Transcript for:
Overview of IFRS 9 Financial Instruments

assalamualaikum welcome to lecture 31 of SBR IFRS 9 which is financial instrument this is the main standard on financial instruments which is going to deal with all the other related issues before this I have covered is 32 which is financial instruments presentation where we talked about definition of financial asset Financial liability then compound instrument then we went through ivara 7 which is on the disclosure financial instruments disclosure now we are moving on to the measurement recognition subsequent recognition and all the other things like derivatives embedded derivatives hedge accounting impairment of financial asset we are going to cover all this this is going to be a very many lecture okay because this has so many passwords okay it's very complex and it's it's complex in a sense of you have to remember a lot of things lot of thinking is a good idea to connect the dots because so much of things are there to remember but don't worry it is not going to be so difficult if you keep on doing questions on IFRS 9 it's going to be one of the easiest standard but in your SBR okay the important thing is the good thing in fact is IFRS 9 is not tested so much usually it is tested for around let's say five to six marks it's not tested very heavily right compared to other standards like is 16 or is38 or if is36 IFRS man is not tested so much and not all the areas of I5 S9 are frequently tested some areas are there which comes frequently some they have never been tested some sometimes it comes sometimes it does not come so it has various patterns of coming right but be prepared for it okay so let's start okay we are going to do lots of question there and this one and it has lots of things lot of contents are here compared to other standards this is going to be uh the most biggest uh standard so we are going through recognition and measurement of financial liabilities first we are going to finish finish off with the financial liabilities before we touch financial asset then is the financial asset then accounting for investments in equity instruments and debt instruments there are two types of instruments that you have to know equity and debt and the way they function are different Financial assets okay impairment of financial assets like any other asset with the tangible intangible even Financial assets have been better okay the recognition of those financial instruments derivatives and embedded derivatives hedge accounting you see there are so many parts to it so when you're studying IFR is 9 you are not studying all of them together you just don't keep reading reading reading it does not help you first have to Master One topic before you go to the next for example if you are studying Financial liability just focus on financial liability and do all the questions once you are done with it move to financial asset then you query instruments then dead instruments then derivatives then hedge accounting like that okay and trust me it is not at all very difficult looks like very complex looks like very challenging from the beginning don't keep this thought in your head that this is going to be something very difficult oh too much I can't handle if you keep if you go and study ifrs9 with that mindset you will never ever remember anything nor you will enjoy it because it is a very technical area the standard and lots of things to remember you need to keep your mind calm and very focused okay you might even need one uh two to three days to cover the standard this one standard alone okay now recognition and measurement of financial liabilities okay initially you recognize it at fair value this is very easy because most of the standards if you see everything they say whether it is default tags or they always say measure it at fair value okay most of the standards in fact so initially Financial liabilities are measured at fair value okay if the financial liability will be held at Family through profit and loss then the transaction cost will be expensed in the statement of profit and loss if the financial liability will not be held at farewell through profit and loss the transaction costs are deducted from the carrying amount of the financial liability you need to remember this thing in the beginning if you are not understanding don't worry as soon as we do a question what you have to do is come back again to this slide okay come back again to this part and then read it re-read it you will be able to understand the whole picture better once we do the calculation or with the number so that's how you have to do go back from the question come back again and revisit okay if you're not understanding in the first uh first time okay because you have an option okay when it comes to financial liability or even financial asset there is an option family through profit and loss then you have a right to elect family through other components of ink okay then we are going to the subsequent measurement initially it is at fair value there is no option but subsequent measurement of financial liability what is financial liability and all we have covered this in is 32 you have to go back and revisit okay it is like any liability the only thing is it's financially it has to deal with cash it is financed like your debtors sorry creditors you you have an obligation to pay them it's a financial liability some liabilities are not Financial they're non-financial liability okay so subsequent treatment could be option either at amortized cost or family through profit and loss you see initially you recognize it at fair value but subsequent measurement gives you an option either at amortized cost of available through profit and loss okay and Financial liabilities like borrowings why borrowing is a financial liability because you have an obligation to pay to the bank or from whomever you have borrow you have an obligation so whenever there's an obligation to pay in cash or financial instruments it's a financial liability okay so borrowing is one example like loan Bond debanger these are Financial liability okay so borings like that are subsequently measured at amortized costs using the effective interest method what is this effective interest method is what we are going to discover now foreign of 10 million for five years and interest is 10 percent so interest will be if you take 10 of 10 million which is 1 million and into five years because it's for five years this is a total interest okay now assume that the company issues are Bond let's come to the bond this also has 10 million interest is 10 percent okay however the company issues the bond for only 9 million and has agreed to repay 12 million to the bondholders in five years time this also since is 10 million and 10 percent interest will be 5 million over 5 years okay but on top of this there's an extra that you have to pay entity has to pay extra 3 million 12 minus 9. right it has received 9 repaying 12 so the difference that means they have to pay three more the difference right so if you add this 5 and 3 is 8 this is the total cost of the loan and this Aid according to the accrual concept should be spread over the five-year period this is achieved by charging interest on the liability using the effective rate of interest and the effective rate is the internal rate of return on the investment it is the i r r in AFM we have studied what is irr in detail right internal rate operator and even if you if you haven't taken AFM but through your financial reporting you know what is irr it is the rate at which Net Present Value is zero right now we'll be moving on to calculating the amortized cost now let's move on to calculating this amortized cost okay first what do you do the initial carrying amount of a financial liability is measured at amortized cost okay measured at amortized cost is its fair value less any transaction cost okay that means the net proceeds from the issue and then you charge an interest on that liability or for interest you can also say Finance cost because interest goes as a finance cost right in your income statement you write interest in as a finance cost so that interest is charged on the liability using what using effective rate of interest this will increase your liability see it's like a loan think of a loan you have to pay the principal amount of the loan with that you have to pay the interest also on top of that is the same so when you're finding that interest on the liability how are you doing it using the effective rate of interest okay so this will be the double entry you debit the finance cost that is the interest that goes as an expense in p l and you credit your liability because it will increase your liability then once you make the cash payment liabilities are reduced so your liabilities debit and you credit your cash amortized cost table this is how an amortized cost table will look like okay you have an opening balance opening liability with that you add your Finance cost this is how you add opening liability into the effective rate you have to take the effective rate okay add then any cash payment deduct that will be your closing liability then this closing liability becomes the opening liability for the next year so if it's given for two three years that's how you move it forward right then this becomes here the opening and on on that you charge Finance costs again cash payment will be same fixed okay how do you get the cash payment on your nominal value that is given to you based on the coupon percentage you multiply okay so here the finance cost this one goes to profit and loss as an expense the cash payment will go to statement of cash flow and the closing liability will go in the statement of financial position okay now let us go through a question illustration One loan that is issued at a discount okay so the loan load was fifty thousand nominal value discount issued at a discount 16 percent the cost of issue was two thousand interest of five percent of the nominal values payable annual in areas Bond must be redeemed on 1st of Jan 2006 that is one two three four five after five years at a premium of this much effective rate of interest is also given they will give you okay how will this be reported in the financial statement over the period to Redemption that means over five years okay so here first you have to you have an option initially what you will recognize your liability at what tell me you will recognize your liability initially at what here is the area where you have to apply your initial measurement and subsequent measurement so let's do that together initial measurement was at fair value if you remember it's a financial liability or you can say net proceeds that is received as net proceeds received okay now what is the face value it was for fifty thousand you have to deduct all your transaction cost okay remember if it is family through profit and loss you have to what the transaction cost and all will be deducted okay less 16 discount not the coupon rate you have to take the discount you have to take this discount always is like this discount or the premium of the coupon value you have to take whatever you're issuing at that you have to deduct so 16 percent of fifty thousand is eight thousand and then issue cost you have to deduct which is two thousand since 40 000 is the initial recognition of a liability okay now then you have a choice amortize or family through profit and loss so this is a loan we go by amortized cost okay foreign just now we went through that table up remember this table this is the table we have to follow over the years so here I will write five years here one two three four and five five okay now opening balance o b then we have the finance cost the interest then we have cash payment then we have the closing balance CB so first year you have to take this initially recognized one here 40 you always have to start like this once you do that okay effective interest rate you have to apply what is the effective interest rate is 12 percent this twelve percent you have to apply on the opening balance is always like this it's fixed effective interest rate only so 12 percent 12 percent on forty thousand will be four thousand eight hundred you add because interest will further increase your liability then any cash payment you deduct what will be your cash payment see on that nominal value okay on that fifty thousand not on this forty thousand on this fifty thousand the discount so sorry it is this one interest of 5 percent of the nominal values payable that is the cash that you're paying okay five percent so it's two thousand five hundred this stream is 2500 for all the four years okay this is fixed if you keep on doing questions like this you will understand the nature okay so 40 plus 4800 minus two thousand five hundred you're going to get closing balances if you do your calculation correctly forty two thousand three hundred now this forty two thousand three hundred becomes the opening balance next year that's how you proceed so on this if you apply 12 person which is effective interest rate just this minus 2544 876 this becomes the opening balance on this you apply 12 percent then it is five three eight five then you are getting four seven seven six one then four seven seven six one okay so it's not triple seven it's just two seven five seven three one then fifty nine nine two then fifty nine nine two six one one nine one see this a rounded figure okay if you add up the total this is 12 500 this is 27111 okay this is the interest this goes in p l as an expense this goes to cash flow statement of cash flow this is cash this the closing balance will go to statement of financial position okay now to show this figure okay you can show like this also what is the repayment I will show this to another figure another way okay what is the capital amount you are issuing it at premium Capital amount was fifty thousand okay premium was you see four six double one at a premium it must be redeemed so four six one one if you add up it's five four six one one now interest add interest with it fifty thousand into five percent into five years it has which is 12 500. this we already know add it 67111 deduct your cash payment that is forty thousand okay cash received it is not this you're deducting this forty thousand then you are getting 2 7 1 1 this is your total Finance cost or total cost for the loan this one two seven one one we are getting it this way also make sure that you know how to get it through both the ways now one thing can you notice that the finance that starts to p l is greater than the cash payment okay what does it mean that means the value of the liability increases over the life of the instrument until it equates the Redemption value at the end of its term when it reaches the end of the term before that until it reaches the end of the term before that liability keeps on increasing okay and if you check from here one to four the balance shown as a liability is less than the amount that will be payable on Redemption therefore the full amount payable must be disclosed in the note to the financial statements okay let's check now let us do test understanding two test your understanding too so in this you have three people raising Finance in three separate ways and you have to explain how under three separate how these three separate Financial instrument should be accounted one is ho one is Wiggins one is Cavendish one by one will go first let us finish with hoy okay raised Finance on 1st of Jan 2001 by the issue of two year two percent bond with the nominal value of ten thousand so it's a two year two percent bond with a nominal value of ten thousand this two person is the coupon rate foreign and redeemable at a premium of this issue cost can be ignored born as an effective rate of interest 10 percent don't get confused okay coupon rate is something else effective rate of interest rate of interest is something else and the discount is the transaction cost anal okay effective rate of interest is to find the finance cost and this coupon rate is to find the cash payment okay I will write it somewhere coupon rate gives you cash payment okay then effective in rate of interest gives you the finance cost and the discount or premium other transaction cost okay remember this so now that's why there are three separate discount the interest two two percent five percent and ten percent do not get confused with this three okay you will always get the same all the questions okay now please understand this is a bond okay bond is a kind of a borrowing so earlier we said that borrowing are measured at what subsequently they are measured at amortized cost okay remember that table of amortized in fact all the borings are like that whether it's a bond whether it's a loan Bond and Loan usually you are given amount or a loan either of this and they are measured at amortized cost basically you just have to follow the table okay but before that okay all the transaction costs see you are measuring this at what amortized cost okay so here when you're doing it okay that means what you're not measuring it five value through profit and loss if it was fabulous through profit and loss transaction costs are expensed they go in the piano but if you are choosing if you are not going through family through profit and loss like in this case you are going through amortized cost then you have to deduct your transaction cost from the value of a financial liability your understanding it's always like this for more times cost you have to deduct your transaction cost okay now so the actual amount of the loan this is how you go step by step okay step one what is the amount of the bond nominal value 10 000 okay step one okay Step One is the nominal value I'm writing it down for you so that you write it somewhere you start with the nominal value now deduct all your discount or any issue cost okay needs to be deducted first before you go through that table do you have an issue cost here no issue cost can be ignored in this case but you have a discount it was discounted five percent okay so you have to discount at five percent means at 95 percent of this okay so 95 of 10 000 will be what after you deduct the in uh discount it will be 9500 this is the amount from here you have to go ahead okay then step two is the table the table amortized table it's always like this since there is no issue cost I am not deducting issue cost otherwise you have to further deduct the issue cost also only discount you have to deduct because it was issued at a discount okay now let us go through table table is only for two years because it's two years Bond okay and it follows the similar structure all the table in fact opening balance balance brought forward then the finance cost FC then the cash paid and then the balance carried forward okay what are the year 31st December two thousand one and two 31st December 2001 31st December 2002. you start here with 9500 that's why you need this from here you proceed to the table it's always like this always whenever amortized table is there this is how you do it that's why I'm going a little slow in this one so that in the next two company I'll be going a little faster okay now comes your Finance cost Finance costs what did I tell you here Finance cost is your effective rate of interest effective rate of interest is 10 percent you see here 10 percent so apply that 10 percent to what opening months to the opening balance 10 so 10 to 9500 is 950. it's always like that always the effective interest is on the opening balance okay or shall I write it down for you click always effective rate of interest on opening balance remember this always put it as a stomach put it somewhere don't forget once you add it add 950 with 9500 deduct the cash payment cash paid what did I tell you in the beginning it is what the coupon rate what is the coupon rate it's next to it always you will get it a two year two person this is the coupon rate even if they don't say mention coupon so two person on what always on the nominal value always on the nominal value never on this 9500 not on this 9500 it's on ten thousand the coupon coupon always on ten thousand so two percent on ten thousand will be two hundred and this is fixed by the way cash payment are fixed remember this is 200 deduct even next year also is 200. you can close your eyes and put it it's fixed I told you this will not change only your Finance cost changes every year so 9500 plus 950 minus 200 will give you ten thousand two fifty you cannot go downwards you have to go horizontally like this because you need this closing balance to find the opening balance of the next year so that 10 to 50 becomes the opening balance of the next year on this again apply 10 percent the effective rate of interest which is one zero two five already deduct 200 okay and get the amount how much will be the amount okay there is nothing to carry forward okay anyway we'll check what is the amount so it is 11 0 75 this one okay now with the same understanding in a similar way similar pattern except the numbers are changed percentages are changed Vegas raised Finance by issuing twenty twenty thousand six percent is the coupon rate it's a four year loan note this is a loan that was a bond but is the way they function and say this was also issued at a discount ten percent at a premium of the smart after four years effective is twelve percent issue cost this time we have thousand okay so Wiggins okay how do you do wagons is the same amortized cost so you deduct