IAS - 39

Financial instruments:
Recognition and
Measurement
 1.1. Background
In April 2001 the International Accounting Standards
Board (IASB) adopted IAS 38 Intangible Assets,
which had originally been issued by the International
Accounting Standards Committee (IASC) in March
1999. That standard had replaced the original IAS 39
Recognition and Measurement, which had been issued
in December 1998. That original IAS 39 had replaced
some parts of IAS 25 Accounting for Investments,
which had been issued in March 1986. In December
2003 the IASB issued a revised IAS 39 as part of its
initial agenda of technical projects. The revised IAS
27 also incorporated an Implementation Guidance
section, which replaced a series of Questions &
Answers that had been developed by the IAS 39
Implementation Guidance Committee (IGC).
 1.2. Introduction
IAS 39 addresses the accounting for financial assets and liabilities,
dealing with the following areas;
1. The recognition of a financial asset or financial liability in the
balance sheet
2. The de-recognition of a financial asset or financial liability from
the balance sheet
3. The classification of a financial asset or financial liability into
different categories, and their measurement
4. Whether a gain or loss on a financial asset or financial liability
should be recognized either in profit or loss, or in reserves.

Presentation and disclosure are dealt with in IFRS 7 and IAS 32.
 1.3. Scope
IAS 39 applies to all types of financial instruments except for the
following, which are scoped out of IAS 39:
1. Interests in subsidiaries, associates, and joint ventures accounted for under IAS
27(CSFS), IAS 28(Investment in associates), or IAS 31(Interests in Joint ventures);
however IAS 39 applies in cases where under IAS 27, IAS 28 or IAS 31 such
interests are to be accounted for under IAS 39. The standard also applies to
derivatives on an interest in a subsidiary, associate, or joint venture.
2. Employer’s rights and obligations under employee benefit plans to which IAS 19
applies
3. Contracts in a business combination to buy or sell an acquire at a future date
4. Rights and obligations under insurance contracts, except IAS 39 does not apply to
financial instruments that take the form of an insurance contract.
5. Financial instruments that meet the definition of own equity under IAS 32
6. Financial instruments, contracts and obligations under share based payment
transactions to which IFRS 2 applies
7. Lease receivables and payables only in limited aspects
8. Loan commitments
9. Financial Guarantees
10. Contracts to buy or sell financial items and non-financial items.
 1.4. Definitions
Financial Financial Assets Financial Equity Puutable
Instruments Liability Instruments Instruments
Defined as a Financial assets are Financial liability Is any contract A puttable
contract that gives – is any liability that evidence a instrument is a
rise to financial a). Cash that is- residual interest financial
asset to one entity, b). An entity instrument that
a). A contractual in the assets of an
and financial instrument of gives the holder
another entity obligation enterprise after
liability or equity i). To deliver cash deducting all of the right to
c). A Contractual
instruments to or any financial its liabilities. put the instrument
right-
another entity. It back to the issuer
i). To receive cash asset to another Example
includes for cash or another
or another financial entity. a). Non-puttable
receivables, asset from another financial asset or
payables, loans
ii). To exchange equity shares is automatically
entity financial b). Certain types
and advances, ii). To exchange put back to the
debentures and instruments with of preference issuer on the
financial assets or
bonds, and financial liabilities another entity shares occurrence of an
derivative with another entity. b). A contract that uncertain future
instruments like d). A contract that will or may be event or the death
options, forwards, will or may be settled in the or retirement of
futures, swaps, settled in the entity’s own the instrument
etc. entity’s own equity equity holder.
instruments and is- instruments and
is-
Derivative with i). Non-derivative i). Non-derivative
positive value is for which the ii). Derivative
financial asset entity is or may Financial
and derivative be obliged to instruments may
with negative receive a variable contain non-
values is number of the financial
financial entity’s own obligation that
equity can be avoided
liability.
instruments only by making a
Cash, demand
ii). A derivative transfer of cash or
and time which will or may other financial
deposits, or may be settled assets is also
commercial other than by termed as FL.
paper, debt and exchange of a Example,
equity securities, fixed amount of accounts payable,
asset backed cash financial bills payable,
securities(collate asset for a fixed loans and
ralized number of entity’s advances payable,
mortgaged own equity bank OD,
obligations, instruments debentures
repos, payable,
securitized outstanding
packages of expenses.
receivables),
 2. Recognition and De-recognition
Recognition: A company should recognize a FA or FL on its balance
sheet when the company becomes a party to the contractual provision
of the instrument, rather than when the contract is settled.
De-recognition of Financial Assets: De-recognition of FA arises if
