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Section 12 – Introduction
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- Section 1
- Section 2
- Section 3
- Section 4
- Section 5
- Section 6
- Section 7
- Section 8
- Section 9
- Section 10
- Section 11
- Section 12
- Section 13
- Section 14
- Section 15
- Section 16
- Section 17
- Section 18
- Section 19
- Section 20
- Section 21
- Section 22
- Section 23
- Section 24
- Section 25
- Section 26
- Section 27
- Section 28
- Section 29
- Section 30
- Section 31
- Section 32
- Section 33
- Section 34
- Section 35
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- Section 1
- Section 2
- Section 3
- Section 4
- Section 5
- Section 6
- Section 7
- Section 8
- Section 9
- Section 10
- Section 11
- Section 12
- Section 13
- Section 14
- Section 15
- Section 16
- Section 17
- Section 18
- Section 19
- Section 20
- Section 21
- Section 22
- Section 23
- Section 24
- Section 25
- Section 26
- Section 27
- Section 28
- Section 29
- Section 30
- Section 31
- Section 32
- Section 33
- Section 34
- Section 35
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Section Downloads
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Contents
12.1 Deciding what instruments come within the scope of section 12.
12.2 Accounting policy choice.
12.2.1 Extract from FRS 102-Sections 12.2–12.2A.
12.2.2.1 What is the accounting policy choice?
12.2.2.2 What accounting policy to choose for an entity.
12.3.1 Extract from FRS 102-Section 12.3–12.5.
12.3.2.1 Items excluded from Section 12 of FRS 102:
12.3.2.2 Items coming within the scope of Section 12 of FRS 102.
12.3.2.2.1.1 Unguaranteed Capital and variation in return linked to a fund.
12.3.2.2.1.2 Collective investment funds.
12.3.2.2.1.3 Loan extension option where rate on the extension is determined at inception.
12.3.2.2.1.5 Variation in return which is dependent on future contingencies.
12.2.2.2.1.7 Investments with profit bonds.
12.3.2.2.1.8 Loans which are linked to value of net assets.
12.3.2.2.1.9 Loan repayments linked to repayments on another loan or tranche of a loan.
12.3.2.2.1.12 Leases with non-standard contractual terms.
12.3.2.2.1.13 Contingent consideration for the seller.
12.3.2.2.1.14.1 The own use exemption.
12.3.2.2.1.16 Warrants that can be settled in cash or in exchange for another financial instrument;
12.3.2.2.1.19 Repurchase agreements;
12.3.2.2.1.20 Compound financial instruments.
12.3.2.2.1.21 A firm commitment which is contractually binding.
12.3.2.2.1.22 Where the variable rate on a loan is leveraged.
12.3.2.2.1.23 Where a bond has a negative yield.
12.4 Initial recognition and subsequent measurement of financial assets and liabilities.
12.4.1 Extract from FRS 102-Section 12.6-12.9.
12.4.2.2 Subsequent recognition.
12.4.2.2.1 Subsequent recognition – General.
12.4.2.2.1.1.1 Financial instruments not permitted to be fair valued under Company Law.
12.4.2.2.1.1.1.1 The accounting treatment where this exception applies.
12.4.2.2.1.1.2.1 The accounting treatment where this exception applies.
12.4.2.2.1.1.3 Where hedge accounting is applied.
12.4.2.2.2 Financial instruments not permitted to be fair valued under Company Law.
12.4.2.2.2.1.1 Financial instruments permitted to be fair valued under Company Law.
12.4.2.2.2.1.1.2.2 Derivative financial instrument.
12.4.2.2.2.1.1.2.2.1 Derivative – defined.
12.4.2.2.2.1.1.2.2.1.1 Examples of Derivatives.
12.4.2.2.2.1.1.2.3 Eliminate an accounting mismatch.
12.4.2.2.2.1.1.2.4 Instrument contains an embedded derivative that is not closely related.
12.4.2.2.2.1.1.2.4.0 Overview.
12.4.2.2.2.1.1.2.4.2 Embedded derivative defined.
12.4.2.2.2.1.1.2.4.3 Identify whether the embedded derivative is or is not closely related.
12.4.2.2.2.1.1.2.4.3.1 Examples where the embedded derivative is not closely related.
12.4.2.2.2.1.1.2.4.3.2 Examples where the embedded derivative is closely related.
12.5.1 Extract from FRS 102 section 12.10 – 12.12.
12.5.2.1 The fair value model to utilise.
12.5.2.2 The fair value of a financial instrument due on demand.
12.5.2.3 Transaction costs and fair value.
12.5.2.4 Examples of fair valuation techniques for complex instruments.
12.5.2.5 Deferred tax and the fair value adjustments.
12.5.2.5.1 Deferred tax and fair value adjustments where they relate to trade assets/liabilities.
12.5.2.5.3 Deferred tax where hedge accounting is applied.
12.5.2.6 Examples of fair valuing financial instruments where market rates are not available.
12.5.2.7 Foreign currency forward contracts.
12.5.2.7.2 Accounting for forward foreign currency contracts – non hedging – Examples.
12.5.2.7.3 Accounting for interest rate swaps – non hedging – Examples.
12.6 Impairment of financial instruments measured at cost or amortised cost.
12.6.1 Extracts from FRS 102 – section 12.3.
12.7 Derecognition of a financial asset or financial liability.
12.7.1 Extract from FRS 102 – section 12.14.
12.7.2.1 Non-hedged instruments.
12.8.1 Extract from FRS102 section 12.15 – 12.17C.
12.8.2.2 Hedged item – defined.
12.8.2.3 Hedging instrument – defined.
12.8.2.4 Purpose of hedge accounting.
12.8.2.5 What can be hedged under hedge accounting?
12.8.2.6.1 Firm commitment – Defined.
12.8.2.6.2 Classification of Firm commitments as a hedge – fair value or cash flow hedge?
12.8.2.6.3 The exception for fair valuing firm commitments – Own use exception to fair value.
12.8.2.6.4 Determining the fair value of a commitment.
12.8.2.7 Forecast transaction.
12.8.2.7.1 Forecast transaction – Defined.
12.8.2.7.2 Forecast transaction – Indicators that such a transaction exists.
12.8.2.8 Intra-group hedging & when hedge accounting can be applied.
12.8.2.8.1 Intra-group hedging – Example.
12.9 Grouping of items as hedged items.
12.9.1 Extract from FRS102-Section 12.16B.
12.10 Hedging a component of an item.
12.10.1 Extract from FRS102-Section 12.16C.
12.10.2.2 Examples illustrating hedging a component of an item.
12.10.2.2.1 Hedging with a forward contract where contract is less than the probable sale amount.
12.10.2.2.2 Hedging part payments.
12.10.2.2.3 Hedging part payments.
12.11.1 Extract from FRS102-Section 12.17-12.17C.
12.11.2.1 What instruments can be classified as a hedging instrument?
12.11.2.2 Portion of a hedging instruments.
12.11.2.3 Instrument used to hedge a foreign currency risk.
12.11.2.4.1 What is an option and what is a written option?
12.11.2.4.2 Determining the fair value of an option and using it as a hedging instrument.
12.12 Conditions for hedge accounting.
12.12.1 Extract from FRS102-Section 12.18-12.18A.
12.12.2.1 When can hedge accounting be applied from and conditions must be met?
12.12.2.2 What is an economic relationship?
12.12.2.3 Designation and documentation.
12.12.2.4 Causes of hedge ineffectiveness.
12.12.2.4.2 Example of hedge ineffectiveness documented for an interest rate swap.
12.13 Accounting for qualifying hedging relationships.
12.13.1 Extract from FRS102-Section 12.19-12.19A.
12.13.2.1 The three types of hedge relationships for hedge accounting.
12.14.1 Extract from FRS102 – Section 12.19B-12.22.
12.14.2.1 What is a fair value hedge and what does it do?
12.14.2.2 The accounting for a fair value hedge.
12.14.2.2.1 Examples of fair value hedges and the accounting for same.
12.14.2.2.1.1 Fixed interest rate on a debt instrument (financial instrument).
