© 2011 IFRS Foundation 1 The IFRS for SMEs Topic 2.1 Section 11 Basic Financial Instruments Section 12 Other Fin. Inst. Issues Section 22 Liabilities and.

© 2011 IFRS Foundation

1The IFRS for SMEs

Topic 2.1

Section 11 Basic Financial Instruments

Section 12 Other Fin. Inst. Issues

Section 22 Liabilities and Equity


2

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The accounting requirements applicable to small and medium‑sized entities (SMEs) are set out in the International Financial Reporting Standard (IFRS) for SMEs, which was issued by the IASB in July 2009.

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3Sections 11-12 – Introduction

• Financial instruments split into two sections:– Sec. 11 Basic Financial Instruments– Sec. 12 Other Financial Instruments

Issues• Together the two sections cover

recognising, derecognising, measuring, and disclosing financial assets and financial liabilities


4Sections 11-12 – Introduction

• Section 11 is relevant to all SMEs• Section 12 is relevant If:

– SME owns or issues ‘exotic’ financial instruments – instruments that impose risks or rewards that are not typical of basic financial instruments

– SME wants to do hedge accounting


5Sections 11-12 – Accounting choice

• Entity may choose to apply either:– Sections 11 and 12 in full, or– Recognition and measurement provisions

of IAS 39 and the disclosure requirements in Sec 11 & 12– No option to use IFRS 9

• The option chosen applies to all financial instruments (not individually)

• To change option, follow Section 10


6Sections 11-12 – Basic principles

• Basic principle of Section 11:– Amortised cost model for all basic FI

except investments in ordinary or preference shares that are publicly traded or whose fair value can be measured reliably – these are fair value through profit or loss (FVTPL).

• Basic principle of Section 12:– FI not covered by Section 11 are at

FVTPL


7Section 11 – Scope

• All basic financial instruments except those covered by other sections of IFRS for SMEs:– Investments in sub, associate, JV (see

Sections 9, 14, 15)– Entity’s own equity (see Sec 22, 26)– Leases (see Section 20)– Employee benefit assets and liabilities

(see Section 28)


8Sections 11-12 – Definitions

• Financial instrument– Contract that gives rise to a financial

asset of one entity and a financial liability or equity instrument of another entity

– Includes cash– But commodities that are ‘near cash’ like

gold are not financial instruments


9Sections 11-12 – Definitions

• Basic financial instrument*– Cash– Debt instrument (accounts, notes, and

loans receivable and payable) that meet conditions on next slide

– Ordinary and preference shares that are not convertible and not puttable

*These notes do not discuss loan commitments


10Section 11 – Basic debt instruments

• Debt instruments are in Section 11 if:– Returns to holder are fixed, variable

referenced to an observable rate, or combination of fixed and variable

– No special provision could cause holder to lose principal

– Prepayment conditions are not contingent on a future event

– No special conditional returns



• Examples of basic debt instruments:– Trade accounts and notes receivable and

payable– Loans from banks and other 3rd parties– Accounts payable in foreign currency– Loans to/from subsidiaries or associates

that are due on demand– Debt instrument that becomes

immediately due if issuer defaults• All of these measured at amortised cost



• Examples of NOT basic debt instruments:– Investment in convertible or puttable

shares or debt– Swaps, forwards, futures, options, rights,

and other derivatives– Loans with unusual prepayment

conditions (based on tax change, accounting change, linked to company performance)

• All of these are FVTPL under Section 12


13Section 11 – Recognition and measurement

• Initial recognition:– When entity becomes a party to the

contractual provisions of the instrument– IFRS for SMEs allows judgement

regarding ‘trade date’ vs ‘settlement date’ accounting, but be consistent



• Initial measurement:– At transaction price– Include transaction costs except for FI

that will be measured at FVTPL– ‘Impute interest’ if payment is deferred

beyond normal terms or below-market interest



• Initial recognition-measurement examples:– Loan made to another entity: Measure

at PV of interest and principal payments– Goods sold to customer (purchased

from supplier) on normal credit terms: Measure receivable (payable) at undiscounted invoice price


16Section 11 – Recognition and measurement• Initial recognition-measurement examples:

– Goods sold (purchased) on 2-year interest free credit: Measure at current cash sale price or PV of receivable or payable

Example: We sell goods for 1,000, payment due 2 years, interest-free. Cash price = 857. IRR = 8%.

