IAS 12 Income Taxes (Part B)

(Part B is to be read after Part A which is published earlier)

Temporary differences

1. Definition

Temporary differences are differences between carrying amount of an asset or liability in the balance sheet and its tax base. Temporary differences may be either:-

Ø Debit balance in the financial statements compared to the tax computations. These will lead to differed tax credit balances. These are known as “taxable temporary differences”.

Ø Credit balances in the financial statements compared to the tax computations. These will lead to deferred tax debit balances. These are known as “deductible temporary differences”.

2. Situations where temporary differences may arise

Ø When income or expenses is included in accounting profit in one period but included in the taxable profit in a different period.

Ø Finance leases recognize din accordance with the provisions of IAS 17 but which fall to be treated as operating leases under local tax legislation.

Ø Revaluation of assets where the tax authorities do not amend tax based when the asset is revalued.

Ø The tax base of an item differs from its initial carrying amounts. For example when an entity receives a non taxable government grant relating to assets.

Ø Cost of a business combination where the net assets are recognized at their fair values but the tax authorities do not allow adjustments.

Taxable temporary differences

Ø These will normally result in deferred tax liabilities

Exclusion of non-taxable items

Ø Unfortunately the definition of temporary differences captures other items that should not result in deferred taxation accounting. For example accruals for items which are not taxed or do not attract tax relief.

Ø The standard includes provisions to exclude such items. The wording of one such provisions is as follows:

“If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount.”

Ø The wording seems a little strange but the effect is to exclude such items from the deferred taxation calculations.

Recognition of deferred Tax Liabilities

The Rule

• A deferred tax liability should be recognized for all taxable temporary differences, under the deferred tax liability arises form:
• The initial recognition of goodwill; or
• Goodwill for which amortization is not deductible for tax purposes; or
• The initial recognition of an asset or liability in a transaction which:
• Is not a business combination; and
• At the time of the transaction, affects neither accounting profits nor taxable profit.

Discussion

All Taxable temporary differences

Ø The standard requires recognition of a deferred tax liability for all taxable temporary differences unless they are excluded by the paragraph above.

Goodwill foe which amortization id not deductible

Ø No deferred tax is recognized if goodwill is not tax deductible. This is consistent with the requirement in IAS 12 that there is no temporary difference – nor a resulting tax liability/asset – if an item is never taxable/deductible.

Ø Deferred tax would be recognized on any temporary difference arising if goodwill is tax deductible.

Initial recognition --- not a business combination

Ø If the initial recognition is a business combination deferred tax may arise

Affects neither accounting profit nor loss

Ø No deferred tax liability would be recognized if the item will not affect profits – it is irrelevant for tax purpose, as no tax will arise on this item.

Recognition of deferred tax assets

The rule

• A deferred tax asset should be recognized for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary differences can be utilized, unless the deferred tax asset arises from the initial recognition of an asset or liability in a transaction which:
• Is not in business combination; and
• At the time of transaction, affects neither accounting profit nor taxable profit (tax loss).
• A deferred tax asset will also be recognized for the carry forward of tax losses and tax credits to the extent that it is probable that future taxable profits will be available against which those losses and credit can be used.
• The carrying amount of a deferred tax asset should be revised at each balance sheet date. The carrying value of a deferred tax asset should be reduced to the extent that it is no longer probable that sufficient taxable profit will be available to utilize the asset.

Discussion

Ø General issues

o Most of the comments made in respect of deferred tax liabilities also apply to deferred tax assets.

o Major differences between the recognition of deferred tax assets and liabilities are in the use of the phrase “to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilized”.

o An asset should only be recognized when the entity expects to receive a benefit from its existence. The existence of deferred tax liability is strong evidence that the asset will be recoverable.

“Initial recognition of an asset or liability in a transaction that affects neither accounting nor tax profit”

Ø This is the same rule as for deferred tax liabilities.

Tax losses and credits

Ø A deferred tax asset will be recognized if the credits or losses can be used.

