Lesson 2 course 0809 - Universidad de Sevillapersonal.us.es/cabad/Lesson 2 course 0809- 1st...

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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008

LESSON 2

Financial Instruments

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Outline

1. Concept.

2. Classification of financial assets and its

accounting treatment.

3. Classification of financial liabilities and its

accounting treatment.

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Financial instruments

P.G.C. Recognition and valuation standard no. 9:– Concept– Recognition– Valuation

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Financial instruments -Concept

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.It may be:– A financial asset.– A financial liability.– An equity instrument.

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Financial instruments -Recognition

An entity shall recognize a financial asset or a financial liability on its balance sheet when, and only when, the entity becomes a party to the contractual provisions of the instrument.

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Financial assets

A financial asset is any asset that is:Cash,An equity instrument of another entity,A contractual right:– To receive cash or another financial asset from

another entity, or– To exchange financial assets or financial

liabilities with another entity under conditions that are potentially favorable to the entity;

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Cash

Trade receivables

Non-trade receivables

Debt instruments

Equity instruments

Financial assetsof the company

Trade payables

Non-trade payables & debts

Debt instruments issued

Equity andFinancial liabilitiesof other company

Capital stock

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Financial assets

It will also be classified as financial asset a contract that will or may be settled in theentity’s own equity instruments and is:A non-derivative for which the entity is or may be obliged to receive a variable number of the entity’sown equity instrumentsA derivative that will or may be settled other thanby exchange of a fixed amount of cash or anotherfinancial asset for a fixed number of the entity’sown equity instruments.

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Format of the Balance Sheet in P.G.C.

Normal model:

C) Current liabilitiesB) Current assets

A) EquityB) Non-current liabilities

A) Non-current assets

LIABILITIESASSETS

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Financial assets

Financial assets shown in the balance sheet include:Cash and cash equivalentsLoans and receivables:– Trade (as accounts receivables)

– Non-trade (as loans to third parties or credits from the sale of tangible fixed assets)

Financial investments in negotiable securities:– Equity instruments (shares)

– Debt instruments (bonds & debentures)Derivative instruments

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Financial liabilities

A financial liability is any liability that is:a contractual obligation: – (i) to deliver cash or another financial

asset to another entity; or – (ii) to exchange financial assets or

financial liabilities with another entity under conditions that are potentially unfavorable to the entity.

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Cash

Trade receivables


Debt instruments

Equity instruments

Financial assetsof othercompany

Trade payables

Non-trade payables & debts

Debt instruments issued

Financial liabilities ofcompany

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Financial liabilities

Financial liabilities shown in the balance sheetinclude:Debts and payables:– Trade (as accounts payable)– Non-trade (as debt with financial institutions or

debt with suppliers of fixed assets)

Debt instruments issued (bonds and debentures)Derivative instruments

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Equity instruments

An equity instrument is any financialinstrument that is:Included in Equity.For example: the ordinary shares issued by the company.

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Cash

Trade receivables


Debt instruments

Equity instruments

Financial assets ofother company

Equity of thecompany

Capital stock

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Financial assets

For presentation purposes:They are classified in a particular way

in the balance sheet

For valuation purposes:They are classified in a different way

in portfolios

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Financial assets -Valuation

For the purpose of valuation, financial assets are classified into the following categories (NV 9ª.2):(1) loans and receivables;(2) held-to-maturity investments;(3) held for trading investments;(4) other financial assets at fair value through profit or loss;(5) Investments in equity of subsidiaries, joint-ventures and associated companies;(6) available-for-sale financial assets.

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Financial assets - Valuation

Investments in equity of other companies with the intention of gaining control

(5) Investments in equity of subsidiaries, joint-ventures & associated companies

Negotiable securities that can be sold, but there is no intention at the moment

(6) available-for-sale financial assets

Negotiable securities acquired to be sold in the short term

(3) held for trading investments

Negotiable securities, representative of debts, that are expected to be held until the reimbursement date

(2) held-to-maturity investments

Trade and non-trade loan and receivables

(1) loans & receivables

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It is enough to know their COST

Investments in equity of other companies with the intention of gaining control

(5) Investments in equity of subsidiaries, joint-ventures & associated companies

Negotiable securities that can be sold, but there is no intention at the moment

(6) available-for-sale financial assets

It is important to know:- their FAIR VALUE, since they are going to be sold or can be sold

Negotiable securities acquired to be sold in the short term

(3) held for trading investments



It is important to know:- their COST- the AMOUNT that is expected to BE COLLECTED



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It is important to know:- their COST- the AMOUNT that is expected to BE COLLECTED



Initial valuation:

Fair value (price of transaction) + transaction costs

Subsequent valuation (*):

Amortized cost

(*) Trade receivables due in less than a year are valued at nominal value

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The amortized cost of a financial asset is:

The amount at which the financial asset is measured at initial recognition,

(-) principal repayments,

(+) the cumulative amortization using the effective interest method of any difference between that initial amount and the maturity amount.


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The effective interest method is a method of calculating the amortized cost of a financial asset and of allocating the interest income over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash receipts through the expected life of the financial instrument to the book value of the financial asset. The calculation includes all fees paid between parties to the contract that are an integral part of the effective interest rate, transaction costs, and all other premiums or discounts.