your transaction from your uh the cash that you have received what is the cash that you have received for wayn is twenty thousand okay you deduct you have issued it at discount that is 10 so that means at 90 percent after deducting ten percent you're left with 90 of 20 000 which is a eighteen thousand okay so from this eighteen thousand deduct issue cost which is thousand I suppose yes this thousand deducted so 18 minus thousand is seventeen thousand this is your opening balance initially you recognize it at this initial recognition when you come to the subsequent then you come to the amortized table okay now remember this always for financial liability okay initially you like recognize it then amortize calls the table initially recognize like this then amortize the table now is the same maybe what I'm going to do is I'm going to keep this here change the date four five 31st December 2006 this is for four years starting with four okay so I'm going to rub this figure out and use the same table for the company okay except this time the effective interest rate is 12 percent okay so 17 000 was my balance 12 on it will be 2 0 40 cash paid with c the coupon was six percent six percent on twenty thousand I told always on nominal value right so six percent on twenty thousand will be 1200 and it's fixed cash payment are fixed so all the four years 1200 you deduct thousand two hundred thousand two hundred thousand two hundred in Excel you can very easily do this in one click this will be Seventeen eight forty bring that here 840 apply 12 percent okay two one four one then eighteen seven eight one Bring It Forward eighteen seven eight one again twelve percent two two five four then you get nineteen eight thirty five nineteen eight thirty five to 380. which will be 21 0150 okay see this figure this figure like this where is it this figure you can easily get it how it was at twenty thousand and it was a premium if you add this you are getting this so that means through the table and like this you have to get the same figure that's how you know that this is correct this closing balance have to match with this one we didn't check about the first one let us check for the first one also first one was the first company hog premium was this nominal value was this so just add up the ten thousand and this I have cut the table but it was something 11 like this this was the figure it matched exactly it should always match okay now the Third company Cavendish okay he is raising a finance zero coupon bond that is zero nominal level is ten thousand bomb will be renewed after two years premium this much issue cost is ignored effective rate of interest is seven percent okay again on the same table I'm going to do for this Commander what is the company cabin dish but we have to find the initial listing for Cavendish initially you have to recognize it how much was it nominal value was 10 000. right there is no coupon nothing it was not discount or anything right there's no discount so or no issue cost so it's 10 000 only so you bring down to this table okay what I'm going to do is I'm going to cut this two line because it's only for two years I'm going to cut this completely off okay it is two thousand five 2005 and 2006. now I'm going to wrap this figure okay now you start with 10 000 here and effective rate was seven percent here which is 700 there is no coupon so cash paid will be nil and you will be left with 10 700 bring forward this next year 10 700 apply seven percent seven Forty Nine no cash payment okay it's a nil so you will be left with what eleven four four nine sorry this will be the cash payment here because you are not going to carry forward the balance any longer entirely this amount so that your balance carried forward will be nil okay you see you're okay wait I think it's very confusing would I will double this tap the last two line okay say this your cash bid your cash paid has to be equal to your actual payment the last cash paid not the balance carry forward your balance carried forward should always be nil sorry even for the previous two it's nil okay it's the cash paid if you add this and deduct your cash paid you will always get the closing balance as nil because it's going to be redeemed the liability will not be there you're not going to carry forward the liability any longer now we'll check whether it equates to this cash payment or not 11449 it was ten thousand and premium so 10 000 if you add the premium one four four nine yes it is adding up you see it should be always like that that's how you know your table is perfectly all right there's a way of checking it you see if you're smart enough you'll be able to figure it out fair value through profit or loss okay now what just now we went through amortized cost but we also told that subsequently you can measure Financial liabilities at Family through profit and loss now we are dealing with the second part fair value through profit or loss we did a question also to show how to deal with amortized cost so that part is over now out of the money derivatives and liabilities that is held for trading are measured fair value through profit and loss anything to do with Trading anything to do with trading this applies for financial asset as well anything for trading goes to profit and loss okay remember it like that then it becomes easy so liability is helpful trading and measured at Family through profit and loss but in the earlier ones earlier example like bonds loan they were at advertised cost why see this kind of liabilities for borrowing they are usually not helpful Trading you give them for long term more than one year that's why it is at amortized cost and not fair value through profit and loss because they are not helpful trading okay and out of the money derivatives what is out of the money derivatives for time being let's leave it forget about it when we go to derivatives later in this lecture I will explain what is out of money derivatives okay to know out of money you have first have to know in the money at the money and out of the money derivative okay now it is also possible to measure reliability at fair value even if normally it would have been measured or amortized cost only if it could eliminate or reduce an accounting mismatch okay in this case IFRS 9 says split the fair value component into two parts the moment in farewell is split into two components first component goes to other components of income second component goes to profit and loss which one goes for the comprehensive income if the fair value changes due to own credit risk that means due to that Financial liability that you are giving there's a risk that you will be unable to repay okay the risk then the entity which has issued that Financial liability are now unable to repay or discharge it then any family changes due to that goes to other comprehensive income okay the remaining fare value change which is not due to this own credit risk goes through profit and loss now let's do a question on this to understand this better before we move on to financial assets because we are over with financial liabilities you only need to remember two things in financial liability how to do the amortized cost and the family through profit and loss that's it but this understanding understand this properly because if you understood this this is like you are setting a ground okay and you are now sowing the seats okay once you sow the seed properly then growing the tree growing up a small plant to a big tree is not a big thing in fact it becomes much easier it's more harder to plant that seed okay so that's it in the grand on a fertilized land this is what you're doing understand the concept of financial liability very well from the beginning itself not at the later stage you want to understand this okay you will be able to apply some of these principles to financial asset also because major portion of financial instrument is on financial asset then on financial liabilities and later we are going to go through equity instruments debt instruments that that time you need this information once again so you cannot forget okay now let us go to the question illustration 2 fair value through profit and loss so here on 1st of Jan 2001 issued a financial liability nominal value is 10 million interest is payable at five percent liability is payable at 31st December 2003. and they trade in the short term at 31st December 2001 Market rates of Interest have risen to 10 okay so now what are you doing here since this is short term you know that this will go this is fabulous through profit or loss okay get that thing cleared first now you have to re-measure to travel with the reporting date okay so since you don't have an active Market to refer to get a fair value you have to calculate by discounting the future cash flows okay and the discount rate will be this one we'll be discounting address the Market Days Of Interest okay so this will be the date the cash flow the discount rate and the present value okay 31st December 2002 and 31st December 2003 okay because it's for two years okay now take five percent on 10 million okay interest so five percent on 10 million will be 0.5 million this will be the interest okay so here it will be 0.5 okay when you discount it it will be 1 divided by 1.1 because 10 percent so you multiply discount rate with the cash flow and Present Value will be 0.45 okay here you add 10 million because you'll be paying the principal amount with the interest so 10 plus 0.5 which will be 10.5 so you did 1.1 to the power 2. okay it will be eight point six eight add up the two nine point 1 3. okay this is the fair value at the end of the year okay but in the first year since on 1st of Jan 2001 okay it was 10 million now you have found the present value okay you want to know at 31st December 2001 what would be the liability amount okay so you need to adjust it you have to reduce it from 10 to 9.13 okay so you see the liability will go down debit liability and credit profit or loss because a liability went down from 10 million to 9.13 the difference so the difference will be 0.87 million this is how you do questions when it is family through profit and loss okay now let us do test understanding three test your understanding three okay here they invest in assets that are measured at Family through profit and loss okay and they have funded this purchase by issuing Bond but if the bonds were not re-measured to fair value there will be an accounting mismatch so due due to uh to prevent that accounting mismatch what did bin do they designated the bond to be measured at fair value through profit and loss why because Bond normally will we would be measuring it at amortized cost check my first question right amortized cost but because it is going to create an accounting mismatch okay so they have designated to keep on measuring it at travel through profit and loss now the fair value of the bond felt 30 million and out of this 30 10 is because of their Own Credit worthiness how do you account for it okay so whenever there is a accounting mismatch yes you can choose fair value through profit or loss but then you have to split the fair value needs to be split between two components oci and profit and loss oci will be due to its own credit risk okay fairly falling due to own credit risk and balance goes to PLL so out of this 10 so 10 will go to oci out of the 30 million drop and 20 will go to profit and loss 20 million okay so we are over with financial liability what you have to know is financial liabilities could be measured or amortized and fairly through profit and loss now we are moving on to financial asset so initially Financial assets are recognized when and old even The Entity becomes party to the contractual provision of that instrument okay examples number one when you are going for a commitment a trading commitment to buy or sell good is not recognized until one party fulfills their part one party of the contract has to fulfill their part okay so it is not when the sales so for example a sales order will not be recognized as a revenue until the goods have been delivered Goods have to be delivered first for you to recognize it as a revenue okay second regarding forward contract forward contracts are derivative Financial assets okay their derivative Financial assets you must have studied forward from your financial management if you have not studied AFM but still three of financial management you know what is what are forward contracts okay they are like commitments to buy something in future at a price that is set today that is that is the meaning of forward in short so forward is a derivative those things are called derivative forward options where Future Okay in finance it is known as derivative so derivatives we are going to study in detail later on also okay just for now know that these are kind of derivatives okay so forward are Financial assets but they are derivative Financial assets okay and they are recognized on the commitment date not when the item under the contract is transferred you can transfer the item under the contract later also doesn't matter which date but the day when you make the commitment that is the date you are going to recognize the financial asset same for the option contract it is not when the item under the option you are going to receive no it is recognized the day the contract is entered into that is the day you recognize the financial asset option contracts also derivative Financial assets okay so for financial asset this is the thing you need to remember now we are moving on to another the third item we are finished with financial liability we are finished with financial asset now we are moving on to equity instruments okay how do you account for equity instruments classification equity in instruments means any investments in equity instruments like you are investing in equity ordinary shares and investment in ordinary shares of another entity this is an example of equipment instrument okay they are measured at two things either family through profit or loss or family throughout the comprehensive income see how it is different from Financial liability we don't have amortized cost here here family through profit and loss favorable through other comprehensive income okay fair value through profit and loss normally it is expected when you when there's a designation for this family through profit and loss Now Fair Value through other comprehensive income okay when you designate for it you must comply with the following conditions number one the equity instrument should not be held for trading please see the connection oci not training oci not trading remember this connection forever this will make your work very easy in case you forget what goes to Providence loss and what goes to other comprehensive income okay if anything is held for training goes to profit and loss anything not help or trading goes to other comprehensive income this is the way you remember it next you make a choice and this choice you cannot reverse it it's fixed it's final ill revocable choice when you are initially recognizing the asset so on the initial recognition of the asset you make an irrevocable choice that you want to go through fair value through other comprehensive income later on you cannot change it in the future it will be forever in other comprehensive income that is the meaning of irrevocable now measurement how do you measure if it's fairly through profit and loss remember initially you measured at fair value and transaction cost are expensed to profit or loss are expensed and at the reporting date again you re-measure okay the asset is revalued to fair value and any gain on loss goes to profit and loss because it's fairly through profit and loss travel through other comprehensive income okay if it's other comprehensive income this time transaction costs are added to the fair value see the difference transaction costs are added to the fair value okay and at reporting date before the disposal acid is again revaluative value but this time gain and loss will go to other components of income that is the only difference and this gain and losses will not be reclassified you cannot ever reclassify them to profit and loss it will forever stay there okay so this is all for Equity Investments let's summarize again fair value through other comprehensive income only if it's not helpful trading second irrevocably designated otherwise everything goes through family through profit and loss now let us do a small question on this before we move on to dead instruments test your understanding five Americano in this question you need to discuss accounting as well as ethical issues raised by the above now please see that this question is very similar to your question number two in SBR the last question why because it's asking you an ethical question and two of your professional marks out of the five are here so you need to be very careful on how you not just what you write but how you write your answer okay no the director of meccano designated the entities investment to be measured Travelers without the comprehensive income on the ground that this minimizes volatility and profit and loss and thereby has a positive impact on their share price okay they argue that this accounting feedback enables them to fulfill their duty to maximize shareholder wealth they buy Equity Investments to trade in the short term can you see see whenever I will give you a hint whenever ethical issues is asked please understand there is always some error some incorrect thing that have happened something that means dating for IFRS okay some incorrect is there which you need to correct that's why ethical issues are there otherwise issues will not raise if they would correctly recorded or correctly recognize it in the first place okay and by reading the last line you clearly know what is the issue because it is to other comprehensive income and it is trading in the short term doesn't go right doesn't fit together because we earlier told that when you're trading something it goes through professional loss and not throughout the comprehensive income but just one line is not enough to get full let's say this question is for 11 marks or nine marks or 7 marks it's not enough you need to develop a habit of writing how do you write when you see the answer often most of you start panicking by looking at the length though how do I start so today I'm going to teach you the technique on how to write answers especially ethical answers like this okay there's a way there's a format you can crack okay if you go through any ethical question it follows the similar pattern okay so what I'm going to do is I'm only going to write the keywords you can make up the paragraph on your own and write answers are there take your own time and read it because this is a exam like question that's why I'm focusing more on this question okay you first need to understand about what type of this one this is an equity investment so this is your starting point please always start with the subject understand what is the subject you are going to talk about then only you can write about elaborate on that this is about Equity investment okay and measurement Equity Investments measurement okay so directly you can start with that point okay that Equity Investments are measure that fair value throughout the comprehensive income if the investment is not held for short-term Trading and irrevocable designation has been made so what are the keywords fair value other comprehensive income I'm writing the short form FBI value oci other components of income if two things are there this is this is in the first paragraph you're writing okay one and two what is it number one what is the number one not hell for trading Equity investment is the keyword here so you start from this point immediately start with that point only that they are you write through oci when hell not hell for trading and irrevocable election irrevocable election has been made okay in these two conditions so you have to talk about these two condition in your answer but if in this answer what happens they are traded for short term so because they are traded for short term you have to write this also because it is treated for short term it goes through fair value profit and loss it goes through Prof family through profit and loss it has to go through this okay so therefore Amica Americano should measure its investment in equity Investments at Family through profit and loss you have to give that statement this is first paragraph okay leave a line second paragraph what is second paragraph you are talking about ethical issue that was an accounting issue that you solved just now there is an end and means another requirement two requirements are there accounting you will get few marks for ethical issues you will get few marks let's say this question is what no 10 marks roughly so five marks for accounting five for ethical that's how normally it is divided okay so accounting issue we have just solved second paragraph now we are talking about ethical issue how do you how do you write it in terms of ethical by saying is not ethical it's unethical no don't use such phrases not only for this not for any question okay start talking about the director okay the director and the shareholder this relation first you talk about this okay so you can say that directors are appointed by shareholder so it is their duty to add in the best interest of the shareholder right duties of I am writing the keywords okay