Measurement issues:-

1. Rates;
1. The tax rate should be used is the rate that is expected to apply to the period when the asset is realized or the liability is settled, based on tax rates that have been enacted by the balance sheet date.
2. The tax rate used should reflect the consequences of the manner in which the entity expects to recover or settle the carrying amount of its assets and liabilities.
2. Change in rates
1. Companies are required to disclose the amount of deferred taxation in the tax expense that relates to change in the tax rates.
3. Accounting for the movement on the deferred tax balance
1. Deferred tax should be recognized as income or an expense and included in the net profit or loss for the period, except to the extent that the tax arises from;

i. A transaction or event which is recognized, in the same or a different period directly in equity; or

ii. Or a business combination that is an acquisition.

2. Deferred tax should be charged or credited directly to equity if the tax relates to items that are credited to charge in the same or different period, directly to equity.

4, Presentation and disclosure

1. Deferred taxation presentation

Ø Tax assets and liabilities should be presented separately from other asset and liabilities in the balance sheet.

Ø Deferred tax asset and liabilities should be distinguished from current tax asset and liabilities.

Ø Offset asset and liabilities if – has a legal enforceable right to setoff the recognized amounts and intents either to settle on a net basis, or to realize the asset and settle the liability simultaneously.

Ø An entity should offset deferred tax asset and deferred tax liabilities if and only if;

o The entity has legal enforceable right to setoff current tax assets against current tax liabilities; and

o The deferred tax asset or deferred tax liability relate to income taxes levied by the same taxation authority on either;

§ The same taxable entity; or

§ Different taxable entities which intend rather to settle current tax liabilities and assets on a net basis, or to realize the asset and settle the liabilities simultaneously, in each future period in which significant amounts of deferred tax liabilities and assets are expected to settled or recovered.

Ø The tax expense related to (income) related to profit/loss from ordinary activities should be presented on the face of the income statement.

2. Deferred taxation—separate discloser

Ø The major components of tax expense/ income including:

o Current tax expense/income

o Adjustments in respect of prior period;

o Deferred tax expense/income;

o Deferred tax expenses/income arising due to change in tax rates;

o Due to change in policy or of a correction of fundamental error.

Ø The aggregate current and deferred tax relating to items that are charged or credited to equity.

Ø As explanation of the relationship between tax expense(income) and accounting profit in the form of a numerical reconciliation either between:

o Tax expense (income) and the product of accounting profit multiplied by the applicable tax rate & basis on which the rate is computed.

o The average effective tax rate and the applicable tax rate, disclosing also the basis on which the applicable tax rate is computed.

Ø An explanation of changes in applicable tax rates compared to the previous accounting period.

Ø The amount (and expiry date, if any) of deductible temporary differences, unused tax losses and unused tax credits for which no deferred tax asset is recognized in the balance sheet.

Ø The aggregate amount of temporary differences associated with investments in subsidiaries, branches and associates and interest in joint ventures.

Ø For each type of temporary difference and each type of unused tax losses and unused tax credit:

o The amount of deferred tax asset and liabilities recognized in the balance sheet for each period presented;

o The amount of deferred tax income or expense recognized in the income statement, if this is not apparent form the changes in the amounts recognized in the balance sheet.

Ø Gain or loss on discontinued operations also from ordinary activities of the discontinued operations for the period. Together with the corresponding amounts for each prior period presented.

Ø An entity should disclose the amount of deferred tax asset and the nature of the evidence supporting its recognition, when:

o The utilization of deferred tax asset is dependant of future taxable profits in excess of the profits arising from the reversal of existing taxable temporary differences and

o The entity has suffered a loss in either the current or preceding period in the tax jurisdiction to which the deferred tax asset relates.

IAS 12 Income Taxes (Part A)

Objective

To describe the rules for recognition and measurement of taxation

Scope

IAS 12 must be applied in accounting for all income taxes.

Income taxes include

• Domestic taxes on taxable profits;
• Foreign taxes on taxable profits, and
• Withholding taxes payable on distribution

Definitions

• Accounting profit is a net profit or loss for the period before deducting tax expenses.
• Tax profit is the profit (loss) for a period on which income taxes are payable( recoverable)
• Current Tax is the amount of income tax payable (recoverable) in respect of taxable profit (tax loss) for a period.
• Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary difference.
• Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of:
• Deductible temporary difference;
• The carry forward of unused tax losses and
• The carry forward of unused tax credit.

