AdvancedFinancial Accounting l l
An IFRS® Standards Approach, 3e Pearl T
l l l l l l
an, Chu Yeong Lim and Ee Wen Kuah
l l l l l l l
Solutions Manual l
Chapter9 l
Financial Instruments: Classification, Recognition and M
l l l l l
easurement
Copyright © 2016 by McGraw-Hill Education (Asia)
l l l l l l
,AdvancedlFinanciallAccountingl(Tan,lLimlandlKuah)lC
hapterl9lsolutions
CHAPTER 9
l
CONCEPTlQUESTIONS
1 Almandatorilylredeemablelpreferencelsharesl(MRPS)lislalpreferencelshareslwithlthelfollo
winglfeatures:
• carrieslalfixedlorldeterminablelredemptionldate
• conditionslforlredemptionlarelnotlsolelylwithinlthelcontrolloflthelissuer.
AlthoughlthelformloflalMRPSlislthatloflalpreferencelsharel(equity),lthelsubstanceloflthelins
trumentlislthatloflalliability.lUnderlIASl32,lalMRPSlisltreatedlaslalfinanciallliabilitylandlnotl
aslanlequitylinstrument.
2 Alcompoundlfinanciallinstrumentlislalfinanciallinstrumentlwithlaldebtlcomponentlandlanle
quitylcomponent.
3 UnderlIASl32,ltheldebtlcomponentlandlthelequitylcomponentloflalcompoundlfinanciallinstr
umentlarelrequiredltolbelseparatelylrecognizedlinlthelfinanciallstatements.lThelrationalelfo
rlsplittinglofltheldebtlcomponentlfromlthelequitylcomponentlislthatlitlprovideslrelevantlinf
ormationltoluserslandlreflectsltheleffectivelborrowinglcostsloflthelissuer.
4 Theldebtlcomponentlisldeterminedlfirstlbylcalculatinglthelpresentlvalueloflcashlflowsloflth
eldebtlandlthelequitylcomponentlisldeterminedlbyldeductinglthelfairlvaluelofltheldebtlcomp
onentlfromlthelproceedsloflthelissue.
5 Financiallassetslarelcategorizedlintolfourlcategories:
(a) fairlvaluelthroughlprofitlorlloss
(b) held-to-maturity
(c) available-for-sale
(d) loanslandlreceivables
Financiallliabilitieslarelcategorizedlinto:
(a) fairlvaluelthroughlprofitlorlloss
(b) otherlfinanciallliabilities
6 Changeslinlthelfairlvalueloflfinanciallassetslclassifiedlaslfairlvaluelthroughlprofitlorllosslare
ltakenltolincomelstatementlwhereaslchangeslinlthelfairlvalueloflavailable-for-
lsalelfinanciallassetslareltakenltolequityluntilltheylareldisposedlof.lFinanciallassetslclassifie
dlaslfairlvaluelthroughlprofitlorllosslarelshort-
termlassetslheldlforltradinglorloperationlpurposes.lTherefore,litlislappropriatelthatlchangesl
inltheirlfairlvaluelareltakenltolthelincomelstatement.lAvailable-for-
salel(AFS)lfinanciallassetslarelpresumedltolbelheldlindefinitely.lByltakinglchangeslinlthelf
airlvalueloflAFSltolequity,lvolatilitylinlreportedlearningslislreduced.
7 Sincelthelintentionlisltolholdlthelfinanciallassetltolmaturity,lchangeslinlthelfairlvalueloflthel
assetlarelnotlrelevantltolthelholders.
8 Pros:
* consistentlaccountingltreatmentlforlalllfinanciallinstruments
* complexitiesloflhedgelaccountinglarelavoided.lC
ons
* fairlvalueldoeslnotlprovidelrelevantlinformationlforlcertainlfinancial
2
2016l©lAlllrightslreserved,lMcGraw-
HilllEducationl(Asia)l StrictlylForlInstructorslUselOnly
NolFurtherlDistributionlOrlReproductionlPermitted
, AdvancedlFinanciallAccounting
Chapterl9lsolutions
instrumentslthatlarelintendedltolbelheldltolmaturity.
* determininglfairlvaluelforlalllfinanciallinstrumentslcouldlbelcostly.
9
(a) No.lThelavailabilityltolthelholderlofltheloptionltolconvertlislinconsistentlwithlthelpr
esumedlintentionloflholdingltolmaturity.
(b) Yes.lThelcallloptionltolthelissuer,liflexercised,lmerelylalterslthelmat
urityldateloflthelinstrument.
(c) No.l Holdingl forl anl indefinitel periodl doesl notl demonstratel intentl tol holdl tolmat
urity.
(d) No.lReitslarelnotldebtlinstruments.
10
(a) Yes.
(b) No.lThelsalelisleffectedlverylnearltoltheldateloflmaturity.
(c) No.lTheldisposelwaslinlresponseltolalsignificantldeteriorationlinlt
helcreditlworthinessloflthelissuer.
(d) Yes;lotherlsecuritieslinlthelportfoliolarelsimilarlyl‘tainted’.
(e) Yes,latlthelgroupllevel.
11
(a) ThelimplementationloflIASl32lcouldlbelcostlylinlthelfollowinglways:
1) IASl32lrequireslrecognitionloflbothldebtlandlequitylcomponents.lTheldebtlcomponentl
usuallylgiveslriseltolaldiscountlonlthelbondlwhichlhasltolbelamortiselusingltheleffectivel
interestlratelmethod.lThelamortizationloflbondldiscountlresultslinlhigherlfinancinglexp
enseslcomparedltolpre-
IASl32lsituationlandlresultslinl lowerlearningslreported.lThislmaylaffectlthelpriceloflthe
lfirm’slshares.
2) Costloflcompoundlfinanciallinstrumentlislhigherlthanlthelcostlofldebt.lThislmaylraiselt
heldiscountlratelforlthelfirmlandlaffectlthelvaluationloflthelfirmlifltheldiscountedlcashlfl
owlmethodlislused.
3) Directlcostsloflaccountinglforlcompoundlfinanciallinstrumentslwilllalsolincreasel–
lthelneedltolpreparelamortizationlschedule,ldetermineltheleffectivelcostlofldebt,letc.
(b) Inlwhatlwayslmaylthelimplementationlbelbeneficiallforlusersloflfin
anciallstatements?
ImplementationloflIASl32lmaylbenefitlbothlinformed/sophisticatedluserslasl uninformed/naïvelus
ers.lWithoutlIASl32lsophisticatedlinvestors/userslwouldlprobablylbel ableltoldetermineltheltruelorl
effectivelborrowinglcostloflthelfirmlalthoughltheylmaylhaveltolincurlcostsltolsearchlforlthelinforma
tion.lWithlIASl32lthisl‘searching’lcostslislsaved.lNaïvel orluninformedluserslwilllbenefitlfromldisc
losurelofltheltruelorleffectivelcostloflfinancinglwithoutlhavingltolincurlcost.
ThelfirmlandlitslshareholderslwouldlprobablylbenefitlfromlIASl32laslitslimplementationlmaylforce
lmanagementltoluselalhigherldiscountlratel(reflectivelofltheltruelcostloflcapital)ltolevaluatelnewlpro
jects.
3
2016l©lAlllrightslreserved,lMcGraw-HilllEducationl(Asia)
StrictlylForlInstructorslUselOnlyl
NolFurtherlDistributionlOrlReproductionlPermitted
, AdvancedlFinanciallAccountingl(Tan,lLimlandlKuah)lC
hapterl9lsolutions
(c) WhylislthelFASB’slstandlalcontroversiallissue?
ThelFASB’slstandlislnotltolrecognizelthelseparateldebtlandlequitylcomponentslinlcompoundlfinan
ciallinstruments.lThislstandlimplicitlylignoreslthelprincipalloflsubstanceloverlform.lFASB’slargu
mentslforlnon-
splittingloflCFIslarelthatltheltwolinstrumentslarelinseparablelandlthelestimationloflthelcostlofltheleq
uitylcomponentlmaylbelunreliable.
12. IASl39l–lHeld-to-maturityl(HTM),lAvailablelforlsalel(AFS),lFVTPL
Inltermsloflmeasurementlmethods,lthelthreelcategoriesloflIFRSl9lcorrespondltolIASl39laslfollows:lI
FRSl9lamortizedlcostlcategorylcorrespondsltolIASl39lHTMlcategory,lIFRSl9lFVTOCIl(Fairlvaluelt
olOCI)lcategorylcorrespondsltolIASl39lAFSlcategory,lIFRSl9lFVTPLlcategorylcorrespondsltolIASl
39lFVTPLlcategory.
Thelkeyldifferencesllielinlhowlfinanciallassetslarelclassifiedlinlthelthreelcategories.lIFRSl9lrequir
eslbusinesslmodellandlcontractuallcashlflowltestsltolbelsatisfiedlforlaldebtlsecurityltolbelclassifiedl
aslamortizedlcost.lIfltheldebtlsecuritylislheldlforlsale,litlislclassifiedlinlFVTPLlcategory.lIfltheldebtl
securitylislheldltolcollectlcontractuallcashlflowslandlforlsale,litlislclassifiedlinlFVTOCIlcategory.l
EquitylsecuritylcanlbelclassifiedlasleitherlFVTOCIl(iflitlislnotlheldlforltrading)lorlFVTPLlbutlnotla
mortizedlcost.
13. Therelhavelbeenlcriticismslthatlthelincurredlloanllosslprovisioninglmethodltendsltoldelayllossl
recognition.lThelcriticismslbecamelsharperlduringlthelfinanciallcrisis.lThelexpectedlloanllosslpro
visioninglmethodlislaimedlatladdressinglthislconcern,landltolrecognizelloanlprovisionslonlaltimel
ylbasis.
However,ltheldownsideloflthelexpectedlloanlprovisionslmethodlislthatlthelloanlprovisionslarelmor
elsubjectivelandlcouldlbelmanagedlbylbanklmanagers.lThusltheladvantageloflthelincurredlloanlpro
visionslmethodlislthatlitlislmorelobjectivelandllesslsubjectltolearningslmanagement.
14. Thelthreelcategorieslare:
(i) Financiallinstrumentslthatlhavelnotldeterioratedlsignificantlylinlcreditlqualitylfromlinitiallrec
ognitionltolreportingldate,
(ii) Financiallinstrumentslwithlsignificantldeteriorationlinlcreditlqualitylfromlinitiallrec
ognitionltolreportingldate,
(iii) Objectivelevidenceloflimpairment.
Keylfactorslinldetermininglexpectedlcreditllosses:
Changelinlprobabilityloflcreditldefaultlfromlinitiallrecognitionltolreportingldatelandllosslrecovery.lT
helprobabilityloflcreditldefaultlisldeterminedlfromlcreditlrisklprofiles,lcreditlrisklratings,landlrisklcha
racteristicsloflborrowerlincludinglitslfinanciallhealth.lLosslrecoverylislaffectedlbylcollateralslandlgu
aranteeslthatlborrowerlhaslobtained.
15. Inlalsecuritizationlprocess,ltheloriginatorslplaceltheirlassetslinlalsecuritizationlentity.lThellatte
rlsellslthelsecuritizedlassetslinltranchesltolinvestors,lwholprovidelfinancingltolthelsecuritizationle
ntity.lOnelkeylobjectiveloflsecuritizationlislforloriginatorsltolfreeluplassetslfromltheirlbooks.
16. Yes,lthelmortgagelbackedlsecuritylislalcontractuallyllinkedlfinanciallinstrument.lThelmortg
agelbackedlsecurityltranchesloriginatelfromlmortgagelloanslwhichlarelcontractuallcash
4
2016l©lAlllrightslreserved,lMcGraw-
HilllEducationl(Asia)l StrictlylForlInstructorslUselOnly
NolFurtherlDistributionlOrlReproductionlPermitted
An IFRS® Standards Approach, 3e Pearl T
l l l l l l
an, Chu Yeong Lim and Ee Wen Kuah
l l l l l l l
Solutions Manual l
Chapter9 l
Financial Instruments: Classification, Recognition and M
l l l l l
easurement
Copyright © 2016 by McGraw-Hill Education (Asia)
l l l l l l
,AdvancedlFinanciallAccountingl(Tan,lLimlandlKuah)lC
hapterl9lsolutions
CHAPTER 9
l
CONCEPTlQUESTIONS
1 Almandatorilylredeemablelpreferencelsharesl(MRPS)lislalpreferencelshareslwithlthelfollo
winglfeatures:
• carrieslalfixedlorldeterminablelredemptionldate
• conditionslforlredemptionlarelnotlsolelylwithinlthelcontrolloflthelissuer.
AlthoughlthelformloflalMRPSlislthatloflalpreferencelsharel(equity),lthelsubstanceloflthelins
trumentlislthatloflalliability.lUnderlIASl32,lalMRPSlisltreatedlaslalfinanciallliabilitylandlnotl
aslanlequitylinstrument.
2 Alcompoundlfinanciallinstrumentlislalfinanciallinstrumentlwithlaldebtlcomponentlandlanle
quitylcomponent.
3 UnderlIASl32,ltheldebtlcomponentlandlthelequitylcomponentloflalcompoundlfinanciallinstr
umentlarelrequiredltolbelseparatelylrecognizedlinlthelfinanciallstatements.lThelrationalelfo
rlsplittinglofltheldebtlcomponentlfromlthelequitylcomponentlislthatlitlprovideslrelevantlinf
ormationltoluserslandlreflectsltheleffectivelborrowinglcostsloflthelissuer.
4 Theldebtlcomponentlisldeterminedlfirstlbylcalculatinglthelpresentlvalueloflcashlflowsloflth
eldebtlandlthelequitylcomponentlisldeterminedlbyldeductinglthelfairlvaluelofltheldebtlcomp
onentlfromlthelproceedsloflthelissue.
5 Financiallassetslarelcategorizedlintolfourlcategories:
(a) fairlvaluelthroughlprofitlorlloss
(b) held-to-maturity
(c) available-for-sale
(d) loanslandlreceivables
Financiallliabilitieslarelcategorizedlinto:
(a) fairlvaluelthroughlprofitlorlloss
(b) otherlfinanciallliabilities
6 Changeslinlthelfairlvalueloflfinanciallassetslclassifiedlaslfairlvaluelthroughlprofitlorllosslare
ltakenltolincomelstatementlwhereaslchangeslinlthelfairlvalueloflavailable-for-
lsalelfinanciallassetslareltakenltolequityluntilltheylareldisposedlof.lFinanciallassetslclassifie
dlaslfairlvaluelthroughlprofitlorllosslarelshort-
termlassetslheldlforltradinglorloperationlpurposes.lTherefore,litlislappropriatelthatlchangesl
inltheirlfairlvaluelareltakenltolthelincomelstatement.lAvailable-for-
salel(AFS)lfinanciallassetslarelpresumedltolbelheldlindefinitely.lByltakinglchangeslinlthelf
airlvalueloflAFSltolequity,lvolatilitylinlreportedlearningslislreduced.
7 Sincelthelintentionlisltolholdlthelfinanciallassetltolmaturity,lchangeslinlthelfairlvalueloflthel
assetlarelnotlrelevantltolthelholders.
8 Pros:
* consistentlaccountingltreatmentlforlalllfinanciallinstruments
* complexitiesloflhedgelaccountinglarelavoided.lC
ons
* fairlvalueldoeslnotlprovidelrelevantlinformationlforlcertainlfinancial
2
2016l©lAlllrightslreserved,lMcGraw-
HilllEducationl(Asia)l StrictlylForlInstructorslUselOnly
NolFurtherlDistributionlOrlReproductionlPermitted
, AdvancedlFinanciallAccounting
Chapterl9lsolutions
instrumentslthatlarelintendedltolbelheldltolmaturity.
