W e Passionately Develop Quality Programmes www.zhtraining.com
Illustrative Examples on
Financial Instruments
Date 11 June 2015 Time 18:30 – 20:30Venue CPA Australia Office
Develop Quality Programmes
Disclaimer
Develop Quality Programmes The materials of this seminar are intended only to provide general information on the subject concerned and shall not be relied upon for technical advice. ZHONGHUI ANDA and the speakers take no responsibility for any errors or omissions in, or for the loss incurred by individuals or companies due to the use of, the materials of this seminar.
No claims, actions or legal proceedings in connection with this seminar brought by any individuals or companies having reference to the materials of this seminar will be entertained by ZHONGHUI ANDA and the speakers.
W e Passionately Develop Quality Programmes
Some Definitions under
HKAS 32 & 39
3 Develop Quality ProgrammesHKAS 39.9
Amortised cost of financial asset or liability is the amount at
which the item is measured at initial recognition minus principal repayments, plus or minus the cumulative amortisation using the effective interest method
Effective interest method is a method of calculating amortised
cost
Effective interest rate is the rate that exactly discounts
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A purchases a debt instrument with five years maturity for CU1,000 (including transaction costs). The instrument has a principal amount of CU1,250 and carries fixed interest of 4.7 per cent that is paid annually (CU1,250 x 4.7% = CU59).
In order to allocate interest receipts and initial discount over the term of the debt instrument at a constant rate on the carrying amount, they must be accrued at the rate of 10 per cent annually.
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HKAS 39 IG B.26 Example of calculating
amortised cost
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W e Passionately Develop Quality Programmes
HKAS 32.16 (fixed to fixed rule)
Equity instrument if, and only if, both conditions (a) and (b) are met.
a. The instrument includes no contractual obligation to deliver cash or another financial asset; or to exchange financial assets or liabilities under conditions unfavourable.
b. If the instrument settled in own equity instruments, it is:
non-derivative includes no contractual obligation to deliver variable number of own equity instruments; or
derivative settled by exchanging fixed amount of cash or another financial asset for fixed number of own equity instruments.
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IFRIC Guidance in April 2005
Classification of instruments as liabilities or equity depends upon whether a fixed amount of foreign currency represents fixed amount of cash or other financial asset
Any obligation denominated in foreign currency represents variable amount of cash
Consequently, contracts settled by delivering fixed number of own equity instruments in exchange for fixed amount of
W e Passionately Develop Quality Programmes 9
Conversion option of HK$ CB of PRC company is not equity
Subsidiary issues CB with rights to exchange fixed number of EI of parent at fixed amount of currency. No decision made.
(IFRIC July 2006 meeting)
Conversion price adjustments of CB
Consider whether adjustment clauses preserve rights of CB holders relative to ordinary shareholders i.e. maintains relative ownership interests and therefore not violate the ‘fixed to fixed’ requirement
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Common Conversion Adjustments
Shares consolidation or subdivision:W e Passionately Develop Quality Programmes 11 Rights issue: G + I G + H
G = number of shares in issue immediately before rights issue H = number of rights issue shares to be issued
I = number of shares which rights issue proceed would purchase at market price
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Shares issued at discount:
R + S R + T
R = number of shares in issue immediately before new issue T = number of new shares issued
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Convertible Loans
13 Develop Quality ProgrammesTwo common types of convertible loans
Loan holders have options to cash repayment or share conversion
Ignore other derivatives
HKAS 32.29
Compound instrument = liability component + equity conversion option
HKAS 39.10
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HKFRS Requirements for
Convertible Loans
15 Develop Quality ProgrammesCompound Instruments
HKAS 32.31 When compound instrument is initially allocated, equity
component is assigned residual amount after deducting from FV of instrument amount for liability component
Value of any derivative features (such as call option)
embedded other than equity component is included in liability component
Sum of amounts assigned to liability and equity components on initial recognition is always equal to FV of instrument as a whole
W e Passionately Develop Quality Programmes 17 HKAS 32.32
First determine amount of liability component by measuring FV of similar liability without associated equity component
HKAS 32.AG31(a)
On initial recognition, FV of liability component is present value of contractually determined stream of future cash flows discounted at market rate of interest applied at that time to instruments of comparable credit status and providing substantially the same cash flows, on the same terms, but without the conversion option
Equity conversion option =
Total – Liability component (Principal – Call option)
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HKAS 32.IE38
Proceeds received on issue of callable convertible bond are CU60. The value of a similar bond without a call or equity
conversion option is CU57. Value to the entity of the embedded call feature in a similar bond without an equity conversion option is CU2.