• The tax base of an asset or liability is the amount attributed tot hat asset or liability for tax purpose.
• Temporary differences are difference between the carrying amount of an asset or liability in the balance sheet and its tax base.

Current Tax

1. The tax payable to (or receivable from) the tax authorities in the jurisdiction in which an entity operates is accounted for according to the basic principle of accounting for liabilities and assets.

2. Current tax (for current and prior period) should, to the extent unpaid, be recognized as a liability.

3. If the amount already paid in respect of current and prior periods exceeds the amount due for those periods, the excess should be recognized as an asset.

4. The benefits relating to a tax loss that can be carried back to recover current tax of a previous period should be recognized as an assets.

Deferred taxation –an introduction

The underlying problem

· In most jurisdiction accounting profit and taxable profit differ, meaning that the tax change may bear little relation to profit in a period.

· Difference arises due to the fact that tax authorities follow rules that differ from IAS rules in arriving at taxable profit.

· Transactions, which are recognized in the accounts in a particular period, may have their tax effect deferred until a later period.

· It is convenient to envisage two desperate sets of accounts:

o One set constructed following IAS rules; and

o A second set following the tax rules of the jurisdiction in which the entity operates (the “tax computation”).

· The difference between the two sets of rules will result in different numbers in the financial statements and in the tax computations. These difference may be viewed from:

o A balance sheet perspective; or

o An income statement perspective.

· The current tax charge for the period will be based on the tax authorities view of the profits, not the accounting view. This will mean that the relationship between the accounting “profit before tax” and the tax charge will be the tax rate applied to the accounting profit figure but the tax rate applied to a tax composition figure.

· At each balance sheet date the deferred tax liability might be identified from a balance sheet or an income statement view.

· The balance sheet view identifies the deferred taxation balance that is required in the balance sheet whereas the income statement approach is identifies the deferred tax that arises during the period.

· IAS 12 takes the first approach called “valuation Adjustment approach” to full provisioning.

· The balance sheet approach calculates the liability (or more rarely the asset) that a company would need to set up on the face of its balance sheet.

· Application of the tax rate to the balance sheet difference will give the deferred tax balance sheet should be recognized in the balance sheet.

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• Accounting for the tax on the difference through the income statement restores the relationship that should exist between the accounting profit and the tax charge. It does this by taking a debit of a credit to the income statement. This then interacts with the current tax expense to give an over all figures that is the accounting profit multiplied by the tax rate.
• Accruals and provisions for taxation will impact on earning per share, net assets per share and gearing.

Tax bases

The tax base of an asset or liability is deferred as the amount attributed to that asset liability for tax purposes.
(continued in Part B)

IAS 7 Cash Flow Statement

Objective

To provide information about historical changes in cash and cash equivalents by means of cash flow statement, which classifies cash flows during the period from the operating, investing and financing activities.

Scope

A. Applies to all entities

• Users of financial statements are interested in cash generation regardless of the nature of the entity’s activities.
• Entities need cash for essentially the same reasons:
1. To conduct operations
2. To pay obligations
3. To provide returns to investors

• Profit is not as cash and profitability does not mean liquidity.

B. Importance of cash

• To show that profits are being realized
• To pay dividends
• To finance further investments

C. Benefits of cash flow information

• Provides information that enables users to evaluate changes in:

Ø net assets;

Ø financial structure

Ø ability to affect amounts and timing of cash flows

• Useful in assessing the ability to generate cash and cash equivalents.
• Users can develop models to assess and compare the present value of future cash flows of different entities.
• Enhances comparability of reporting operating performance by different entities.
• Historical cash flow information may provide an indicator of the amount, timing and certainty of future cash flows.

Definitions

Cash—cash on hand and demand deposits.

Cash equivalents-- short term, highly liquid investments:

• Readily convertible in known amount of cash;
• Subject to an insignificant risk of changes in value;
• Excluding equity investments unless they are, in substance, cash equivalents (e.g. preferred shares acquired within a short period of their maturity and a specified redemption date).

