The financial instrument is a very complicated topic,which relates to IAS 32,IFRS9 and IFRS 7.However there are some hints and tips for the understanding and application of these standards into the scenario,especially for tackling section C single-entity accounts preparation question in the exam for ACCA F7 financial reporting,..
In this article,let us start by looking at the definition of a financial instrument,which is that a financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.
With references to assets,liabilities and equity instruments,the statement of financial position immediately comes to mind.Further,the definition describes financial instruments as contracts,and therefore in essence financial assets,financial liabilities and equity instruments are going to be pieces of paper.
For example,when an invoice is issued on the sale of goods on credit,the entity that has sold the goods has a financial asset-the receivable-while the buyer has to account for a financial liability–the payable.Another example is when an entity raises finance by issuing equity shares.The entity that subscribes to the shares has a financial asset-an investment-while the issuer of the shares who raised finance has to account for an equity instrument-equity share capital.A third example is when an entity raises finance by issuing bonds(debentures).The entity that subscribes to the bonds–ie lends the money–has a financial asset-an investment–while the issuer of the bonds–ie the borrower who has raised the finance–has to account for the bonds as a financial liability.
Then we talk about accounting for financial instruments,in simple terms what we are really talking about is how we account for investments in shares,investments in bonds and receivables(financial assets),how we account for trade payables and long-term loans(financial liabilities)and how we account for equity share capital(equity instruments).(Note:financial instruments do also include derivatives,but this will not be tested in exam paper F7)
In considering the rules as to how account for financial instruments there are various issues around classification,initial measurement and subsequent measurement.
This article will consider the accounting for equity instruments and financial liabilities.Both arise when the entity raises finance–ie receives cash in return for issuing a financial instrument.
Distinguishing between debt and equity
For an entity that is raising finance it is important that the instrument is correctly classified as either a financial liability(debt)or an equity instrument(shares).This distinction is so important as it will directly affect the calculation of the gearing ratio,a key measure that users of the financial statements use to assess the financial risk of the entity.The distinction will also impact on the measurement of profit as the
finance costs associated with financial liabilities will be charged to the statement of profit or loss.Thus reducing the reported profit of the entity,while the dividends paid on equity shares are an appropriation of profit rather than an expense.
When raising finance the instrument issued will be a financial liability,as opposed to being an equity instrument,where it contains an obligation to repay.Thus,the issue of a bond(debenture)creates a financial liability as the monies received will have to be repaid,while the issue of ordinary shares will create an equity instrument.In a formal sense an equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities
It is possible that a single instrument is issued that contains both debt and equity elements.An example of this is a convertible debt-ie:where the bond contains an embedded derivative in the form of an option to convert to shares rather than be repaid in cash.The accounting for this compound financial instrument will be considered in a subsequent article.
Equity instruments
Equity instruments are initially measured at fair value less any issue costs.In many legal jurisdictions when equity shares are issued they are recorded at a nominal value,with the excess consideration received recorded in a share premium account and the issue costs being written off against the share premium.
Regards to the initial and subsequent measurement for the financial liability and issued equity instrument,we will further look at these deeply in the next article.
▎本文作者為高頓財(cái)經(jīng)ACCA研究中心F7教研組，來源高頓網(wǎng)校。原創(chuàng)文章，歡迎分享，若需引用或轉(zhuǎn)載請(qǐng)注明來源高頓網(wǎng)校。更多內(nèi)容請(qǐng)關(guān)注微信號(hào)(gaodunacca)，掌握最全面ACCA政策以及學(xué)習(xí)方法，更有在線小編為你解答各種困惑，會(huì)說話的公眾號(hào)，你見過嗎？