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Section 11: Basic Financial Instruments.
11.2 Accounting policy choice.
11.2.1 Extract from FRS 102 Section 11.2-11.2A.
11.2.2 OmniPro comment – Accounting Policy Choice.
11.3 Scope of the Section 11 and Section 12.
11.3.1 Extract from FRS 102 Section 11.3, 11.5, 11.7 and Glossary to FRS 102.
11.3.2 OmniPro comment – Scope of Section 11.
11.3.2.1 Financial assets and liabilities not within the remit of Section 11 and 12.
11.4 Classification of financial instruments.
11.4.1 Extract from FRS 102 Section 11.6 and 11.8.
11.4.2 OmniPro comment – classification of financial instruments and scope (within Section 11 or 12)
11.4.2.2 – Investment in Shares.
11.5 Conditions for debt instruments to meet the definition of a basic financial instrument
11.5.1 Extract from FRS 102 Section 11.9.
11.5.2 OmniPro comment – basic financial instruments.
11.6 Initial and subsequent measurement of debt instruments.
11.6.1 Extract from FRS 102 Section 11.12-11.20.
11.6.1.2 Subsequent measurement
11.6.1.3 Amortised cost and effective interest method.
11.6.2.2 Short-term receivables/payable within one year
11.6.2.3 Transaction costs – definition/treatment
11.6.2.4 Effective interest rate calculation and amortised cost
11.6.2.4.1 Effective interest rate
11.6.2.4.3 Put or call options when calculating effective interest rate
11.6.2.4.4 Diagram 1 Rules for Accounting for basic financial instruments
11.6.2.4.5 – Financing Arrangement
11.6.2.4.6 Steps in determining the effective interest rate
11.6.2.4.7 Changes in cash flow estimates (amortised cost model)
11.6.2.4.8 Non market loans- inter-company loan / director’s loans
11.6.2.4.8.1 Determining the market rate of interest
11.6.2.4.8.2: Analysis of debt and credits on initial recognition of loans – financing arrangements.
11.6.2.4.9 Sales and purchases made under unusual credit terms – Debtors/creditors
11.6.2.4.11 Loans repayable on demand
11.6.2.4.12 Loan repayable on demand but with notice of 1 year and 1 day
11.6.2.4.15 Variable interest rate over the life of the loan
11.6.2.4.16 Issues surrounding directors or intra-group loans
11.6.2.4.16.1 Factors that indicate a related party loan is not at market rates.
11.7.1 Extract from FRS 102 Section 11.27-11.32.
11.7.2.1.2 Fair value hierarchy
11.8 Impairments of financial assets held at cost or amortised cost
11.8.1 Extract from FRS 102 Section 11.21-11.26.
11.8.2.1 Indicators of Impairment
11.8.2.2 Individual and group impairments.
11.8.2.3 Impairment debt instruments.
11.8.2.4 Reversal of Impairments.
11.8.2.5 Impairment of financial assets carried at cost
11.9 Derecognition of a Financial Asset
11.9.1 Extract from FRS 102 Section 11.33-11.35.
11.9.2 OmniPro comment – Decrecognition of Financial Assets.
11.10 Derecognition of financial liabilities.
11.10.1 Extract from FRS 102 Section 11.36-11.38.
11.6.2.4.5 Derecognition rules – overview
11.10.2.2 Derecognition of Financial Liability.
11.11.1 Extract from FRS 102 Section 11.38A.
11.11.2 OmniPro comment – Presentation – set off
11.12.1 Extract from FRS 102 Section 11.39-11.48A.
11.12.2.1 Disclosure requirements.
11.12.2.2 Sample Disclosure requirements.
11.12.2.2.1 Extract from accounting policy notes
11.12.2.2.2 Extract of notes to the financial statements – Financial instruments note disclosures
11.12.2.2.3 Extract of notes to the financial statements – interest disclosures.
11.12.2.2.3.1 Note: Interest receivable and similar income.
11.12.2.2.3.2 Note: Interest payable and similar expenses.
11.12.2.2.4 – Debtors Disclosures
11.12.2.2.5 – Creditors disclosures
11.12.2.2.7 Statement of Comprehensive Income
11.12.2.2.8 – Statement of Change in Equity
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11.7 Fair valuing investments for debt instruments and non-puttable/non-convertible ordinary and preference shares within the scope of Section 11
11.7.1 Extract from FRS 102 Section 11.27-11.32
11.27 Paragraph 11.14(b) and other sections of this FRS make reference to the fair value guidance in paragraphs 11.27 to 11.32, including Section 9 Consolidated and Separate Financial Statements, Section 12 Other Financial Instruments Issues, Section 13 Inventories, Section 14 Investments in Associates, Section 15 Investments in Joint Ventures, Section 16 Investment Property, Section 17 Property, Plant and Equipment, Section 18 Intangible Assets other than Goodwill, Section 27 Impairment of Assets, Section 28 Employee Benefits (in relation to plan assets) and Section 34 Specialised Activities. In applying the fair value guidance to assets or liabilities accounted for in accordance with those sections, the reference to ordinary shares or preference shares in these paragraphs should be read to include the types of assets and liabilities addressed in those sections.