12.14.2.2.1.1.1 Amortised cost on cessation of hedging where financial instrument exists.
12.14.2.2.1.2 Firm commitment not recognised on balance sheet.
12.14.2.2.1.3 Hedge of a foreign currency risk of an unrecognised firm commitment.
12.15.1 Extract From FRS 102 – Section 12.22(b) and 12.23.
12.15.2.1 Cash flow hedge defined.
12.15.2.2 Accounting for cash flow hedges – hedge accounting.
12.15.2.3 Examples of cash flow hedge accounting.
12.15.2.3.1 Forward contract for a probable forecasted sale.
12.15.2.3.1.1 Forward contract for a probable forecasted sale.
12.15.2.3.1.2 Forward contract for a probable forecasted purchase.
12.15.2.3.2 Hedge of variability in cash flows in a floating rate loan due to interest rate risk.
12.15.2.3.2.1.1 Fair valuing an interest rate swap.
12.15.2.3.2.3 Hedge of variability in cash flows in a floating rate loan due to interest rate risk.
12.16 Hedges of a net investment in a foreign operation.
12.16.1 Extract from FRS 102 Section 12.24.
12.16.2.1 Net investment in a foreign operation defined.
12.16.2.2 When can a net investment in a foreign operation be hedged?
12.16.2.3 What is the hedged item and instrument in a net investment in a foreign operation?
12.17 Discontinuing hedge accounting.
12.17.1 Extract from FRS102 Section 12.25 to 12.25A.
12.17.2.2 When can/must hedge accounting be discontinued and is it applied retrospectively.
12.17.2.2.1 Fair value hedge and discontinuance rules.
12.17.2.2.2 Cash flow hedge and discontinuance rules.
12.17.2.2.3 Net investment in a foreign operation hedge and discontinuance rules.
12.17.2.2.4 Examples of discontinuance.
12.18 Taxation of fair valuing derivatives – current and deferred tax.
12.19.1 Extract from FRS102-Section 12.25B.
12.20.1 Extracts from FRS 102 section 12.26 – 12.29.
12.20.2.2 Sample Disclosure requirements.
12.20.2.2.1 Extract from accounting policy notes.
12.20.2.2.2 Extract of notes to the financial statements – Financial instruments note disclosures.
12.20.2.2.3 Extract of notes to the financial statements – interest disclosures.
12.20.2.2.3.1 Note: Interest receivable and similar income.
12.20.2.2.3.2 Note: Interest payable and similar expenses.
12.20.2.2.4 – Debtors Disclosures.
12.20.2.2.5 – Creditors disclosures.
12.20.2.2.7 Statement of Comprehensive Income.
12.20.2.2.8 – Statement of Change in Equity.
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Section 12 Other Financial Instruments Issues Quick Guide (PDF) (120 downloads )
Summary
Section 12 deals with more complex financial instruments and transactions which do not come within the scope of Section 11 and also have similar exceptions to Section 11 (as detailed in Section 11 of this guide) which are detailed in Section 12.3. In addition to the Section 11 exclusions the below are also excluded from Section 12:
- Contracts for contingent consideration in a business combination (see Section 19 Business Combinations and Goodwill). This exemption applies only to the
- Any forward contract between an acquirer and a selling shareholder to buy or sell from an acquiree that will result in a business combination at a future acquisition The term of the forward contract should not exceed a reasonable period normally necessary to obtain any required approvals and to complete the transaction.
A derivative financial instrument is a financial instrument or other contract with all three of the following characteristics:
- its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable (sometimes called the ‘underlying’), provided in the case of a non-financial variable that the variable is not specific to a party to the contract;
- it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and
- it is settled at a future
What is new?