you deserve directors towards shareholders this is in your second paragraph you're going to write okay because they are appointed by the shareholders they have a responsibility to add in the passengers of the shareholder this is shown by caring for maximizing your profit okay once you say that however use connecting words however Dash what is it do they only have one duty they also have another Duty what is it public interest they have an interest towards public public interest so when you're talking about public interest they have to produce financial statements that Faithfully represent the financial position of performance and cash flow okay Faithfully represent this word has to be there Faith fully represent the financial statements this is the key word this has to be the annual answer it comes from your conceptual framework you're getting keep these are keywords don't forget you are going to get points for this marks are there okay so it is up to the accountants to not to breach the code of ethics and conduct they have certain code of ethics and conduct to comply with right they are bound by it now third paragraph I'm writing three means third paragraph don't write three neurons okay you're dealing online and going to the next you are going to talk about touching on what the five fundamental accs code of ethics five fundamental code of ethics accs code of ethics ACC have given five fundamental code of ethics what are they can you recall you have to talk about this which one out of this five are breached you have to talk about it there are five confidentiality yes objectivity Integrity professional competence and UK professional behavior I'm not writing the five it's there you have to know it okay bye-hearted know the definition you don't have to write the definition you don't have to write all the five by saying these are the five fundamentals is Code of Ethics no no no no no no you directly you have to jump to out of this file which one is breached check if you are going okay you are manipulating the measurement of financial asset how by showing something through other comprehensive income which you should have shown through profit and loss what are you doing you are simply manipulating manipulating my spelling might be wrong it's fine financial statement this is if you are manipulating financial statement measurement okay this you are breaching which of the five no then objectivity no integrate when you're manipulating something knowingly you know it as integrity you this has to be there in your answer you're getting marks for it you're breaching Integrity integrity means being honest and straightforward even if you don't like the definition of integrate it's fine but you are preaching Integrity here next if you are having a next code of ethics that is being breached go to the next paragraph and explain that one principle or one Code of Ethics in one paragraph next in langst okay only one point one paragraph that's how the Acca answer goes one point in one paragraph next are there anything that is breached C it is just not that you want to maximize profit okay okay you are not being honest that's fine another one by showing something through other comprehensive income you are Manu you are biasing the result okay or it is biased towards showing a particular performance right so this demo demonstrates a lack of objectivity this is objectivity you're not being objective next is objectivity which has been breached because they are showing your answer towards one side you want to show in a favorable light lack of objectivity okay and finally comes your conclusion fourth is your conclusion sorry this is the fourth fifth is your conclusion this could be in one or two lines keep it very brief conclusion always very small okay what is it despite the director's Claim about the impact on the shahul as well directors have an ethical responsibility to Faithfully represent okay so this I will write it for you conclusion because you can modify it somewhat in your answer but you can use this kind of words in your arms see how they have concluded it okay therefore despite the director's claim okay you have to use the word directors because it is that it was the director's claim about the impact on shareholders wealth they said that this will positively impact shareholders will so therefore despite the director's claim about the impact on shareholders wealth the directors have an ethical responsibility to Faithfully represent see the words I'm using Faithfully americanos use the company's name financial statement and how is this achieved this is achieved this is achieved through compliance with IFR standard that is IFRS 9 in this case that means you have to go through profit and loss not other comprehensive income through compliance with IFR as 9 status IFRS stands this is how you end it any ethical answer okay now so we are finished with financial liability financial asset and equity instruments now we are moving on to debt in instruments okay debt instruments can be measured in one of the three ways amortized cost fair value through other comprehensive income fair value through profit and loss if it's amortized cost okay this is how you decide whether an investment in a debt in instrument is measured at amortized cost or not you have to see the business model very important even in your exam look at the business model of the entity if the entities business model is to collect the assets contractual cash flow that means they are not planning to sell the asset they are going to keep that asset until the majority date okay then second the terms contractual terms of financial asset that means the cash flow that they are receiving is only the interest and the payment sorry interest and the principal amount solely this too okay then amortize cost for example the interest rate on convertible Bond convertible bond is a debt instrument it's a debt right so the interest rate on convertible Bond will be lower than the market rate why because holder is getting the benefit to choose in cash or shares on Redemption so in this case contractual cash flow is not solely principle and interest therefore you cannot use amortized cost for convertible Bond understanding then for fair value through comprehensive income the business model is you are collecting and you are selling the financial asset you are selling when you're not selling amortized costs if you're not selling other components of income okay and most of the time you sell a debt instrument when you have a possibility of buying another investment at a higher return another debt instrument at a higher return so here also the cash the the contractual term means the payment that you're receiving is purely interest and the principal amount now let us do a small question on this test your understanding six in this question advise how the finance director on how the bond should be measured so he has purchased a new financial asset the asset is a bond which is going to measure in three years he buys the debt with the intention of holding them until majority but on some occasions sold some Investments if cash flow deteriorated Beyond acceptable level they pay a market rate of interest so now they don't know whether they have to measure it at amortized cost of family throughout the comprehensive income okay you have to see see for a debt instrument to be measured at amortized costs there are two things intention they have the intention of holding number one number two contractual cash flow is entirely the principal amount and the interest so in this case what is this objective objective is to hold the financial asset until maturity right they are holding the asset until majority so it does not matter whether they sell in between they sell some Investments if cash flow deteriorated okay it does not contradict this objective they still have this objective okay even if in between they are selling it does not contradict with this objective number one so number one is true number two what about the cash flow the bond is paying at a market rate of interest so market rate of Investments they are compensating it for the time okay time value of money and credit risk associated with the principal amount that is outstanding okay this Market rate of return compensates for it both the time value and the credit risk this means the asset can be measured at amortized cost why because it is the interest as well as the principal amount this one so they are receiving solely principal amount and the principle interest in the principle amount summarize cost okay sometimes what you can do is see Financial assets are classified based on your initial recognition Okay initially when you're recognizing something through fair value through profit and loss rather confidence of income or amortized cost it remains like that but sometimes you can reclassify you can change the classification how for example an entity wants to change his business model okay once you change your business model earlier you were holding the financial asset until majority now you want to sell so once you change the business model your financial asset the affected financial asset also will be reclassified for example from family through profit and loss to amortized cost let's say you're changing but this change can only take place for investments in debt remember why see for equity in investment you cannot change anything from fair value through other comprehensive income to anything else next there is normalized cost for Equity investment in instruments it is only for debt instruments that we have so you can only change fair value through profit and loss to amortized costs only for debt investment in debt remember that debt instruments now amortize costs when you're measuring it the debt initially it is family plus transaction cost here it is plus okay interest income this time because it's an asset on your assets see debt in instrument means what investment in a debt instrument means you are giving you are giving debt to someone on which you are earning the income so it's an interest income for you you are receiving that income okay so this interest income is same way like Financial liability is calculated using effective rate of interest there it was interest payment here it is interest income that was interest cost that's the only difference but the way you calculate is on the effective rate of interest then fair value throughout the comprehensive income here also initially Fair Value Plus transaction cost same like amortized same interest income calculated using effective rate of interest okay but the difference come here at the reporting date assets will be revalued to fair value gain and loss will go to other comprehensive income but see how it is different from Equity instrument an equity instrument you couldn't reclassify to p l but here you can reclassify to profit and loss when you are disposing the asset okay Now Fair Value through profit and loss the difference is here in the earlier two you are adding the transaction cost to the fair value this time transaction costs are expensed to be error okay but initially everything is at fair value next at the reporting date as it will be revalued to fair value and gain and loss will go to profit and loss this is something easy note on loss allowances if you are having a debt instrument that is either measured at amortized cost or fair value through other comprehensive income there will be a loss allowance that is our next topic loss allowance impairment of financial asset that is our next topic but it could the impairment on financial as it is only for debt instruments that is measured at either amortized cost or family through other comprehensive income it is not for fair value through profit and loss you don't have loss allowance for those kind of debt instruments so in summary investment in debt amortized cost if contractual cash flow characteristics test passed what is the meaning of it contractual cash flow means the cash flow that you are getting should only have interest and principle solely and the business model to hold it until maturity other comprehensive income again you have to pass the cash flow into only the interest and the principle but the business model is you are holding and you are selling profit and loss if it is neither amortized nor the comprehensive income now let us do questions before we move on to the impairment of financial asset test your understanding 7 Tokyo so in this question you have been given three scenarios with three different business model you have to use amortize fair value through other comprehensive income and fairly through profit and loss okay this is a very good question to attempt because this one question will solve all your doubts on how to do a question if it's amortized cost or travel through oci or family through profit and loss so a business model is to hold the bond until majority which method should you use if you are holding it amortized cost get this fact straight away you should be able to tell once you see the business model which method you should use next one you are holding the bond but you are selling it okay holding the bond and selling so fair value through other comprehensive income next you are trading the bond for short term you are selling this bond for its fair value on 1st of Jan 2002 this is fair value through profit and loss okay no you have been given the family of the bond on 31st December 2001 and 2. okay this you have to attach this figure only when you are using fair value for amortized cause we don't need it okay so we are coming to the information on first of Jan 2001 talking about a hundred thousand five percent bond for 95 000 issue cost was two thousand interest Ed in areas the bond will be redeemed at a premium of this much effective rate of interest is eight percent so you have been given every information now you have to do the calculation and while you are doing the calculation you have to explain because read the requirement very carefully don't be in a hurry just to explain sorry just to calculate explain with calculations how the bond will be accounted for over all the 11 years with calculation so you have to explain explanation part I'm giving it up to you because the answers are there behind your textbook you can nicely read the explanation but while doing the calculation I'll be explaining you okay so let's start with a okay now so because it is amortized cost first you have to find when the asset is initially recognized okay so when the asset is initially recognized for a okay then you have to add your cost width all the transaction costs are added with the fair value so if you see it has been 95 000 okay hundred thousand one five percent amount for ninety five thousand so with this 95 000 see if it was Financial liability you would have deducted the transaction cost but this is a financial asset okay investment in jet instruments but it's a financial asset you are giving a loan to someone that's why it's a dead instrument but for you it's a financial asset so you are adding a pure transaction cost okay plus transaction cost so your transaction costs are your issue cost in this case is 2000 you are adding this it's always like this debt in instruments okay you have to add your transaction cost so plus 2000 which is equal to 97 000. so from here onwards you start the table okay you start the table the three dates year ended 31st December 2001 year ended 31st December 2002 year ended 31st December 2003 okay now the balance brought forward then we have on that we are going to charge interest at what percent effective interest rate eight percent okay it is this they've already given the effective rate of interest is eight percent then we have her seat it's not cash outflow it's a receipt you are on the receiving side you are giving the bond so you are receiving it and then the carry forward balance remember this table okay memorize it this is how it's always going to be so broad forward will be this one that's why you need it 97 000. from here onwards you start so apply eight percent or ninety seven thousand which will be 7760 and receipt when you're working out the receipt you are working this the coupon rate so it's five percent on hundred thousand which is five thousand okay so it's five thousand so the seed so it's an addition oh it's a receipt button we have to deduct it okay because they are giving you that five thousand right that receipt so because of that receipt it's see see it in this way it's a dead okay you are giving a loan to someone you are giving a bond so they're paying you now receipt you are getting that receipt so because of that receipt your amount of your debt will reduce further it's like they are paying you the loan amount so the loan amount value of your loan value for liability goes down that's why you're deducting the receipt 5000 here understand this logic okay that's fine so carried forward will be 99 760. in Excel you should be able to do it very quickly please do this in Excellency how much of time you're taking becomes the carrying forward balance of 31st December 2001 becomes the opening balance of the next year again apply eight percent on it which is seven nine eight one this remains five thousand it's fixed and 102 741 then it's 102 741 here eight two one nine five thousand there will be no carry forward balance it will be nil because you have to pay off everything will be paid off okay here finally you are receiving your in addition to this you are also receiving extra what is it the amount of the bond 100 000 with it you are adding the premium 5960. so hundred thousand plus the premium five nine sixty it should be 105 960. 105 960. this is what you're going to receive at the end the entire amount and if you go by like this you add this and you deduct this you have to get a zero here it has to be always like this because at the end there's no balance to carry out same for the financial liability also it works in similar way okay so now for each year so when you're going for 31st December 2001 what are you what are you recording this is an interest income interest income of 7760 goes to p l straight away and what's next asset the financial asset what is the amount this one nine nine seven sixty goes to statement of financial position straight away okay so like this same pattern you have to apply for the other two years also 31st December 2002. interest income is this much 7981 goes to piano this goes to statement financial position the asset 2003 this goes in the pnn that's it nothing goes to step in a financial position now with this understanding we are going to go and do Part B Part B this is family through other comprehensive income okay here is the same okay for fair value through other comprehensive income it is 97 000. it's the same figure you have to use ninety seven thousand okay the older thing is because it's fair value okay this will change okay I'm going to rub it for you in the same table only I'm going to do it okay see regarding the interest okay effective interest eight percent Remains the Same as as a okay as party in Part B also this will remain same interest will not change only the broad forward and the carry forward balance will change even the receipt will remain the same five thousand but you start with ninety seven thousand starting is same so 97 000 this does this carry forward balance will be oh this time you will have another section what is it after receipt uh after a seed you should have again error loss because it's fair value so total then gain or loss then we have the correct forward balance okay so if you add up this total here it will be 99 760. but if you go here and see carry forward balance should be 110. for 2001. this is the fair value of the bond so it's it should be here 110 000. check out the difference between these two this is a financial asset okay so if you see closing balance is more it's an asset see it from the point of an acid value is more it's a gain it's again value went up carry forward balances more so the gain is the difference between these two which is hundred and ten thousand minus 99 760. is the gain what is it 10 to 40. so the gain is 10 2 4 it's again now hundred and ten thousand so he also will be hundred and ten thousand the total will be 112 981. this time also they have given you the carried forward balance which is hundred and four thousand but this time if you see from 112 981 value went 204 000 it's a loss so the difference is the loss okay it is 8 9 81. this is the loss and when you are coming here it will be 104 000. okay and when you are coming here okay proceed please understand here it will be 105 960 because 100 000 plus that premium this will be same in all the three years this amount Okay so if you check the total this 104 plus the interest minus this amount you will be left with one two five nine so there'll be nothing nailed so it's a loss one two five nine this is a loss okay this will be the table now the explanation will be same like part A that this figures will go to profit and loss okay each year correct year by year you have to explain in different paragraphs in the year and 31st December 2001 this will go to pnl this will go to other companies they become this will go to statement of financial position like that you have to explain for 2002 like this like this like this 2003 like this like this like this okay so everything is Remains the Same except this I will highlight it for you these are evaluation gain or losses only this three