Paragraph 11.14(d)(i) requires an investment in non-convertible preference shares and non-puttable ordinary shares or preference shares to be measured at fair value if the shares are publicly traded or if their fair value can otherwise be measured reliably.
An entity shall use the following hierarchy to estimate the fair value of the shares:
(a) The best evidence of fair value is a quoted price for an identical asset in an active market. Quoted in an active market in this context means quoted prices are readily and regularly available and those prices represent actual and regularly occurring market transactions on an arm’s length basis. The quoted price is usually the current bid price.
(b) When quoted prices are unavailable, the price of a recent transaction for an identical asset provides evidence of fair value as long as there has not been a significant change in economic circumstances or a significant lapse of time since the transaction took place. If the entity can demonstrate that the last transaction price is not a good estimate of fair value (eg because it reflects the amount that an entity would receive or pay in a forced transaction, involuntary liquidation or distress sale), that price is adjusted.
(c) If the market for the asset is not active and recent transactions of an identical asset on their own are not a good estimate of fair value, an entity estimates the fair value by using a valuation technique. The objective of using a valuation technique is to estimate what the transaction price would have been on the measurement date in an arm’s length exchange motivated by normal business considerations.
Valuation Technique
11.28 Valuation techniques include using recent arm’s length market transactions for an identical asset between knowledgeable, willing parties, if available, reference to the current fair value of another asset that is substantially the same as the asset being measured, discounted cash flow analysis and option pricing models. If there is a valuation technique commonly used by market participants to price the asset and that technique has been demonstrated to provide reliable estimates of prices obtained in actual market transactions, the entity uses that technique.
11.29 The objective of using a valuation technique is to establish what the transaction price would have been on the measurement date in an arm’s length exchange motivated by normal business considerations. Fair value is estimated on the basis of the results of a valuation technique that makes maximum use of market inputs, and relies as little as possible on entity-determined inputs. A valuation technique would be expected to arrive at a reliable estimate of the fair value if:
(a) it reasonably reflects how the market could be expected to price the asset; and
(b) the inputs to the valuation technique reasonably represent market expectations and measures of the risk return factors inherent in the asset.
No active market
11.30 The fair value of ordinary shares or preference shares that do not have a quoted market price in an active market is reliably measurable if:
(a) the variability in the range of reasonable fair value estimates is not significant for that asset; or
(b) the probabilities of the various estimates within the range can be reasonably assessed and used in estimating fair value.
11.31 There are many situations in which the variability in the range of reasonable fair value estimates of assets that do not have a quoted market price is likely not to be significant. Normally it is possible to estimate the fair value of ordinary shares or preference shares that an entity has acquired from an outside party. However, if the range of reasonable fair value estimates is significant and the probabilities of the various estimates cannot be reasonably assessed, an entity is precluded from measuring the ordinary shares or preference shares at fair value.
11.32 If a reliable measure of fair value is no longer available for an asset measured at fair value (e.g. ordinary shares or preference shares measured at fair value through profit or loss), its carrying amount at the last date the asset was reliably measurable becomes its new cost. The entity shall measure the ordinary shares or preference shares at this cost amount less impairment until a reliable measure of fair value becomes available.
11.7.2 OmniPro comment
11.7.2.1 Listed shares and non puttable ordinary and preference shares with less than significant influence.
As stated in Section 11.14 (d)(i) of FRS 102 Investments in non-convertible preference shares and non-puttable ordinary shares (the investment is not an associate, joint venture or subsidiary i.e. <20% investment or where significant influence is not achieved) are to be measured at fair value if the shares are publically traded or they can otherwise be measured reliably. Section 11.27 of FRS 102 provides the hierarchy for determining market value. Section 11.27 (a) of FRS 102 requires the bid price to be utilised for listed shares.
Where they cannot be measured reliably and they are not publicly traded they should be stated at cost less impairment at each reporting date as stated in Section 11.30 of FRS 102 above. See example 18c below: As per Section 11.30 to 11.32 of FRS 102 such shares can be measured reliably where:
- The variability in the range of the estimate is not significant
- The probability of the estimates can be reasonably assessed
If following initial valuations the shares can no longer be measured reliably the carrying amount at that date becomes the deemed cost and the cost less impairment rules are used (Section 11.32 of FRS 102) See Example 18a below.
