity?
Apply hedge accounting NO
Is there intention to sell in the
short term?
Is it created by giving money, goods or services directly to debtor?
YES
YES NO NO
YES
Financial assets at fair value through P&L
Loans and receivables
Available for sale
Held to maturity

20. Categories of financial liabilities – IAS 39
Financial liabilities at fair value through profit or loss
designated as such upon initial recognition and
classified as held for trading
Derivatives unless accounted for as hedges

21. Categories of financial liabilities – IAS 39
Financial liabilities measured at amortised cost
Residual category –
Liabilities that are not classified in another category

22. Derivatives Financial instruments with following characteristics:
Value changes in response to changes in an ‘underlying’ price or index
Requires no initial net investment or an initial net investment that is smaller than would be required to purchase the underlying instrument
Settled at a future date.

23. Recognition and Initial measurement
All financial assets and liabilities need to be recognised
At fair value
When the entity becomes party to the contractual provisions of the instrument

24. Fair value
Amount for which an asset could be exchanged or liability settled
Between knowledgeable willing parties
In an arm’s length transaction

25. Example of fair value of a debt instrument classified as HTM
Loan given to a vendor Rs 10000
For a period of 5 years,
Carries interest at a rate of 5% (payable annually)
Interest rate for similar loans from the market is 10%.
The loan’s fair value is calculated as a net present value of
interest payments
and principal repayments
discounted at 10% is 8,105

26. Subsequent measurement
INSTRUMENT Financial assets at fair value through profit or loss
MEASUREMENT Fair Value
VALUE CHANGES P&L

27. Subsequent measurement
INSTRUMENT Held-to-maturity investments
MEASUREMENTA mAmortised cost effective interest ratertised cost
(effective interest rate)
VALUE CHANGES Not relevant
(unless impaired)

28. Subsequent measurement
INSTRUMENT Loans and receivables
MEASUREMENTA mAmortised cost
(effective interest rate)rtised cost
(effective interest rate)
VALUE CHANGES Not relevant
(unless impaired)

29. Subsequent measurement
INSTRUMENT Available-for-sale
MEASUREMENTA cFair Valuest
(effective interest rate)
VALUE CHANGES Equity

30. IAS 32 DEBT EQUITY CLASSIFICATION
Classification - substance of a financial instrument rather than its legal form
Debt - Contractual obligation to deliver cash or another financial asset under conditions that are potentially unfavourable
Equity - Exposure to the risk of fluctuations in price or residual interest of issuer’s equity

31. FINANCIAL INSTRUMENTS – DEBT EQUITY CLASSIFICATION
Yes No
Is settlement in cash either:
-mandatory
-at the option of the holder
Does the settlement depend on the outcome of uncertain future events or circumstances beyond the issuing undertaking’s control?
In substance, does the issuing undertaking have full discretion to avoid cash settlement?
Is the possibility that the issuing undertaking will be required to settle in cash/other financial asset remote?
Is settlement in a variable number of the issuing undertaking’s equity securities?
Is the holder exposed to the risk of fluctuations in (a)price or (b)(b)residual price or (b) residual interest in the issuing undertaking's own equity securities?
EQUITY
LIABILITY :

32. IAS 32 DEBT EQUITY CLASSIFICATION
A financial instrument is
a liability if it is a contractual obligation to deliver cash or other financial assets
- equity if it evidences a residual interest in the assets of an undertaking after deducting all of its liabilities.

33. IAS 32 DEBT EQUITY CLASSIFICATION
Convertible debt that gives the holder choice of repayment in cash or in shares -- separated into its debt and equity components.
Analysed into an issue of ordinary debt at a discount, and a credit to equity for the conversion right.

34. IAS 32 DEBT EQUITY CLASSIFICATION
A convertible bond Rs 100 carrying 6% interest p.a,
Convertible in 25 equity shares after 3 years
Bond without convertible feature carry 9%.
Value of debt = PV of interest payments + PV of 9% = =92.4
Value of equity = = 7.6

35. IAS 32 Convertible instruments
Fixed for fixed principle
Contract to exchange a financial asset for an entity’s own equity instruments is classified as equity only if
the amount of financial assets
And
the number of equity instruments are fixed.

36. IAS 32 FCCB
If the amount is fixed but in a currency other than the functional currency of the issuing entity, then the amount is not fixed for the purpose of classifying the financial instrument
FCCBs to be accounted for as liability at fair value through profit and loss.

37. Reclassification Trading Not permitted
Loans and receivables Trading - If pattern of short term profit making
Held-to-maturity Trading / Available for sale Tainting

38. Reclassification
Available for sale Trading - If pattern of short term profit making
Held to Maturity Change in intent and if all criteria met

39. Amortisation Calculated using the effective interest rate method
= the rate that exactly discounts estimated future cash flows through the expected life of the financial instrument
IRR

40. Amortisation To continue the previous example Value of debt = 92.4
Cost of issue 1%
Net proceeds = 91.48
The rate that equates this inflow with outflows of 6,6,106 is 9.38%
This rate is called effective interest rate and used for amortisation

41. Amortisation Opening balance Interest @9.38% Cash paid Closing
liability
91.48
8.58 6
9.48
94.06
8.82
96.88
9.09
/ 100

42. Derecognition
Derecognition is removal of an asset or liability from the balance sheet
The standard combines the ‘risk and rewards approach’ and ‘control approach

43. Derecognition
A financial liability is removed from the balance sheet only when it is extinguished –that is when the obligation specified in the contract is discharged or cancelled, or expires
A transaction is accounted for as a collateralised borrowing if the transfer does not satisfy the conditions for derecognition

44. Derecognition When The rights to the cash flows from the asset expire
The rights to the cash flows from the asset and substantially all risks and rewards of ownership of the asset are transferred

45. Derecognition
An obligation to transfer the cash flows from the asset is assumed and substantially all risks and rewards are transferred
Substantially all the risks and rewards are neither transferred nor retained but control of the asset is transferred.