one of the following criteria is met;
1. The contractual rights to the cash flows of the financial asset have expired
2. The FA has been transferred (sold) and the transfer qualifies for de-recognition
based on the extent of the transfer of the risks, and the rewards of ownership of
the FA.
The contractual rights to cash flows may expire because, for instance, a party
has paid-off an obligation to the company, or an option held by the company has
expired worthless. De-recognition occurs because the rights associated with the
financial asset no longer exists. The second criterion for de-recognition occurs
when an financial asset is transferred or sold to other party. Here, the company
must evaluate the extent to which it has transferred the risks and rewards of
ownership to the other party. This evaluation is based on a comparison of the
amounts and timing of the net cash flows of the assets before and after the
transfer of the asset. If a company transfers substantially all risks and rewards of
ownership of a financial asset, the company de-recognizes the financial asset
entirely. The
De-recognition of Financial Liability:
A financial liability should be de-recognized (removed)
from the balance sheet when and only when, it is
extinguished, that is, when the obligation specified in the
contract is either discharged or cancelled or expires.
Where there has been an exchange between an existing
borrower and lender of debt instruments with
substantially different terms, or there has been a
substantial modification of the terms of an existing
financial liability, this transaction is accounted for as an
extinguishment of the original financial liability and the
recognition of a new financial liability. A gain or losses
from extinguishment of the original financial liability is
recognized in profit and loss.
 3. Classification
There are four categories of financial assets and two categories of
financial liabilities. Classification determines;
1. The measurement of the item at cost, amortized cost, or fair value in
the balance sheet
2. Where a gain or loss should be recognized, either in profit or loss or
equity (reserves).
A). Classification of Financial Assets:
A company is required to classify its financial assets into;
1. Financial Assets at fair value through profit or loss: These
include financial assets that the company either holds for trading
purposes or has otherwise elected to classify into this category. FA
that are held for trading are always classified as FA at fair value
through profit or loss. A FA is held for trading if the company
acquired it for the purpose of selling it in the near future, or it is part
of a portfolio of financial assets subject to trading. Derivatives are
always treated as held for trading unless they are effective hedging
instruments.
2. Held-to-maturity investments: These include investments in debt instruments
that the company will not sell before their maturity date, irrespective of changes
in market prices or the company’s financial position or performance. Generally,
investments in shares do not have a maturity date, and should not be classified as
held-to-maturity investments. In order to classified as held-to-maturity, a
financial asset must also be quoted in an active market. This differentiates
between held-to-maturity investments and loans and advances. Loans and
advances, and financial assets that are held for trading cannot be classified as
HTM investments.
3. Loans and advances: These includes financial assets with fixed or determinable
payments that do not have a quoted price in an active market. A company can
classify accounts receivables and loans to customers in this category. FA with a
quoted price in an active market, and FA that are held for trading cannot be
classified as loans and receivables.
4. Available for sale financial assets: This category includes FA that do not fall,
into any of the other categories, or those assets that the company has elected to
classify into this category. FA held for trading cannot be classified as available for
sale financial assets. Example;
a). An investment in shares that has a quoted price, and that is not held-for
trading, should be treated as FA available for sale.
b). An investment in an equity instrument that is not quoted, and for which there
is no intention to sell, should be classified as FA available for sale.
Financial Liabilities: These are classified into two categories;
1. Fair value through profit or loss; FL at fair value through
profit or loss include FL that the company either has incurred
for trading purposes or has otherwise elected to classify into this
category. Derivative liabilities are always treated as held-for
trading unless they are designated as effective hedging
instruments. An issued debt instrument that the company intends
to repurchase soon- to make a gain from short-term movements
in interest rates is an example of a liability held for trading.
2. Measured at amortized cost: FL measured at amortized cost
are the default category for FL that do not meet the definition of
FL at fair value through profit or loss. For many companies,
most FL will fall into this category. Example, accounts payable,
loan payable, issued debt instruments and deposits from
customers.
 4. Initial Recognition of Financial Assets and
Financial Liabilities
Financial Assets/ Financial Liabilities Initial Recognition