Cash flows—inflows and outflows of cash and cash equivalents.

Operating activities—principal revenue producing activities and other activities that are not investing or financing activities.

Investing activities—acquisition and disposal of long term assets and other investments not included in cash equivalents.

Financing activities—result in changes in the size and composition of equity capital and borrowings. Bank borrowings generally included.

Presentation of a cash flow statement

Classification:- IAS 7 requires cash inflows and outflows to be analyzed across three headings:

Operating

- Key indicators of sufficiency of cash flows to:

o repay loans;

o maintain operating capability;

o pay dividend;

o Make new investments.

Without recourse to external sources of finance

- Useful in forecasting future operating cash flows.

- Primarily derived from principal revenue-producing activities.

- Generally results from transactions and events so included in net profit or loss.

Investing

- Separate disclosure is important – cash flows represent extent to which expenditures have been made for resources intended to generate future income and cash flows

Financing

Separate disclosure is useful in predicting claims on future cash flows by providers of capital

Reporting cash flows from operating activities

There are two ways permitted to present cash flows from ordinary activities:

Direct Method

- Disclosure major classes of gross cash payments.

- Information obtained either from accounting records; or

- By adjusting sales, cost of sales for:

o Changes during period in inventories and operating receivable and payables:

o Other non-cash items:

o Other items for which cash effects are investing/ financing cash flows.

Indirect Method

- Adjusts net profit or loss for effects of:

o Non-cash transactions (e.g. depreciation);

o Any deferrals or accruals of past or future operating cash receipts or payments;

o Items of income or expense associated with investing or financing cash flows.

Techniques

Direct method:-

Step 1: Cash receipts from customers

Less: cash paid to suppliers and employees

= Cash generated from operations

Step 2: Payments for interest and income taxes

= net cash from operating activities

Indirect method:-

Step I (i) Profit before tax

Step (ii) Adjust for non-cash items and investing and financing accounted for on the accruals basis.

= Operating profit before working capital changes

Step (iii) Making working capital changes

=cash generated from operations (same as figure calculated under direct method).

Indirect Method is much more widely used in the practice.

Reporting cash flow from investing and financing activities

Separate reporting

· Major classes of gross cash receipts and gross cash payments arising from investing and financing activities should be reported separately.

Investing activities

· Purchase of property plant and equipment –this must represent actual amounts paid.

· Proceeds from sales of tangible assets.

Financing activities

· Again the approach is to reconcile balance sheet moments to identify the cash element.

Components of cash and cash equivalents

Reconciliation

· Disclose components of cash and cash equivalents and present a reconciliation of amounts in cash flow statements with equivalent items reported in balance sheet (if necessary, in a note to the cash flow statement).

Proforma of

Direct method (mostly in use)

Cash flows from operating activities

Cash receipts from customers X

Cash paid to suppliers and employees (X)

----

Cash generated from operations X

Interest paid (X)

Income Taxes paid (X)

----

Net cash flow from operating activities X

Purchase of property, plant and equipment (X)

Proceeds from sale of equipment X

Interests received X

Dividends received X

----

Net cash used in investing activities X

Cash flows from financing activities

Proceeds from issuance of share capital X

Dividends received X

----

Net cash used in financing activities X

-----

Net increase in cash and cash equivalents X

Cash and cash equivalents at beginning of period X

-----

Cash and cash equivalents at the end of period X

-----

Indirect Method

Cash flows from operating activities

Net profit before taxation

Adjusted for

Depreciation

minus Investment Income

Plus Interest expenses

Operating profit before working capital changes

Minus Increase in trade and other receivables

Plus Decrease in inventories

Minus Decrease in trade payables

Cash generated from operations

Note to Cash Flow Statement

Cash & cash equivalents: cash on hand and balances with banks

Short term investments

Additional Disclosures

· There are a number of extra disclosures which should be made in most cases to support the main cash flow statement:

o Analysis of cash & cash equivalents

o Major non cash transactions;

o Cash and cash equivalents held by the groups

o Reporting futures, options and swaps;

Voluntary disclosers.