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Loans and receivablesExample: Credit from the sale of tangible

fixed assets• 2/1/2008 a vehicle is sold.• Acquisition price: 24,000• Accumulated depreciation: 16,000• Selling price: 10,000 (in cash)• Date of receipt: in 2 years time• Amount to be collected in 2 years time: 12,000

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fixed assets2/1/08 31/12/08 31/12/09

Selling price: 10,000

Cash Collection: 12,000

Interest revenue: 2,000 Implicit

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Loans and receivablesExample: Credit from the sale of tangible fixed

assets

Initial valuation:Fair value (price of transaction) + transaction costs = 10,000 €

2,0001,600

(771) Profits from disposal of tangible fixed assets(477) V.A.T. collected

(281) Tangible fixed assets accumulated depreciation(57) Cash

16,000

1,600

24,000(218) Vehicles

to(253) Long-term credit from the sale of tangible fixed assets

10,000

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fixed assets2/1/08 31/12/08 31/12/09

Long termcredit: 10,000

Long-term credit: 12,000

Interest revenue: 2,000

1,000 1,000

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31/12/2008:

Subsequent valuation: amortized cost using the effective interest methodEffective interest rate:

2)1(000,12000,10i+

=

Effective interest rate: i = 9.545%



fixed assets

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fixed assets2/1/08 31/12/08 31/12/09

Long termcredit: 10,000

Long-termcredit: 12,000

Long-term credit: 10,954.4

10,000 * 0.09545 = 954.4

10,945.5 * 0.09545 = 1,045.6

Total interest = 954.4 + 1,045.6 = 2,000

Amortizedcost

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assets

Subsequent valuation:Amortized cost

(12,000)

0

(-) principal repayments

01,045.610,954.4

10,954.4954.410,000

Amortized cost(+) interestValue at initial recognition

12,000

+

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assets

954.4(762) Revenues of creditsto(253) Long-term credit from the sale of tangible fixed assets

954.4

31/12/2008:

Subsequent valuation: Amortized cost

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assets

12,000(253) Long-term credit from the sale of tangible fixed assets

to(57) Cash12,000

1,045.6(762) Revenues of creditsto(253) Long-term credit from the sale of tangible fixed assets

1,045.6

31/12/2009:

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Financial assets-Valuation

Held-to-maturity investments

Example: Bonds and debentures

Debt instrument in the form of a document that implies the promise to pay back money owed. They can be transferred.

• Bonds

• Debentures

Fixed interest securities

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Bonds and debentures- Example:

• A large amount of debt finance: $50 million

• May be divided into 50,000 bonds or debentures having a face value of $1,000.

• These would be sold to the public and could be owned by as many as 50,000 individuals (although some individuals might buy more than one debenture).


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• The bond or debenture would require the payment of $1,000 to the investor at some time in the future (called the “principal amount” or “face value” of the bond), perhaps in ten years time.

• and require the payment of interest at a specified rate at regular intervals.


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For example, a bond or debenture might provide the holder with:

• A right to receive interest at say 5% semiannually, or in other words, a right to receive $50 every six months until maturity.

• At maturity the holder would have the right to receive $1,000.


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Another possibility a bond or debenture might provide the holder with:

• A right to receive a higher amount(reimbursement value) at maturity.

• At maturity the holder would have the right to receive, of example, $1,500.


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http://www.tesoro.es/en/deuda/valores/vls_letras.asp

http://www.tesoro.es/en/deuda/valores/vls_bonos.asp

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• Bond• Issuing value: 1,000• Maturity: in 3 years time• Reimbursement value: 1,500• Interest: 0%


Held-to-maturity investmentsExample: Bonds and debentures

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1/1/Y1 31/12/Y1 31/12/Y3

Issuing value: 1,000

Reimbursementvalue: 1,500

Implicit interest: 500

31/12/Y2

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Initial valuation:Fair value (price of transaction) + transaction costs = 1,000 €

1,000(57) Cashto(251) Long-term debt instruments

1,000

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31/12/Y1:

Subsequent valuation: amortized cost using the effective interest methodEffective interest rate:

3)1(500,1000,1

i+=

Effective interest rate: i = 14.47%



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1,000 * 0.1447= 144.71

Total interest = 144.71 + 165.66 + 189.63 = 500

1/1/Y1 31/12/Y1 31/12/Y3Issuing value:

1,000Reimbursement

value: 1,500

Amortized cost: 1,144.71

31/12/Y2

1,144.71 * 0.1447=165.66

1,310.37 * 0.1447=189.63

Amortized cost: 1,310.37

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Subsequent valuation:Amortized cost

0(1,500)189.631,310.37

0

0

(-) principal repayments

1,310.37165.66 1,144.71

1,144.71144.711,000

Amortized cost(+) interestValue at initial recognition

1,500

+

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144.71(761) Revenues of debtinstruments

to(251) Long-term debt instruments

144.71

31/12/Y1:

Subsequent valuation: Amortized cost



165.66

31/12/Y2:

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1,500(251) Long-term debt instruments

to(57) Cash1,500



189.63

31/12/Y3:

Lesson 2 course 0809 - Universidad de Sevillapersonal.us.es/cabad/Lesson 2 course 0809- 1st...

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