46. Derecognition
If the undertaking retains control of the asset but does not retain or transfer substantially all the risks and rewards
The asset is recognised to the extent of the undertaking’s continuing involvement.

47. Derecognition
If an undertaking has neither transferred nor retained substantially all the risks and rewards of ownership of the transferred asset
Then
It assesses whether it has retained control over the transferred asset.

48. Derecognition If the undertaking has retained control
It continues to recognise the transferred asset to the extent of its continuing involvement in the transferred asset
If it has not retained control it derecognises the transferred asset.

49. Derecognition SPEs etc
Many derecognition structures use
undertakings (trusts, partnerships, etc.) that have been specifically set up for the acquisition of the transferred assets.
The transfer of assets may qualify as a legal sale
If the transferor controls the transferee, the transferor needs to consolidate the transferee.

50. Derecognition sequence
Consolidate all subsidiaries (including all SPEs)
Derecognition provisions are applied on a consolidated level
Consider the subject of the derecognition provisions (financial asset, group of similar financial assets or a portion of a financial instruments or a group of similar financial instruments)
Apply derecognition rules

51. DECISION TREE FOR DERECOGNITION OF ASSETS

52. Derecognition
Financial liability (or part thereof) is removed from the balance sheet when it is extinguished
when the obligation is
discharged or
cancelled or
expires

53. IFRS 7 Disclosures Qualitative description Quantitative data
Level of information
Overburdening vis a vis obscuring due to aggregation

54. IFRS 7 Disclosures Objectives
Information about FAs & their impact on financial performance
Assessment of risk and how it is managed

55. IFRS 7 Disclosures Disclosures relate to the following risks
Credit risk
Liquidity risk and
Market risk

56. IFRS 7 Disclosures The disclosures shall be either
In the financial statements or
Incorporated by cross-reference from the financial statements to some other statement, such as a management commentary or risk report
Available to users on the same terms as the financial statements and at the same time.

57. Qualitative disclosures
For each type of risk, an undertaking shall disclose
(i) the exposures to risk and how they arise
(ii) its objectives, policies and processes for managing the risk and the methods used to measure the risk and
any changes in (i) or (ii) from the previous period

58. Qualitative disclosures
Credit quality disclosures
about the credit quality of financial assets that are neither past due nor impaired
For ex - the amounts of credit exposures for each external credit grade
- the rating agencies used;
- the amount of an entity’s rated and unrated credit exposures

59. Qualitative disclosures
Market risks
Open positions in interest rate, currency and equity products, all of which are exposed to general and specific market movements.

60. Quantitative disclosures
For each type of risk, an undertaking shall disclose
Summary quantitative data about its exposure to that risk at the reporting date.
Based on the information provided to key management, such as the board of directors or chief executive officer.

61. Disclosure of concentrations of risk
From financial instruments that have
Similar characteristics and
Affected similarly by changes in economic or other conditions.
Requires judgement reflecting the circumstances of the undertaking.

62. Disclosure of concentrations of risk
Includes
how management determines concentrations;
the shared characteristic that identifies each concentration (eg counterparty, geographical area, currency or market)
the amount of the risk exposure associated with all financial instruments sharing that characteristic

63. Disclosure of concentrations of risk
Concentrations of assets, liabilities and off-balance sheet items
Geographical
Currency
Industry
Market
Type of counterparty

64. Credit risk - disclosures
Failure to pay by a counterparty causing financial loss
Maximum credit exposure for each class of FI.
Collateral and other credit enhancements obtained

65. Credit risk - disclosures
The amount that best represents its maximum exposure to credit risk at the reporting date, without deducting any collateral held or other credit enhancements (such as netting agreements that do not qualify for offset – see IAS 32)
In respect of the amount disclosed in (i), a description of collateral held as security and other credit enhancements;

66. Credit risk - disclosures
Information about the credit quality of financial assets that are neither past due nor impaired and
The carrying amount of financial assets that would otherwise be past due or impaired whose terms have been renegotiated

67. Credit risk - disclosures
Past due / impaired
Age analysis
Analysis of asset
Description and Fair value of collateral

68. Liquidity risk An undertaking shall disclose
(i) a maturity analysis for financial liabilities (owed by the undertaking) that shows the remaining contractual maturities and
(ii) a description of how it manages the liquidity risk inherent in (i).

69. Market risk Sensitivity analysis
A sensitivity analysis is needed for each type of market risk to which the entity is exposed.
A sensitivity analysis is disclosed for each currency to which an undertaking has material exposure.

70. Sensitivity analysis
Not to include worst case or stress test situations
Methods like VaR
( A technique used to estimate the probability of portfolio losses based on the statistical analysis of historical price trends and volatilities)

71. IFRS 7
Usefulness?
Voluminous
Subjectivity
Lack of comparability

72. THANK YOU
Dr.Anjali Bhave