Cartes mémoires Accounting for Financial Instruments Set 2

Cartes-fiches	33
Langue	English
Catégorie	Gestion d'entreprise
Niveau	Université
Crée / Actualisé	19.02.2013 / 21.02.2013
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Criter of classificaiton - Overview

Classification of a financial instrument as equity or financial liability implies three steps of verification
- is there a redemption obligation of the nominal value (e.g. special termination right)?
- is there an obligation of periodic payments (interest and dividends payments)?

Redemption obligations

Contractual redemption obligation results in classification as a financial liability
- mandatory repurchase obligation (e.g. buy sell back)
- agreed redemption or agreed maturity (e.g. investments in debt instruments)
Redemption obligation established indirectly through the terms and conditions of a financial instrument results in classification as a liability
- obligation to deliver cash or another financial asset indirectly via ters and conditions
- but - see IFRIC update March 2006
Ordinary termination rights of the investor
- puttable instruments to be classified as financial liabilities
  - statutory termination right equivalent to contractual termination right
  - maturity and termination deadline not relevant for classification purposes
Exceptional termination right of the investor
- Termination rights linked to remote conditions or liquidation have no negative impact on classification as equity
- pure protection rights for extreme cases
Restriction on the ability of an entity to satisfy a contractual obligation or holder termination options which are not exercised do not negate the entity's contractual obligation
Fulfilment of payment obligations in own equity instruments with non-derivative contracts
- actual instruments without a contractual obligation to deliver a variable number of its own equity instruments are classified as equity

Ongoing payments

Contractual and indirect obligations to deliver cash or another financial asset (e.g. interest) result in classification as a financial liability
- the entity cannot avoid the obligation to deliver cash or another financial asset
Exceptions
- obligations linked to remote conditions or liquidation have no negative impact on classification as equity
Payment features resulting in classification as equity
- distributions at the discretion of the issuer (dividends or other distributions of equity)
- agreed payments linked to dividend payments for shareholders

Characteristics of memebrs' shares in cooperative entities and similar instruments (IFRIC 2)

Contractual right of the holder of financial instrument to request redemption does not, in itself, require that a financial instrument is to be classified as a financial liability
- members' shares are equity if the entity has an unconditional right to refuse redemption of the members' shares
- members' shares are equity if there is an unconditional prohibition on the redemption by local law, regulation or the entity's governing charter (e.g. kind of minimum capital)
Through the amendment of the GenG in October 2006 by statute it is possible to
- reduce the payment of credit balance of a retiring member's capital account (redemption)
- adopt a minimum capital
In accordance with an amendment of the stature (requires 3/4 majority) shares in cooperative entities' credit balance are equity capital

Compound instruments

Financial instruments may contain both a financial liability and an equity component
Financial liability and equity components to be treated separately by the issure (split accounting)
Separation of the financial liability and equity components of a convertible instrument is not revised as a result of a change in the likelihood that a conversion option will be exercised
- entity's contractual obligation to make future payments extinguish through conversion, maturity of the instrument or some other transaction
Valuation of financial liability and equity components
- determining the fair value of financial liability component
- equity component as residual amount after deducting the fair value of the financial liability from the fair value of the entire instrument
- no impact on profit or loss arises from initial recognition

Measurement - Financial liabilities

Initial recognition at fair value
Subsequent measurement at amortised cost
Subsequent measurement of financial liabilities which are categorised as held for trading or fair value option at fair value through profit or loss

Measurement - Equity instrument

Measurement of the consideration's carrying amount at issue date
No subsequent measurement

Measurement - Effects on the financial statements

Classification of a financial instrument as a financial liability or an equity instrument determines how interests, dividends, losses and gains are treated
- gains and losses associated with redemptions or refinancings of financial liabilites to be recognised in profit or loss
- redemptions or refinancings of equity instruments to be recognised as changes in equity

Profit participation right - Issue

Financial instrument
- X-Bank issues a registered profit participation right for EUR 70 milion
- holder is Z-AG, which has paid the entire purchase price
Repayment
- no term to maturity restriction (perpetual)
Termination
- exclusion of termination rights for Z-AG (holder)
- termination option of X-Bank after 10 years for the nominal amount
PAyment obligation
- coupon of 7% p.a. of the nominal amount of the profit participation right outstanding
- payment is omitted if distribution results in or increases an accumulative loss in annual financial statement of commercial law (HGB)
- omitted distributions are subsequently paid if this does not result in any new accumulated loss