three things are new in Part B where will this go oci are the components of income this figure will go to statement of financial position so every year you have to write okay now we are coming to part C it is you are trading it for short term profit and loss and you are selling it on 1st of Jan 2002. okay so now when you are taking it there is a difference here difference will be for part C this time it will be only be 95 000. okay part C is only ninety five thousand you are not taking the issue cost and adding it why because the issue cost issue cost two thousand goes to profit and loss they'll be expensed and this only happens when it's available through profit and loss fair value through profit and loss in this all the transaction like issue cost for example goes to plb they're expensed you do not add it with the fair value so fair value remains 95 000. okay now so for here you don't have to make that table it's not required okay 31st December 2001 what happened interest income will be five thousand we have already calculated it right five percent of hundred thousand that's five thousand this will go to piano there's no doubt this will remain the same okay asset would be revalued to hundred and ten thousand why because at that date look at the fair value at that date the fair value is hundred and ten thousand this is revalued 110 000. what is the value initially ninety five thousand so from hundred ten thousand minus ninety five thousand it was evalued upwards what is the gain 15 000 right fifteen thousand gain where does it go to a p l because this is even though it's a revaluation but it's family through profit and loss so the gain will go in devaluation gain will go through profit and loss now when you're selling it off you are selling it for the fair value that means you are selling it for 110 000 so when you're selling it for 110 000 on this date 1st of Jan 2002 cash proceeds of hundred and ten thousand this much you are receiving and financial asset what's happening when you're selling the financial asset financial asset would be de-recognized you have to rewrite this word now you're no longer going to recognize the financial asset you are selling it off so you're receiving the cash and you're recognizing the financial asset please do this question on your own if you'll find a similar question like this in your past paper or revision kit please do it it's very important that you get the pattern set from the beginning itself before we proceed more because as more and more we go further okay we are going to learn new new things so that you might forget all those things foreign okay this is not like just understanding seven it's little different and it's easier okay so that's the thing once you're over with that tough part okay doing easy things makes more sense okay now on 1st of Jan 2001 Mac Pi lens 2 million this loan is interest-free and it will be repaired in two years time as it is classified at amortized cost no transaction fees Market rates of Interest are eight percent loss allowance can make note you have to say how this accounting entries will be done in 31st December 2001 that's the question okay so please understand okay whether this loan you always need to understand the nature whenever they give don't immediately apply IFR as 9 don't jump to a conclusion to use ifrs9 first see whether it's a financial asset or a financial liability if it's not then there's no point of using as far as nine first understand this loan whether it's a financial asset or not understand this you first have to write that in your answer so this loan okay this loan in this question is a financial asset you are giving the loan to someone as you're not taking a loan okay don't get confused with loan and financial liability I know that patent that has been set in your mind don't means liability romance liability you are not taking alone you are giving the loan you are lending alone that means you are getting the return okay why this is a financial asset give reasons because macpy have a contractual right okay the word contractual right when you are giving a loan you have a contractual ride right you have you have a right to receive cash whenever you have a contextual right to receive cash in any through any way loan Bond events or whatever shares it's a financial asset okay contextual right back pie please mention the name of the company Mac Pi has a contextual right to receive cash in two years time that's why it's a financial asset now you apply IFRS 9. so initially initially okay second paragraph initially you will recognize it at fair value because all financial asset or financial initial recognition is fair value please remember this okay so Financial assets I'm using short form fa but you don't use it okay ah initially recognized at fair value okay see so in this case you cannot easily get the fair value why did they give you the family no if you see market rate of interest is eight percent right you have to make sure that this is mentioned in your answer I'm not writing it please check the answer answers are there but I'm just explaining you what do you have to write Mark address are eight percent that means Market participants would receive eight percent on this type of loan but if you see the loan that has been made to the supply is interest free it's not in line with the market it's interest-free so that means this transaction was not done at the Via value correct so that means the financial asset will not be recognized at this price because this is not a farewell instead you have to estimate the value now how by finding the discount you have to Discount the cash flow that's how you do you calculate the present value of the future cash flow from the loan okay so now you start doing it it's 2 million right you discount it multiply by 1 divided by 1 Point C you have to discount it using this rate only market rate eight percent and it's for two years time in two years time so one plus eight percent that means it will be 1.08 to the power 2 because for two years this is how you find the present value which will be 1.71 okay so the entry will be your debit financial asset 1.71 you debit profit and loss will leave the figure because it's a balancing figure you credit cash how much you are lending 2 million so the difference you are lending 2 million Financial assist debit and profit and loss will be it's a loss of 0.29 the difference now that's not enough okay this is initially but subsequent measurement financial asset is subsequently method you have to use these words okay in your answer subsequently measured at amortized cost how do I know amortize cost true two things I will understand one look at the business model if the business model is holding it until Redemption amortized cost but in this question they have already told that it will be measured at amortized cost already they told us so it's easy one either in the question they will tell you directly otherwise they will give the business model and then you will know so that means that table only for one year you have to do it 31st December oh it is that the first December 2001 okay so on that date okay it will be 1.71 this is first of Jan 2001 1.71 you are getting it from here this amount 1.71 interest of eight percent see earlier you are using that interest to Discounter you are using the same interest to find the interesting car this eight person only okay because no other interest has been mentioned so interested eight percent eight percent of 1.71 is 0.14 receipt you see there'll be no receipt why because interest free loan interest free loan there's no coupon rate if there was a coupon rate you would have got the receipt so it's nil so by 31st December 2001 just add it will be 1.85 okay so now this interest income you have to record debit financial asset 0.14 credit profit and loss again 0.14 your financial asset value will further go up you have to increase it up to 1.85 that's why you're debating 0.14 and you're crediting it because it's an interest income okay so please understand why again this is 0 because loan is interest-free interest-free means you are not receiving any cash okay so by 31st December 2001 financial asset will be at 1.85 and what about 31st December 2002 financial asset will have a carrying amount of 2 million understand this and this amount will then be repaid by the supplier because they told in two years time then someone will be you'll be learning this amount so it will be repaid by supplier by the end that's why we know that carrying amount initially will increase up to 2 million and then supplies will entirely pay off this 2 million so now we are moving on to the impairment of financial asset foreign of financial assets okay loss allowances like any other asset whether it's tangible or intangible same for financial assets also we have impairment but what you need to remember is that this impairment is only for dead instruments Financial assets that are dead instruments not Equity only dead instruments okay and that instruments which are measured at amortized cost or fair value through other comprehensive income only for this two impairment is there now if the credit risk on the financial asset has not increased significantly okay since the initial recognition the loss alone should be equal to 12 month expected credit losses please understand if the risk does not increase significantly 12 month expected credit losses that should be your loss allowance if the credit risk increases significantly then it is the lifetime expected credit losses we'll see in the next slide what are the terms credit risk loss allowance this 12th month and lifetime expected credit losses then you have to make adjustments to the statement of profit and loss what are these adjustments okay adjustments to the loss allowances are charged to the statement of profit or loss okay next unless credit embed interest income is recognized on the assets cross carrying around example sorry yeah excluding the loss allowance excluding the loss allowance means from the assets carrying on that means the financial assets carrying amount you do not deduct the loss allowance no so when you are calculating interest income see how on what amount you calculate interest income on the opening balance right the on the carrying amount of the asset so this carrying amount of the asset okay it is the gross gross means you do not deduct loss allowance net carrying amounts you deduct the loss allowance and then you calculate interest income but this is only when your assets are not credit impaired that means the credit risk did not increase significantly okay interest income is the effective you have to use the effective rate of interest to calculate interest income we have done this right now the definition very important the four definition these are the four definitions that you have to know credit loss what is credit loss credit loss means when there's a difference between the contractual cash flow and the cash flow that entity expects to receive there's a difference it's not the same the amount that you expect to receive is something else and you are actually receiving this less than that then it's a credit loss okay expected credit losses are the weighted average credit losses lifetime expected credit losses means when the expected credit losses that result from all possible default that means from all the conditions You can conclude that your financial assets the risk has increased significantly the credit risk 12 month expected credit loss is just a portion of that lifetime expected credit losses that might occur for 12 months after the reporting date just a portion okay we are definitely going to do questions on this so do not worry next significant increases in credit risk okay to see this to assess this that whether the creditors increase security or not IFRS 9 says you have to compare how can you say it increase significantly you have to compare you have to compare at the reporting date what was the assets risk of default and at the date of initial recognition what is the risk of default you have to compare this to one on the reporting date the other one on the initial recognition the assets risk of default entities should not solely rely on past information when determining if credit risk as increase theoretically or not no third if see see it's normal for an entity assume that credit risk will not increase significantly for those instruments that already has a low credit risk at the reporting rate it's very unlikely right having no credit is suddenly will increase so much but if they have then if the credit risk is high already in the initial recognition then yes it makes sense that it will increase significantly now credit risk can be assumed to have increased significantly if the contractual cash flow takes more than 30 days to be paid okay if it's more than 30 days credit risk increases significantly now let us do a question on this [Music] test your understanding nine so in this you are supposed to discuss the accounting treatment of the bond okay here they have issued a bond send friends now they they hold the financial asset until majority and they deem to have low credit risk but because there were some adverse changes in economic environment it is having impact on their liquidity let's see what are the information sales have decline of 15 percent over the past six months external agencies are reviewing its credit rating but no genders have yet been made and although bond prices have remained static San Francisco's bond price this is the market bond price San Francis bond price have fallen dramatically okay the Market's bond price are static static means they didn't change so now how are you going to explain this so you have to first see whether the credit risk increased significantly or not from the date of Inception okay credit risk of the bond then you can see that performance has declined right decline of 15 percent that means performance has declined this can have an impact on their liquidity right it is having an impact so you can talk about it next about the review bot so because they are reviewing this that means they're more concern about the performance and the position of the company right then the bond price mention this third point okay even though the market bond price is static but San Francisco's bond price there's a decline okay so because it has fallen Graphics together there's a decline you can say that this is likely to be a response to San Francisco credit risk increased significantly right it could be a response to that so now you can give a conclusion that based on the above it looks like that credit risk has increased significantly right it's no longer a low credit risk looking at all the facts from the bond price to external agency rating and to the performance of the decline right it seems that now the grid address increased significantly okay so because credit has increased significantly what should you do how do you account for it recognize loss allowance okay you have to recognize a loss allowance equal to what equal to Lifetime because it increased significantly it's a lifetime not 12 months lifetime expected credit losses on the want now let us do test understanding okay [Music] test your understanding 10 okay so here you have to discuss the current accounting treatment okay of this James trade receivers are short-term and do not contain a stickman financing component okay now using historical observe default rate they updated for changes in forward looking estimate okay so they have given not over to you 1 to 30 days 31 to 60 days over what would be the default rate now coming to the gross carrying amount they have given you there's a loss allowance of 0.2 billion that has been brought forward from the previous Financial year okay you need to understand that trade receivable are financial asset so according to IFRS 9 you have to deal and at what cost normally it is measured at amortized cost okay now how are you going to calculate the expected credit losses you have been given the probability and you have been given the amount so just multiply okay multiply the expected risk of default with the carrying amount right and since because receivers are for short term you don't have to discount them okay now lifetime expected credit losses let's do that it's lifetime okay no so not overdue Not Over You means you have to multiply this to 0.5 percent with 10.1 that's how you multiply the default rate with the cross carrying amount multiply so it would be 10.1 into 0.5 percent which would end up to 0.05 all these are in millions then we have 1 to 30 days over the overdue which is 4.3 into 1.5 percent 0.06 then 31 to 60 days 1.6 into 6.1 percent 0.10 then we have more than 60 days okay 1 into 16.5 percent if you it will do 16.5 percent so with British weight is 70. okay round off Southern showing zero one one six five is better to show 0.17 rounding up to two decimal places now it would be 0.38 okay so this would be the allowance 0.38 then you need to recognize but the current allowance already you have recognized 0.2 because you have carried it forward from the previous year and it has increased further to 0.38 okay so the difference 2 minus zero point three eight wait is it two 0.2 sorry difference is 0.18 okay so this 0.18 is a Express which goes to PLL the incremental amount okay now if the acid is credit impaired okay you have to compare okay the difference between the asses gross carrying amount and the present value of the expected future cash flow when discounted at the original effective rate of interest okay and ifrs9 also suggests some events which says that asset might be credit impaired number one where borrower or issuer are having significant financial difficulty a bridge of contracts such as a default borrower being granted concession it is becoming probable that borrower will enter bankruptcy so in all these four as it is creating impaired okay and if the asset is created impaired you have to calculate the interest income on the assets and net carrying amount remember earlier we told that if the asset is not created impaired interest income is calculated on the assets cross carrying amount here if it is created in bed it is the assets net carrying amount that's the difference net carrying amount means you deduct from the gross carrying amount you deduct less allowance you deduct the loss allowance that's what you do and on that you calculate interest income which is based on effective rate of interest now let us do a question so here you are supposed to discuss accounting treatment of the financial asset at 31st December 2000 one please go a little slow in this once from here onwards because the questions from here in words are going to be little tricky a little difficult to understand in the first instance you need to reread it okay so go a little slow on 1st of Jan 2001 they purchased a Bonoff for 1 million measured at amortized costs interest was 10 percent renewable on 31st December 2003 effective rate of interest is 10 percent so it's the same okay coupon rate and their effectively.10 Napa received 31st December 2001 they received interest of 100 000. that is 10 of 1 million probability of default within the next 12 months is 0.5 percent if default occurs within the 12 months then I've estimated that no for the interest will be receiving that only fifty percent of the capital will be repaid on this one the accredited risk is low okay now how do you start with this the creditors increase significantly or not no because it would if it would have increased significantly they would have given you the lifetime expected credit losses they give you 12th month and also said the credit risk is low okay so the credit risk did not significantly increase okay let's write it down okay did not increase significantly so creditors did not increase significantly means what loss allowance is equal to 12 a month expected credit losses credit loss okay you can use 12 month expected credit loss no let's find the credit loss okay you have to work the credit loss how date 31st December 2002 and 31st December 2003 and 31st December 2003. now expected cash outage discounted you have to discount it and the present value this is how you do you find the present value so the cash shortage the interest only you are receiving which is hundred thousand hundred thousand hundred thousand but in 2003 you are also receiving fifty percent of the capital that is 50 of this one million which is 500 000. okay they told if default occurs within next 12 months then Napa estimates that no for the interest will be received and only fifty percent of the capital will be repeat on 31st December 2003. which is 500 000. okay discount rate is 10 percent three for three years okay so you multiply the cash orders into discount rate and find the present value ninety nine zero nine eighty two six forty five four hundred and thirteen two two three add up the present value it is 586 777 this one okay this is a credit loss that we have been working out this is exactly how you have to do when you are given the cash you have to find the present value of it that is the credit loss okay now what is the expected query this is the credit loss on the asset the expected credit loss expected the moment you see the word expected you have to know that there's a probability that is there you have to work around probabilities okay expected credit loss so the moment you see the word expected probability is there that means you're multiplying the