Receivables Payables At the time of revenue recognition under IAS

18 when purchase contract is entered into

Purchase of equity instruments or debentures When contract to purchase the financial

instruments is entered into.
In an IPO, when the application money is
paid, the contract to purchase
shares/debentures is not entered into. Issuance
of the allotment letter by the issuer signifies
formal contract. So, share/debenture
application advance is just like advance to
asset purchase. This Advance is derecognized
and investment in it is recognized on receipt
of allotment letter.
In a purchase of share/debenture from the
secondary market, purchase contract may be
recognized on trade date or settlement date.
Commitment to grant a loan Firm commitment to grant a loan is not
recognized as a financial asset by the
prospective lender (similarly, not recognized
as a financial liability by the prospective
borrower) unless one of the parties performs
as per the firm commitment.
However, firm commitment itself can be
recognized as financial asset or financial
liability under IAS 39 in case;
a). Loan commitment for trading
b). Loan commitment in the nature of
derivative
c). Below market rate loan commitment
In Case financial asset/ financial liability is
recognized at fair value on the commitment
date

When the parties entered into the loan

Granting Loans agreement
Firm commitment to buy/sell non-financial It may be recognized as financial
item asset/financial liability under IAS 39. If the
firm commitment fulfills the conditions
stated in IAS 39, financial asset/financial
liability is recognized at fair value on the
commitment date.

Derivatives like futures, forwards, swap, When the contract is entered into.
options
 5. Measurement
Measurement principles are set out in Para 43, IAS 39
are as follows-
a). A FA or FL at fair value through profit or loss
should be measured at fair value on the date of
acquisition or issue.
b). Short-term receivables and payables with no stated
interest rate should be measured at original invoice
amount if the effect of discounting is immaterial
c). Other FA/ FL should be measured at fair value plus/
minus transaction costs that are directly attributable
to the acquisition or issue of the financial asset or
financial liability
 Measurement bases of Financial Assets
Nature of Financial Assets Initial Recognition Subsequent measurement
Held for trading At Fair Value At Fair Value

FA classified as fair value At Fair Value At Fair Value

through profit or loss at
initial recognition
Directly attributable Gain or loss arising out of
transaction cost is charged to change in fair value is
profit or loss account charged profit and loss
account
Available for sale At fair value plus directly At Fair Value
attributable transaction cost
FA classified as available for At fair value plus directly At Fair Value
sale at initial recognition attributable transaction cost

Gain or loss arising out of

change in fair value is
charged directly to equity.
Held to maturity At fair value plus At amortized cost
directly attributable
transaction cost

