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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
LESSON 2
Financial Instruments
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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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 Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial instruments
P.G.C. Recognition and valuation standard no. 9:– Concept– Recognition– Valuation
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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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 Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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 Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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 Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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 Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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 Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Cash
Trade receivables
Non-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 Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Cash
Trade receivables
Non-trade receivables
Debt instruments
Equity instruments
Financial assets ofother company
Equity of thecompany
Capital stock
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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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 Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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 Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets - Valuation
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
Negotiable securities, representative of debts, that are expected to be held until the reimbursement date
(2) held-to-maturity investments
It is important to know:- their COST- the AMOUNT that is expected to BE COLLECTED
Trade and non-trade loan and receivables
(1) loans & receivables
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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets - Valuation
Negotiable securities, representative of debts, that are expected to be held until the reimbursement date
(2) held-to-maturity investments
It is important to know:- their COST- the AMOUNT that is expected to BE COLLECTED
Trade and non-trade loan and receivables
(1) loans & receivables
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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.
Financial assets -Valuation
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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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.
Financial assets -Valuation
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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets -Valuation
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets -Valuation
Loans and receivablesExample: Credit from the sale of tangible
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets -Valuation
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets -Valuation
Loans and receivablesExample: Credit from the sale of tangible
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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%
Financial assets -Valuation
Loans and receivablesExample: Credit from the sale of tangible
fixed assets
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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets -Valuation
Loans and receivablesExample: Credit from the sale of tangible
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets -Valuation
Loans and receivablesExample: Credit from the sale of tangible fixed
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets -Valuation
Loans and receivablesExample: Credit from the sale of tangible fixed
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets -Valuation
Loans and receivablesExample: Credit from the sale of tangible fixed
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 Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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).
Financial assets-Valuation
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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Bonds and debentures- Example:
• 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.
Financial assets-Valuation
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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Bonds and debentures- Example:
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.
Financial assets-Valuation
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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Bonds and debentures- Example:
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.
Financial assets-Valuation
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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Bonds and debentures- Example:
Financial assets-Valuation
http://www.tesoro.es/en/deuda/valores/vls_letras.asp
http://www.tesoro.es/en/deuda/valores/vls_bonos.asp
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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
• Bond• Issuing value: 1,000• Maturity: in 3 years time• Reimbursement value: 1,500• Interest: 0%
Financial assets-Valuation
Held-to-maturity investmentsExample: Bonds and debentures
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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets -Valuation
Held-to-maturity investmentsExample: Bonds and debentures
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets -Valuation
Held-to-maturity investmentsExample: Bonds and debentures
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
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%
Financial assets -Valuation
Held-to-maturity investmentsExample: Bonds and debentures
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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets -Valuation
Held-to-maturity investmentsExample: Bonds and debentures
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets -Valuation
Held-to-maturity investmentsExample: Bonds and debentures
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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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets -Valuation
Held-to-maturity investmentsExample: Bonds and debentures
144.71(761) Revenues of debtinstruments
to(251) Long-term debt instruments
144.71
31/12/Y1:
Subsequent valuation: Amortized cost
165.66(761) Revenues of debtinstruments
to(251) Long-term debt instruments
165.66
31/12/Y2:
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Financial Accounting 08/09 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2008
Financial assets -Valuation
Held-to-maturity investmentsExample: Bonds and debentures
1,500(251) Long-term debt instruments
to(57) Cash1,500
189.63(761) Revenues of debtinstruments
to(251) Long-term debt instruments
189.63
31/12/Y3: