Financial Instruments

Transcription

1 LESSON 2 Financial Instruments 1 Outline 1. Concept. 2. Classification of financial assets and its accounting treatment. 3. Classification of financial liabilities and its accounting treatment. 2 1

2 Financial instruments P.G.C. Recognition and valuation standard no. 9: Concept Recognition 3 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. 4 2

3 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. 5 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; 6 3

4 Financial assets of the company Equity and Financial liabilities of other company Cash Trade receivables Non-trade receivables Debt instruments Equity instruments Trade payables Non-trade payables & debts Debt instruments issued Capital stock 7 Financial assets It will also be classified as financial asset a contract that will or may be settled in the entity 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 s own equity instruments A derivative that will or may be settled other than by exchange of a fixed amount of cash or another financial asset for a fixed number of the entity s own equity instruments. 8 4

5 Format of the Balance Sheet in P.G.C. Normal model: ASSETS LIABILITIES A) Non-current assets A) Equity B) Non-current liabilities B) Current assets C) Current liabilities 9 Financial assets Financial assets shown in the balance sheet include: Cash and cash equivalents Loans 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 10 5

6 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. 11 Financial assets of other company Financial liabilities of company Cash Trade receivables Non-trade receivables Trade payables Non-trade payables & debts Debt instruments Debt instruments issued Equity instruments 12 6

7 Financial liabilities Financial liabilities shown in the balance sheet include: 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 13 Equity instruments An equity instrument is any financial instrument that is: Included in Equity. For example: the ordinary shares issued by the company. 14 7

8 Financial assets of other company Equity of the company Cash Capital stock Trade receivables Non-trade receivables Debt instruments Equity instruments 15 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 16 8

9 Financial assets - 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, jointventures and associated companies; (6) available-for-sale financial assets. 17 Financial assets - (1) loans & receivables (2) held-to-maturity investments (3) held for trading investments (6) available-for-sale financial assets (5) Investments in equity of subsidiaries, joint-ventures & associated companies Trade and non-trade loan and receivables Negotiable securities, representative of debts, that are expected to be held until the reimbursement date Negotiable securities acquired to be sold in the short term Negotiable securities that can be sold, but there is no intention at the moment Investments in equity of other companies with the intention of gaining control 18 9

10 Financial assets - (1) loans & receivables (2) held-to-maturity investments (3) held for trading investments (6) available-for-sale financial assets (5) Investments in equity of subsidiaries, joint-ventures & associated companies Trade and non-trade loan and receivables Negotiable securities, representative of debts, that are expected to be held until the reimbursement date Negotiable securities acquired to be sold in the short term Negotiable securities that can be sold, but there is no intention at the moment Investments in equity of other companies with the intention of gaining control It is important to know: - their COST - the AMOUNT that is expected to BE COLLECTED It is important to know: - their FAIR VALUE, since they are going to be sold or can be sold It is enough to know their COST 19 Financial assets - (1) loans & receivables (2) held-to-maturity investments Trade and non-trade loan and receivables Negotiable securities, representative of debts, that are expected to be held until the reimbursement date 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 20 10

11 Financial assets - 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. 21 Financial assets - 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

12 Financial assets - Loans and receivables Example: 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, Financial assets - Loans and receivables Example: Credit from the sale of tangible fixed assets 2/1/08 31/12/08 31/12/09 Selling price: 10,000 Cash Collection: 12,000 Interest revenue: 2,000 Implicit 24 12

13 Financial assets - Loans and receivables Example: Credit from the sale of tangible fixed assets Initial valuation: Fair value (price of transaction) + transaction costs = 10,000 10,000 (253) Long-term credit from the sale of tangible fixed assets to (218) Vehicles 24,000 16,000 1,600 (281) Tangible fixed assets accumulated depreciation (57) Cash (771) Profits from disposal of tangible fixed assets (477) V.A.T. collected 2,000 1, Financial assets - Loans and receivables Example: Credit from the sale of tangible fixed assets 2/1/08 31/12/08 31/12/09 Long term credit: 10,000 1,000 1,000 Long-term credit: 12,000 Interest revenue: 2,

14 Financial assets - Loans and receivables Example: Credit from the sale of tangible fixed assets 31/12/2008: Subsequent valuation: amortized cost using the effective interest method 12,000 Effective interest rate: 10,000 = 2 (1 + i) Effective interest rate: i = 9.545% 27 Financial assets - Long term credit: 10,000 Loans and receivables Example: Credit from the sale of tangible fixed assets 2/1/08 31/12/08 31/12/09 10,000 * = Long-term credit: 10, ,945.5 * = 1,045.6 Long-term credit: 12,000 Amortized cost Total interest = ,045.6 = 2,

15 Financial assets - Loans and receivables Example: Credit from the sale of tangible fixed assets Subsequent valuation: Amortized cost Value at initial recognition 10,000 (+) interest (-) principal repayments 0 Amortized cost 10, , ,045.6 (12,000) 0 12, Financial assets - Loans and receivables Example: Credit from the sale of tangible fixed assets Subsequent valuation: Amortized cost 31/12/2008: (253) Long-term credit from the sale of tangible fixed assets to (762) Revenues of credits

16 Financial assets - Loans and receivables Example: Credit from the sale of tangible fixed assets 31/12/2009: 1,045.6 (253) Long-term credit from the sale of tangible fixed assets to (762) Revenues of credits 1, ,000 (57) Cash to (253) Long-term credit from the sale of tangible fixed assets 12, Financial assets- 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 32 16

17 Financial assets- 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). 33 Financial assets- 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

18 Financial assets- 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, Financial assets- 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,

19 Financial assets- Bonds and debentures- Example: Financial assets- Held-to-maturity investments Example: Bonds and debentures Bond Issuing value: 1,000 Maturity: in 3 years time Reimbursement value: 1,500 Interest: 0% 38 19

20 Financial assets - Held-to-maturity investments Example: Bonds and debentures 1/1/Y1 31/12/Y1 31/12/Y2 31/12/Y3 Issuing value: 1,000 Reimbursement value: 1,500 Implicit interest: Financial assets - Held-to-maturity investments Example: Bonds and debentures Initial valuation: Fair value (price of transaction) + transaction costs = 1,000 1,000 (251) Long-term debt instruments to (57) Cash 1,

21 Financial assets - Held-to-maturity investments Example: Bonds and debentures 31/12/Y1: Subsequent valuation: amortized cost using the effective interest method 1,500 Effective interest rate: 1,000 = 3 (1 + i) Effective interest rate: i = 14.47% 41 Issuing value: 1,000 Financial assets - Held-to-maturity investments Example: Bonds and debentures 1/1/Y1 31/12/Y1 31/12/Y2 31/12/Y3 1,000 * = , * = , * = Reimbursement value: 1,500 Amortized cost: 1, Amortized cost: 1, Total interest = =

22 Financial assets - Held-to-maturity investments Example: Bonds and debentures Subsequent valuation: Amortized cost Value at initial recognition (+) interest (-) principal repayments Amortized cost 1, , , , , (1,500) 0 1, Financial assets - Held-to-maturity investments Example: Bonds and debentures Subsequent valuation: Amortized cost 31/12/Y1: (251) Long-term debt instruments to (761) Revenues of debt instruments /12/Y2: (251) Long-term debt instruments to (761) Revenues of debt instruments

23 Financial assets - Held-to-maturity investments Example: Bonds and debentures 31/12/Y3: (251) Long-term debt instruments to (761) Revenues of debt instruments ,500 (57) Cash to (251) Long-term debt instruments 1,