Change fair value is not

recognized

Loans and advances At fair value plus At amortized cost

directly attributable
transaction cost

Change fair value is not

recognized
 Measurement bases of Financial Liabilities
Nature of Financial Initial recognition Subsequent measurement
Liabilities
FL at fair value through At fair value directly At fair value
profit and loss includes attributable transaction cost Derivatives which are linked to
derivative liability is charged to profit and loss unquoted equity instruments or
account to be settled by unquoted equity
instruments, whose fair value
can not be measured, are
measured at cost.
FL arising out of Measured at amortized cost
continuing involvement or fair value
asset
Financial guarantee Higher of the;
contract less cumulative a). Amount initial recognized
amortization recognized b). Valuation as per IAS 37
Other FL including At fair value At amortized cost
derivatives, bonds, Directly attributable
preference shares, transactions cost is
classified as FL, loans, included in the fair value.
advances payable
 6. Impairment
IAS 39 requires an assessment at each balance sheet date as to
whether there is any objective evidence that a financial asset is
impaired, and whether the impairment has any impact on the
estimated future cash flows of the financial asset. The company
recognizes any impairment loss in profit or loss, and only losses
that have been incurred can be reported. Therefore, losses
expected from future events are not recognized. The impairment
requirement apply to the following assets:
1. Loans and receivables
2. HTM investments
3. available for sale financial assets
4. investments in unquoted equity instruments whose fair value
cannot be reliably measure.
 7. Derivatives
Derivatives are contracts such as options, forwards, futures and
swaps.
A derivative is a financial instrument which has the following
characteristics;
1. Its value changes in response to the change in a specified
interest rate, financial instrument price, commodity price,
foreign exchange rate, index of prices or rates, credit rating,
credit index or other variable.
2. It requires no initial investment or the investment is small
3. It is settled at a future date.
It may be classified into financial derivatives and commodity
derivatives.
 8. Embedded Derivatives
If a contract has explicit or implicit terms affecting the cash- flow
or the value of other exchanges in a way similar to the stand-alone
derivative, then such terms of a contract are treated as embedded
derivatives and are to be separately accounted for as a derivative
provided the following conditions are fulfilled.
● risks and economic characteristics are different from the host
contract
● a separate instrument with same terms would be accounted for as
a derivative
● the hybrid instrument embedding the terms of the nature of a
derivative is not required to be measured at fair value.
The examples of such contracts are convertible bonds, warrants
issued with preference shares or bonds, leveraged inflation indexed
interest payments etc. Interest rate caps, collars and floors are
excluded from being considered as embedded derivatives if at the
time of issue the cap was more than market rate or the floor was
less than the market rate.
 9. Hedge Accounting
• In order to meet the growing challenges caused due
to growing financial instruments in accounting the
International Accounting Standards Board (IASB)
has came out with an Accounting Standard IAS-32
exclusive for disclosure and presentation of financial
instruments, which has been implemented on
January 1, 1996.
• Hedge accounting can be defined as a method of
accounting, for hedge instruments, and other
underlying hedged items, which reflects the
reduction in exposure to risk. It differs from
conventional accounting system. The accounting
practice depends upon the nature of derivative
transactions, for this purpose the transaction can be
classified into following 3 categories;
01. Specific hedge transaction
It refers to that which can be identified with a specific asset,
liability, or commitment at the time of execution of the
hedge transaction.
02. General Hedge Transaction
It may be refer to such transaction which does not identify
particular asset or liability or commitment, rather it used to
cover broad risks for the entity as a whole.
03. Trading Transaction
It refers to such transactions which are of speculative or
arbitrage nature or transactions undertaken by financial
market intermediaries for whom derivatives are regular
business (bankers, brokers, speculators, arbitrageurs etc.)
If a derivative instrument meets certain hedge accounting
criteria, an entity may designate the instrument as one of the
following hedges:
01. Fair value Hedge: A hedge of the exposure to
changes in the fair value of (a) a recognized asset or
liability (b) an unrecognized firm commitment.
02. Cash flow hedge: A hedge of the exposure to
variability in the cash flows of (a) a recognized asset
or liability (b) a forecasted transaction
03. Foreign Currency hedge: A hedge of the foreign
currency exposure (a) an unrecognized firm
commitment, (b) a recognized asset or liability, (c) a
forecasted transaction, or (4) a net investment in
foreign operation.
The relationship between the hedged items and the
hedging instruments are typically referred to as
hedging activities and hedging transactions and are
subject to specific hedge accounting criteria outlined
in the accounting guidance.
Hedging Instruments:
Hedging instrument is an instrument whose fair value or cash flows
are expected to offset changes in the fair value or cash flows of a
designated hedge item. (All derivative instruments excluding
written options).
Hedged Items:
Hedged item is an item that exposes the entity to risk of changes in
fair value or future cash flows and is designated as being hedged. A
hedged item can be:
1. A single recognized asset or liability, firm commitment, highly
probable transaction or a net investment in a foreign operation
2. A group of assets, liabilities, firm commitments, highly probable
forecast transactions or net investments in foreign operations with
similar risk characteristics
3. A HTM investment for foreign currency or credit risk
4. A portion of the cash flows or fair value of a FA or FL