* determininglfairlvaluelforlalllfinanciallinstrumentslcouldlbelcostly.
9
(a) No.lThelavailabilityltolthelholderlofltheloptionltolconvertlislinconsistentlwithlthelpr
esumedlintentionloflholdingltolmaturity.
(b) Yes.lThelcallloptionltolthelissuer,liflexercised,lmerelylalterslthelmat
urityldateloflthelinstrument.
(c) No.l Holdingl forl anl indefinitel periodl doesl notl demonstratel intentl tol holdl tolmat
urity.
(d) No.lReitslarelnotldebtlinstruments.
10
(a) Yes.
(b) No.lThelsalelisleffectedlverylnearltoltheldateloflmaturity.
(c) No.lTheldisposelwaslinlresponseltolalsignificantldeteriorationlinlt
helcreditlworthinessloflthelissuer.
(d) Yes;lotherlsecuritieslinlthelportfoliolarelsimilarlyl‘tainted’.
(e) Yes,latlthelgroupllevel.
11
(a) ThelimplementationloflIASl32lcouldlbelcostlylinlthelfollowinglways:
1) IASl32lrequireslrecognitionloflbothldebtlandlequitylcomponents.lTheldebtlcomponentl
usuallylgiveslriseltolaldiscountlonlthelbondlwhichlhasltolbelamortiselusingltheleffectivel
interestlratelmethod.lThelamortizationloflbondldiscountlresultslinlhigherlfinancinglexp
enseslcomparedltolpre-
IASl32lsituationlandlresultslinl lowerlearningslreported.lThislmaylaffectlthelpriceloflthe
lfirm’slshares.
2) Costloflcompoundlfinanciallinstrumentlislhigherlthanlthelcostlofldebt.lThislmaylraiselt
heldiscountlratelforlthelfirmlandlaffectlthelvaluationloflthelfirmlifltheldiscountedlcashlfl
owlmethodlislused.
3) Directlcostsloflaccountinglforlcompoundlfinanciallinstrumentslwilllalsolincreasel–
lthelneedltolpreparelamortizationlschedule,ldetermineltheleffectivelcostlofldebt,letc.
(b) Inlwhatlwayslmaylthelimplementationlbelbeneficiallforlusersloflfin
anciallstatements?
ImplementationloflIASl32lmaylbenefitlbothlinformed/sophisticatedluserslasl uninformed/naïvelus
ers.lWithoutlIASl32lsophisticatedlinvestors/userslwouldlprobablylbel ableltoldetermineltheltruelorl
effectivelborrowinglcostloflthelfirmlalthoughltheylmaylhaveltolincurlcostsltolsearchlforlthelinforma
tion.lWithlIASl32lthisl‘searching’lcostslislsaved.lNaïvel orluninformedluserslwilllbenefitlfromldisc
losurelofltheltruelorleffectivelcostloflfinancinglwithoutlhavingltolincurlcost.
ThelfirmlandlitslshareholderslwouldlprobablylbenefitlfromlIASl32laslitslimplementationlmaylforce
lmanagementltoluselalhigherldiscountlratel(reflectivelofltheltruelcostloflcapital)ltolevaluatelnewlpro
jects.
3
2016l©lAlllrightslreserved,lMcGraw-HilllEducationl(Asia)
StrictlylForlInstructorslUselOnlyl
NolFurtherlDistributionlOrlReproductionlPermitted
, AdvancedlFinanciallAccountingl(Tan,lLimlandlKuah)lC
hapterl9lsolutions
(c) WhylislthelFASB’slstandlalcontroversiallissue?
ThelFASB’slstandlislnotltolrecognizelthelseparateldebtlandlequitylcomponentslinlcompoundlfinan
ciallinstruments.lThislstandlimplicitlylignoreslthelprincipalloflsubstanceloverlform.lFASB’slargu
mentslforlnon-
splittingloflCFIslarelthatltheltwolinstrumentslarelinseparablelandlthelestimationloflthelcostlofltheleq
uitylcomponentlmaylbelunreliable.
