PAS 32/PFRS 9 – FINANCIAL INSTRUMENT

Financial Accounting and Reporting

RM Montalban

PAS 32, paragraph 11, defines financial instrument as any contract that gives rise to a financial asset of
one entity and a financial liability or an equity instrument of another entity.

The characteristics of financial instrument are:

(a) There must be a contract.
(b) There are at least two parties to the contract.
(c) The contract shall give rise to a financial asset of one party and financial liability or equity
instrument of another party.

Classification of financial assets

PFRS 9, paragraph 4.1.1, financial assets are classified into three, namely:
1. Financial assets at fair value through profit or loss – include both equity and debt securities.
2. Financial assets at fair value through other comprehensive income – include both equity securities
and debt securities.
3. Financial assets at amortized cost – include only debt securities.

The classification depends on the business model for managing financial assets which may be:
(a) To hold investments in order to realize fair value changes.
(b) To hold investments in order to collect contractual cash flows.

Measurement of financial assets

PFRS 9, paragraph 5.1.1. provides that at initial recognition, an entity shall measure a financial asset at
fair value, plus in the case of financial asset not at fair value through profit or loss, transaction costs that
are directly attributable to the acquisition of financial asset.

Subsequent measurement
PFRS 9, paragraph 5.2.1, further provides that after initial recognition, an entity shall measure a financial
asset at:
(a) Fair value through profit or loss
(b) Fair value through other comprehensive income
(c) Amortized cost

The following financial assets shall be measured at fair value through profit or loss:
(a) Financial assets held for trading (trading securities) as required by the standard.
(b) All other investments in quoted equity instruments by consequence in accordance with the
Application Guidance B5 of PFRS 9.
(c) Financial assets by irrevocable designation of fair value option in accordance with Paragraph 4 of
PFRS 9.
(d) All debt investments that do not satisfy the requirement measurement at amortized cost and at fair
value through other comprehensive income by default in accordance with PFRS 9, paragraph 4.

Appendix A of PFRS 9 provides that a financial asset is measured at fair value through profit or loss if:
(a) It is acquired principally for the purpose of selling or repurchasing it in the near term.
(b) On initial recognition, it is part of a portfolio of identified financial assets that are managed
together and for which there is evidence of a recent actual pattern of short-term profit taking.
(c) It is a derivative, except for a derivative that is a financial guarantee contract or a designated and
an effective hedging instrument.

PFRS 9, paragraph 4.1.2, provides that a financial asset shall be measured at amortized cost if both of the
following conditions are met:
(a) The business model is to hold the financial asset in order to collect contractual cash flows on
specified date.
(b) The contractual cash flows are solely payments of principal and interest on the principal amount
outstanding.

Furthermore, PFRS 9, paragraph 5.7.5., provides that an entity may make irrevocable designation to
present in other comprehensive income subsequent changes in fair value of an investment in equity
instrument that is not held for trading. When the entity made a designation to present the financial
instrument in OCI, under PFRS 9, paragraph 5, at initial recognition the asset shall be recognized at fair
value plus transaction cost directly attributable to the acquisition.

PFRS 9, paragraph 4.1.2A, provides that a financial asset shall be measured at fair value through
comprehensive income if both of the following conditions are met:
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(a) The business model is achieved both by collecting contractual cash flows and by selling the
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financial asset.
 (b) The contractual cash flows are solely payments of principal and interest on the principal
outstanding.

In other words, PFRS 9, paragraph 5.7.1, gain and loss on financial asset measured at fair value shall be
presented in profit or loss, except:
(a) When the financial asset is part of a hedging relationship.
(b) When the financial asset is an investment in nontrading equity instrument and the entity has
irrevocably elected to present unrealized gain and loss in other comprehensive income.
(c) When the financial asset is a debt investment that is measured at fair value through other
comprehensive income.

More so, PFRS 9, paragraph 5.7.2, provides that gain and loss on financial asset measured at amortized
cost and is not part of a hedging relationship shall be recognized in profit or loss when the financial asset
is derecognized, sold, impaired or reclassified, and through amortization process.

On the other hand, PFRS 9, paragraph 3, provides that on derecognition of a financial asset, the difference
between the carrying amount and the consideration received, including new asset obtained less any new
liability assumed shall be recognized in profit or loss.

However, gain or loss on disposal of equity investment measured at fair value through other
comprehensive income is recognized in retained earnings in accordance with PFRS 9, paragraph 5, and
any cumulative gain or loss previously recognized in other comprehensive income is also transferred to
retained earnings in accordance with PFRS 9 Application Guidance paragraph 5.