For companies that did not adopt FRS 26 under old GAAP the whole standard is new.
Derivative financial instruments are required to be recognised initially at fair value on the statement of financial position and subsequently at fair value, with changes reported in the profit and loss. The only exceptions to this measurement requirement are; certain hedging instruments and investments in equity instruments which are not publicly traded and whose fair value cannot be reliably measured.
Under old GAAP there was no such requirement other than Company law requirements to have them disclosed in a note to the financial statements. This will result in significant volatility to the profit/loss of entities year on year unless hedge accounting is adopted.
Section 12 allows companies to apply hedge accounting. There was no concept of hedge accounting for non FRS 26 adopters. In order to apply hedge accounting the entity needs to have designated and documented the hedging relationship, and needs to expect that the hedge will be highly effective in offsetting the designated hedged risk (Section 12.18). Section 16.16B deals with certain exclusions for use of hedge accounting for intra group transactions.
Guidance on derecogntion and impairment are the same as what has been detailed in Section 11.
What is different?
FRS 26 adopters:
- No concept of embedded derivatives;
- Hedge accounting under FRS 102 is simpler;
- The disclosure requirements in Section 11 and Section 12 is less onerous that FRS 29; and
- Under FRS 102, assets which have been individually assessed for impairment and found not to be impaired do not subsequently need to be included in a collective assessment of
Other standards which impact Section 12 where differences arise:
Section 29 – Income tax – Likely to be deferred tax on any transition adjustments which arise as a result of fair valuing at the date of transition. Also likely that tax will be payable /refundable on adjustments that fell out for tax purposes on transition.
Section 22 – Liability and equity – The liability component of a compound financial instrument (i.e. preference shares issued which meet the definition of a liability and is convertible to equity) is to be accounted for in line with Section 11 and Section 12.
Section 35 – Transition to FRS 102 – Small entities applying Section 1A can elect not to restate prior year comparative financial statement to comply with Section 11 and 12; financial instruments where they have not been fair valued under old GAAP. Instead Section 11 and Section 12 can be applied from the last day of the comparative period with an adjustment posted through equity and an explanation as to the policies applied in the comparative year.
In relation to financing transactions involving related parties treated under Section 11 i.e. intercompany loans at non market rates, a small company can determine the present value at the first reporting date as opposed to the facts and circumstances at the time the liability or asset was first recognised and abilty not to apply hedge accounts if conditions not met before sign off.
What are the key points?
- Derivative financial instruments will need to be fair valued and recognised on the statement of financial position. For non FRS 26 adopters under old GAAP these were not recognised and instead disclosed. Examples of derivative financial instruments are: forward currency contracts, interest rate swaps, put and call options
- Hedge accounting can be utilised if it meets the conditions specified in Section 12.18.
An instrument is a hedging instrument provided all the following conditions are met:
- It is financial instrument measured at fair value through the profit and
- It is a contract with an external party to the reporting entity; and
- It is not a written option, except as described in Section 12.17C.
- There are three types of hedges as defined in Section 12.19, namely; a) Fair value hedge, b) cash flow hedge and c) hedge of a net investment in a foreign
- Where a fair value hedge exists the gain/loss is posted to the profit and loss
- Where a cash flow hedge or a net investment in foreign operation exists, the gain/loss on the hedging instrument is posted to other comprehensive income to the extent that this offsets against the loss/gain posted on the hedged item with the ineffective portion posted to the profit and loss account.
- For the net investment in foreign operation hedge the cumulative gain or loss posted on the hedging instrument relating to the effective portion of the hedge that has been accumulated in equity shall not be reclassified from equity to the profit and loss on disposal or partial disposal of the foreign operation (Section12.14).
- An entity can choose to discontinue hedge accounting provided the entity has documented its election and provided the hedging instrument has expired/is sold/ terminated or exercised or the conditions no longer exist (Section 25).
- Section 12.26 to Section 12.29A deals with the disclosure requirements which are extensive.
