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Section 11 – Introduction

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Section 11 – Analysis

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Section 11 – Analysis

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Section 11 – Analysis

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Section 11 – Analysis

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Section 11 – Analysis

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Section 11 – Analysis

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Section Downloads

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Section 11: Basic Financial Instruments.

11.1 Overview of Section 11.

11.2 Accounting policy choice.

11.2.1 Extract from FRS 102 Section 11.2-11.2A.

11.2.2 OmniPro comment – Accounting Policy Choice.

11.3 Scope of the Section 11 and Section 12.

11.3.1 Extract from FRS 102 Section 11.3, 11.5, 11.7 and Glossary to FRS 102.

11.3.2 OmniPro comment – Scope of Section 11.

11.3.2.1 Financial assets and liabilities not within the remit of Section 11 and 12.

11.4 Classification of financial instruments.

11.4.1 Extract from FRS 102 Section 11.6 and 11.8.

11.4.2 OmniPro comment – classification of financial instruments and scope (within Section 11 or 12)

11.4.2.1 Debt Instruments.

11.4.2.2 – Investment in Shares.

11.5 Conditions for debt instruments to meet the definition of a basic financial instrument

11.5.1 Extract from FRS 102 Section 11.9.

11.5.2 OmniPro comment – basic financial instruments.

11.6 Initial and subsequent measurement of debt instruments.

11.6.1 Extract from FRS 102 Section 11.12-11.20.

11.6.1.1 Initial Recognition.

11.6.1.2 Subsequent measurement

11.6.1.3 Amortised cost and effective interest method.

11.6.2 OmniPro comment

11.6.2.1 Initial recognition.

11.6.2.2 Short-term receivables/payable within one year

11.6.2.3 Transaction costs – definition/treatment

11.6.2.4 Effective interest rate calculation and amortised cost

11.6.2.4.1 Effective interest rate

11.6.2.4.2 Amortised cost

11.6.2.4.3 Put or call options when calculating effective interest rate

11.6.2.4.4 Diagram 1 Rules for Accounting for basic financial instruments

11.6.2.4.5 – Financing Arrangement

11.6.2.4.5.1 Financing arrangement for small entities for loans from directors (who are natural persons) to the entity.

11.6.2.4.6 Steps in determining the effective interest rate

11.6.2.4.7 Changes in cash flow estimates (amortised cost model)

11.6.2.4.8 Non market loans- inter-company loan / director’s loans

11.6.2.4.8.1 Determining the market rate of interest

11.6.2.4.8.2: Analysis of debt and credits on initial recognition of loans – financing arrangements.

11.6.2.4.9 Sales and purchases made under unusual credit terms – Debtors/creditors

11.6.2.4.10 Employee Loans

11.6.2.4.11 Loans repayable on demand

11.6.2.4.12 Loan repayable on demand but with notice of 1 year and 1 day

11.6.2.4.13 Subordination

11.6.2.4.14 Deferred Tax

11.6.2.4.15 Variable interest rate over the life of the loan

11.6.2.4.16 Issues surrounding directors or intra-group loans

11.6.2.4.16.1 Factors that indicate a related party loan is not at market rates.

11.6.2.4.17 Bonds

11.7 Fair valuing investments for debt instruments and non-puttable/non-convertible ordinary and preference shares within the scope of section 11.