Journal entries Debit Credit

At time of sale Receivable 857

Sales Revenue 857

End of year 1 Receivable 69

8% x 857 = 69 Interest Revenue 69



• Subsequent measurement:– Debt instruments in the scope of Section

11 (even if publicly traded):

– Amortised cost using the effective interest method

– Equity instruments in scope of Section 11:

– If publicly traded or FV can be measured reliably: FVTPL

– All others: cost less impairment



• What is ‘amortised cost’?– Amount measured at initial recognition– Minus repayments of principal– Plus or minus cumulative amortisation of

any difference between initial measurement and maturity amount (using effective interest method)

– Minus (for assets) reduction for impairment or uncollectibility



• What is ‘effective interest method’?– Effective interest is rate that exactly

discounts future cash payments (receipts) to the carrying amount– Also called ‘Internal Rate of Return’

– Amortised cost = PV of future cash receipts (payments) discounted at effective interest rate

– Interest expense (income) = carrying amount at beginning of period x effective interest rate


20Section 11 – Effective interest example1/1/X0 buy 5-year bond for 900, transaction cost = 50, cash interest = 40/year, mandatory redemption at 1,100 at 31/12/X4.

Year Carrying amount beginning

Int. income at 6.9583%*

Cash inflow

Carrying amt ending

X0 950.00 66.10 (40) 976.11

X1 976.11 67.92 (40) 1,004.03

X2 1,004.03 69.86 (40) 1,033.89

X3 1,033.89 71.94 (40) 1,065.83

X4 1,065.83 74.16 (40) 1,100.00

*6.9583% is the rate that exactly discounts the cash flows to 950.00



• What is ‘fair value’?– Amount for which FI could be sold or

settled in an arm’s length transaction– Best: Quoted market price in an active

market (bid price)– Next: Price in a recent transaction for

identical asset (unless circumstances have changed)

– Estimate using a valuation technique (a model)


22Section 11 – Impairment

• Impairment only applies to FI measured at cost or amortised cost

• At each reporting date, look for evidence that FV is below carrying amount

– Significant financial difficulty of issuer– Default or delinquency– Abnormal concession granted to debtor by

creditor– Probable debtor bankruptcy or reorg.



• Impairment assessment:– Individually for all equity instruments– Individually for debt instruments that are

individually significant– For other debt instruments, either

individually or grouped based on similar risk characteristics

• Impairment recognition:– Write-down is recognised in P&L



• Measurement of the impairment loss:– Debt instruments: Difference between

carrying amount and current PV of estimated cash flows discounted at asset’s original effective interest rate. (Use current rate if variable.)

– Equity instruments: Difference between carrying amount and best estimate (approximation) of the amount (might be zero) that entity would receive if asset were sold at reporting date.



• Reversal of an impairment loss:– Required if the problem causing the original

impairment reduces– Write up but not to more than what carrying

amount would have been had no impairment been recognised (ie not to FV but to new ‘amortised cost’)

– Reversal recognised in P&L


26Section 11 – Derecognition

• Derecognition of a financial asset:– Derecognition = remove from balance sheet– Only when:

a. Rights to cash flows expire or settledb. Substantially all risks and rewards (cash

flows) transferred to other entityc. Transferred some but not substantially all

risks and rewards, and physical control of asset transferred to another party who has the right to sell the asset to an unrelated third party.



• Derecognition of a financial asset:– In case (c) above:

– Derecognise old asset entirely, and– Recognise separately any rights and

obligations retained or created in the transfer (measure at fair value)

– If transfer does not result in derecognition, keep transferred asset on books and recognise financial liability for the consideration received – Do not offset



• Derecog. of financial asset – examples:– Must derecognise: Sell receivables to bank

but we continue to collect and remit, for a handling fee. Bank assumes credit risk.

– May not derecognise: Same facts except entity agrees to buy back any receivables in arrears for more than 120 days. Entity continues to recognise the receivables until collected or writeoff as uncollectible.



• Derecognition of a financial liability:– Only when extinguished, that is:

a. Dischargedb. Cancelledc. Expired

• If existing debt is replaced with new one with substantially different terms (or there is a significant modification of terms):

– Treat as new liability and extinguishment of original liability


30Section 11 –Disclosure

• Disclose accounting policies for FI• Disclose financial assets and liabilities by

categories in the balance sheet: – Equity or debt at FVTPL– Debt at amortised cost– Equity measured at cost less impairment– Liabilities at FVTPL– Liabilities at amortised cost


31Section 11 – Disclosure


32Section 11 – Disclosure

• Items of income, expense, gains and losses:– Changes in FV for instruments measured at

FVTPL– Total interest income and total interest

expense on FI not measured at FVTPL– Impairment loss by class of financial asset



• Initial recognition:– When entity becomes a party to the

contractual provisions of the instrument• Initial measurement:

– At FV (normally the transaction price)– Transaction costs are charged to expense



• Subsequent measurement:– At FVTPL except:

– Equity instrument that is not publicly traded and cannot get FV reliably, then measure at cost less impairment

– Also measure a contract linked to such equity instrument at cost less impairment

– If previously at FVTPL, but now a reliable FV measure is no longer available, treat most recent FV measure as ‘cost’ going forward.


35Section 12 – Hedge accounting

• ‘Hedging’ and ‘hedge accounting’ are two different things

• What is hedging?– Managing risks by using one financial

instrument (‘hedging instrument’) purposely to offset the variability in FV or cash flows of a recognised asset or liability, firm commitment, or future cash flows (‘hedged item’)



• What is hedge accounting?– Matching the change in FV of the hedging

instrument and the hedged item in the same income statement

– Hedge accounting is only an issue when normal accounting would put the two FV changes in different periods – sometimes referred to as an ‘accounting mismatch’



• The hedger’s accounting dilemma:– I have a risk in an asset or liability measured at

amortised cost– Any change in FV or cash flows from that

asset or liability is recognised only when realised in cash (asset is sold, liability is settled, cash flows occur)

– To hedge, I buy a derivative, which is measured at FVTPL at each reporting date

• I need special hedge accounting to fix this ‘mismatch’



• The hedger’s accounting dilemma – an illustration:– Entity has note payable at a fixed rate of interest

due in 3 years. Note measured at amortised cost.– Buys swap to convert receive fixed interest to pay

variable. Swap is measured at FVTPL.– End of year 1, interest rate declines. Therefore

loss on derivative immediately recognised – but an offsetting gain (not yet recognised) because we will be paying the lower variable rate of interest in future.



• Hedge accounting matching the gain (loss) on the derivative with the loss (gain) on the hedged item.

• Hedge accounting is optional.



• To qualify for hedge accounting:– Designate and document hedging

relationship up front– Clearly identify the hedged risk

– Hedged risk is listed in ¶12.17– Hedging instrument is listed in ¶12.18– Entity expects hedging instrument to be

‘highly effective’ in offsetting the designated hedged risk.



• Hedged risk must be (12.17):– Interest rate risk in debt measured at cost– FX or interest rate risk in firm commitment

or highly probable forecast transaction– Price risk in a commodity owned or to be

acquired in a firm commitment or highly probable forecast transaction

– FX risk in a net investment in a foreign operation



• Hedged risk must be (12.17):– FX risk in debt instrument measured at cost is not

in this list. Why?– Under ¶30.10 (FX) the debt is translated at

spot rate and FX gain or loss is recognised in profit or loss

– Change in FV of the swap (hedging instrument) is also recognised in profit or loss (measured using forward rate)

– ‘Natural hedge’



• Hedging instrument must be (12.18):– Interest rate swap, FX swap, FX forward,

commodity forward– Entered into with external party– Notional amount = principal or notional

amount of hedged item– Specified maturity not later than maturity or

settlement of hedged item– Cannot be prepaid or terminated early


44Section 12 – Hedge accounting• Hedge of fixed interest rate risk or

commodity price risk of commodity held– Recognise hedging instrument as asset or

liability– Change in FV of hedging instrument in P&L– Change in FV of hedged item in P&L and

adjustment of carrying amount of hedged item – even though hedged item is otherwise measured at cost

This is called Fair Value Hedge in IAS 39.