credit loss by the probability so here it is 5 8 6 7 7 multiply by what what is the probability of occurs 0.5 percent that is going to default within 12 months so 0.5 percent okay so if you take 0.5 percent of this it would be 2 9 3 4. okay that means this is an impairment loss also this loss will create an impairment loss because this is what if financial asset only the moment you have credit loss and all it's an impairment so impairment loss of 2934 will go to p l account profit and loss okay now let us find the net carrying amount of the financial asset in the statement of financial position because it was impaired there's a net carrying amount in your statement of financial position it will be the net carrying amount ah financial asset on the statement of financial position what was the amount of the bond 1 million you deduct the 293 for the expected credit loss which will be nine nine seven zero six six in your statement financial position this is the amount of your financial asset which will go now remember interest in the future period will continue to be charged on the gross carrying amount on this one million in the future okay why see the credit risk did not increase significantly because we are only finding the 12th month expected credit losses so we work out the interest in on this gross carrying amount not on the net when you're finding the interest because the risk did not increase significantly it is only a 12 month expected credit loss okay now so we have done the working that's it now we'll be moving on to test understanding 12. how they should be accounted for first of Feb 2006 they made a four year loan of ten thousand coupon rate is six percent effective rate is also six percent then on 1st of Feb 2009 that is 678 after three years after four years six seven eight times they had a significant financial difficulty current market rate is eight percent no more interest only at six thousand they estimate that they will receive no more Capital it also estimate that only six thousand of the capital will be repaired on the Redemption date the recognition loss allowance of 1000 already so now let's see how should this be accounted for you have to write calculation is not enough okay so because there are significant financial difficulty that means significantly it has increased right so now remember this time the coupon and the effective interest rate are the same because they are same carrying on one of the asset will remain at 10 000. because the effective and the coupon rate are six percent they are same okay now let's find out the like the previous one you have to find the present value of the future cash flow so present value of future cash flows discounted using effective rate you have to use effective rate always to discount so future Capital only six thousand you're receiving okay and when you're discounting it it will be one divided by six percent six to the power 2. I'm sorry not two it's just six because you are discounting it or one year okay just see here so it will be five six six zero okay now this is expected credit losses that's what you're finding okay so you have to deduct this from the amount because you need the net figure right so ten thousand minus this figure expected query sorry this is not expected credit loss now what you are going to find will be the expected credit loss okay it will be the this one 4 3 40. the expected losses so this at this amount you have to recognize your loss allowance okay already you have recognized here thousand so you have to increase this to this amount up to 4 3 40. right so the difference only will go to profit and loss 4 340 minus thousand so three three forty we'll go to PNR okay you have to increase your loss allowance by this amount now because the you can say the asset is credit impaired so interest income will now be calculated on the net amount okay so what is the gross carrying amount let's find the net amount ten thousand minus the allowance which is 4 3 40 the total which will be 5 6 60. it's equals to 5 6 60. so it is 560 you have to find on this this is the net amount okay so consequently in the last year of the loan the interest income will be recognizing profit and loss and last year of loan interest income will be how much this you have to take the effective interest rate six percent because this is the net amount right so on that you charge what six percent so once you apply the effective rate you are going to get the interesting come up 340. this will go to pnn as an interesting term one is lost allowance don't forget the other one is interesting okay foreign purchased or originated credit impaired financial asset what happens when the financial asset that you have bought is already credit impaired on initial recognition that time the interest income that you calculate should be by using credit adjusted effective interest rate see normally you use effective interest rate this time you have to to credit adjusted effective interest rate to calculate interest income second the credit adjusted effective interest rate incorporates all the contextual terms of financial assets as well as the expected credit losses that means higher the expected credit losses lower the credit adjusted effective interest rate it's opposite third since credit losses anticipated an Inception will be recognized through credit adjusted effective interest rate see whatever happens right credit losses that you anticipate at Inception it is already reflected in your credit adjusted effective interest rate that means how the credit is lower the interest rate so the loss allowance on purchased credit impact financial asset should be measured only as the change in the lifetime expected credit losses since initial recognition that means when you calculating the loss allowance this time for those type of assets you only have to see when the lifetime expected credit losses changes since initial recognition only when it changes then you recognize the loss allowance right next death instruments at Family throughout the comprehensive income that's the second type of debt instruments that could be that where Financial assets could be impaired here because the assets are held at fair value so you do not deduct the uh you do not deduct anything from the carrying amount of the asset okay loss allowance are not deducted from the carrying amount of the asset in the financial statement instead that allowance goes through other comprehensive income let's do a question now test your understanding 13 okay this is your fair value through other comprehensive income and expected losses how do you revaluate explain how the revaluation and impairment of the financial decision should be accounted for okay so here they purchase a debt in instrument for one thousand on 1st of Jan 2001 the interest rate is same as effective for it and 31st December 2001 still the bond is a thousand after it was December 2001 the year end fair value went down to 950. okay there one there was not any significant increase in the credit risk so they used 12 month expected credit losses this is deemed to be at 30. how do you account for it see fair value went down from 1000 to 950 already there's a loss okay loss of 50. there's a loss of 50. this is a loss where will it go to other comprehensive income because this is fair value through other comprehensive income so it will go to oci loss your debit oci 50 annual credit financial asset fa 50. okay now what about the credit loss 12 month expert credit loss 30. you debit the 13 piano where you credit you do not deduct it from the canning amount of the asset instead you credit that and other components of income so debit employment impairment loss through p l 30 and you credit this time in oci okay so overall impact if you see OCS debit 50 credit 30. so 50 and 30. 50 minus 30 20. so cumulative loss cumulative loss in oci is 20 50 minus 30. okay the fair value change in 50 is offset by the impairment amount of 30. simplifications now IFRS 9 has allowed some simplification number one loss allowances should always be measured at an amount equal to Lifetime credit losses but for what for date receivable and contract asset only for these two things you measure it always at lifetime credit losses there is no option of choosing 12th month or lifetime it is always lifetime credit losses only for trade receivable that is your debtors and contract asset contract asset is those that are recognized according to by Paris 50. okay but if they do not have a significant financing component in your exam they will tell you whether they have a significant financing component or not if it does not then lifetime but okay for lease receivable as balance trade visible and contract assets with the significant financing component if they have a significant financing component then entity can choose whether to measure it at lifetime expect lifetime credit losses or not okay now impairment reversal it's quite often that sometimes it could be reversed right at that time you need to recalculate your loss allowance at each reporting date second it may be that allowance okay was previously equal to Lifetime expected credit losses now it is changed to 12 month expected credit losses why because credit risk reduced that time it was high credit risk now it reduced so now from Lifetime to 12 month when this change happens there's a substantial reduction in the allowance required you can see that your allowances are reducing third because of this you are going to have some gain or loss right so gain on loss on the re-measurement of the loss allowance go through profit and loss okay now so that's it with impairment of financial asset now we are moving on to another part that is a deer recognition of financial instruments both financial asset and financial liability are der recognized if certain conditions are there for financial asset if contractual right of receiving the cash is no longer there it's expired for example earlier you have an option now that option is no longer there either it has elapsed or lapsed or it became worthless second reason could be you are selling of the financial asset when you are selling off please make sure that all the rests and rewards of the ownership of that asset are also transferred from seller to buyer if this too happens then only you do recognize okay but if not okay if you are retaining the risks and Rewards you should not be recognize the financial asset even if you are selling even if a legal is selling the financial asset if you are having the riskan rewards of the ownership of the asset with you you should not de-recognize the asset you you should still recognize the asset IFRS 9 says that Financial instrument is consistent okay is consistent with the conceptual Frameworks regarding the Der recognition part it goes IFRS 9 goes with the conceptual framework in terms of derecognition now let us shift to financial liability with the same understanding that we have for financial asset is the same this just is the opposite here it's the obligation okay you do recognize Financial liability when the obligation is discharged that means you no longer have an obligation either it is discharge or cancel or gets expired and this is the accounting treatment okay so the difference whenever there's a d recognition this is the accounting treatment the difference between the carrying amount of that asset or reliability and the amount that you have received or paid the difference is recognized as a profit and loss okay next for investments in equity investment Equity instrument sorry for investments in equity instrument which is held at Family through other components of income all the cumulative gain and losses in the other comprehensive income are not reclassified to Provident loss on disposal the difference in debt in instrument is they are reclassified any debt instruments that go through other comprehensive income the gain and loss are reclassified to profit and loss once they are sold off once they are disposed that is the only difference in equity instruments not really classified to provide a loss debt in instrument yes it is reclassified to profit and loss so let's do three questions before we move on to our next topic that is derivative another very interesting topic test your understanding 14. here we are going to do three test understanding 14 test to understanding 15 and test understanding 16. test your understanding 14 is about two factoring arrangements okay what is factoring factoring means when you are hiring a person to collect your debt on behalf of you and you are paying a commission to this Factor okay so there are two Factor okay now this is about receivable okay mink has two receivable that it has factored to a bank in Return of immediate cash proceed it has factored it to a bank so bank is going to receive and give it to make okay now let's see the first receivable is for 200 000. okay Ming had received 180 from the factor and what are the terms of this the term is that Ming will not have to repay this money even if the customer does not settle the debt and this is said the factoring Arrangement is said to be without recourse you don't repay second receivable is 400 000. mink has received 70 000. and Ming will receive a further five thousand if the customer searches the account on time okay now if the customer does not settle the account then the receivable will be resigned back to Ming who will then be obliged to refund the factor with the original 70 000. this is said to be factored arrangement with three course so these are the two factoring this thing now tell me how do you account for it let's deal with the first okay the two hundred thousand the question here is about disabled right you have to know this whether you have to de-recognize or not okay this is regarding receivable rate receivable so for trade receivable this is trait restricted receivables okay when it's about trade receivable the important question you need to ask is are you transferring or are you selling off all of your risks and Rewards to the factor okay if yes you do recognize the receivable if no you do not der recognize so in the first one you have to see the 200 000 receivable here are you transferring the risks and Rewards is Ming transferring it to the factor okay in this case there is could be bad date right that could be a risk regarding to trade receivable main risk of trade receivable is what bad date so now the first arrangement if you see 180 000 and if you see The Mink is not going to repay so who is bearing the risk ultimate risk is born by whom the factor the factor is going to Bear the risk so in this case okay the risk and the reverse that means the risk of bad date has been passed from Ming to factoring factoring Bank okay so because it has been part of a bank is the one is going to suffer because Ming is not going to make any more Arrangement right Ming is not going to repeat that amount whether the customer pays or not so here Ming has to de-recognize Ming should D recognize because he has transferred the risk of bad date to the factoring Bank Main should d recognize okay being should D recognize what the receivable so if you see the difference receivable was for 200 000 Ming has already received 180 000 what is the difference twenty thousand is the risk twenty thousand this twenty thousand they have to be recognize okay so there will be an expense of 20 000 recognized twenty thousand expense recognize okay they should dercognize what the receivable this is regarding the first Arrangement now the second arrangement in the second Arrangement you see they are topping up the payment okay and in fact if the customer settles the account on time Bing is going to receive offer the five thousand so you see the discount rewards still stays with the mink they didn't transfer it to the factor in the second arrangement understanding and money received a refundable in the event of default so that means it represents an obligation okay even if okay so despite the passage of legal title over the receivable even if the legal title is with the factor on receiving the receivable still the riskan rewards of slow payment and bad date stays with mink in this case okay so that means you should not de-recognize you should keep continuing to recognize this in the second arrangement okay so in substance mink has done what Ming has borrowed seventy thousand they have receive seventy thousand from the factor means what they have borrowed the 70 000 from them it's like a loan so you have to recognize this immediate immediately you should recognize okay immediately recognize this the seventy thousand it's like a loan you are taking okay it's like a borrowing so because it's a loan what happens it increases the gearing of make gearing off mink will increase okay gearing means when your debt increases your Financial Risk increases that is the meaning of gearing now let us go to test understanding 15. okay so test your understanding 15. advice the directors of case as to the acceptability of the above accounting treatment case holds Equity Investments at fair value through profit and loss okay due to the short-term cash flow shortages they sold some Equity Investments for 5 million carrying one was four million okay the terms of the disposal state that case has the right to repurchase the shares at any point over the next two years at their fair value on the repurchase date case has not de-recognized the investment because the debtors believe that repurchase is highly likely okay so now what do you suggest an entity has transferred a financial asset if it has transferred the contractual right also to receive the cash flow from that asset then only you can say it has transferred its financial asset okay it's very important because this is regarding transfer of financial asset and liability okay this is a financial asset so now if you have transferred you have to see who is bearing the risk and reward of that financial asset okay if they have also transferred the risk and rewards then yes they recognize a financial asset otherwise you have to recognize okay and remember gain and losses on disposal okay gain and losses on disposal goes to PNF so in this case okay let's see the case do does he have an obligation to buy back the shares no no obligation he has no obligation if he wants he can buy but he has no obligation to buy back the shares okay so because he has no obligation to buy back their shares that means he's protected from any future share price decline the understanding and even if the case does repurchase the share there will be at fair value you see at fair value it is not at a some fixed price prefixed price so this is not having any risk or reward relating to the price fluctuations on the share price understanding so because the risk and rewards are have been transferred what happened K should be recognize K should der recognize the financial asset the fa okay once you did recognize the financial asset you have to recognize a profit remember you're selling it for 5 million carrying amount was four so it's 1 million profit and this goes to profit and loss account this one million profit goes to profit and loss account now test understanding 16. John's bought an investment in equity share this is also an equity for 40 million plus transaction cost of 1 million asset was designated as family throughout the comprehensive income this is through other comprehensive income this time not profit and loss that's the difference fair value increased to 60 million and was sold for 70 million a how should the investment be accounted for B if it went through profit and loss how it would be different if it was classified as family through profit and loss so let's do a okay remember this is recorded at fair value right so transaction costs also you have to add because it's true fair value through other comprehensive income you have to add the transaction cost with the fair value that is 40 plus 1 so 41. okay so you debit the asset financial asset 41 because you're buying it and you're buying it for cash credit 41. okay now there's a re-measurement from 260 right revalued to 60. so from 41 it went to 60 my value 19. okay so this 19 again you are debiting financial asset by 19 and where are you crediting other comprehensive income oci 19. next you are selling it for 70. okay but before selling the asset is re-measured to fair value to 70. remember before selling so from 60 to 70 it's 10. okay again you are debating financial asset by 10 and you're crediting other comprehensive income by 10. now you have to de-recognize the asset do you recognize so D recognize means you are debating cash you are receiving cash and you are crediting the financial asset how much you are crediting you are selling it for 70 and you're crediting 70. okay and remember when you are selling it off okay it is not reclassified to profit and loss okay not reclassified because this is equity Investments through oci it is never reclassified to profit and loss when you're selling the financial asset or der recognizing so not reclassified coming to Part B if it was through profit and loss okay if it was through profit and loss transaction costs are expensive profit and loss they are not deducted so they are not added with the fair value so asset would be debit financial asset at 40 only not 41 you do not add that one a new credit cash this will be same only the amount will be different okay and you debit profit and loss y1 you need to debit that 1 million and you need to credit cash one