Definition 1 - Financial Instrument or Asset is any asset that is Cash, any Equity instrument (e.g., Shares) of another company & a contractual right to receive Cash.
Definition 2 - It covers a contract between two parties which gives to one party financial asset & to other party financial liability & Equity. The simple words, financial asset means right to receive Cash.
Definition 3 - In Simplest Language – In IFRS9 you Show financial assets at today’s market value, and decide whether the gain goes to profit or a separate place (OCI), based on why you bought the asset.
What type of assets are covered in IFRS 9?
1. Shares - Buying Tata / Apple shares
2. Bonds / Debentures - Giving loan to a company
3. FD / Loan given - Bank FD or money lent to someone
4. Mutual Funds - Equity or debt MF
5. Derivatives - Gold future, dollar contract
Note - Land, building, car, inventory is not covered here
Now Understand what is fair value in very simple manner
Fair Value means today’s market price. Forget about the purchase price, how much you paid. Only ask “If you sell it today, how much money will you get?”
Example - You bought a share at ₹2,000
Today’s market price = ₹2,300
Fair Value = ₹2,300
Now the question comes where to show this ₹300 Gain or loss (if any). Then you have to identify. Why did you buy this asset? Based on your answer, the profit goes to different places.
Case 1: You bought shares to make quick profit. With a though of “Price will go up. I will sell and earn”.
Example: Buy share at ₹1,500. Year-end price = ₹1,800. Gain = ₹300
This ₹300 is shown directly as profit
This is called - Fair Value through Profit & Loss (FVTPL)
Case 2: You bought shares as long-term investment. With a though of “I will keep it for many years”.
Example - Buy share at ₹1,000, Year-end value = ₹1,200. Gain = ₹200
This ₹200 is not treated as normal profit. As you have not booked it yet. It is shown in a separate box, not in profit. This separate box is called OCI (Other Comprehensive Income).
This method is called:
Fair Value through OCI (FVTOCI)
Case 3: Now understand FD / Loans / Bonds
Example: You give ₹1,00,000 to a bank or company. You expect Fixed interest every year & Full money back at the end. Here no daily buying or selling. no market guessing. So, in this case IFRS 9 says “Do NOT change its value daily”. You just show interest income & keep the original amount
SPPI Test - SPPI only asks ONE simple question:
Will you receive only my money + interest?
If you will get Simple interest type return SPPI Test pass. But if you will get Market-linked return then SPPI test is fail.
SPPI – Pass >>> Examples: Bank FD, Simple loan Fixed-interest bond
SPPI – failed >>> Examples: Return depends on share price, Return depends on gold or dollar price
How do you get Fair Value - Real market numbers
Level 1 – Direct market price for Listed shares and Mutual fund NAV >>> Stock exchange price
Level 2 – You have to do Market comparison for Unlisted bond from Similar interest rate data >>>RBI rates, bank yields
Level 3 – in Case of Startup investments Estimated value for Private company shares >>> Expected future profits (best estimate)
What you bought
Why you bought
Value based on
Shown where
Shares (trading)
Quick profit
Market price
Profit
Shares (long term)
Investment
Market price
Separate box (OCI)
FD / Loan
Interest
Original amount
Interest income
Derivatives
Speculation
Market price
Profit
Okay now we are going to connect the real word accounting with what we have learnt. Here we are going to learn about Two Financial Assets.
Investment in Equity instrument – IFRS9
|
Method |
When Applicable |
|
1. Fair
Value through P&L |
Default
option for all Equity Investments |
|
2. Fair Value through OCI |
Irrevocable
Election at initial recognition (non trading Only) Simple
– If management decided the URGL of particular equity will go to OCI. Then 2 conditions
need to Follow 1.
The
decision will be irrevocable for URGL transfer to OCI 2.
If
the Equity will be sold in future, then realised gain or loss will not transfer
to P&L. it will go to Retained earnings |
Fair Value through P&L (FVTPL)
· Default classification
· Mandatory for equity Instruments held for Trading
· Also used when entity does not make OCI election
· Example – investing in shares of listed company for short term gain (Intraday or swing trading)
Fair Value Through OCI (FVTOCI)
· Only for equity instruments not held for trading.
· Requires an irrevocable election at the time of initial recognition.
· Suitable when investment is made for strategic reasons or long-term holding.
· Example: Investment in shares of a business partner company for long-term strategic interest.
Important Point
· Equity shares do not have fixed or contractual payments like principal and interest.
· Returns (like dividends or capital appreciation) are not predictable or contractual.
· There's no maturity or repayment obligation in shares.
· Conclusion: Equity investments cannot be measured at amortised cost under IFRS9 -
they must be measured at fair value (either through P&L or OCI).
Accounting
for Equity Investments- Comparison (FVTPL vs FVTOCI)
|
Aspect |
Fair Value Through P&L (FVTPL) |
Fair Value Through OCI (FVTOCI) |
|
Initial
Measurement |
At
fair value +
Transaction costs →P&L (expensed) |
At
fair value+ Transaction costs → Capitalised |
|
Subsequent
Measurement |
Fair
value changes -> P&L (gain/loss) |
Fair
value changes → OCI (gain/loss) |
|
Dividend
income |
Goes
to P&L if it represents return on investment |
Goes
to P&L if it represents return on investment |
Accounting for Investment in Debt instrument – IFRS9
Debt instrument (e.g. Bonds, Debentures Can be classified under three Measurement Categories)
1. Fair Value through P&L (FVTPL)
2. Fair Value through OCI (FVTOCI)
3. Amortisation Cost
For accounting of investment in debt instrument you have to check two test
1. BMT – Business Model test – Whether the business model is to hold the asset to collect the contractual Cash flows
2. CCFT (SPPI)– Contractual cash flow test – are the Cash flow from the asset solely payments of principal and Interest (SPPI) if you are going to received Interest and principal amount at maturity
Three Accounting methods for financial Asset Debt instruments
1. If BMT & CCFT both test Pass then show at amortisation cost means ignore fair Value (Held to collect cash flows)
2. If BMT fails and CCFT test Pass then show as FVTOCI (Held to Collect + Sell)
3. Fails CCFT or Default Category will go in FVTPL (Trading / Complex Instruments)
For any query regarding the post or if you want to learn any topic you can write me on
Website : - https://rohitjain.royalrichie.com
Follow on Linked in - https://www.linkedin.com/in/rohit-jain45298380/
WhatsApp Channel:- https://whatsapp.com/channel/0029Vb5s32kEquiYjAofWP20
Thank you for reading & keep learning.
No comments:
Post a Comment