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Section 12: Other Financial Instruments Issues
Section 12 provides guidance on the recognition, measurement, derecognition of ‘complex’ financial instruments including derivative financial instruments. When an entity only has basic financial instruments it should account for these under Section 11. However the entity review contracts and transactions to see if any come within the scope Section 12 before defaulting to section 11.
Public benefit entities or other members of a public benefit entity group that make or receive public benefit entity concessionary loans shall refer to the relevant paragraphs of Section 34 Specialised Activities for the accounting requirements for such loans.
Accounting policy choice-Extract from FRS 102-Sections 12.2–12.2A
12.2 An entity shall choose to apply either:
(a) the provisions of both Section 11 and Section 12 in full; or
(b) the recognition and measurement provisions of IAS 39 Financial Instruments: Recognition and Measurement (as adopted for use in the EU), the disclosure requirements of Sections 11 and 12 and the presentation requirements of paragraphs 11.38A or 12.25B; or
(c) the recognition and measurement provisions of IFRS 9 Financial Instruments and/or IAS 39 (as amended following the publication of IFRS 9) subject to the restriction in paragraph 12.2A, the disclosure requirements of Sections 11 and 12 and the presentation requirements of paragraph 11.38A or 12.25B;
to account for all of its financial instruments. Where an entity chooses (b) or (c) it applies the scope of the relevant standard to its financial instruments. An entity’s choice of (a), (b) or (c) is an accounting policy choice. Paragraphs 10.8 to 10.14 contain requirements for determining when a change in accounting policy is appropriate, how such a change should be accounted for and what information should be disclosed about the change in accounting policy.
12.2A An entity, including an entity that is not a company, that has made the accounting policy choice in paragraph 12.2(c) to apply the recognition and measurement provisions of IFRS 9 shall depart from those provisions of IFRS 9 as follows: A financial asset that is not permitted by the Small Companies Regulations, the Regulations, the Small LLP Regulations or the LLP Regulations to be measured at fair value through profit or loss shall be measured at amortised cost in accordance with paragraphs 5.4.1 to 5.4.4 of IFRS 9.
OmniPro comment
On transition to FRS102, Section 12.2 provides an accounting policy choice to either:
- Apply the recognition, measurement and hedge accounting requirements of IAS 39 or IFRS 9 with Section 11 and Section 12 disclosures; or
- Apply the recognition, measurement and hedge accounting requirements of Section 11 and Section 12.
Consideration should be given as to what suits a company. In reality for small to medium companies it might make sense to adopt Section 11 and Section 12 for the following reasons:
- No concept of embedded derivatives which can cause complex accounting issues;
- Hedge accounting is simpler under Section 12 than IAS 39 and IFRS 9 and the requirements are not as stringent; and
- When assets are assessed individually for impairment they do not have to be reassessed as part of a group of assets.
Careful consideration should be given as if an entity changes the standard under which it accounts for financial instruments this would constitute a change in accounting policy and therefore a prior year adjustment would be required.
Scope of Section 12-Extract from FRS 102-Section 12.3–12.5
12.3 Section 12 applies to all financial instruments except the following:
(a) Those covered by Section 11.
(b) Investments in subsidiaries (see Section 9 Consolidated and Separate Financial Statements), associates (see Section 14 Investments in Associates) and joint ventures (see Section 15 Investments in Joint Ventures).
(c) Employers’ rights and obligations under employee benefit plans (see Section 28 Employee Benefits).
(d) Insurance contracts (including reinsurance contracts) that the entity issues and reinsurance contracts that the entity holds (see FRS 103 Insurance Contracts).
(e) Financial instruments that meet the definition of an entity’s own equity and the equity component of compound financial instruments issued by the reporting entity that contain both a liability and an equity component (see Section 22 Liabilities and Equity).
(f) Leases (see Section 20 Leases) unless the lease could, as a result of non-typical contractual terms, result in a loss to the lessor or the lessee.
(g) Contracts for contingent consideration in a business combination (see Section 19 Business Combinations and Goodwill). This exemption applies only to the acquirer.
(h) Any forward contract between an acquirer and a selling shareholder to buy or sell an acquiree that will result in a business combination at a future acquisition date. The term of the forward contract should not exceed a reasonable period normally necessary to obtain any required approvals and to complete the transaction.
(i) Financial instruments, contracts and obligations to which Section 26 Share-based Payment applies, except for contracts within the scope of paragraph 12.5.
(j) Financial instruments issued by an entity with a discretionary participation feature (see FRS 103).
(k) Reimbursement assets accounted for in accordance with Section 21 Provisions and Contingencies.
(l) Financial guarantee contracts (see Section 21).
A reporting entity that issues the financial instruments set out in (d) or (j) or holds the financial instruments set out in (d) is required by paragraph 1.6 to apply FRS 103 to those financial instruments.
12.4 Most contracts to buy or sell a non-financial item such as a commodity, inventory, or property, plant and equipment are excluded from this section because they are not financial instruments. However, this section applies to all contracts that impose risks on the buyer or seller that are not typical of contracts to buy or sell non-financial items. For example, this section applies to contracts that, as a result of its contractual terms, could result in a loss to the buyer or seller that is unrelated to changes in the price of the non-financial item, changes in foreign exchange rates, or a default by one of the counterparties.
12.5 In addition to the contracts described in paragraph 12.4, this section applies to contracts to buy or sell non-financial items if the contract can be settled net in cash or another financial instrument, or by exchanging financial instruments as if the contracts were financial instruments, with the following exception: contracts that were entered into and continue to be held for the purpose of the receipt or delivery of a non-financial item in accordance with the entity’s expected purchase, sale or usage requirements are not financial instruments for the purposes of this section.
OmniPro comment
To summarise the following items are excluded from Section 12:
- Any basic financial instruments accounted for under Section 11;
- Investment in subsidiaries, associates and joint ventures;
- Insurance contracts issued by entities;
- Own equity instruments;
- Leases with no non-typical terms;
- Contingent consideration from the point of view of the purchaser;
- Forward contract between an acquirer and selling shareholder to buy or sell a business that will result in a business combination;
- Share based payments;
- Employee benefits;
- Contingent assets;
- Financial guarantee contracts; and
- Non-financial items i.e. commodities, inventory or PPE where risks are not imposed by contractual terms that could result in loss to either party that is unrelated to the change in price in the non-financial asset or the contract can be settled net in cash or another financial instrument with the exception of contracts entered into for the purpose of delivery of non-financial items in accordance with the entity’s purchase, sale or usage requirements. In effect the own use exception applies.
Leases
Examples of typical non-standard contractual terms in leases that could result in a loss to the lessor or the lessee. Examples include the following:
- terms related to changes in the price of the leased asset;
- changes in interest rates; or
- changes in foreign exchange rates; or
- consequences of a default by one party.
Contingent consideration
Contingent consideration from the perspective of the seller comes within the remit of Section 12 as it does not have a fixed price.
Non-financial items- contracts for commodities, inventories, PPE
Where the items are for own use then they do not come within the remit of Section 12. There is no ‘get in clause’ i.e. it cannot be accounted for under Section 12.
Net settlement here means that the entity will pay or receive cash (or a financial asset of equivalent amount) to and from the counterparty, equal to the net gain or loss on the contract or exercise or settlement.
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