million okay then you are then it went from 40 to 60 fair value so you debit financial asset again 20 and you credit profit and loss this time because everything goes through profit and loss 20. earlier it was how the comprehensive income then when you are selling it okay you are debiting cash 70. you are crediting the financial asset how much 60. because their carrying amount is 65 value is 60. and then the profit okay it's a profit you are selling for more than the carrying amount which is 10. the difference so this is the only change when you are taking it through fair value through profit and loss okay now let us go through derivatives derivatives okay so derivative is a financial instrument which has the following characteristics number one the value of this that means the value of the derivative changes in response to change in some other variable for example that variable could be interest rate security prices commodity price exchange rate credit rating right you can say for all these variables underlying so if the value of the underlying changes so does the value of the derivative right to understanding that is the meaning of derivative B it requires little or no initial net investment related to other types of contracts that have a similar response to changes in market conditions so if this if it has this characteristics that Financial estimate is a derivative it is different compared to your financial asset Financial liability investment in debt instruments or equity instruments derivatives a little different okay that's why it is separate it is settled at a future day there which is always something to be settled at a future date okay so these are the three characteristics a derivative has now a contract let's say a contract to buy or sell a non-financial item like contract to buy inventory or plant and machinery is only a derivative if number one it can be settled net in cash or using another financial asset see even cash is a financial asset so if you're using cash to settle it is derivative and the contact was not entered to use those items to meet the entity's operating requirements okay third now iPhone S9 says you have to you have to remember this okay because SBR in your SBR exam they can ask questions from this derivative part or embedded derivative which is going to be the next topic okay so be so B uh what do I say more focus on this area Okay derivative had come it came in the exam before right so it could come derivatives or embedded derivatives so IFRS 9 says a contract to buy or sell a non-financial item is considered to be said net in cash when those things are there the terms of the contract permits either party to settle the contract in net odd The Entity has a practice of setting it in net those contracts third for similar contract okay they have a practice of taking delivery of that item and then quickly selling it in order to benefit from the family changes so you buy it you buy the item through a contract sell it shortly and get the benefit of the family changes fourth the non-financial item is readily convertible to cash so in these four conditions okay you can settle it net in cash okay now if a contract is not a derivative it is simply an executory contract executive contracts are not recognized anywhere you need to understand this it is outside the scope of ifrs9 okay such contracts are not normally accounted for until the sale or the purchase date understand this now conceptual framework defines an executory contact as what as a contract that is equally underperformed that means it has not been performed by both the parties how none of the parties fulfill their obligation an example would be you have an contract to pay or employ 10 for every r but let's say employee did not work that house okay did not work any hours in fact so you do not have an obligation to pay the employee so either the employee is fulfilling their obligation nor The Entity so it's underperformed so this is an example of an executory contract executory contracts are not recognized in financial statements unless it is an honorious contract honorious contract are recognized according to is37 you recognize the provision for it now these are the common derivatives and these are the derivatives which you have went through in your financial management or in Advanced Financial Management okay in detail they are forward forward contracts are a contract to buy or sell okay a definite amount of a specific underlying asset at a specified price at a specified future date future contracts are similar to forward the old differences it comes in a standard quantity okay it comes at a standard quantity and traded on a financial exchange where is forward they are counted they are tailor made they're not standard and they are not traded on Foreign Exchange then we have swapped swab is something which you are exchanging you are swapping between the two bodies okay this could be done over a specified period of time at some specified interval okay for example there is an interest rate swap that means one party wants to pay at fixed the other party wants to pay it floating they are swapping with each other okay and the interest payment are calculated by reference to some notional principal amount then we have options okay this gives the holder the right but not the obligation to sell see it gives the right not the obligation to buy or sell an underlying asset on or before the specified future date measurement of derivatives all derivatives are measured at fair value on initial recognition so that means transaction costs are expressed to profit and loss and at reporting date they are re-measured to fair value so any moment in Fair Value are recognized in profit and loss now let us do question before we move on to embedded derivatives [Music] okay so in this question you have been given three uh okay it is interesting understanding seven I'm sorry so accounting for derivative okay entity a has a reporting rate of 30th September it enters into an option option to purchase 10 000 shares okay price was 10. now the purchase price of each option is one dollar Okay so this is how the double entry will be like okay you have got an option okay with cash okay obviously you have bought that option with cash so you debit option and you credit cash how much 10 000 into one because this is the purchase price of the option you are getting 10 000 shares worth of one dollar so option is ten thousand and you have paid cash to get that option ten thousand okay now by 30th September fair value increased to 1.3 so now because the family increased only the incremental amount you will write in the option okay earlier fair value was one dollar now it's 1.3 so the difference which is 0.3 okay so 0.3 into 10 000 will be three thousand you debited into option because option value will go up and it's a gain or a loss it's a gain why because remember the nature derivative this is a financial asset it's in a form of a derivative but it's a financial asset so when the value fair value of the financial asset goes up it's again so that's why it is three thousand it's credited where in profit and loss now on 1st of November option is exercised okay here the family increases to 1.5 and the share price on that same debt is 11.5 okay so exercise options are exercised on that date and also it is classified as fabulous through profit and loss okay so now let us go through the Double Entry you need to debit invest in investment in share that fair value it's always okay it's an investment it's an asset so it's debited how much 11.5 into 10 000 workings are done here for you so this is how much you recognize your financial asset 115 000 then you credit cash already you bought your option for this okay this was already calculated 10 000 into 10. the purchase price of the option okay sorry it is 10 000 shares for 10 sorry 10 per share so this much of cash you have paid option option you can see you can go back and see 10 000 was debited then later you debited three thousand so together if you add both is thirteen thousand credit why why are you crediting it because you need to close down the option once you are exercising the option you der recognize option there is no longer any option then it becomes a financial asset that's why you're debating financial asset and you're crediting the option earlier option was debited now you credit and closed down the option when you exercise option options are closed so you credit then this is the balancing figure okay it's a balancing figure you can see that there's a shortage on the credit side that means it's a profit which is a gain on option okay so with this understanding we are going to do test understanding 17 also it is similar derivative is not something very difficult okay provided you know how to go about so there are three situation that is given to you first options are sold for 15. second share price is 8 option is unexercized in the third option is exercised and share price is 25. okay so he bought 100 options for five and share price was 10. now with this understanding okay see first go in the order first what did you get option so you need to debit option and you need to credit cash so debit because is the derivative option is a derivative which you have bought your understanding so you debit derivative you can say the financial asset only it's the same thing how much 100 options into 5 5 per option so 100 into 5 which is 500. and you credit where cash because you need to pay cash to get that option which is also 500. now we are coming to A okay when it is sold see when you are selling something you are selling it for share price is eight okay but you need to look at the sorry I'm sorry I went to the B it's a 15. so how many options are there 100 into 15. so this is the amount that you have sold it for 1500 how are you going to write the double entry your debit cash because you're going to receive see when you are selling it you are going to receive the cash so debit cash 1500. and you need to credit your asset because you have to de-recognize your asset now because they're selling it off which is how much already you have debited year 500. this only you are crediting here and their balance so if you see you're getting more cash than the amount of the asset so it's a profit right credit p l whenever pnl account is credit it's a profit the difference 1500 minus 500 minus 500 so it's thousand okay always balance and see where the debit side is equal to credit side or not so debit is 1500 and if you add the credit 500 and thousand it's one thousand five hundred it should be always like that now we are moving on to B where it is unexercised and share price is eight okay so when it is UN exercised you're letting the option lapse okay what's happening you have to do recognize option is to be derecognized and the loss is taken to the loss we are not exercising the option so the losses you are taking to piano okay so you debit profit it's a loss how much the amount the option the amount of the option go back and see this one option is 500 right this you need to Credit Now because you are D recognizing it you're understanding the option you are der recognizing because you're not exercising it so you created the option of financial asset 500. the losses debited now see you are exercising the option and share price is 25. so because you are exercising the option what happens option is D recognized okay but entity records the cache that is paid upon exercise and investment in shares is recognized at fair value okay an immediate profit is recognized so what you do you instead record a financial asset debit asset how much 100 option was there into the price what is it 25 is the share price now you are going to receive this when you exercise the option only you're going to receive this right so it's debit 2500 then you are going to credit cash once you exercise the option you're going to receive you are going to this one record the cache that is paid upon exercise when you're exercising you are paying the cash so you need to credit how much 100 options into 10. it is the option of the price option this one 10 per share right to buy a share at this which is thousand then we have credit asset but the option when you're crediting asset this is the option that you're crediting you have to de-recognize how much you recognized it at 500 so you created 500 the full amount and finally there's a gain the balancing figure which is thousand right so you see it isn't that difficult now let us go through embedded derivatives so now we are moved forward to embedded derivatives okay embedded derivative is a component of a hybrid contract that includes a non-derivative host with the effect that some of the cash flows of the combined instrument vary in a way very similar to stand alone derivative in short in other words embedded derivative means it has two contract in one one contract okay it is partially derivative and partially non-derivative so how do you account for it that is the meaning of embedded derivative okay accounting treatment for letters you need to memorize this okay because embedded derivative has been tested for SBI I think three to four times okay so you need to be very careful you need to memorize this accounting treatment for embedded derivative specifically with regards to the accounting treatment of embedded derivative if the host contract see host contract is a major contract inside that there might be another contract okay we'll see we'll do a question if the host contract is within the scuba 5 is 9 then the entire contact must be classified and measured in according to that standard that means according to I virus 9. but if the host contract is not within the scope of RS 9 then it's not a financial asset or a financial liability then embedded with embedded derivative can be separated out and measured out fairly through profit and loss okay you can separate it out only when these things are there see this area specifically this slide has been tested in your exam before you can go and see your past paper in SBR this has been tested it has been asked right like what are the occasions or what conditions are there for you to separate the embedded embedded derivative for the host contract so you need to remember these points number one the economic characteristics and the risks of the embedded derivative are not closely related to The Host contract so if the risks and the characteristics are different it's better to separate the two out second the separate instrument with the same terms as the embedded derivative would mean the definition of a derivative third the entire instrument is not measured recognizing profit and loss then you need to separate no see because it's very complex right splitting out and all so what does ifrs9 says regard for embedded derivative IFR is 9 gives okay it permits for a hybrid contract hybrid contact mess it has features of two things it has a features of derivative and an derivative in that one single contract okay where the host element is outside the scope of 5 rs9 that means that host element is not a financial asset or a financial liability then measure the entire contract at fabulous profit and loss entire contract rather than splitting it out because it's difficult right but remember you have to know the reasons uh or the conditions in which you can split you have to know the conditions they might ask you second and mostly mostly in this area embedded derivative what I have seen they ask a discussion question like you have to write what are the accounting treatments more than the numbers more than the calculation I have not seen a question where calculation has been asked on on this area next for vast majority of embedded derivatives the whole contract will simply be measured at families of profit and loss okay now an investor this is an example a very good example an investment in a convertible Bond first tell me a convertible Bond bond is a financial asset right so it falls within the scoop of five hours nine okay the C and entity as an investment in a convertible bond which can be converted into a fixed number of equity shares at Future so you see there are two things in the in the one contract one it's a convertible Bond second you can convert it into Equity shares so if you see the bond okay the bond is a non-derivative host contract it's the host main thing is the bond okay what so that main thing is known as host contract only right in short how do you understand what is host contract it is the bond okay because without that Bond you cannot convert into shares you need that Bond so that bond is known as host contract okay in this case it is the bond which is the host contract okay so see the bond is a non-derivative is it a derivative no bond is non-derivative it's a financial asset so it's a non-derivative hose contract but the option to convert to share see there is an option also in that whenever in a contract there is a in a financial asset or a financial liability contract you have to see whether there's a forward there's an option there's a swap there's a future attached to it or not if it is attached then it's a embedded derivative you're understanding you have a non-derivative in this case it's a bond and you have a derivative component also which is option to convert to shares so bond is a financial asset that means it falls within the scuba five rs9 that means you have to use the ifrs9 rule to the entire contract now the bond would fail the contractual cash flow characteristics why what is contractual cash flow characteristics for this you need to go back to my investment in debt instruments right it says that if you are having an asset and you are selling it or you are keeping the asset until the Redemption okay what are the measurement you have to use how do you measure it varies contractual cash flow characteristics means your cash amount that your CV should only be interest and the principal amount but in this case because you are converting it into shares it is just not purely your interest and principal amount that's why it fails the contextual cash flow characteristic test the bond so therefore the entire contract is measured at Family through profit and loss for this you need to go back to the investment in debt in instruments the three methods amortized cost family through other comprehensive income family through profit and loss and when in which condition do you use this so when the asset fails the contractual cash flow characteristics it is available through provider loss so the entire contract will be measured family through profit and loss now you understand foreign what is hedge accounting so hedge accounting is the last part of ifrs9 that we are going to go through but to understand hedge accounting okay you need to understand this example very well this is a good example to understand hedge accounting see hedging means taking any action that minimizes your risk it could be nearest your currency risk your interest rate risk or let's say you want to buy a commodity or fixing a price today so that due to exchange rate changes or interest rate changes the price is fixed you are hedging yourself you are not entirely eliminating the risk but somewhere you are reducing the risk that is the meaning of the that is the meaning of hedge right the meaning of the Hedge is this so we have accounting for that also which is known as hedge accounting okay and this hedge accounting is for financial instruments because Financial instrument is very risky so you need to hedge for it if you are my AFM students if you have watched my AFM you know what is it you know hedging very well it's very easy for you to understand this is nothing for you but if you have not at least through your financial management you know what hedge is right your heading current service and interest rate risk by using what derivatives you use options for our future Swap and so many other things it's the same thing here the way how you account for it is what we are going to study in SBR right not not the whole heading process no no no no no okay but for to go to hedge accounting you need to understand this derivative so let's say an entity has inventories of gold okay and the cost is 8 million whose value has increased to 10. so entity is worried that the fair value of this inventory might fall so what do they do they enter into a feature contract to sell the inventory for 10 million okay what can you see let's say by the reporting date the Fable of the inventory had fallen by 1 million so from 10 to 1 it fell down to nine but inventory fell down but the fair value of the derivative increased by 1 million this is how derivative work when your actual commodity that is there in the question the family falls down there is always an opposite reaction in the derivative that will increase that's how you hedge the risk it needs to be offset increasing something needs to be decreasing something okay and it is exactly the same amount you will see okay so the Fable of the inventory had fallen by one but favor of the derivative increase by one so you see there's a gale on the derivative according to my father's name so how do you recognize this gain you debit derivative 1 million and you credit pm now according to is2 why is2 gold is is true it's inventory inventories are dealt according to iOS 2. that 1 million decline will not cause any issue okay why because inventories are measured at lower of cost and NRV that is net reliable value net well as well value will be 9 because 