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IFRS market interest rates and non market interest rates

IFRS market interest rates

IFRS market interest rates: Initial recognition IAS 39 requires an entity to recognise a financial asset or liability on its balance sheet only when it becomes a party to the contractual provisions of the  instrument.

Initial measurement: financial assets and liabilities are initially measured at fair value (discussed in the measurement chapter). This is usually the same as the fair value of the consideration given (in the case of an asset) or received (in the case of a liability). However, if this is not the case, any difference is accounted for in accordance with the substance of the transaction. For example, if the instrument is valued by reference to a more favourable market than the one in which the transaction took place, an initial profit is  recognised.

Transaction costs: These are included in the initial carrying value of financial assets and liabilities unless they are carried at fair value through profit or loss when the transaction costs are recognised in the income statement.

IFRS market interest rates: Fair value

Entities are required to disclose the fair value of each class of financial assets and financial liabilities in a way that permits it to be compared with its carrying value. They also disclose the methods and significant assumptions applied in determining fair values for each class of financial assets or financial liabilities.

Management classifies fair value measurements using a fair value hierarchy that reflects the significance of the inputs used in making the measurements (the same hierarchy as in SFAS No. 157 ‘Fair Value Measurements issued by the FASB). The fair value hierarchy has the following levels:

  • Level 1 – quoted prices (unadjusted) in active markets for identical assets or
  • Level 2 – inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or
  • Level 3 – inputs for the asset or liability that are not based on observable market data (unobservable inputs).

IFRS market interest rates

For fair value measurements recognised in the statement of financial position management discloses for each class of financial instrument:

  • Fair value measurements by level of the fair value hierarchy (Level 1, Level 2 or Level 3).
  • Any significant transfers between Level 1 and Level 2 of the fair value
  • A reconciliation from the beginning balances to the ending balances for Level 3
  • For Level 3, the amount of total gains or losses recognised in the income statement that relate to assets and liabilities held at the end of the reporting
  • For Level 3, if changing one or more of the inputs to reasonably possible alternative assumptions would change fair value significantly, state that fact and disclose the effect of those changes

IFRS market interest rates

A contract that will be settled by the entity (receiving or) delivering a fixed number of its own equity instruments in exchange for a fixed amount of cash or another financial asset is an equity instrument. For example, an issued share option that gives the counterpart a right to buy a fixed number of the entity’s shares for a fixed price or for a fixed stated principal amount of a bond is an equity instrument. Changes in the fair value of a contract arising from variations in market interest rates that do not affect the amount of cash or other financial assets to be paid or received, or the number of equity instruments to be received or delivered, on settlement of the contract do not preclude the contract from being an equity instrument. Any consideration received (such as the premium received for a written option or warrant on the entity’s own shares) is added directly to equity.
Any consideration paid (such as the premium paid for a purchased option) is deducted directly from equity. Changes in the fair value of an equity instrument are not recognised in the financial statements.

The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. Market risk comprises three types of risk: currency risk, interest rate risk and other price  risk.

IFRS market interest rates

Active market – quoted market price: the existence of published price quotations in an active market is the best evidence of fair value, and they are used to measure the financial instrument. ‘Quoted in an active market’ means that quoted prices are readily and regularly available from an exchange, dealer, broker, industry group, pricing service or regulatory agency, and those prices represent actual and regularly occurring market transactions on an arm’s length basis. The price can be taken from the most favourable market readily available to the entity, even if that was not the market in which the transaction actually occurred. The quoted market price cannot be  adjusted for ‘blockage’ or ‘liquidity’ factors. The fair value of a portfolio of financial instruments is the product of the number of units of the instrument and its quoted market   prices.

IFRS market interest rates

No active market – valuation techniques: if the market for a financial instrument is not active, fair value is established by using a valuation technique. Valuation techniques that are well established in financial markets include recent market transactions, reference to a transaction that is substantially the same, discounted cash flows and option pricing models. An acceptable   valuation technique incorporates all factors that market participants would consider in setting a price and should be consistent with accepted economic methodologies for pricing financial instruments. The amount paid or received for a financial instrument is normally the best estimate  of fair value at inception. However, where all data inputs to a valuation model are obtained from observable market transactions, the resulting calculation of fair value can be used for initial recognition.

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