Reclassification
PFRS 9, paragraph 4, provides that an entity shall reclassify financial assets only when it changes its
business model for managing financial assets. Where reclassification occurs, paragraph 5.6.1 provides
that an entity shall apply the reclassification prospectively from the reclassification date.

As defined by Appendix A of PFRS 9, the reclassification date is the first day of the reporting period
following the change in business model that results in an entity reclassifying financial asset.

The following are the cases presented in the standard affecting reclassification:
(1) When an entity reclassifies a financial asset from amortized cost to fair value through profit or
loss, the fair value is determined at reclassification date. The difference between the previous
carrying amount and fair value is recognized in profit or loss (par. 5.6.2)
(2) When an entity reclassifies a financial asset from fair value through profit or loss to amortized
cost, the fair value at the reclassification date becomes the new carrying amount of the financial
asset at amortized cost (par. 5.6.3).
(3) When an entity reclassifies a financial asset at amortized cost to fair value through other
comprehensive income, the fair value is measured at reclassification date. Any gain or loss arising
from the difference between the amortized cost carrying amount and fair value is recognized in
OCI (par. 5.6.4).
(4) When an entity reclassifies a financial asset from fair value through other comprehensive income
to amortized cost, the fair value at the reclassification date becomes the new carrying amount of
the financial asset at amortized cost. However, the cumulative gian or los previously recognized
in other comprehensive income is removed from equity and adjusted against the fair value at
reclassification date (par. 5.6.5).
(5) When an entity reclassifies a financial asset from fair value through profit or loss to fair value
through other comprehensive income, the financial asset continues to be measured at fair value.
The fair value at reclassification date becomes the new carrying amount (par. 5.6.6).
(6) When an entity reclassifies a financial asset from fair value through other comprehensive income
to fair value through profit or loss, the financial asset continues to be measured at fair value. The
fair value at reclassification date becomes the new carrying amount. The cumulative gain or loss
previously recognized in other comprehensive income is reclassified to profit or loss at
reclassification date (par. 5.6.7).

Impairment
PFRS 9, paragraph 5.5.1, provides that an entity shall recognize a loss allowance for expected credit
losses on:
(1) Debt investment measured at amortized cost
(2) Debt investment measured at fair value through other comprehensive income

Furthermore, paragraph 5.5.3 provides that an entity shall measure the loss allowance for a financial
instrument at an amount equal to the lifetime expected credit losses if the credit risk on the financial
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instrument has increased significantly since initial recognition. Credit losses are the present value of all
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cash shortfalls. PFRS 9 does not prescribe any particular method of measuring credit losses.
Types of Dividends
(1) Cash dividends
(2) Property dividends
(3) Liquidating dividends
(4) Stock dividends of the same class (bonus issue)
(5) Stock dividends of different class
(6) Shares in lieu of cash dividends
(7) Cash received in lieu of stock dividends

Share split
Is the restructuring of the corporation of its capital by effecting a change in the number of shares without
capitalizing retained earnings or changing the amount of its legal capital. Which may be either:
(a) Split up, a transaction whereby the outstanding shares are called in and replaced by a larger
number, accompanied by a reduction in the par or stated value of each share.
(b) Split down, the reverse of split up.

Special assessments
Additional capital contribution of the shareholders. On the part of the shareholders, special assessments
are recorded as additional cost of investment and on the part of the entity as share premium.

Stock Rights
Is a legal right granted to shareholders to subscribe for new shares issued by a corporation at a specified
price during a definite period. The IAS term for stock right is right issue. PFRS 9 does not address the
accounting for stock rights. However there are two provisions of the standard which may address this
issue, namely:
(1) Application Guidance B5.4.14 of PFRS 9 provides that all investments in equity instruments and
contracts on those instruments must be measured at fair value. Stock rights are equity
instruments, therefore should be measured at fair value. This calls that a portion of the investment
should be allocated to stock rights.
(2) PFRS 9 paragraph 4.3.3. provides that an embedded derivative shall be separated from the host
contract and accounted for separately under certain conditions. However if the host contract is
within the scope of PFRS 9, the classification requirements of PFRS 9 are applied to the
combined host contract in its entirety.

The issue for accounting stock rights remained unresolved nowadays.

