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[/et_pb_text][/et_pb_column][/et_pb_row][/et_pb_section][et_pb_section admin_label=”Section” fullwidth=”off” specialty=”off”][et_pb_row admin_label=”Row”][et_pb_column type=”1_2″][et_pb_text admin_label=”Text” background_layout=”light” text_orientation=”center” text_font_size=”14″ use_border_color=”off” border_color=”#ffffff” border_style=”solid”] [button link=”http://www.frs102.com/members/premium-toolkit/” type=”big” color=”red”] Return to Main Index[/button] [/et_pb_text][/et_pb_column][et_pb_column type=”1_2″][et_pb_text admin_label=”Text” background_layout=”light” text_orientation=”center” text_font_size=”14″ use_border_color=”off” border_color=”#ffffff” border_style=”solid”] [button link=”http://frs102.com/members/premium-toolkit/section-12/” type=”big” color=”red”] Return to Section 12 Home[/button] [/et_pb_text][/et_pb_column][/et_pb_row][/et_pb_section][et_pb_section admin_label=”Section” fullwidth=”off” specialty=”off” transparent_background=”off” allow_player_pause=”off” inner_shadow=”off” parallax=”off” parallax_method=”off” padding_mobile=”off” make_fullwidth=”off” use_custom_width=”off” width_unit=”on” make_equal=”off” use_custom_gutter=”off” gutter_width=”3″][et_pb_row admin_label=”Row”][et_pb_column type=”4_4″][et_pb_text admin_label=”Main Body Text” background_layout=”light” text_orientation=”justified” use_border_color=”off” border_color=”#ffffff” border_style=”solid”]Initial recognition and measurement of financial assets and liabilities
Extract from FRS 102-Section 12.6-12.9
12.6 An entity shall recognise a financial asset or a financial liability only when the entity becomes a party to the contractual provisions of the instrument.
Initial measurement
12.7 When a financial asset or financial liability is recognised initially, an entity shall measure it at its fair value, which is normally the transaction price (including transaction costs except in the initial measurement of financial assets and liabilities that are measured at fair value through profit or loss). If payment for an asset is deferred beyond normal business terms or is financed at a rate of interest that is not a market rate, the entity shall initially measure the asset at the present value of the future payments discounted at a market rate of interest for a similar debt instrument.
Subsequent measurement
Extract from FRS 102 sections 12.8 – 12.9
12.8 At the end of each reporting period, an entity shall measure all financial instruments within the scope of Section 12 at fair value and recognise changes in fair value in profit or loss, except as follows:
(a) investments in equity instruments that are not publicly traded and whose fair value cannot otherwise be measured reliably and contracts linked to such instruments that, if exercised, will result in delivery of such instruments, shall be measured at cost less impairment;
(b) hedging instruments in a designated hedging relationship accounted for in accordance with paragraph 12.23; and
(c) financial instruments that are not permitted by the Small Company Regulations, the Regulations, the Small LLP Regulations or the LLP Regulations to be measured at fair value through profit or loss shall be measured at amortised cost in accordance with paragraphs 11.15 to 11.20.
12.9 If a reliable measure of fair value is no longer available for an equity instrument (or a contract linked to such an instrument) that is not publicly traded but is measured at fair value through profit or loss, its fair value at the last date the instrument was reliably measurable is treated as the cost of the instrument. The entity shall measure the instrument at this cost amount less impairment until a reliable measure of fair value becomes available.
OmniPro comment
The instrument should be valued at transaction price initially and afterwards at fair value. Where there is a financing element then the rules in Section 11 should be followed with regard to determining the market rate and discounting the asset/liability back to its present value rate using the market rate as the discount rate.
Examples of financial instruments which would come within the requirements of Section 12 include the following:
- options to purchase or sell items that can be settled in cash or in exchange for another financial instrument (e.g. option to purchase something in the future);
- warrants that can be settled in cash or in exchange for another financial instrument;
- forward contracts that can be settled in cash or in exchange for another financial instrument;
- interest rate swaps that can be settled in cash or in exchange for another financial instrument;
- repurchase agreements;
- Compound financial instrument (the debt element is measured at amortised cost); and
- A firm commitment which is contractually binding (fair value would be the movement on what the asset could be purchased at year end date compared the committed price paid).
Fair value
Extract from FRS 102 section 12.10 – 12.12
12.10 An entity shall apply the guidance on fair value in paragraphs 11.27 to 11.32 to fair value measurements in accordance with this section as well as for fair value measurements in accordance with Section 11.
12.11 The fair value of a financial liability that is due on demand is not less than the amount payable on demand, discounted from the first date that the amount could be required to be paid.
12.12 An entity shall not include transaction costs in the initial measurement of financial assets and liabilities that will be measured subsequently at fair value through profit or loss.
OmniPro comment
Section 12 states that fair value can be determined first from an active market, where this is not available a recent price for an identical asset or if this is not available then a valuation technique should be used which makes the most of all market based information.
The fair value of an item due on demand is its transaction price.
Any transaction costs are expensed as incurred.
Foreign currency forward contracts
Where a forward currency forward contract is entered into, under Section 12 an entity is required to fair value this contract at the reporting date. Where this is not hedged it can create volatility in the profit and loss year on year.
Fair value of such a contract can be determined at the reporting date by assessing the forward contract rate that could be obtained from a third party (e.g. a bank) to hedge on the very same maturity date that the contract that is held matures on (i.e. the difference between what you could theoretically sell the existing forward contract and what you could buy another forward contract at with the very same maturity date and conditions).
e.g. Company A entered into a foreign currency forward contract to sell FC100,000 of foreign currency (FC) at a rate of CU1:FC0.80 on 1 November which matures on 1 February 2014. The year-end date is 31 December. At the year-end date the bank is offering a rate of CU1:FC0.75 for a foreign currency (FC) forward contract which matures on 1 February. In this case the fair value of the forward contract is the difference between the rate of CU1:FC0.80 and CU1:FC0.75.
