The IFRS for SMEs 2

International Financial Reporting Standards

Section 11 Basic Financial Instruments

Section 12 Other Fin. Inst. Issues
Section 22 Liabilities and Equity
Paul Pacter
Day 2 08:00−10:00 and 10:30−11:30

Copyright © 2010 IASC Foundation.

All rights reserved.

Sections 11-12 – Introduction 3 Sections 11-12 – Introduction 4

• Financial instruments split into two • Section 11 is relevant to all SMEs

sections: • Section 12 is relevant If:
– Sec. 11 Basic Financial Instruments – SME owns or issues ‘exotic’ financial
– Sec. 12 Other Financial Instruments instruments – instruments that impose
Issues risks or rewards that are not typical of
• Together the two sections cover basic financial instruments
recognising, derecognising, measuring, – SME wants to do hedge accounting
and disclosing financial assets and
financial liabilities

Sections 11-12 – Accounting choice 5 Sections 11-12 – Basic principles 6

• Entity may choose to apply either: • Basic principle of Section 11:

– Sections 11 and 12 in full, or – Amortised cost model for all basic FI
– Recognition and measurement provisions except investments in ordinary or
of IAS 39 and the disclosure requirements preference shares that are publicly traded
in Sec 11 & 12 or whose fair value can be measured
reliably – these are fair value through
– No option to use IFRS 9
profit or loss (FVTPL).
• The option chosen applies to all financial • Basic principle of Section 12:
instruments (not individually)
– FI not covered by Section 11 are at
• To change option, follow Section 10 FVTPL
Section 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)
Sections 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
Section 11 – Basic debt instruments 11
• 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
7 Sections 11-12 – Definitions 8
• 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
9 Section 11 – Basic debt instruments 10
• 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
Section 11 – Basic debt instruments 12
• Examples of NOT basic debt instruments:
– Investment in convertible or puttable
shares
– 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
Section 11 – Recognition and measurement 13
• 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
Section 11 – Recognition and measurement 15
• 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
Section 11 – Recognition and measurement 17
• 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
Section 11 – Recognition and measurement 14
• 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
Section 11 – Recognition and measurement 16
• 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%.entries
Journal Debit Credit
At time of sale Receivable 857
Sales Revenue 857
End of year 1 Receivable 69
8% x 857 = 69 Interest Revenue 69
Section 11 – Recognition and measurement 18
• 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
Section 11 – Recognition and measurement 19 Section 11 – Effective interest example 20

• What is ‘effective interest method’? 1/1/X0 buy bond for 900, transaction cost = 50,
interest 40/year for 5 years, mandatory redemption
– Effective interest is rate that exactly
at 1,100 at 31/12/X4.
discounts future cash payments (receipts)
to the carrying amount Year Carrying amount Int. income Cash Carrying amt
beginning at 6.9583%* inflow ending
– Amortised cost = PV of future cash receipts X0 950.00 66.10 (40) 976.11
(payments) discounted at effective interest X1 976.11 67.92 (40) 1,004.03
rate X2 1,004.03 69.86 (40) 1,033.89
– Interest expense (income) = carrying X3 1,033.89 71.94 (40) 1,065.83
amount at beginning of period x effective X4 1,065.83 74.16 (40) 1,100.00
interest rate *6.9583% is the rate that exactly discounts the cash flows to 950.00

Section 11 – Recognition and measurement 21 Section 11 – Impairment 22

• What is ‘fair value’? • Impairment only applies to FI measured at

– 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)
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.

Section 11 – Impairment 23 Section 11 – Impairment 24

• Impairment assessment: • Measurement of the impairment loss:

– 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
– 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.
Section 11 – Impairment 25
• 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
Section 11 – Derecognition 27
• 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
Section 11 – Derecognition 29
• 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.
Section 11 – Derecognition 26
• Derecognition of a financial asset:
– Derecognition = remove from balance sheet
– Only when:
a. Rights to cash flows expire or settled
b. Substantially all risks and rewards (cash
flows) transferred to other entity
c. 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.
Section 11 – Derecognition 28
• Derecognition of a financial asset:
– Transferor gives noncash collateral:
– If transferee can sell or repledge the
collateral: Transferor must show the asset
separately in its balance sheet
– If transferee sells: It must recognise a
liability to return the collateral
– If transferor defaults: It derecognises the
collateral, and transferee recognise it at FV
(or if it has already sold it, derecognise the
liability)
Section 11 – Derecognition 30
• Derecognition of a financial liability:
– Only when extinguished, that is:
a. Discharged
b. Cancelled
c. 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
Section 11 – Disclosure 31
• 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
Section 11 – Disclosure 33
• 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
Section 12 – Recognition and measurement 35
• 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
Section 11 – Disclosure 32
Section 12 – Scope 34
• All FI not covered by Section 11 (and not
scoped out of Sections 11 and 12)
• Contract to buy or sell non-financial item
(commodity, inventory, PP&E) is not a FI.
– But if it has ‘exotic’ feature and acts as a
derivative, it is in scope of Sec 12.
– Also it is in Sec 12 if it can be settled net in
cash and was not entered into to buy or sell
non-financial item to meet the entity’s
expected sale or usage requirements.
Section 12 – Recognition and measurement 36
• 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.
Section 12 – Hedge accounting 37
• ‘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’)
Section 12 – Hedge accounting 39
• 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’
Section 12 – Hedge accounting 41
• To achieve hedge accounting, either...
– Defer recognising change in FV of hedging
instrument to same period in which change in FV
of the hedged item is recognised under IFRSs; or
– Recognise the change in FV of the hedged item
earlier.
• IFRS for SMEs permits both, depending on
circumstances.
– Hedge accounting is optional.
Section 12 – Hedge accounting 38
• 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’
Section 12 – Hedge accounting 40
• The hedger’s accounting dilemma – an
illustration:
– Entity has note payable in a foreign currency due
in 3 years. Note measured amortised cost.
– Signs FX forward contract to hedge FX risk.
Contract is measured at FVTPL.
– End of year 1, foreign currency weaker compared
to entity’s home currency. Therefore loss on
derivative – but it will take fewer home currency to
pay off the note when it becomes due at end of
year 3 (gain on payable).
Section 12 – Hedge accounting 42
• To qualify for hedge accounting:
– Designate and document hedging
relationship up front
– Clearly identify the hedged risk
– Hedged risk is listed in Sec 12.17
– Hedging instrument is listed in Sec 12.18
– Entity expects hedging instrument to be
‘highly effective’ in offsetting the designated
hedged risk.
Section 12 – Hedge accounting 43
• 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
Section 12 – Hedge accounting 45
• 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
Section 12 – Hedge accounting 47
• Hedge of fixed interest rate risk and
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.
Section 12 – Hedge accounting 44
• Hedged risk must be (12.17):
– FX risk in debt instrument measured at cost is not
in this list. Why?
– Under Sec 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’
Section 12 – Hedge accounting 46
• Hedge of fixed interest rate risk and
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
Section 12 – Hedge accounting 48
• 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
Section 12 – Hedge accounting 49
• Balance sheet at time loan is made:
Cash 1,000
Loan payable 1,000
• Adjust loan end of year 1 to reflect rate change:
Loan payable 110
P&L 2
Derivative (Liability) 112
• Balance sheet end of year 1:
Cash 1,000
Equity 2 – If 890 is not Fair Value, what is it?
Derivative (Liability) 112
Loan payable 890
Section 12 – Hedge accounting 51
• 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.
Section 12 – Hedge accounting 53
• 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.
Section 12 – Hedge accounting 50
• 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?
Section 12 – Hedge accounting 52
• 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 or 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.
Section 12 – Hedge accounting 54
• 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
Section 12 – Hedge accounting
• 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...
Section 12 – Hedge accounting
• 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
Section 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
continued...
55 Section 12 – Hedge accounting 56
• 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
57 Section 12 – Hedge accounting 58
• 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
59 Section 22 – Liabilities and equity 60
• Scope of Section 22, continued
– Treasury shares
– Distributions to owners
– Non-controlling interest and transactions in
shares of a consolidated subsidiary
Section 22 – Liabilities and equity 61
• 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)
Section 22 – Liabilities and equity 63
• 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
Section 22 – Liabilities and equity 65
• 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
Section 22 – Liabilities and equity 62
• 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
Section 22 – Liabilities and equity 64
• 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
Section 22 – Liabilities and equity 66
• 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)
Section 22 – Liabilities and equity 67 Section 22 – Liabilities and equity 68

• Bonus issues (stock dividends) and share • Issuance of convertible debt

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
– Must account separately for debt component and
equity component (conversion right)
– Split proceeds between debt and equity
– 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)

Section 22 – Liabilities and equity 69 Section 22 – Liabilities and equity 70

• Issuance of convertible debt - Example Date Inter- Interest Amort. of Bond Net bond
– 1/1/X1 issue at par a 4% convertible bond, est expense discount dis- liability
paid @ 6% count
par and maturity amount = 50,000
1/1/X1 4,212 45,788
– If no conversion feature, would have paid 6%
31/12/X1 2,000 2,747 747 3,465 46,535
– Calculate present value of cash flows at 6%:
– PV 50,000 due in 5 years @ 6% = 37,363 31/12/X2 2,000 2,792 792 2,673 47,327
– PV annuity 2,000/year 5 years @ 6% = 8,425 31/12/X3 2,000 2,840 840 1,833 48,167
– Total PV = 45,788 31/12/X4 2,000 2,890 890 943 49,057
Debit cash 50,000 31/12/X5 2,000 2,943 943 0 50,000
Credit financial liability 45,788 31/12/X1: Debit interest expense 2,747
Credit equity (conversion right) 4,212 Credit financial liability 747
Credit cash 2,000

Section 22 – Liabilities and equity 71 Section 22 – Liabilities and equity 72

• Treasury shares • Distributions to owners

– 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
– 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
Section 22 – Liabilities and equity 73 Questions or comments? 74

• 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
Expressions of individual views by members
of the IASB and its staff are encouraged.
The views expressed in this presentation are
those of the presenter.
Official positions of the IASB on accounting
matters are determined only after extensive
due process and deliberation.

– No adjustment of carrying amounts of assets

or goodwill
© 2010 IASC Foundation | 30 Cannon Street | London EC4M 6XH | UK | www.iasb.org

75

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+workshops.htm

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.
The IASC Foundation, the authors and the publishers do not
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