• Hedge of fixed interest rate risk or commodity price risk of commodity held (continued)– If hedged risk was fixed interest in debt

measured at cost, recognise in P&L the periodic net settlements from the derivative (interest rate swap) in the period in which the net settlements occur.



• Example – Assumptions:– Entity borrows 1,000, 3 years, 5% fixed rate,

payable measured at amortised cost– Hedged with a derivative whose value is linked to

an interest rate index– End of year 1, market rate = 6%. FV of 1,000

payable 2 years 6% = 1,000 x .889996 = 890, but this 110 ‘gain’ is not recognised

– Value of the derivative declines to -112 – Note there is small ineffectiveness = 2


47Section 12 – Hedge accounting• Balance sheet at time loan is made:

Cash 1,000Loan payable 1,000

• Adjust loan end of year 1 to reflect rate change:Loan payable 110P&L 2

Derivative (Liability) 112• Balance sheet end of year 1:

Cash 1,000Derivative (Liability) 112Loan payable 890Equity (2)



• Conceptual question regarding the previous example: – Does the 890 carrying amount of the loan

payable at end of year 1 represent the Fair Value of the loan?

– Hint: Does the 890 reflect change in credit risk or prepayment risk?

– If 890 is not Fair Value, what is it?



• Hedge of fixed interest rate risk and commodity price risk (continued)– Discontinue hedge accounting when:

– Hedging instrument expires– Hedge no longer meets conditions– Entity revokes designation

– Any gain or loss that was included in the carrying amount of the hedged item is amortised to P&L over remaining life of hedged item.



• Hedge of variable interest rate risk, FX or commodity price risk of commodity held, highly probable forecast transaction, or net investment in foreign operation– Recognise change in FV of hedging

instrument in OCI (assuming it was effective; ineffectiveness reported in P&L)

– 'Recycle' amount recognised in OCI when hedged item hits P&L or hedging relationship ends.


51Section 12 – Hedge accounting• Hedge of variable interest rate risk, FX or

commodity price risk of commodity held, highly probable forecast transaction, or net investment in foreign operation (continued)– If hedged risk was variable interest in debt

measured at cost, recognise in P&L the periodic net settlements from the interest rate swap in the period in which the net settlements occur.

This is called Cash Flow Hedge in IAS 39.



• Example – Assumptions:– Entity sells goods for 1,000 floating rate 3-

year note receivable– Interest rate risk managed with a derivative

(interest rate swap)– End of year 1 interest rates increase – PV

of cumulative cash flows increase by 100– But FV of swap decreases by 105– Note: Some hedge ineffectiveness



• Opening balance sheet:Receivable 1,000

Equity 1,000

• Ineffective portion of hedge:P&L* 5*

OCI (Equity) 100

Derivative (Liability) 105

*Ineffective portion of hedge

example continued next slide...



• Closing balance sheet:Receivable 1,000

Equity (OCI)* 100*

Derivative (Liability) 105

Equity 995

*Effective portion of the hedge (loss on derivative), which will be amortised to P&L as the higher floating rate interest payments are earned and recognised in P&L in years 2 & 3



• Hedge of variable interest rate risk etc... – Discontinue hedge accounting when:

– Hedging instrument expires– Hedge no longer meets conditions– Forecast transaction no longer probable– Entity revokes designation

– Any prior gain or loss on forecast transaction that was recognised in OCI is recycled to P&L



• Disclosures relating to hedge accounting– For each type of hedge: Description of hedge

(risk, hedged item, instrument)– Special disclosures for hedge of fixed interest

rate risk and commodity price risk of commodity held

– Special disclosures for hedge of variable interest rate risk, FX or commodity price risk of commodity held, highly probable forecast transaction, or net investment in foreign operation


57Section 22 – Liabilities and equity

• Scope of Section 22– Principles for classifying an instrument as

debt or equity– Original issuance of shares and other

equity instruments– Sale of options, rights, warrants– Bonus issues and share splits– Issuance of convertible debt

continues...