IFRS 7: Financial Instruments: Disclosure

(The recognition & measurement and presentation is discussed in earlier post)

IFRS 7: Financial Instruments: Disclosure

Application

• Disclosure if:
• Factors affecting the amount, timing and certainty of cash flows;
• The use of financial instruments and the business purpose they serve
• The associated risks and management’s policies for controlling those risks.

Scope

This standard should be applied in presenting and disclosing information about all types of financial instruments; both recognized and unrecognized, except for financial instruments that are dealt with by other standards, i.e.

• Interests in subsidiaries, associates, and joint ventures accounted for under IAS 27, IAS 28 and IAS 31 respectively;
• Contracts for contingent consideration in a business combination under IFRS 3 (only applies to the acquirer);
• Employer’s rights and obligations under employee benefit plans, to which IAS 19 applies;
• Certain insurance contracts accounted for under IFRS 4; and

Financial instruments, contracts and obligation under share-based payment transactions to which IFRS 2 applies (unless relating to treasury shares).

Disclosure

1. Rules

• The purpose of the disclosure is to:
• Enhance understanding of the significance of financial instruments to an entity’s financial position, performance and cash flows:
• Assist in assessing the factors affecting the amount, timing and certainity of future cash flows associated with those instruments; and
• Provide information to assist users of financial statements in assessing the extent of related risks.
• Financial instruments are grouped into classes that are appropriate to the nature of information disclosed.
• Information sufficient to allow reconciliation to the line items in the balance sheet must be provided.
• The information disclosed should be facilitates users evaluating the significance of financial instruments on an entity’s financial position and performance.

2. Balance Sheet

A. Categories of financial assets and liabilities

• An entity must disclose the carrying amounts analyzed into the following categories:
• Financial assets at fair value through profit and loss, showing separately:
• Those designed on initial recognition, and
• Those classed as held for trading;
• Held to maturity investments;
• Loans and receivables;
• Available-for-sale financial assets;
• Financial liability at fair value through profit and loss, showing separately
• Those designed on initial recognition; and
• Those classes as held for trading;
• Financial liabilities measured at amortized cost.
• Disclosure may be on the face of the balance sheet or within the notes.

B. Financial assets or liabilities at fair vale through profit and loss

• If a loan or receivable is designed at fair vale through profit or loss, an entity must disclose:
• The maximum exposure to credit risk;
• The extent of any related credit derivatives that may mitigate the exposure to credit risk and their change in fair value;
• The amount of change, both in the period and cumulatively, in fair value of the instrument that is attributable to changes in credit risk.
• If a financial liability is designated at fair value through profit or loss, an entity must disclose:
• The amount of change, both in the period and cumulatively, in the fair value of the instrument that is attributable to any change in credit risk;
• The difference between the carrying amount of the instrument and the amount contractually required to settle the instrument at maturity.

C. Derecognition

• If an entity transfers financial assets that do not meet the derecognition criteria, partially or wholly, it must disclose:
• The nature of the assets;
• Any risks and rewards to which the entity is still exposed;
• The carrying amount of the asset and any associated liability that remains wholly or partially recognized; and
• For those assets that are partially derecognized. The carrying amount of the original asset.

D. Collateral

· An entity must disclose:

o The carrying amount of financial assets pledged as collateral for liabilities and

o The terms and conditions of the pledge.

E. Allowances

Impairment of financial assets that are accounted for by recording the loss in separate account, rather than against the asset, will require an entity to disclose a reconciliation of the movement in the account for the period.

F. Defaults and breaches

For all loans payable, an entity discloses:

· Details of any defaults in the period;

· The carrying amount of loans in default; and

· Whether the default was remedied or the terms of the loan renegotiated.

IAS 32:Financial Instrument: Presentation

IAS 32: Financial Instruments: Presentation

(The recognition and measurement and disclosure is discussed the earlier post)

Application

• Classification of financial instruments between:
• Financial assets;
• Financial liabilities; and
• Equity instruments.
• Presentation and effect of financial instruments and the related interest, dividends, losses and gains.
• Disclosure of:
• Factors affecting the amount, timing and certainty of cash flows;
• The use of financial instruments and the business purpose they serve; and
• The associated risks and management’s policies for controlling those risks.