Profit participation right - Assessment

No redemption obligation
No holder termination right
In view of the absence of redemption obligations and holder termination rights, profit participation right characterises equity
Payment for the holder of the profit participation right
- contractual obligation of the bank to pay interest
- payment obligation is omitted if there is an accumulated loss
  - bank-specific reserves provide scope which may result in the generation of a accumulated loss
  - payments are subject to the discretion of the bank
  - there are some consequences of §340 (e.g. profit participation right conditions), otherwise its possible to make a claim according §§ 242 or 313 BGB
- with regard to such payments, profit participation rights are classified as equity

Profit participation right - Variation of issue

Public statement of the X-bank that no "harmful" reserves will be set up in accordance with §340g HGB
Profit participation right is a financial liability since X-bank can not evade the payment obligation

Silent partnership - Issue

Financial instrument
- silent partnership in a bank (fully paid up)
Repayment
- 20 years term to maturity (limited maturity)
Termination
- both silent partner and bank hold termination rights
Payment obligation
- contractual fixed percentage of nominal amount plus a percentage of dividend defined for the corresponding financial year
- annual payment
- payment is omitted if distribution results in or increases an accumulative loss
- omitted distributions are subsequently paid if it does not result in any new accumulated loss

Silent partnership - Assessment

Redemption obligation
- silent partnership with limited maturity
- obligation to take back the financial insturment and repay capital at the end of the life of the instrument
Termination right
- exisiting holder termination right
With regard to the redemption obligation and holder termination right, silent partnership characterises a liability
Payments to the silent partner
- contractual payment obligation of the bank
- payment obligation is omitted if there is an accumulated loss
  - bank-specific reserves provide scope which may result in the generation of an accumulative loss (funds for general banking risk - to be checked under national law)
  - payments are at the discretion of the bank
- with regard to payments, the silent partnership has the character of equity

Silent partnership - Result

Silent partnership is a compound instrument
There is a contracutal obligaton to pay nominal amount (puttable instrument
- financial liability
Payments are at the discretion of the bank
- equity
Split accounting

Silent partnership - Variation of situation

Silent partnership with unlimited maturity and an excluded termination right of the holder
Classification of the silent partnership as equity instrument since it is no "puttable instrument" (the maturity is not limited and there is no termination right for the holder)

Characteristics of (stand-alone) derivatives under IAS 39.9

Commandes clavier:

= tourner,

= avant/arrière,

= faire défiler

Value is marked to changes in a specific underlying (examples of underlyings in IAS 39.10 are interest rates, financial instrument prices, commodity prices, foreign exchange rates, indices of prices or rates, credit ratings ore credit indices, or similar variables)
Insignificant or substantially reduced initial net investment compared with underlying
Settlement at a future date

Irrevocable loan commitments - Scope of application

Commandes clavier:

= tourner,

= avant/arrière,

= faire défiler

IAS 39 includes only loan commitments that
- are designated as financial liabilities at fair value through profit or loss
- are settled net in cash or by delivering or issuing another financial instrument (those loan commitments are derivatives)
- provide a loan at an interest rate below market rate
- had a past parctice of selling the sassets resulting from its loan commitments shortly after origination (to all its loan commitments in the same class)
Result - fair value accounting influences profit or loss
Other loan commitments are in scope of IAS 38 Provisions, contigent liabilities
Loan commitments are usually no "onerous contracts" in sense of IAS 37, because the ost of fulfilling the contract are not higher than the economic benefits expected

Financial guarantee contracts - Definition

Commandes clavier:

= tourner,

= avant/arrière,

= faire défiler

Contract that
- requires the issuer to make specified payments to reimburse the holder
- for a loss it incurs (has to be a loss)
- because a specified debtor fails to make payment when due
- in accordance with the original or modified terms of a debt instrument
Debt instrument
- e.g. loans, bonds
Protection buyer
- party that accounts the debt instrument and carries therefore the potential risk of losing this asset
Protection seller
- party that assumes the default risk by receiving some fees
Payment
- reimbrsement of the debt instrument's loss

