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IFRS Identification of financial instruments

IFRS Identification of financial instruments: Accounting for financial instruments under IFRS is complex. This publication provides a broad overview of the current requirements of IAS 32, ‘Financial instruments: Presentation’, IAS 39, ‘Financial instruments: Recognition and measurement’, and IFRS 7, ‘Financial instruments: Disclosures’. For first-time adopters and other entities in territories transitioning to IFRS, these standards are likely to change the way they account for financial instruments and will involve substantial changes to systems processes and  documentation.

IFRS Identification of financial instruments

This includes the following topics:

  • The scope
  • Debt/equity Initial recognition
  • Subsequent
  • Fair values and
  • Hedge

Below we have discussed the main concepts:

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IFRS Identification of financial instruments

They provide an ‘at a glance’ summary of the key issues for the topic. They also contain a summary of the transition rules for first-time adopters. A summary of the disclosure requirements of IFRS 7 and a glossary of terms are included in the Appendix.

IFRS Identification of financial instruments

Leases

Lease receivables are included in the scope of IAS 39 for derecognition and impairment purposes only. Finance lease payables are subject to the derecognition provisions. Any derivatives embedded in lease contracts are also within the scope of IAS  39.

IFRS Identification of financial instruments

Commodity contracts

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Contracts to buy or sell non-financial items are within the scope of IAS 32, IAS 39 and IFRS 7 if they can be settled net in cash or another financial asset and they do not meet the test of being entered into and continuing to be held for the purpose of receipt or delivery of non-financial items to meet the entity’s expected purchase, sale or usage requirements (known as ‘own-use commodity contracts’). Settling net includes taking delivery of the underlying and selling it within   a short period after delivery to generate a profit from short-term fluctuations in   price.

IFRS Identification of financial instruments

Loan commitments

Loan commitments are outside the scope of IAS 39 if they cannot be settled net in cash or by some other financial instrument unless: they are held for trading or to generate assets of a class which the entity has a past practice of selling; or the entity chooses to include them with other derivatives under IAS 39.

IFRS Identification of financial instruments

Financial guarantees

Financial guarantee contracts are within IAS 39’s scope from the issuer’s perspective, unless the issuer has previously asserted explicitly that it regards such contracts as insurance contracts and has used accounting applicable to insurance contracts. In this case, either IAS 39 or IFRS 4, ‘Insurance contracts’, may be  applied.

IFRS Identification of financial instruments

Financial statements are monetary contracts between parties. They can be created, traded, modified and settled. They can be cash, evidence of an ownership interest in an entity, or a contractual right to receive or deliver cash.

International Accounting Standards IAS 32 and 39 define a financial instrument as “any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.

IFRS Identification of financial instruments: can be either cash instruments or derivative instruments:

  • Cash instruments —instruments whose value is determined directly by the markets. They can be securities, which are readily transferable, and instruments such as loans and deposits, where both borrower and lender have to agree on a transfer.
  • Derivative instruments —instruments which derive their value from the value and characteristics of one or more underlying entities such as an asset, index, or interest rate. They can be exchange-traded derivatives and over-the-counter (OTC) derivatives.

Alternatively, financial instruments may be categorised by “asset class” depending on whether they are equity-based or debt-based. If the instrument is debt, it can be further categorised into short-term or long-term. Foreign exchange instruments and transactions are neither debt- nor equity-based and belong in their own category.

IFRS Identification of financial instruments: Presentation includes requirements for the classification of financial instruments between liabilities and equity that result in significant practice issues when applied to many financial instruments with characteristics of equity.

In the past, the IFRS Interpretations Committee received several queries in this area and referred some to the IASB because the issue required consideration of fundamental concepts in IFRS.

The Board issued a DP Financial Instruments with Characteristics of Equity in 2008. Since then, the Board has discussed some of the challenges as part of its project on the Conceptual Framework for Financial Reporting. 1 In May 2015, the Board formally resumed the project on financial instruments with characteristics of equity, having decided to split it into two work streams – classification, and presentation and disclosures.

Financial Instruments highlights the IASB’s discussions in March 2017. The IASB continued its discussions on financial instruments with characteristics of equity, having previously considered applying the Gamma approach to the contractual terms of a financial instrument and to the accounting within equity for different types of equity instruments.

IFRS Identification of financial instruments:Highlights Financial instruments with characteristics of equity.

The Board discussed: − the classification under the Gamma approach of derivatives on non-controlling interests (NCI) with an exercise price denominated in a foreign currency; and − the interaction of the FICE project with other standards and research projects.

The Board also considered the due process steps undertaken and gave permission for the staff to draft the discussion paper (DP). The next steps for the project will be to publish the DP towards the end of 2017. Dynamic risk management The IASB staff outlined the proposed project approach, project stages and next steps

IFRS Identification of financial instruments:What was discussed?

May 2015- The conceptual and application challenges in distinguishing between liabilities and equity.

June 2015- Features that are relevant in measuring claims and in distinguishing between liabilities and equity.

July 2015- The relevance of these features for assessments that users might make using information in the statements of financial position and performance.

September 2015- The classification of non-derivatives. − The extent to which the requirements in IAS 32 capture the features that users need to make their assessments. − Three possible classification approaches.

October 2015- The challenges of classifying and accounting for derivatives on ‘own equity’ and how IAS 32 addresses these challenges.

February 2016-Using sub classes of financial liabilities to provide additional information for assessing financial performance and position, and using sub classes within equity to provide additional information about relevant features. − Claims with conditional alternative settlement outcomes.

April 2016-The scope of any separate presentation requirements for liabilities that depend on a residual amount. − Possible ways to attribute profit or loss and other comprehensive income (OCI) to equity claims (both non-derivatives and derivatives) other than ordinary shares.

May 2016- Attribution approaches, including another way to attribute profit or loss and OCI to derivative equity claims.

July 2016- How to apply the Gamma approach to: the classification of derivatives on own equity, asset/equity exchange derivatives and liability/equity exchange derivatives.

September 2016- For derivatives on own equity under the Gamma approach: − the presentation of specific types of derivatives classified as liabilities; and − how disclosures could complement approaches to classification and presentation.

October 2016- Claims where an issuing entity can choose between alternative settlement outcomes and whether economic incentives should affect classification.

November 2016- Classification under the Gamma approach of instruments meeting the existing put tables exception in IAS 32 and the merits of retaining the exception.

December 2016- The application of the Gamma approach to derivatives on own equity and, in particular, how it addresses some issues that arise in practice when applying the fixed-for-fixed condition in IAS 32.

February 2017-  Whether the effects of law should be considered for the purposes of classifying financial instruments under the Gamma approach. − Proposed application guidance and illustrative examples that clarify how the Gamma approach would apply to the accounting within equity for different sub classes of equity instrument.

IFRS Identification of financial instruments:

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