Scope

• This standard should be applied in presenting and disclosing information about all types of financial instrument, both recognized and unrecognized, except for financial instrument that are dealt with by other standards, i.e.
• Interest in subsidiaries, associates, and joint ventures accounted for under IAS 21, IAS 28 and IAS 31 respectively;
• Contracts for contingent consideration in a business combination under IFRS 3 (only applies to the acquirer );
• Employers’ rights and obligations under employee benefit plans, to which IAS 18 applies;
• Certain insurance contracts accounted for under IFRS 4; and
• Financial instruments, contracts and obligations under share-based payment transactions to which IFRS 2 applies (unless relating to treasury shares).

Definitions

1. A financial asset is any asset that is:
1. Cash;
2. A contractual right to receive cash or another financial asset from another entity;
3. A contractual right to exchange financial instrument with another entity under conditions that are potentially favorable;
4. An equity instrument of another entity; or
5. Certain contracts that will (or may) be settled in the entity’s own equity instruments.
2. A financial liability is any liability that is a contractual obligation:
1. To deliver cash or another financial asset to another entity;
2. To exchange financial instrument with another entity under conditions that are potentially unfavorable; or
3. Certain contracts that will (or may) be settled in the entity’s own equity instruments.
3. An equity instrument is any contract that evidences a residual interest in the asset of an entity after deducting all of its liabilities.
4. Fair Value is the amount for which an asst could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.

Presentation

Liability and equity

• On issue, financial instruments should be classified as liability or equity in accordance with the substances of the contractual arrangement on initial recognition.
• Some financial instruments may take the legal form of equity, but are in substance liabilities.
• An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.

Settlement in own equity instruments

• A contract is not an equity instrument solely because it may result in the receipt or delivery of the entity’s own equity instruments.
• A financial liability will arise when:
• There is a contractual obligation to deliver cash or another financial asset, to exchange financial assets or financial liabilities under conditions that are potentially unfavorable to the issuer:
• There is a non derivative contract to deliver or to be required to deliver, a variable number of own equity instruments,
• There is a derivative that will or may be settled other then by issuing a fixed number of on equity instruments.
• An equity instrument will arise when:
• There is a non derivative contract to deliver, or be required to deliver a fixed number of own equity instruments.
• There is a derivative that will or may be settled other than by issuing a fixed number of own equity instruments.

Offset

• Financial assets or liabilities must be offset where the entity:
• Has a legal right offset; and
• Intends to settle on a net basis or to realize the asset and settle the liability simultaneously.

Interest, dividends, losses and gains

• Interest, dividends, losses and gains relating to financial instrument (or a component) that is classified as a liability, shall be recognized in the profit or loss as income or expense.
• Dividend on preference shares classified as financial liability are accounted foe as an expenses rather than as distributions of profit.
• Distribution to holder of equity instrument should be debited directly to equity.
• Gains or losses on refinancing or redemption of a financial instrument are classified as income/expense or equity according to the classification of the instrument.
• Transaction cost relating to the issue of a compound financial instrument are allocated to the liability and equity components in proportion to the allocation of proceeds.

Compound instruments

Presentation

• Financial instrument that contain both a liability and an equity element are classified into separate component parts.
• As an example convertible bonds are primary financial liabilities of the issuer which grant an option to the holder to convert them into equity instruments in the future. Such bonds consist of:
• The obligation to repay the bonds, which should be presented as a liability: and
• The option to convert, which should be presented in equity.

Carrying amounts

• The equity component I the residual amount after deduction of the more easily measurable debt component from the value of the instrument as a whole.

Contingent settlement provisions

• An entity may issue a financial instrument where the rights and obligations regarding the manner of settlement depend on the outcome of uncertain future events that are beyond the control of both the issuer and the holder of the instrument.
• As the issuer of the instrument does not have the unconditional right to avoid delivering cash or another financial asset, the instrument shall be classified as financial liability.