12. IASl39l–lHeld-to-maturityl(HTM),lAvailablelforlsalel(AFS),lFVTPL
Inltermsloflmeasurementlmethods,lthelthreelcategoriesloflIFRSl9lcorrespondltolIASl39laslfollows:lI
FRSl9lamortizedlcostlcategorylcorrespondsltolIASl39lHTMlcategory,lIFRSl9lFVTOCIl(Fairlvaluelt
olOCI)lcategorylcorrespondsltolIASl39lAFSlcategory,lIFRSl9lFVTPLlcategorylcorrespondsltolIASl
39lFVTPLlcategory.
Thelkeyldifferencesllielinlhowlfinanciallassetslarelclassifiedlinlthelthreelcategories.lIFRSl9lrequir
eslbusinesslmodellandlcontractuallcashlflowltestsltolbelsatisfiedlforlaldebtlsecurityltolbelclassifiedl
aslamortizedlcost.lIfltheldebtlsecuritylislheldlforlsale,litlislclassifiedlinlFVTPLlcategory.lIfltheldebtl
securitylislheldltolcollectlcontractuallcashlflowslandlforlsale,litlislclassifiedlinlFVTOCIlcategory.l
EquitylsecuritylcanlbelclassifiedlasleitherlFVTOCIl(iflitlislnotlheldlforltrading)lorlFVTPLlbutlnotla
mortizedlcost.
13. Therelhavelbeenlcriticismslthatlthelincurredlloanllosslprovisioninglmethodltendsltoldelayllossl
recognition.lThelcriticismslbecamelsharperlduringlthelfinanciallcrisis.lThelexpectedlloanllosslpro
visioninglmethodlislaimedlatladdressinglthislconcern,landltolrecognizelloanlprovisionslonlaltimel
ylbasis.
However,ltheldownsideloflthelexpectedlloanlprovisionslmethodlislthatlthelloanlprovisionslarelmor
elsubjectivelandlcouldlbelmanagedlbylbanklmanagers.lThusltheladvantageloflthelincurredlloanlpro
visionslmethodlislthatlitlislmorelobjectivelandllesslsubjectltolearningslmanagement.
14. Thelthreelcategorieslare:
(i) Financiallinstrumentslthatlhavelnotldeterioratedlsignificantlylinlcreditlqualitylfromlinitiallrec
ognitionltolreportingldate,
(ii) Financiallinstrumentslwithlsignificantldeteriorationlinlcreditlqualitylfromlinitiallrec
ognitionltolreportingldate,
(iii) Objectivelevidenceloflimpairment.
Keylfactorslinldetermininglexpectedlcreditllosses:
Changelinlprobabilityloflcreditldefaultlfromlinitiallrecognitionltolreportingldatelandllosslrecovery.lT
helprobabilityloflcreditldefaultlisldeterminedlfromlcreditlrisklprofiles,lcreditlrisklratings,landlrisklcha
racteristicsloflborrowerlincludinglitslfinanciallhealth.lLosslrecoverylislaffectedlbylcollateralslandlgu
aranteeslthatlborrowerlhaslobtained.
15. Inlalsecuritizationlprocess,ltheloriginatorslplaceltheirlassetslinlalsecuritizationlentity.lThellatte
rlsellslthelsecuritizedlassetslinltranchesltolinvestors,lwholprovidelfinancingltolthelsecuritizationle
ntity.lOnelkeylobjectiveloflsecuritizationlislforloriginatorsltolfreeluplassetslfromltheirlbooks.
16. Yes,lthelmortgagelbackedlsecuritylislalcontractuallyllinkedlfinanciallinstrument.lThelmortg
agelbackedlsecurityltranchesloriginatelfromlmortgagelloanslwhichlarelcontractuallcash
4
2016l©lAlllrightslreserved,lMcGraw-
HilllEducationl(Asia)l StrictlylForlInstructorslUselOnly
NolFurtherlDistributionlOrlReproductionlPermitted