Financial guarantee contracts - Initial Recognition

Commandes clavier:

= tourner,

= avant/arrière,

= faire défiler

Fair value
Fair value of a market price transaction equals the premium of guarantee benefit

Financial guarantee contracts - Subsequent measurement

Commandes clavier:

= tourner,

= avant/arrière,

= faire défiler

Measurement at the higher of
- amount determined in accordance with IAS 37.40, and
- amount initially recognised (less, cumulative amortisation recognised in accordance with IAS 18)

Financial guarantee contracts - Differences to credit derivatives

Commandes clavier:

= tourner,

= avant/arrière,

= faire défiler

Payments do not require that the holder is exposed to, and has incurred a loss on the filure of the debtor to make payments on the guaranteed asset when due
Derivatives in accordance with IAS 39
e.g. credit default swap, requiring payments in response to changes in a specified credit rating or credit index

Embedded derivatives - Definition

Commandes clavier:

= tourner,

= avant/arrière,

= faire défiler

Financial instruments combined with other financial assets or liabilities to form new financial instruments (hybrid, structured products)
Normally a combination of
- host contract and
- embedded derivative

Embedded derivatives shall be separted if

Commandes clavier:

= tourner,

= avant/arrière,

= faire défiler

Hybrid (combined) instrument is not measured at fair value (with changes in fair value recognised in profit or loss)
Separate instrument with the same terms as the embedded derivative would meet the definition of a derivative
Economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host contract

Embedded derivatives - Consequence of the condition not closely related

Commandes clavier:

= tourner,

= avant/arrière,

= faire défiler

Embedded derivatives and host contracts shall e separated, if the components have different risk factors

Embedded derivatives - Accounting of single components of embedded derivatives

Commandes clavier:

= tourner,

= avant/arrière,

= faire défiler

Accounting of derivative elements which are separated from host contracts
- at fair value
Accounting of host contracts in accordance with the specific rules particular to the instrument, often
- at amortised cost
If it is impossible to measure the derivative element, measurement of the entire contract
- at fair value

Embedded derivatives - Determination of the accounting apporach for the initial measurement of embedded derivatives in accordance with IAS 39

Fair value of the host contract is calculated by the difference of hybrid instruments' and the embedded derivatives' fair value
Other methods of splitting are excluded

Embedded derivatives - Convertible bond

Definition
- Bonds that can be converted by the investor into stocks of the issuer or a third party at maturity date
- convertible bonds expire after stock conversion (in contrast to callable bonds)
Elements
- host contract - bond
- derivative - call options on stocks
Accounting from the investor's perspective
- embedded derivative fulfils the definition of an derivative financial instrument in accordance with IAS 39.9
- embedded derivatives' economical attributes and risks (share price risk) are not closely related with the economical attributes and risks of the host contract (interest rate risk)
- consequence - derivative to be separated

Embedded derivatives - Loan contract with termination right

Definition
- Loan contract that gives (only) the debtor a termination right of the contract after 10 years
Elements
- host contract - loan contract
- derivative - termination right
Accounting from the investor's perspective
- embedded derivative fulfils the defintion of an derivative financial instrument in accordance with IAS 39.9
- embedded derivatives' economical attributes and risks are closely related with the economical attributes and risks of the host contract (interest rate risk)
- consequence - accounting as one contract

Embedded derivatives - Mortgage savings plan with the option of future usage of a loan

Definition
- Investor gets the right to take up a loan at reduced rates of interest after the savings accumulation period
Elements
- Host contract - mortgage savings plan
- Derivative - Option of future usage of a loan
Accounting from the investors' perspective
- embedded derivative fulfils the definition of an derivative financial instrument in accordance with IAS 39.9
- embedded derivatives' economical attributes and risks are closely related with the economical attributes and risks of the contract (interest rate risk)
- consequence - accounting as one contract

Financial instrument

Financial instruments are any contracts that
- give rise to financial asset of one entity and
- a financial liability or equity instrument of another entity
Classification in financial liability, financial asset or equity instrument at initial recognition
Economic substance of a financial instrument, rather than its legal form, governs its classification

Accounting for Financial Instruments Set 2

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