11.7.1 Extract from FRS 102 Section 11.27-11.32.

11.7.2 OmniPro comment

11.7.2.1 Listed shares and non puttable ordinary and preference shares with less than significant influence.

11.7.2.1.1 Deferred Tax

11.7.2.1.2 Fair value hierarchy

11.8 Impairments of financial assets held at cost or amortised cost

11.8.1 Extract from FRS 102 Section 11.21-11.26.

11.8.2 OmniPro comment

11.8.2.1 Indicators of Impairment

11.8.2.2 Individual and group impairments.

11.8.2.3 Impairment debt instruments.

11.8.2.4 Reversal of Impairments.

11.8.2.5 Impairment of financial assets carried at cost

11.9 Derecognition of a Financial Asset

11.9.1 Extract from FRS 102 Section 11.33-11.35.

11.9.2 OmniPro comment – Decrecognition of Financial Assets.

11.10 Derecognition of financial liabilities.

11.10.1 Extract from FRS 102 Section 11.36-11.38.

11.10.2 OmniPro comment

11.6.2.4.5 Derecognition rules – overview

11.10.2.2 Derecognition of Financial Liability.

11.11 Presentation.

11.11.1 Extract from FRS 102 Section 11.38A.

11.11.2 OmniPro comment – Presentation – set off

11.12 Disclosures.

11.12.1 Extract from FRS 102 Section 11.39-11.48A.

11.12.2 OmniPro comment

11.12.2.1 Disclosure requirements.

11.12.2.2 Sample Disclosure requirements.

11.12.2.2.1 Extract from accounting policy notes

11.12.2.2.2 Extract of notes to the financial statements – Financial instruments note disclosures

11.12.2.2.3 Extract of notes to the financial statements – interest disclosures.

11.12.2.2.3.1 Note: Interest receivable and similar income.

11.12.2.2.3.2 Note: Interest payable and similar expenses.

11.12.2.2.4 – Debtors Disclosures

11.12.2.2.5 – Creditors disclosures

11.12.2.2.6 FINANCIAL ASSETS

11.12.2.2.7 Statement of Comprehensive Income

11.12.2.2.8 – Statement of Change in Equity

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Section 11 – Basic Financial Instruments

Summary

Section 11 defines basic financial instruments for all companies with the exception of public benefit entities. Basic financial instruments coming within the scope of section 11 are:

It goes on to provide characteristics and examples of financial instruments.

Section 11 applies to all financial instruments meeting the conditions of paragraph 11.8 except for the following:

  1. Investments in subsidiaries, associates and joint ventures; (Section 9, Section 14 and Section 15)
  2. Financial instruments that meet the definition of an entity’s own equity and the equity component of compound financial instruments issued by the reporting entity that contain both a liability and an equity component; (section 12 Other Financial Insturment Issues)
  3. Leases, to which Section 20 Leases applies;
  4. Employers’ rights and obligations under employee benefit plans, to which Section 28 Employee Benefits applies;
  5. Financial instruments, contracts and obligations to which Section 26 Share-based
  6. payment applies, and contracts within the scope of paragraph 12.5;
  7. Insurance contracts (including reinsurance contracts) that the entity issues and reinsurance contracts that the entity holds (see FRS 103 Insurance Contracts);
  8. Financial instruments issued by an entity with a discretionary participation feature (see FRS 103 Insurance Contracts);
  9. Reimbursement assets accounted for in accordance with Section 21 Provisions
  10. and Contingencies; and
  11. Financial guarantee contracts (see Section 21).

A financial instrument is defined in Section 11.3 as a contract that gives rise to a financial asset of one entity and a financial liability of another entity.

 

 

What is new?

For previous FRS 26 adopters there are very few new concepts or differences. For non FRS 26 adopters under old GAAP, there was no equivalent standard.

Under FRS 102 entities have the option to apply either the provisions of Section 11 or Section 12 in full or utilise IAS 39 depending on the financial instrument held.

Section 11.8 defines the financial instruments which are within the scope of section 11 as basic instruments. They have been summarised in the summary above.

Section 11.9(a) states the primary conditions for a debt instrument that needs to be satisfied for the debt to be regarded as basic and so may be measured at amortised cost are:

  1. a fixed amount;
  2. a positive fixed rate or a positive variable rate; and
  3. or a combination of a positive or a negative fixed rate and a positive variable rate (e.g. LIBOR plus 200 basis points or LIBOR less 50 basis points, but not 500 basis points less LIBOR).

Initial measurement

Under old GAAP financial assets were measured at the invoiced or issued amounts less provision for impairment. Financial liabilities and debt instruments were measured at the amount of the fund received/paid regardless of when it was payable and regardless of whether they were at non-market rates. They were not required to be present valued under any other old GAAP accounting standard.

In contrast Section 11.13 deals with initial recognition, and states (with the exception of non-convertible preference shares, non-puttable ordinary shares or preference shares) the financial asset or liability is measured at the transaction price including transaction costs unless the arrangement in effect constitutes a financing arrangement. Therefore, for a loan received or a trade debtor balance a entity would record it at the value of the loan received or the value of the sales invoice issued (net of costs for loans). This would be similar for a payable position or a loan payable.

If a financing arrangement takes place which is at anything other than non-market rates then section 11.13 requires the entity to measure the financial asset/liability at the present value of the future receipts/payments discounted at a market rate of interest for a similar debt i.e. the rate of interest that would be charged on such a receivable/payable if the entity were to go to an outside party e.g. a bank etc. to get the credit. Even where a rate of interest has been charged, it still needs to be at market rates so it would have to be present valued accordingly.

A debt instrument which is repayable on demand will be carried at the consideration received or the amount of the loan provided on initial recognition as the amortised cost equates to the same amount.