W e Passionately Develop Quality Programmes HKAS 39.43
Initially measure at FV plus (not at FVTPL) transaction costs HKAS 32.22
Changes in FV of equity instrument not recognised HKAS 39.47
Normally measure financial liabilities at amortised cost using effective interest method
HKAS 32.AG32
On conversion at maturity, derecognise liability component and recognise it as equity. Original equity component remains as equity (may be transferred within equity). No gain or loss on conversion at maturity
HKAS 32.38
Transaction costs allocated to liability and equity components in proportion to allocation of proceeds
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Combined Instruments
HKAS 39.AG28 Initial carrying amount of host instrument is residual amount after separating embedded derivative
HKAS 39.43
Initially measure at FV plus (not at FVTPL) transaction costs
HKAS 39.55(a)
Gain or loss on derivatives recognised in profit or loss
HKAS 39.47
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Illustrative Example of Compound Instrument
Convertible loan issued at par: HK$1,000,000
Conversion option meets equity and no other derivatives
Transaction cost: HK$50,000
Loan period: 3 years
Coupon rate: 1% p.a. (HK$10,000)
Market interest rate on date of issue: 6% p.a.
21 Develop Quality Programmes Cash flow NPV at 6% HK$ HK$ End of year 1 (10,000) 9,434 End of year 2 (10,000) 8,900 End of year 3 (1,010,000) 848,015 FV of liability component on date of issue 866,349
Residual amount of equity component
W e Passionately Develop Quality Programmes 23
Transaction cost allocated to liability component
HK$50,000 x 866,349 / 1,000,000 43,317
Transaction cost allocated to equity component
HK$50,000 x 133,651 / 1,000,000 6,683
Initial amount of liability
HK$866,349 – HK$43,317 823,032 Amount of equity HK$133,651 – HK$6,683 126,968 Develop Quality Programmes
Liability component carried at amortised cost
(a) (b = a x 7.84813%) (c) (d = a + b - c) Year Amortised cost at year beginning Interest
expense Cash flows
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Accounting
entries:
Date of issue HK$ HK$ Dr. Bank 950,000 Cr. Conversion equity 126,968 Cr. Convertible loan 823,032 25 End of year 1 HK$ HK$Dr. Convertible loan interest 64,593
Cr. Bank 10,000
Cr. Convertible loan 54,593
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If conversion at end of year 1 HK$ HK$ Dr. Conversion equity 126,968
Dr. Convertible loan 877,625
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Illustrative Example of Combined Instrument
Convertible loan issued at par: HK$1,000,000
Not fixed to fixed conversion option and no other derivatives
Transaction cost: HK$50,000
Loan period: 3 years
Coupon rate: 1% p.a. (HK$10,000)
FV of conversion derivative on date of issue: HK$100,000
FV of conversion derivative at end of year 1: HK$200,000
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FV of conversion derivative on date of issue 100,000
Residual amount of liability component on date of issue
HK$1,000,000 – HK$100,000 900,000
Transaction cost allocated to conversion derivative
HK$50,000 x 100,000 / 1,000,000 5,000
Transaction cost allocated to liability component
HK$50,000 x 900,000 / 1,000,000 45,000 Initial amount of liability
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Liability component carried at amortised cost
29 (a) (b = a x 6.47205%) (c) (d = a + b - c) Year Amortised cost at year beginning Interest
expense Cash flows
Amortised cost at year end 1 855,000 55,336 (10,000) 900,336 2 900,336 58,270 (10,000) 948,606 3 948,606 61,394 (1,010,000) 0 Develop Quality Programmes
Accounting entries:
Date of issue HK$ HK$ Dr. Bank 950,000Dr. Convertible loan expense 5,000
Cr. Conversion derivative liability 100,000 Cr. Convertible loan 855,000
End of year 1 HK$ HK$
Dr. Convertible loan interest 55,336
Cr. Bank 10,000
W e Passionately Develop Quality Programmes 31 End of year 1 HK$ HK$
Dr. Fair value loss 100,000
Cr. Conversion derivative liability 100,000
If conversion at end of year 1 HK$ HK$ Dr. Conversion derivative liability 200,000
Dr. Convertible loan 900,336
Cr. Share capital and premium 1,100,336
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Accounting for
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Conversion option
HKAS 39.AG 30(f) Equity conversion feature embedded in convertible debt instrument is not closely related to the host debt instrument from perspective of holder
Conversion option is therefore derivative asset i.e. at FVTPL.
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Host contract
HKAS 39.9 Loans and receivables (not quoted in active market)
HKAS 39.9 & 39.55(b)
Available-for-sale investment
Effective interest income to profit or loss
HKAS 39.11A
W e Passionately Develop Quality Programmes Held-to-maturity investment???
Initial cost allocation method not mentioned in HKFRS
Follow HKFRS 3.2(b)
Cost allocated to identifiable assets and liabilities on basis of their relative fair values
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