11.7.2.1.1 Deferred Tax
Section 29.6 of FRS 102 requires deferred tax to be recognised on all taxing differences. In relation to shares which we held at Fair Value as the fair value movement will be recognised in the profit and loss account but will not be tax/tax deductible for tax purposes until the shares are disposed of, this creates a timing difference. In assessing what rate to recognise the deferred tax at, one needs to assess how it will be taxed on disposal, if any. As shares are a chargeable asset, tax will be payable on sale at the CGT rate at that time, if applicable. Indexation should also be taken into account. For non listed shares that are valued an assessment will have to be made as to whether they will be exempt from CGT because of certain reliefs (e.g. participation relief).
A deferred tax asset should only be recognised if there are either Capital deferred tax liabilities to set this against as Section 29.7 of FRS 102 makes it clear that a deferred tax asset should only be recognised when it is probable it will be utilised in the future or if there are other gains to set against losses. You cannot nett a deferred tax asset against a deferred tax liability if they are not in the same tax jurisdiction or if one relates to a trade and the other relates to Capital losses/gains.
Example 18a: Non-convertible preference shares and non-puttable ordinary shares – traded price or can be reliably measured
A company purchased 200 shares which were publicly quoted at a price of CU10 per share plus acquisition costs of CU100. At year end, the bid price of each share was CU15.
Therefore, as the shares are publicly traded on initial recognition the amount to be recognised was CU2,000. The CU100 is ignored and is expensed. Therefore the movement between the date of acquisition and year end of CU1,000 should be posted as a credit to the P&L so that the year-end value reflects its fair value. Deferred tax will also need to be recognised on the movement which is posted to the tax line in the profit and loss account. The tax rate to be used is the sales tax (CGT) rate. See illustration of the journals below assuming the CGT rate is 20%:
| CU | CU | |
| Dr Financial Assets at Fair Value | 2,000 | |
| Dr Professional fees | 100 | |
| Cr Bank | 2,000 |
Being journal to reflect the purchase of the shares and the related transaction costs
| CU | CU | |
| Dr Financial Assets at Fair Value (CU3,000-CU2,000) | 1,000 | |
| Cr Other Operating Income – FV movement | 1,000 | |
| Dr Deferred Tax in P&L (CU1,000*20%) | 200 | |
| Cr Deferred Tax Liability | 200 |
Being journal to reflect the movement in fair value during the year and the related movement on deferred tax
If the fair value can no longer be reliably measured then the value stated at that date is deemed to be its original cost.
Example 19: Non-convertible preference shares and non-puttable ordinary shares – not traded or cannot be reliably measured
A company purchased 200 shares which were not publically quoted at a price of CU10 per share plus acquisition costs of CU100. The fair value of these shares cannot be reliably measured.
Therefore, on initial recognition the amount to be recognised is CU2,100. The subsequent carrying amount at each year end will be the cost of CU2,100 less any impairment.
If a reliable measurement can be obtained, it must be fair valued, there is no choice. For non-traded investments it is usually still possible to determine the fair value using valuation models which are utilised within the industry. However where the range of reasonable fair value estimates are significantly wide and the probabilities of the various estimates cannot be reasonably assessed, then the entity cannot use fair value. It is not permissible to measure the instrument at fair value by arbitrarily picking an estimate within a wide range.
11.7.2.1.2 Fair value hierarchy
The fair value hierarchy as stated in Section 11.27 of FRS 102 is
- Use a quoted price if available
- The price of a recent transaction for an identical asset
- If 1 or 2 is not available use a valuation technique which makes the most use of market inputs that a market participant would use in the valuation and that represents market expectations.
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Examples
Example 1: Investment in shares.
Example 2: Investment in shares – 15%.
Example 3: variable and fixed interest payments.
Example 5: Fixed and variable interest payments.
Example 6: Fixed rate loan for a set period and then a reversion to the banks variable rate.
Example 8: Loan/bond which is convertible into the borrower’s equity.
Example 9: Loan issued which is linked to a general inflation index.
Example 10: Variation in return.
Example 11: Prepayment options.
Example 12: Loan extension option.
Example 12a: Unguaranteed Capital
Example 12b: Collective investment funds.
Example 13: loan at market rates with transaction costs.
Example 13a: Change in estimate.
Example 14: Intercompany loan from a parent company.
Example 15: Loan provided to the company by a director
Example 16a: Intercompany loan from a related party or a fellow subsidiary.
Example 16b: Loan from subsidiary to the parent company.
Example 16c: Sale with unusual credit terms.
Example 16d: Purchase with unusual credit terms.
Example 17a: Loans repayable on demand..
Example 17b: Loan repayable on demand but with notice of 1 year and 1 day.
Example 18: Bonds – discount/premium.
Example 20: Impairment of debt instruments.
Example 20a: Bonds with an impairment
Example 21: Asset recognised due to settlement
Example 22: Sale of debtors with recourse.
Example 23: Sale of debtors without recourse.
Example 24: Transfer of assets at fair value subject to a call option.
Example 25: Substantial modification of a loan.
Example 26: Sample disclosure requirements
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