 

Subsequent measurement

The debt instruments should be measured at amortised cost using the effective interest rate method at each reporting date. In effect if there are transaction costs then these transaction costs are charged/credited to the profit and loss over the life of the debt instrument or earlier if the period to which they relate is shorter. This contrasts with old GAAP where transaction costs on debt instruments were expensed to the profit and loss when incurred.

Section 11.15 defines amortised cost at each reporting date as the net of the following amounts:

Section 11.14 (d) states that investments in non-convertible preference shares, non-puttable ordinary and preference shares are required to be measured at:

Section 11.27 to 11.32 details the hierarchy when using the fair value model and details the requirements that are needed in order to be able to use fair value. The order of preference is:

Under old GAAP where entities have not adopted FRS 26, investment in equities of this nature was accounted for at cost less impairment with an option to fair value if the entity adopted FRS 26. Therefore if an active market is present then it must fair value these equities under Section 11.

Impairments

Section 11.21 to 11.25 deals with impairment of financial assets. An impairment loss is recognised in the profit and loss where there is objective evidence of an impairment.

Under old GAAP there are no specific requirements relating to impairment of financial assets where FRS 26 was not adopted. For fixed asset investments (other than investments in subsidiaries, investment and joint ventures i.e. <20% investment), permanent diminution in value had to be recognised in the P&L under old GAAP. Current assets were measured at lower of cost and net realisable value. Section 11 gives more detailed guidance.

Derecognition

Derecognition of financial assets for non FRS 26 adopters was dealt with in FRS 5, where the substance of a transaction was considered. Under Section 11 there is detailed guidance in relation to when an asset is to be derecognised but essentially it should come to the same answer as under old GAAP. FRS 5 allowed linked presentation which is not allowed in FRS 102.

Derecognition of financial liabilities were not specifically dealt with in old GAAP instead FRS 5 approached liability derecognition as an issue of derecognition of a related asset. Section 11 provides detailed guidance on when to derecognise a liability and in section 11.36 it states that it should only be derecognised when the obligations specified in the contract are discharged, settled or expired.

What is different?

For FRS 26 adopters under old GAAP, the following differences arise:

Under old GAAP there was very little disclosure required for financial assets and liabilities unless scoped into FRS 13. Under Section 11 the disclosures are a little more onerous.

Other standards which impact Section 11 where differences arise:

Section 29 – Income tax – Likely to be deferred tax on any transition adjustments which arise as a result of fair valuing at the date of transition. Also likely that tax will be payable /refundable on adjustments that fell out for tax purposes on transition.

What are the key points?

See below available options and a summary of the standard.

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Examples

Example 1: Investment in shares.

Example 2: Investment in shares – 15%.

Example 3: variable and fixed interest payments.

Example 4: A zero coupon.

Example 5: Fixed and variable interest payments.

Example 6: Fixed rate loan for a set period and then a reversion to the banks variable rate.

Example 7: Fixed and variable interest payments where there a fixed positive return and a negative variable return

Example 8: Loan/bond which is convertible into the borrower’s equity.

Example 9: Loan issued which is linked to a general inflation index.

Example 10: Variation in return.

Example 11: Prepayment options.

Example 12: Loan extension option.

Example 12a: Unguaranteed Capital

Example 12b: Collective investment funds.

Example 13: loan at market rates with transaction costs.

Example 13a: Change in estimate.

Example 14: Intercompany loan from a parent company.

Example 15: Loan provided to the company by a director

Example 16a: Intercompany loan from a related party or a fellow subsidiary.

Example 16b: Loan from subsidiary to the parent company.

Example 16c: Sale with unusual credit terms.

Example 16d: Purchase with unusual credit terms.

Example 17: Employee loan.

Example 17a: Loans repayable on demand..

Example 17b: Loan repayable on demand but with notice of 1 year and 1 day.

Example 18: Bonds – discount/premium.

Example 18a: Non-convertible preference shares and non-puttable ordinary shares – traded price or can be reliably measured.

Example 19: Non-convertible preference shares and non-puttable ordinary shares – not traded or cannot be reliably measured.

Example 20: Impairment of debt instruments.

Example 20a: Bonds with an impairment

Example 21: Asset recognised due to settlement

Example 22: Sale of debtors with recourse.

Example 23: Sale of debtors without recourse.

Example 24: Transfer of assets at fair value subject to a call option.

Example 25: Substantial modification of a loan.

Example 26: Sample disclosure requirements

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