- No concept of an embedded
- Own use exception not to fair value certain instruments where there are used for production, onward sale etc. in the trade. If this condition applies, it cannot be fair valued. There is no choice in this instance.
What do accountants need to do?
Be aware of the requirements for accounting for derivative financial instruments (e.g. forward contracts, interest rate swap etc) and advise clients accordingly.
Review their client portfolio for companies where forward contracts and other derivatives exist and advise clients of the need to get these fair valued so that they can be taken onto the balance sheet.
Advise clients impacted of the volatility this section may cause to the results if hedge accounting is not adopted.
Advise impacted clients on how to apply hedge accounting where the option is adopted.
Advise clients on the need for tax adjustments on transition to be included in the current year tax computation and beyond where items have fallen out for tax purposes as a result of the opening balance sheet being restated to show fair value of financial instruments which is non- permanent in nature.
Review contracts for options (put or call) and assess whether the subject of the contract is for own use or not. Where it is not for own use they should be fair valued.
What do companies need to do?
Review contracts entered into to assess if a derivative exists to determine if the standard is applicable. Review contracts for options (put or call) and assess whether the subject of the contract is for own use or not. Where it is not for own use they should be fair valued.
Where a derivative exists, arrange for such a derivative to be fair valued so that the transition adjustments can be determined.
Assess whether it is possible to apply hedge accounting at the date of transition.
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Examples
Example 1: Unguaranteed Capital and variation in return linked to a fund.
Example 2: Collective investment funds.
Example 3: Loan extension option (Section 11.9 (AB) of FRS 102).
Example 5: Variation in return (Section 11.9 (aB) of FRS 102).
Example 6: Prepayment options (Section 11.9 (c) of FRS 102.
Example 6a: Investments held at fair values – market rates available.
Example 6b: Fair valuing complex financial instruments where no active market available.
Example 6c: Fair valuing complex financial instruments where no active market available.
Example 6d: Fair valuing complex financial instruments where no active market available.
Example 8: Foreign currency forward contract to hedge a sale.
Example 9: Foreign currency forward contract to hedge a future purchase.
Example 10: Interest rate swap – non hedge accounting.
Example 11: Hedging in a group context.
Example 13: Hedging with a forward contract where contract is less than the probable sale amount.
Example 14: Hedging part payments.
Example 15: Hedging part payments.
Example 16: Partial term hedging.
Example 17: Portion of a hedging instruments.
Example 19: Forward contract option.
Example 22: Hedge of a foreign currency risk of an unrecognised firm commitment.
Example 23: Forward contract for a probable forecasted sale.
Example 24: Probable forecasted purchase of equipment.
Example 26: Fair valuing an interest rate swap.
Example 27: Hedge of variability in cash flows in a floating rate loan due to interest rate risk.
Example 28: Net investment in a foreign operation (Extracted from Appendix to Section 12 of FRS 102.
Example 29: Discontinuance of a cash flow hedge – forecasted sale/purchase.
Example 30: Cash flow hedge example.
Example 31: Interest rate swap – cash flow hedge accounting.
Example 32: Sample Disclosure Requirements.
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Section 12 - Transition Adjustments (4 downloads )
Downloads
FRS 102 35 Part Differences Quick Guide (859 downloads )
FRS 102 35 Part Differences Guide (581 downloads )
FRS 102 Differences on Transition Checklist (1119 downloads )
FRS 102 Differences on Transition Examples Appendix (1092 downloads )
Fillable Differences on Transition Checklist (866 downloads )
Website Links
Difference Guide – Other Financial Instruments Issues
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Downloads
Section 12 Other Financial Instruments Issues Detailed Guide (PDF) (159 downloads )
Website Links
Initial Recognition and Measurement of Financial Assets and Liabilities
Discontinuing Hedge Accounting
Taxation of Fair Value Derivatives
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Downloads
Section 12 Disclosure Examples (84 downloads )
FRS 102 Disclosure Checklist (PDF) (745 downloads )
Website Links
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