Example 1: Forward Contracts
Company A entered into a forward contract to hedge against foreign exchange movements as the company engages in a significant volume of foreign currency (FC) sales. The year end is 31 December. It entered into a forward contract on 1 November to sell CU100,000 of FC in return for CU at a set rate of CU1:FC0.80 maturing on 31 March.
Assume the spot rate at 31 December was CU1:FC0.70.
The forward rate quoted for an FC contract at 31 December by the bank for a contract that matures on 31 March is CU1:FC0.75.
The accounting requirement as a result of entering into this forward contract at 31 December year end assuming it does not meet the conditions for hedge accounting are:
| CU | CU | |
| Dr Foreign Exchange Loss in P&L | 8,333 | |
| Cr Forward Contract Liability | 8,333* |
Being journal to reflect fair value of the forward contract at the year end
*Fair value of the forward contract:
Amount of CU that will be obtained on 31 March at contracted rate of CU1:FC0.80= FC100,000/0.80= CU125,000
Note any FC balances in the balance sheet at 31 December should be retranslated to the year-end spot rate.
Amount of CU that could theoretically be obtained on 31 March at contracted rate of CU1=FC0.75= FC100,000/0.75= CU133,333
Fair value loss at 31 December = CU133,333-CU125,000 – CU8,333
The accounting required on 31 March on settlement is (assuming no movement between year-end date and 31 March):
| CU | CU | |
| Dr Forward Contract Liability | 8,333 | |
| Cr Foreign Exchange Gain | 8,333 |
Being journal to derecognise the liability on the contract maturing
Example 2: Foreign currency forward contract to hedge a sale
Company A expects to sell a large volume of goods for FC100,000 on 31 March. The year-end date is 31 December. As a result the company enters into a forward contract to sell FC100,000 to the bank at a rate of CU1:FC0.80.
Assume it does not meet the conditions for hedge accounting.
The forward rate quoted for FC contract at 31 December by the bank for a contract that matures on 31 March is CU1:FC0.75.
The accounting required at 31 December is the same as example 1. On the eventual sale here if we assume the spot rate was CU1:FC0.85 the journal would be:
| CU | CU | |
| Dr Bank | 117,647 | |
| Cr Sales (FC100,000/0.85) | 117,647 |
Being journal to reflect sale
| CU | CU | |
| Dr Bank (CU125,000-CU117,647) | 7,353 | |
| Dr Forward Contract Liability | 8,333 | |
| Cr Foreign Exchange Gain | 15,686 |
Being journal to reflect cash received from the bank on transfer of the FC100,000 at the forward rate of CU7,353 and the reversal of the prior fair value adjustment as the sale is now closed out. Therefore the overall gain in the contract is CU7,353 which is what has ultimately been reflected in the P&L (CU8,333 debit in year 1 – CU7,353 credit on completion and CU8,333 credit on derecognition of the forward contract liability).
Example 3: Foreign currency forward contract to hedge a future purchase
Company A expects to purchase a piece of equipment for FC100,000 on 31 March. The year-end date is 31 December. As a result the company enters into a forward contract to purchase FC100,000 from the bank at a rate of CU1:FC0.80.
Assume it does not meet the conditions for hedge accounting.
The forward rate quoted for the FC contract at 31 December by the bank for a contract that matures on 31 March is CU1:FC0.75.
The accounting at 31 December is as follows:
| CU | CU | |
| Dr Forward Contract Asset | CU8,333 | |
| Cr Foreign Exchange Gain | CU8,333 |
Being journal to reflect fair value of option.
Example 4: Interest rate swap – non hedge accounting
Company A gets a loan for CU100,000 at a fixed rate of 5% which is repayable in 5 years.
At the same time Company A enters into an interest rate swap with a third party e.g. another bank for a 5 year period whereby Company A will pay the floating rate to the third party and the third party will pay the fixed rate to Company A. The notional amount hedged is CU100,000. Assume the current average variable interest rate for the year was 6%.
Assume this does not meet the requirements for hedge accounting and that interest is paid every 6 months (no accruals) and there is no credit risk on debt. Assume at the end of year 1 that there was a loss of CU5,000 in the interest rate swap.
The accounting entries required at the end of year 1 would result in the following P&L and balance sheet impact. The effect is that an additional CU5,000 hits the profit and loss for the fair value of the swap at the year-end:
Impairment of financial instruments measured at cost or amortised cost
Extracts from FRS 102 section 12.3
12.13 An entity shall apply the guidance on impairment of a financial instrument measured at cost in paragraphs 11.21 to 11.26 to financial instruments measured at cost less impairment in accordance with this section.
OmniPro comment
The impairment of financial instruments has been discussed in detail in Section 11. Please refer to Section 11 of this guide for further details.
Derecognition of a financial asset or financial liability
Extract from FRS 102 section 12.14
12.14 An entity shall apply the derecognition requirements in paragraphs 11.33 to 11.38 to financial assets and financial liabilities to which this section applies.
OmniPro comment
Non-hedged instruments
See Section 11 of this manual for full details. In relation to forward contracts and interest rates swaps that do not meet hedging requirements the assets or liabilities are derecognised when the contract matures. The net release will always hit the profit and loss as the initial recognition was also shown in the profit and loss.
Hedged instruments
See examples below.
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