• Scope of Section 22, continued– Treasury shares– Distributions to owners– Non-controlling interest and transactions in

shares of a consolidated subsidiary



• Principles for classifying an instrument as debt or equity– Equity = residual interest in assets minus

liabilities– Liability is a present obligation (entity does

not have a right to avoid paying cash)



• The following are equity:– Puttable instrument that entitles holder to

pro rata share of net assets on liquidation– Instrument that is automatically redeemed if

an uncertain future event occurs or death or retirement of holder

– Subordinated instrument payable only on liquidation



• The following are liabilities:– Instrument is payable on liquidation, but

the amount is subject to a maximum ceiling

– Entity is obliged to make payments before liquidation – such as mandatory dividend

– Mandatorily redeemable preference shares



• Members’ shares in a cooperative are equity only if:– Coop has unconditional right to refuse

redemption of members’ shares, or– Redemption is unconditionally prohibited

by law or entity’s charter• Otherwise – liability



• Original issuance of shares and other equity instruments– Recognise when equity is issued and subscriber

is obligated to invest– If equity is issued before the entity gets cash, the

receivable is an offset to equity (not an asset)– If entity gets (nonrefundable) cash before equity

is issued, equity is increased– No increase in equity is recognised for subscribed

shares that have not been issued and entity has not received cash



• Sale of options, rights, warrants– Same principles as for original issuance of

shares (previous slide)• Transaction costs in issuing equity

instruments– Accounted for as a reduction of equity (not

an expense)



• Bonus issues (stock dividends) and share splits– These do not change equity – Accounted for as reclassification of

amounts within equity (out of retained earnings and into permanent capital)

– Amounts reclassified should be based on local laws



• Issuance of convertible debt– Must account separately for debt component and

equity component (conversion right)– Debt proceeds = FV of similar risk debt without

conversion feature (PV calculation)– Equity proceeds are the residual– Recorded at issuance; not subsequently revised– Subsequently, debt discount = additional interest

expense (effective interest method)


67Section 22 – Liabilities and equity• Issuance of convertible debt - Example

– 1/1/X1 issue at par a 4% convertible bond, par and maturity amount = 50,000, maturity in 5 years

– If no conversion feature, would have paid 6%– Calculate present value of cash flows at 6%:

– PV 50,000 due in 5 years @ 6% = 37,363– PV annuity 2,000/year 5 years @ 6% = 8,425– Total PV = 45,788 Debit cash 50,000

Credit financial liability 45,788Credit equity (conversion right) 4,212



Date Inter-est

paid

Interest expense

@ 6%

Amort. of discount

Bond dis-

count

Net bond liability

1/1/X1 4,212 45,78831/12/X1 2,000 2,747 747 3,465 46,53531/12/X2 2,000 2,792 792 2,673 47,32731/12/X3 2,000 2,840 840 1,833 48,16731/12/X4 2,000 2,890 890 943 49,05731/12/X5 2,000 2,943 943 0 50,00031/12/X1: Debit interest expense 2,747

Credit financial liability 747Credit cash 2,000



• Treasury shares– Equity instruments entity has issued and

later reacquired– Measure at cash paid or FV of other

consideration given to acquire \– Present as deduction from equity (not

asset)– No gain or loss recognised on purchase,

sale, or cancellation



• Distributions to owners– If cash – measurement = cash paid– If non-cash – measurement = FV of assets

distributed– Amount reduces equity– If entity gets tax deduction for dividend, tax

benefit is adjustment of equity– Not reduction of income tax expense– If entity pays withholding tax on dividends

paid, tax reduces equity as part of dividend



• Non-controlling interest (NCI) and transactions in shares of a consolidated subsidiary– In consolidated balance sheet NCI is part of

equity (not liability or ‘in between’)– Change in parent’s controlling interest that does

not result in loss of control is a transaction with owners– Equity adjustment, not through P&L– No adjustment of carrying amounts of assets

or goodwill

© 2011 IFRS Foundation 1 The IFRS for SMEs Topic 2.1 Section 11 Basic Financial Instruments Section 12 Other Fin. Inst. Issues Section 22 Liabilities and.

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