STRAIGHT PROBLEMS

1. On January 1, 2016, Meredith Company purchased equity securities held for trading.
Purchase price Transaction cost Market - 12/31/2016
Security A 1,000,000 100,000 1,200,000
Security B 2,000,000 200,000 1,500,000
Security C 3,000,000 300,000 3,100,000

On July 1, 2017, the entity sold Security A for P1,800,000. What amount should be reported as gain on
sale of trading securities in the 2017 income statement?
a. 800,000 b. 600,000 c. 300,000 d. 700,000

FOR ITEMS 2 – 3 USE THE FOLLOWING INFORMATION

On January 1, 2015, Yuri Company purchased non-trading equity securities.

Purchase price Transaction cost Market - 12/31/2015

Security A 1,000,000 100,000 1,200,000
Security B 2,000,000 200,000 1,400,000
Security C 4,000,000 400,000 4,100,000

On July 1, 2016, the entity sold Security C for P4,900,000 incurring P100,000 in brokerage commission
and taxes.
2. What amount of gain on sale should be recognized in 2016 if the securities are designated as measured
at FVTOCI (PFRS 9)?
a. 900,000 b. 600,000 c. 800,000 d. 0

3. What amount of gain on sale should be recognized in 2016 if the securities are as FVPL?
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a. 700,000 b. 500,000 c. 600,000 d. 400,000

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FOR ITEMS 4 – 5 USE THE FOLLOWING INFORMATION
On January 1, 2016, Raphael Company acquired a non-trading equity investment for P5,000,000. On
December 31, 2016, the market value of the investment was P4,000,000. On December 31, 2017, the
issuer of the equity instrument was in severe financial difficulty and the fair value of the equity
investment has fallen to P1,500,000. The decline is judged to be non-temporary.

4. What cumulative loss should be reported in the statement of changes in equity for 2017 as component
of OCI if the investment is designated as measured at FVOCI (PFRS 9)?
a. 1,000,000 b. 2,500,000 c. 3,500,000 d. 0

5. What cumulative loss should be reported in the statement of changes in equity for 2017 as component
of OCI if the investment is classified as FVPL (PFRS 9)?
a. 1,000,000 b. 3,500,000 c. 2,500,000 d. 0

6. Sealtiel Company received dividends from ordinary share investments during the current year as
follows:
 A stock dividend of 10,000 shares from A Company when the market place of the share was
P10.
 A cash dividend of P1,500,000 from B Company in which the entity owned a 15% interest.
 5,000 shares of C Company in lieu of cash dividend of P20 per share. The market price of the
share was P150. The entity had 50,000 shares of C Company and owned 5% interest in C
Company.
What amount of dividend revenue should be reported for the current year?
a. 2,500,000 b. 2,250,000 c. 1,500,000 d. 2,350,000

7. Mike Company provided the following data pertaining to dividends on ordinary share investments for
the current year.
 On October 1, the entity received P600,000 liquidating dividend from A Company. The entity
owned a 10% interest in A Company.
 The entity owned a 20% interest in B Company which declared and paid a P4,000,000 cash
dividend to shareholders on December 31.
 On December 1, the entity received from C Company a dividend in kind of one share of D
Company dor every 4 C Company shares held. The entity had 100,000 C Company shares
which have a market price of P50 per share on December 1. The market price of D Company
share was P10.
What amount should be reported as dividend income for the current year?
a. 1,650,000 b. 1,050,000 c. 850,000 d. 250,000

8. Seth Company owned 50,000 shares of another entity. These 50,000 shares were originally purchased
for P100 per share. On October 1, 2016, the investee distributed 50,000 rights to the entity. The entity
was entitled to buy one new share for P140 and five of these rights. On October 1, 2016, each share
had a market value of P150 and each right had a market value of P10. On December 31, 2016, the
entity exercised all rights. The stock rights are accounted for separately and measured initially at fair
value. What total cost should be recorded for the new shares that are acquired by exercising the rights?
a. 1,400,000 b. 1,900,000 c. 1,650,000 d. 1,000,000

9. Barry Company issued rights to subscribe to its stock, the ownership of 4 shares entitling the
shareholders to subscribe for 1 share at P100. An investor owned 50,000 shares with total cost of
P5,000,000. The share is quoted right-on at 125. The stock rights are accounted for separately and
measured initially at fair value. What is the cost of the new investment assuming all of the stock rights
are exercised by the investor?
a. 1,500,000 b. 1,250,000 c. 1,562,500 d. 1,450,000

10. During 2017, Magic Company purchased 80,000 shares at P60 per share. The investment was
classified as trading. During the year, the entity sold 20,000 shares for P70 per share. On December
31, 2016, the market price per share is P55. What net amount of gain or loss should be recognized for
2017?
a. 540,000 loss b. 200,000 gain c. 300,000 loss d. 100,000 loss

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