10 minus 1 and cost is eight because initial it was 8. so you will recognize it at 8 anyways it will not have any impact so you see in your inventory it is not having any impact but in the derivative you see there's a profit so this is creating a volatility it is showing a profit which actually it is not because inventory is not affected so this can affect your EPS earnings per share you see and it is it could also be a reason to get concern for home the dividend receipts because this also will be valid and then based on earnings per share even though some investors are risk seeking but most of them prefer 3D and predictable returns so you see derivative is creating a volatility so that's why entity choose hedge accounting so this volatility will be eliminated now we are going to go in depth to understand what is hedge accounting so hedge accounting okay you don't need to memorize the definitions and anything but you need to know from hedge accounting some key areas that you need to memorize and as we go along I will specify on that area which you need to go through more okay but hedge accounting means you are managing Risk by designating one or more hedging instruments so that that change in fair value that means the hedging instruments change in fair value is offset by a change in the fair value or the cash flow of the hedged item okay what is an hedged item you need to know this definition what is the hedging industry man what is the hedged item hedged item could be any asset or liability okay that exposes the nd2 to a risk of changes in the family or cash flow see risk could be due to two things either the fair value changes or the cash flow could change that's why we are going to go through two types of hedging fair value hedge and cash flow hedge you need to know these two things okay but before they do things commonly we should know what is hedge accounting okay just now we are going through the definition hedge item hedging instrument on all those things before we move on in detail to cash flow hedge and fair value hedge because this two changes either your future cash flow might change that's a risk or the fair value might go up and down that's a change risk so two types of risk we are dealing here okay now there are three types of hedged item number one a financial assets sorry a recognized asset or reliability second it is not recognized but it's a commitment let's say a binding agreement to exchange some goods or services at some price in the future for that also you can hedge third a highly probable focused transaction probability is very high but it is uncommitted okay and uncommitted but anticipated future transaction so this three could be hedged item in your exam you have to see which one is it out of this three but if it could be any of these three but the way you deal with it is same for all these three okay now what is a hedging instrument hedging instrument is a designated derivative or it could be a non-derivative financial asset or reliability either it could be derivative either it could be a non-derivative financial asset or reliability okay whose fair value could change whose fair value or cash flow of sex the change in the family or the cash flow changes in the hedged item you see they work opposite see please understand hedging instrument and hedged item Works in opposite direction if you're having a gain use the hedging instrument you're going to have a log in the hedged item that's how the risks offset imagine if you're having risk in the both if you are losing in both the sides then there's no use of hedge accounting right the reason why we are hedging is what to minimize the risk so how do you minimize status by offsetting the gain on one side with the loss on the other side two types of hedge accounting fair value and cash flow hinge fair value Hedges first we are going to cover fair value hash and then we are going to move towards cash flow hedge we are going to do questions for both of those and in your SBR these are the two main things that you need to focus on from your point of exams as we are exam one is fair value hedge how to account for it one is cash flow H how to account for it and by reading the case study in your exam you need to be able to identify correctly whether it's a fair value hedge or a cash flow H that is needed they might not say sometimes most of the time they don't see okay so fair value hedge is easy changes in the fair value cash flow changes in the cash flow briefly right it could be anything changes in the family of the recognized asset or an unrecognized form commitment right and this changes are recorded where normally goes through profit and loss but it could be recognized in other comprehensive income only for Equity Investments Equity Investments measured at Family through other components of income for this it is recorded in other components of income okay coming to cash flow Hedge this also could be due to changes in the cash flow now there are some criteria this criteria also you need to memorize you need to know this has been asked in the exam before criteria for hedge accounting three conditions needs to be there okay if it's there then only you can apply hedge accounting otherwise it's not applicable number one hedging relationship consists only of eligible hedging instruments and hedge item that means hedging instruments should go with head items they should be eligible second at the start there should be a formal documentation that says that this is the Hedge item and this is the hedging instrument third hedging relationship meets all the effectiveness requirement then they are very effective with each other so these are the three conditions you need to memorize it if they ask you if you're lucky they might ask you straightforward questions like this and you just need to write these three points right here for hedge accounting now moving on to accounting treatment of a fair value Hedge if it's a fair value at the reporting date you will re-measure to fair value hedging in instrument are re-measured to fair value and the hedged item you just change the carrying amount of the hedged item you adjust with the change in pair value now please see the line read this line very carefully the gain or loss on the hedging instrument and then the loss of the gain on the Hedge item you see if you are having a gain in the hedging instrument you are going to have a loss on health item if you're having a loss in the heading industry when you're going to have a gain in the Hedge writer is the opposite is always opposite it's not gain gain or loss loss it's gain on the one side and loss on the other side or loss on one side and again on the other side that's how it works okay so this is recorded like this most of the time in profit and loss because fair value hedge but under one condition it goes through other comprehensive income I told you earlier that is when equity in instruments are measured at fair value throughout the components of income that time it is at other comprehensive income now first let us do questions on Fair Value hedge before we move on to cash flow Hedge so this example is picked from the previous one where we have been mentioning the inventors of gold price was Aid and then fair value increased to 10. sorry whose value had increased to 10 and they had a fear that value will go down by one right two nine so we are doing the same question okay and we are going to change this to hedge accounting how are we going to use hedge accounting to solve the issue remember in the previous one derivative was debited and it was a gain on the derivative of 1 million with no impact in inventory so there was a volatility in the Providence loss now we are going to eliminate it okay so this was designated as a family hedge that same scenario please recall it I'm not going to go through it again and explain the same scenario okay because it's going to take a lot of time so The Entity believe that all Effectiveness criteria has been met okay see how do you understand whether you have to use hedge accounting or not for Simplicity in SBR good thing is they will always mention this okay that means you don't have to do any test or do anything they will say that Effectiveness criteria has been met that means you can use hedge accounting okay now so this is a fair value Hedge please understand this was the normal situation right we debited derivative and credited one million now we are going to change this by using hedge accounting how we are going to remove this gain so we are going to debit 1 million credit debit there is no gain on loss it gets canceled off and you are going to credit inventory 1 million so from inventory we are going to reduce that one million see what's happening here by applying hedge accounting The Profit impact of re-measuring the derivative to fair value has been offset by the moment in the travel of the inventory now there is no more gain it gets canceled off eliminated so that means the volatility in the profit is reduced now impact is reduced okay but the change is taking place where in the inventory inventory was supposed to be measured at lower of net well as well value and cost eight or nine but you see it is now measured at seven earlier it was at eight right so from 8 reduce 1 because inventory was credit so seven so it's neither at Cost nor at NRV but even lower than that so what's happening when you're using hedge accounting you are changing the normal accounting treatment of inventory this has been changed when you are using hedge accounting rules you can do that okay so now let us do two more questions on Fair Value hedge just to understanding 18 and 19. [Music] test your understanding 18. this is a question on Fair Value hedge Okay so this is an equity Investments through fair value okay fair value was nine hundred thousand now by the reporting date fair value of equity instrument had fallen to 800 000 and fair value of the future contract has risen to 900 000 C one fell down one increased hedge item and hedging instrument you need to understand this okay so now the middle part is regarding all the conditions saying that Effectiveness criteria has been made everything was properly correctly documented right and hedging instrument and hedged item has been identified things like that now so with this understanding what would be the double accounting treatment that means double entry see in this case profit and loss will go through oci because it has been designated as oci Equity investment so not profit and loss okay now there was an increase in the farewell of derivative you see derivative is the future contract it increased by ninety thousand and fall in The Well of the equity interest that is hedge item by hundred thousand from 900 to 800. so how do you record this form increase derivative increased so your debit derivative how much ninety thousand and you credit what the hedged item the equity investment how much hundred thousand because of 900 to 800 the difference now here you need to debit oci okay it's again ninety thousand but here you need to credit oci again sorry debit oci again because it's a loss many good investment fell by hundred thousand so what can you see you can see oci this is uh credit okay and this is sorry this is credit this is debit debit is more right 119 the difference so there's a difference of ten thousand ten thousand loss if you take the difference 190 there's a loss right small loss of 10 000 in oci the net result this is the net result of oci this is how you need to deal with fair value hedge now let us do test understanding 19. test your understanding 19 okay unlike the previous one where it was a fixed assets where it was the asset or reliability recognize asset or reliability this is a firm commitment even this could be used as a hedget item okay so in a b or not using hedge accounting B we are using the Hedge accounting okay so here they have made a firm commitment to buy some machinery okay and here they have a risk of exchange rate fluctuation on 1st of October they enter into a future contract to buy for one million and 31st December it would cost them 1.1 million fair value of the future increased to 95 000. there was no future contract before now it increased to 95 000. so now if we don't use the Hedge accounting okay how should we account for it please understand the nature of the question okay if hedge accounting is not used understand their future contract okay in this case future contract is a derivative okay because I told the option future forward swap these are derivatives so because it's a derivative derivatives are how our derivatives measured we went through this earlier fair value they have fair value through profit and loss so derivatives are measured at families with profit and loss now if you see the fair value of the future contract it was from nil 0 you can say 0 to 95 000. it increased to 95 000. okay so you can see that there's a rise so because this arise how are you going to recognize this debit derivative in this case derivative is the asset 95 000. okay and this gain will be accredited in profit and loss credit pnl 95 000. okay now we are coming to B with hedge accounting you see okay so the same thing we are going to recognize okay this we can easily do okay just copy paste this debit derivative and credit p l 95 000. this will be same the only thing is in the Hedge accounting okay you need to debit because there'll be a loss in the piano and there will be credit firm commitment the commitment is a hedge item here so you can credit that okay we need to find the value for it see before it was 1 million now it increased to this much it's more cost right that means you can say the fair value fell down by hundred thousand the difference between this 1.1 million and 1 million is 100. hundred thousand right so there's a hundred thousand fall in the farewell of the commitment don't say it increased no that's not how you look look at the bigger picture okay earlier purchasing would cost them one million now is 1.1 million it's more so therefore you can say when the cost is more the fair value fell down okay it's a hundred thousand so you record hundred thousand now you see here debit is 100 and credit is 50 you have a gain of 95 000 and a loss of hundred thousand the net loss is five thousand so small loss still will be there okay but still even if you have a net loss of 5000 it is still better than living it unhed you see earlier the profit it shows a profit of ninety five thousand it's a much bigger picture but now it has been reduced to a net loss of just five thousand so leaving it on edge is still not safe right hedging is still better than living it unhed because it reduces your volatility accounting treatment of cash flow hedge this is a little difficult compared to fair value hedge you need to keep doing questions to understand the pattern okay it could be a little tricky in the beginning but as you get used to it you will love it okay so cash flow Hedge for cash flow Hedges now it is changed earlier for fair value it was the hedging hedged item that was rematched to fair value for cash flow hedge it is the hedging instrument that is remissioned to fair value at the reporting date and gain and loss are recognition are the components of income you see in profit and fair value it was through profit and loss but in gain and in cash flow H it is through other components of income however if the gain and the loss of the hedging instrument is more than the gain of the loss on the hedged item then the excess gain and loss goes to profit and loss we'll do a question on this don't worry now accounting treatment if hedged item results in the recognition of a financial asset or reliability then gain and losses are then gain and losses are reclassified to profit and loss from other comprehensive income okay and this reclassification is done in the same period during which the hedged focused cash flow affects your profit and loss if the hedged item leads to a recognition of a non-financial asset or liability okay you do not you do not reclassify to profit and loss okay instead the gain and loss inequity are adjusted again the carrying on one of the non-financial asset or liability so you change the carrying amount of the non-financial asset or liability with the gain and loss you do not bring from oci to profit and loss that means it does not affect other components of income if the hedged item leads to recognition of non-financial asset or liability now let us do three questions on cash flow Edge test your understanding 20 cash flow hedge okay so you have been given a question okay this is a derivative contract in order to protect his future calcium flow relating to a recognized financial asset okay now loss in respect of future cash flow amounted to 9100. but you have to do a and b right when the heading instrument fair value was eight thousand five hundred and ten thousand how do you account for it a okay when hedging in instruments fair value was 8500 C it is below 9100. right list so the movement on the hedging and instrument is less than the moment in the hedged item therefore everything goes to oci normally normal way okay so your debit derivative eight thousand five hundred the problem only comes when hedging instruments changes more like for Part B A is easy so you credit oci other comprehensive income this is cash flow hedge okay B here it's 10 000 is more than 9100 so heading instrument changes more than the hedged item therefore the X's goes to profit and loss what is the excess 900 this 900 will go to profit and loss so here also your debit derivative how much 10 000. you credit oci 9100. up to the farewell of the hedged item anything more than that profit unlocks which is 900. okay just do test understanding 21. foreign blink so here you are required to discuss the accountant treatment of hedge in the year 31st December 2001 B you are having an inventory cell Okay so accounting treatment of the inventory cell and the future contract settlement on 31st March 2002. let's first finish with a okay so here on 31st October you have some inventories of gold cost 6.4 and you would want to sell for 7.7 okay now they went into a future contract to sell the good for 7.7 okay now 31st December 2001 the farewell of the goal was 8.6 you see there's a rise from 7.7 to 8.6 whereas the fair value of the future contract fell down by 0.9 from that date onwards till 31st March there is no change in the family of the goal or the future contract okay so this looks quite easy I think you'll be able to do it right isn't it so this is a cash flow hedge so cash flow hedge will go through oci okay so a you can quickly do a it's a loss you see the future contact fell down by 0.9 so it's a loss okay this loss goes through all the comprehensive income so debit oci 0.9 and you trade it derivative 0.9 okay now coming to B when you are actually settling it right the inventory sale and the future contract settlement first we'll go by the inventory cell so when you're selling the inventory you are receiving cash so your debit cash how much it is for 8.6 this amount because fair value does not change from this date till the reverse Mass so it remains at 8.6 next you need to credit Revenue you are recognizing a revenue it's a sale which is 8.6 again you need to you are selling an inventory so when you're selling an inventory debit cost of sales credit inventory okay so how much see this is regarding cash and sales okay but your inventory was was for 6.4 this was the cost that you bought it so this is the inventory you have to reduce from your inventory now so debit 6.4 credit 6.4 okay now sale of inventory fair value okay so now this is regarding this part is for wait this part is for sale of inventory next part will be settling the settlement of the future contract so when you're settling the future contract okay you credited derivative here okay now it will be reversed you are debating derivative how much 0.9 you need to close down your derivative you had a credit balance now you debit 0.9 and you are settling so credit cash you have to pay cash for the financial instrument right to get it 0.9 again now just you have to reclassify the losses that is inequity through profit and loss okay because during that same period fair value has been affected means your profit gets affected right so if the Hedge item affects the profit and loss in the same period you have to reclassify to profit and loss right so now the loss is debited to profit and loss and credit to oci 0.9 and 0.9 y c the difference 8.6 and 7.7 okay during this time if you see here you are selling the good for 7.7 now get the gold now the gold is more the farewell of the gold is 8.6 so it increased so it increase means what your cash flow is suffering right so in this period that change that loss has to has to be reclassified to profit and loss from oci understanding what I'm saying 0.9 so you have to remove it from oci and dividend profit and loss because it's affecting your cash flow it's affecting our profit obviously your cash flow will be more now you have to now spend more for the gold okay 8.6 but it will affect your profit also so that's why you debit profit and you create those here now the last question for this lecture which is just understanding 22 okay this is a highly probable transaction remember out of the three we told that there are three types of hedge items this is the third one okay this is regarding currency okay some dollar okay so they want to buy an item or plant in one