Treasury shares

• If an entity acquires its own equity instrument, those instruments (‘’treasury shares’’) are deducted form equity.
• No gain or loss is recognized in profit or loss on the purchase, sale, issue or cancellation of an entity’s own equity instruments.
• Such treasury shares may be acquired and held by the entity or by other members of the consolidated group.
• Consideration paid or received is recognized directly in equity.
• The amount of treasury shares held is disclosed separately either on the face of the balance sheet or in the notes, in accordance with IAS 1.

Financial Instrument:IAS 32, 39 & IFRS 7

‘Financial Instrument’

• IAS 39: Recognition and Measurement
• IAS 32 Presentation-discussed in another post
• IFRS 7: Disclosure- discussed in another post

IAS 39: Financial Instruments: Recognition and Measurement

Application

1. Recognition, derecognition and classification of financial assets and financial liabilities.
2. Initial measurement and subsequent measurement of financial assets and financial liabilities.
3. Definition of hedge accounting.
4. criteria and rules for hedge accounting.

Scope

1. This standard should be applied by all entities to the recognition and measurement of all financial instruments except for financial instruments that are dealt with by other standards, i.e.

a. interests in subsidiaries, associates, and joint ventures that are accounted for under IAS 27, IAS 28 and IAS 31 respectively;

This standard does not change the requirements relating to accounting by a parent for investments in subsidiaries, associates or joint ventures in the parent’s separate financial statements as set out in IAS 27, 28 and 31.

o Rights and obligations under leases, to which IAS 17 applies;

o Employers’ assets and liabilities under employee benefit plans, to which IAS 19 applies;

o Financial instruments issued by the entity that meet the definition of an equity instrument (IAS 32) including options and warrant;

However, the holder of such equity instruments applies IAS 39 to those instruments, unless they meet the exception relating to IAS 27, IAS 28 or IAS 31.

• Contracts for contingent consideration in a business combination under IFRS 3 (only applies to acquirer);
• Contracts between an acquirer and a vendor in a business combination to buy or sell an acquire at a future date; and
• Financial instruments, contracts and obligation under share-based payment transaction to which IFRS 2 applies.

Definition

Derivatives

A derivative is a financial instrument:

· Whose value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices, or rates, credit rating or credit index, or other variable (sometimes called the “underlying”);

· That requires little or no initial investment relative to other types of contracts that would be expected to have a similar response to changes in market conditions and

· that is settled at a future date.

Categories of financial assets

1) A financial asset or financial liability at “fair value through profit or loss” is a financial asset or financial liability that is either:

a) Classified as held for trading: or

b) Designed initially at fair value through profit or loss.

2) Held-to maturity investments are non derivative financial assets with fixed or determinable payments and fixed maturity that an entity has the positive intent and ability to hold to maturity other than those:

a) Designed as at fair value through profit or loss on initial recognition:

b) Designed as available for sale; or

c) Meeting the definition of loans and receivables.

3) Loans and Receivables are non derivative financial assets with fixed or determinable payments that are not quoted in an active market, other than those:

a) Intended for immediate sale (classified as held for trading);

b) Designed initially as fair value through profit or loss or available for sale; or

c) Where repayment of the initial loan is in doubt (other than where there is a fall in credit rating), in which case they will be classed as available for sale.

d) Available-for-sale financial assets are those non-derivative financial assets that are designed available-for-sale or are not classified as:

i) Loans and receivables;

ii) Held to maturity investments; or

iii) Financial assets at fair value through profit or loss.

Recognition and measurement

• Amortized cost of financial assets or financial liability is:
• The amount at which it was measured at initial recognition;

Minus

• Principal repayments

Plus or minus

• The cumulative amortization of any difference between that initial amount and the maturity amount; and

Minus

• Any write down (directly or through the use of an allowance account) for impairment or uncollectability.
• The effective interest method is a method of calculating the amortized cost of a financial asset or a financial liability, using the effective interest rate and of allocating the interest.
• The effective interest rate that exactly discounts estimated future cash payments or receipts through the expected useful life of the financial instrument to the net carrying amount of the asset (or financial liability). The computation includes all cash flows ( e.g. fees, transactions cost, premiums or discounts) between the parties to the contract.
• Transaction costs are incremental costs that are directly attributable to the acquisition, issue of disposal of a financial asset (or financial liability).