year's time at this okay now they went into a forward rate agreement okay so for this this is the fixed sum okay hundred thousand they have to pay to go for this forward rate agreement okay fair value of the contact ad Inception was 0 and it was designated as a heading instrument by 31st this went to ninety thousand hundred thousand went to ninety thousand it reduced and the Fable of the derivative declined by ten thousand how do you account for this this is a forward rate agreement in this case derivative is the forward rate agreement it was nil before now it has been and it declined by 90 or sorry 10 000. even though derivative declined but cash flow had increased by 10 000. how see earlier it was hundred thousand now it's ninety thousand it's cheaper now so you're saving on cash so it's a cash flow Edge cash flow will increase right it's now ten thousand cheaper to buy the asset so because it is the cash flow Hedge you need to debit you need to you need to go through other comprehensive income okay it's again sorry it's a derivative loss sorry sorry there's a fall in value of derivative don't see the head item see the hedging instrument derivative went down so debit oci is a loss of ten thousand and you credit derivative 10 000. fair enough now C what type of acid is it this is item of Planet property planning equipment okay so it's a non-financial item the word is non-financial item so because it's a non-financial item you have to adjust the carrying amount of the plant you do not recognize any Providence laws or Rosia you had just okay so this would be the entry when you adjust okay so for the settlement of the derivative and purchase of asset okay you debit plan because you are buying the asset how much ninety thousand from hundred it fell down by ten thousand so ninety thousand you are also debating a liability or let's say derivative how much 10 000. it went down by 10 000. see here you credit a derivative so close down the derivative by debuting it settlement of derivative is there'll be no derivative balance and your credit cash to buy Plan you need cash how much hundred thousand cash will be hundred thousand only right this nothing is happening to the Casual is the file value changed of the plant now you have to adjust remember what do you do you have to adjust this the carrying amount of the plant with the loss so what is the loss loss is ten thousand so that ten thousand you have to add with the plant so you debit 10 000 more and you created this from where cash flow hedge Reserve from here now see if you add this okay debit 10 000 and plan ninety thousand so if you add 90 and 10 it adds up to 100 000. okay and now if you see that was exactly what the Hedge was guaranteed for you see fixed sum of hundred thousand I'll highlight it for you boom you see this is what hedge accounting does there was a loss of 10 000 you adjusted in the canning amount of the plant right so this would be the total amount of cash that would be spent hundred thousand even your derivative was guaranteed at this position in the beginning hedge Effectiveness we went through this earlier okay but now we are going to go in depth and you need to memorize this spot the Hedge Effectiveness okay so hedge accounting can only be used if hedging relationship means all the effectiveness requirement okay in all the questions we have done so far it has been met okay and IFRS 9 says that when you're starting okay the start of the heading relationship okay and at each reporting date entity must assessed whether a hedging relationship meets the Hedge Effectiveness requirement or not hedge Effectiveness requirements are thus number one remember there are three requirements okay and this three requirements you should hold the answer when the question asks you otherwise it is assumed default position is hedge Effectiveness is there I have not seen any question in SBR where they say h there is hedge ineffectiveness everything is hedge Effectiveness if a numerical question is asked if a numerical question is not asked they might ask you generally what are the Hedge Effectiveness requirement then you can give these three requirements memorize the three requirements but with understanding first there should be an economic relationship between the hedged item and the hedging instrument for example when the price of the share Falls by 10. fair value of the future contact should Rise by 10. you understanding then only there's an economic relationship if the share price Falls and there is no effect on the future contract that means there's no relationship so hedge is ineffective you're understanding second the effect of the credit risk does not dominate the value change that result from the economic relationship for example credit risk okay may lead to Electric family moments it could be either the hedging instrument or the Hedge item for example let's say a counterparty of the derivative experiences are decline in credit worthiness what happens travel of the derivative will suffer because of that right which is the hedging instrument will fall substantially so this fault in the Fable of the derivative is unrelated to the changes in the family of the item you see this shift in the Fable of the derivative is not because of the change in the family of the Hedge item it's different it is because of the it's a credit risk so this movement is unrelated to changes in the value of the item therefore this will lead to hedge ineffectiveness because it is not related to the farewell of the item this hedge is ineffectiveness you understanding they should be they should be related if it's unrelated hedge ineffective third hedge ratio that's what we are going to go through next hedge ratio hedge ratio is same that means we are using this sorry the Hedge ratio of the hedging relationship is the same as that resulting from the quantity of the hedged item and the quantity of the heading instrument is the same we'll go through in detail what is h ratio hedge ratio okay let's say an entity owns 120 000 gallons of oil and it enters into one future contract for to sell 40 000 gallons okay so the middle part I'm not reading it's a fair value hedge okay oil is the hedged item con future contract is the hedging instrument okay and it is effective okay so if deemed effective everything will go through profit and loss because it's a fair value hedge it will be recorded profit or loss okay but if you see you are having 120 but future but hedging industry is 40 000. because of this change it's not same if it would be one feature contract to sell 120 000 gallon makes sense but there's a very huge difference so you can see that this will have an effect on your hedge ratio so the Hedge ratio means gain or loss on the item will be much bigger than the loss again on the instrument it should not be so that's why you have to adjust this hedge ratio you have to adjust hydration must be adjusted to avoid this imbalance why because if it is so okay it creates a volatility profit and loss and this goes against hedge accounting odds with the purpose of hedge accounting the meaning of hedge accounting is to reduce or eliminate volatility loss if it's creating more volatility it is against the rule of hedge accounting so that's why you have to adjust this head ratio so this imbalance goes off okay this is how we do that now change it the hedget item should be designated as 40 000 gallons of oil with the hedging instrument as one feature contract only you're not changing the hedging instrument by the hedged item you see it was 120 000 gallon change that to 40 000 y because you have a contract to sell forty thousand so change that hedged item to forty thousand so H forty thousand rather than 120. okay and the other eighty thousand the balance eighty thousand one forty thousand is hedge item correct out of 120 balance eighty thousand you account it as inventory according to I used that's it so now let's go through rebalancing rebalancing okay many hedging relationships involves basis risk okay what is Basis risk because of this basis risk okay we need to rebalance okay but many hedging relationships involves basis risk okay basis risk means the risk that the gain or loss on the item the hedged item will not be equal to the gain or loss on the instrument see when you are having the gain in the item and a loss in the instrument they are same that's why you can offset but if there's a different okay there's a difference between the risk and gain of the item with the gain and loss of the instrument then it is said to have a basis risk okay the name is called as basis risk and sometimes this risk is significant if it is insignificant you can ignore but if it is significant you cannot ignore then what should you do you have to rebalance your hedging ratio but before coming to that let us go through one example of airline companies how do they hedge okay sometimes they have to hedge their fuel cost right by entering into future contract so let's say they enter into a future contract to buy crude oil okay but the cost of the Airplane Fuel is not just by the crude oil there are so many other factors okay and at the reporting date you came to know that the fair value of the hedged item hashed item in this case is the field okay this has moved considerably more than the farewell of the hedging instrument that is the future contract you see there's a difference both are not moving in the same line they are different so what happens in this case you may need to enter into some additional future contract right so when you enter into additional future contract what happens hedge hedge ratio changed we earlier went through hedge ratio right so hedger ratio needs to change now you have to change it because if you don't change it will not comply with the effectiveness requirement remember to to apply hedge accounting okay there should be the hedging relationship should be effective if it's not effective you cannot apply hedge accounting that was the condition number one that's why you have to adjust your hedging ratio right otherwise you cannot use hedge accounting so if you want to apply hedge accounting you have to rebalance rebalance what the designated quantities of hedged idiom and the designated quantities of hedging instrument let's see okay so now now we are in the last part of hedging account that is conditions when you can discontinue hedge accounting okay you can see the Hedge accounting if any of the following occur number one the hedging investment expires or it is exercised or it is sold or terminated number two the Hedge no longer missed the hedging criteria maybe the heading relationship was not effective maybe it was not documented well right you need to go back and check the hedging criteria number three the forecast future transaction that qualified as a hedge title is no longer highly probable so in any of these three condition apply you have to discontinue hedge accounting and remember once you discontinue hedge accounting you have to account for it prospectively prospectively means you have to change from the today and future onwards you don't have to go back and change your uh past right so entries posted to date are not reversed the discontinued happen from the day when any of this falling occurred and you have to apply it in the future you don't have to go in the past and change next upon discontinuing a hedge cash flow hedge okay the treatment of gain and losses on the heading instrument depends on the reason for that continuation how you are going to deal with that gain and losses are you going to transfer to profit and loss or you are not going to transfer it depends on the reason for that discontinuation number one if IFRS 9 says okay if the focus transaction is no longer expected to occur gain and loss will be recognizing profit and loss from other components of income immediately if the transaction is expected to occur gain and loss will remain in the equity until the format aged transaction occurs so if the transaction is known or no longer expected gain and losses will go to profit and loss from other components of income if the transaction is expected to occur it remains in all the components of income the gain and loss okay so that's it for iPhone S9 since iPhone S9 is a very lengthy lecture I know that's why I have summarized all the separate paths that we went through and Summarize each part in different like under different small small subheadings so that it becomes easier for you to grasp even if you have missed out the whole thing through the summary you can understand the main points okay so let us go first we went through financial liabilities when we started ifrs9 okay initially you recognize Financial liability at fair value but subsequent measurement there is a choice amortized cost of family through profit and loss for financial asset a trading commitment to buy a good and sell to buy a good sell good is not recognized until one party has fulfilled as part of contract okay next forward contracts are derivative Financial assets and their recognized on the commitment date option are recognized on the date when you entered into the contract not when you have exercised that is also a derivative financial asset number three Equity instrument investments in equity instruments are measured at either loss of family through other comprehensive income it is not measured through amortized cost right instrument only these two fair value through other comprehensive income can be used if if not help or trade or is devocably designated is revocably designated means you cannot go back to profit and loss once you have elected for it forever it is through the competence of income then gain and loss will never be reclassified to profit and loss for equity instruments it is little different and little similar to dead instrument okay dead instruments three methods are there you can measure it at amortized cost also advertise cost if if contractual cash flow characteristics test pass what is what does it mean contractual cash flow means it should only include interest and the principal amount for example if you are giving a loan or a bond only the entrance and the principal if it includes other than this two then it does not pass the test business model has to hold the debt until maturity okay other comprehensive income if contractual tests here also is the same contractual cash flow characteristics test needs to be passed and business model is holding to maturity but selling and selling so please understand this difference if you keep it till maturity and sell it is other comprehensive income if you do not sell it is amortized cost then that instruments can also be measured at Family through profit and loss if it's not at amortized or other comprehensive income and gain and losses unlike Equity instrument you can classify to reclassify to profit and loss when the asset is disposed that is when the debt instrument is disposed debt instrument measured at either amortized or family through other comprehensive income then you have to recognize the Lost allowance please understand there is the next topic impairment of financial assets like any other asset even your financial asset might be impaired right impairment we went through our in is 36 okay so for financial asset it is based on the credit risk if the credit risk on the financial asset does not increase significantly from the initial recognition then your loss allowance must be calculated based on the 12 month expected credit loss and if the credit risk increases significantly then the expected sorry the loss allowance is equal to lifetime expected query loss please understand this if risk credit risk does not increase significantly 12-month expected credit loss if credit risk increases significantly lifetime expected credit loss okay impairment of financial assets loss allowance should always be measured at an amount equal to Lifetime credit loss for what for trade receivable and contract asset if they do not have a significant financing component you need to memorize these points by the way okay because a small portion of it might come for your exam you never know for least receivable as well as trade receivable and contract asset with a significant financing component entity can choose entity can choose to measure the loss allowance equal to Lifetime expected credit loss impairment reversal sometimes it reverses how maybe credit risk reduced or so in that case gain or losses on re-measurement of this loss allowance are recorded in profit and loss okay now sixth sixth topic was D recognition on financial instruments financial asset is D recognized if one of the following occur number one either the contextual right expired the conjecture right to receive cash expired or let's say the option held by The Entity lapsed or became worthless financial asset has been sold or substantially the riskan rivers has been transferred to the buyer Financial liability these do you recognize when obligation is discharged for derivatives is number seven right on initial recognition please understand derivative is very easy derivatives are measured at fair value on initial recognition Okay derivatives means options forward Future these are derivatives okay and at reporting date they are again re-measured to fair value so any moment in this fair value is recognized in profit and loss in short everything goes to profit and loss for in derivatives okay a contract to buy or sell a non-financial items if if it's a financial item it's very easy universe is mine because IFR is nine means financial instruments but what if it's a non-financial item that you have a contact to buy yourself in that case okay even that is a derivative by the way if you are having a contract because contract itself is a derivative if you're having a future to buy or sell a non-financial item okay is only a derivative if it has this three condition number one it can be settled net in cash or using another financial asset then it's a derivative and the contract was not entered for the purpose of the receipt or delivery of that item to me then it is operating requirement if it is this then see you entered into a contract to hedge you go you buy yourself okay you go into the derivative to hedge that is your purpose so if you are entering into a contract for the purpose of resid it's not a derivative okay okay then the third if the contract is not a derivative how do you account for it it is a simply an executory contract an executive contract is outside this group of RS 9. you have to write it embedded embedded derivatives okay this part part eight be very careful on this one because this has been tested in the exam this has been tested even during my time right embedded David I think it came for five marks whether we have to separate from the host contract or not the derivative right if the host contract is within the scope of RS 9 the entire contract is classified and measured according to that standard that desire is 9. okay if the host contract is not within the scope of IFR is 9 the embedded derivative has to be separated it needs to be separated out and measured family through profit or loss if these things are there economic risks and characteristics of the embedded derivative are not in line with host contract they are separate that's why you have to separate right if they are similar why would you have to separate thing like that think logically second a separate instrument with the same terms have embedded derivative would mean the definition of a derivative and the entire instrument is non-measured value with the changes in family recognizing proven and loss then you need to separate okay so IFRS 9 permits a hybrid contract hybrid means it has two okay where the host element is outside the scope of IFR is nine okay IFRS 9 says it to be measured at Family through profit and loss in its entirety that was entirely metadata available okay next vast majority of embedded derivatives okay that is the whole contract will simply be measured value to profit and loss so they so basically this question if they asked in the exam they normally ask this as a discussion question rather than you to solve some numbers or calculator it does not come in numerics so it's easy if you memorize these points okay if you underst if you memorize these points with an understanding it's even better okay condition where you need to separate the host contract from them embedded is this three condition okay that is embedded derivative and the whole contract their risks are different their characteristics are different they are not measured uh at fair value then you separate okay hedge accounting that one was the last one so we went through fair value hedge cash flow hedge criteria for Edge accounting all your hedging Effectiveness hedge ratio and all those things and discontinuing hedge accounting okay so that's it for IFRS 9 and I know it's a very lengthy lecture but what to do I mean this is a very important and a very challenging topic on its own and I've done lots of questions now is your job to go to your revision kid and do all the question from IFRS 9 right you need to touch all the area separately whether it's embedded derivative whether it is financial asset Financial liability equity instrument debt instrument financial asset impairment everything needs to be touched okay so thank you for watching and don't forget to subscribe to my channel if you haven't subscribed yet right so see you in the next lecture again another interesting lecture which is IFRS 10.