CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS

Lesson 12 PFRS 9 – Financial instruments

PFRS 7 – Financial instruments disclosures

Lesson Objectives:
1. State the core principle under PFRS 9 and PFRS 7
2. Apply the standards on financial instruments and financial instruments disclosures
3. Describe the accounting and reporting requirements of PFRS 7 and PFRS 9.
Discussion:
Lesson 12.1 - PFRS 9: Financial Instruments
PFRS 9 establishes the financial reporting principles for financial assets and financial liabilities, its classification and
measurement.

- Financial assets and financial liabilities are recognized only when the entity becomes a party to the
contractual provisions of the instrument.
- Financial assets are classified as subsequently measured at:
o Amortized cost – when the following conditions are met:
 Hold to collect business model – objective is to hold the financial asset to collect
contractual cash flows. However, it still remains appropriate even when some sales
occur or expected to occur in the following circumstances:
 Sales of financial assets due to increase in credit risk
 Sales of financial assets with insignificant value even when such sales are
frequent
 Sales of financial assets that are infrequent, even when the sales have
significant value
 Sales made close to the maturity when sales proceeds approximate the
collection of the remaining cash flows.
 Solely payments of principal and interest (SPPI) – the terms give rise on specified
dates to cash flows.
o Fair value through other comprehensive income (FVOCI) - when the following conditions are
met:
 Hold to collect and sell business model – this is appropriate when the entity’s
objective is
 To manage everyday liquidity needs
 To maintain a particular interest yield profile
 To match the duration of the financial assets to the duration of the liabilities
that those assets are funding.
 Solely payments of principal and interest (SPPI) – the terms give rise on specified
dates to cash flows.
o Fair value through profit or loss (FVPL) – if the conditions for amortized cost or fair value
through profit or loss is not met, except –
 Election to measure investments in equity securities that are not held for trading at
FVOCI
 Option to designate financial assets to be measured at FVPL if doing so significantly
reduces or eliminates accounting mismatch.
 - Basis of classification of financial assets:
o The entity’s business model for managing the financial assets
o The contractual cash flow characteristics of the financial assets.
- Measurement of financial assets –
o Initial measurement – measured at fair value plus transaction costs, except FVPL, which is
measured at fair value only.
Transaction costs include fees and commissions paid to agents, advisers, brokers, dealers,
levies by regulatory agencies, security exchanges and transfer taxes and duties, are expensed
outright. It does not include debt premiums or discounts, financing costs or internal
administrative or holding costs.
o Subsequent measurement – see above.
Summary:
Classificatio Statement of Initial Subsequent Statement of comprehensive
Composition
n financial position measurement measurement income
Debt or
Changes in fair value are
FVPL equity Current assets Fair value Fair value
recognized in P/L
securities
Changes in fair value are
FVOCI Equity Current or non- Fair value plus
Fair value recognized in OCI (without
(election) securities current assets transaction costs
recycling)
- Changes in fair value are
recognized in OCI (with recycling)
- Interest income computed using
FVOCI Debt Current or non- Fair value plus effective interest method
Fair value
(mandatory securities current assets transaction costs recognized in P/L
- Impairment gains/losses are
recognized in P/L (with offset to
OCI)
- Interest income computed using
Amortized
effective interest method
Amortized Debt Current or non- Fair value plus cost less
recognized in P/L
cost securities current assets transaction costs impairment
- Impairment gains/losses are
allowance
recognized in P/L

- Reclassification – financial assets are reclassified only when the entity changes its business model
for managing financial assets.
o It is applied prospectively from the reclassification date
 Reclassification date is the first day of the first reporting period following the change
in the business model that results in an entity reclassifying financial assets.
o Gains, losses or interests recognized in the prior periods are not restated.
o Only debt instruments can be reclassified, not equity instruments.
- Impairment – the standard uses an expected credit loss model to recognize impairment losses on
debt-type financial assets.
o ECL model 3 approaches depending on the type of asset or credit exposure, summarized as
follows:

Type of Asset/Exposure Approach

Trade receivables, contract assets and lease receivables Simplified approach
Originated or purchased credit-impaired financial assets Changes in lifetime ecpected credit losses approach
Other assets/exposures General approach (3-stage approach)

General Approach: This is based on 3 stages which are intended to reflect the credit deterioration and improvement
of financial instrument.
 Stage 1 Stage 2 Stage 3
 Credit risk has increased
 Credit risk has not increased
 Credit risk has increased significantly since initial
significantly since initial
significantly since initial recognition plus there is
recognition
recognition objective evidence of
 Low credit risk’ expediency
impairment
Recognize 12-month expected credit Recognize lifetime expected credit Recognize lifetime expected credit
losses losses losses
Interest revenue is computed on the Interest revenue is computed on the Interest revenue is computed on the
gross carrying amount of the asset. gross carrying amount of the asset. net carrying amount of the asset.

Change in credit risk since initial recognition

IMPROVEMEN DETERIORATION

Loss allowance – allowance for expected credit losses on financial assets within the scope of the impairment
requirements of the standard
Expected credit losses the weighted averge of credi losses with the respective risks of a default occurring as the
weights
Credit loss – the difference between all contractual cash flows due to entity in accordance with the contract and cash
flows the entity expects to receive discounted at the original effective interest rate.
12-month expected credit losses – portion of lifetime expected credit losses that represent the expected credit losses
that result from default events on a financial instrument that are possible within 12 months after the reporting date
Low credit risk expediency – an entity may assume that the credit risk has not increased significantly since initial
recognition
Lifetime expected credit losses – the expected credit losses that result from all possible default events over the
expected life of a financial instrument.

- Derecognition – financial assets are derecognized when

o The contractual rights to the cash flows expire (collected, cancelled or become uncollectible).
o The financial assets are transferred if the entity
 Transfers the contractual rights to receive cash flows of the financial asset or
 Retain the contractual rights to receive cash flows but assumes an obligation to remit
the collections to a recipient in an arrangement that meets all the following
conditions:
 The entity is not obligated to pay the recipients unless it collects an equivalent
amount from the original asst.
 The entity is prohibited from selling or pledging the original asset except as
security in favor of the recipient
 The entity is obligated to remit collections to the eventual recipients without
material delay.
o If the entity transfers substantially all the risks and rewards of ownership of the financial
asset.
- Financial liabilities classification and subsequent measurement – at amortized cost except the
following:
o Financial liabilities at FVPL and derivative liabilities (subsequently measured at fair value.
 o Financial liabilities that arise when a transfer of a financial asset does not qualify for
derecognition (subsequently measured on the basis that reflects the rights and obligations the
entity has retained)
o Financial guarantee contracts and commitments to provide a loan at a below market interest
rate, subsequently measured at the higher of
 The amount of the loss allowance and
 The amount initially recognized less the cumulative amount of income recognized.
o Contingent consideration recognized by an acquirer in a business combination, subsequently
measured at FVPL
Reclassification of financial liabilities after initial recognition is prohibited.

- Measurement of financial liabilities –

o Initial measurement – at fair value minus transaction costs, except financial liabilities at
FVPL wherein transaction costs are expensed outright.
o Subsequent measurement:
 Financial liabilities classified as amortized cost – at amortized costs
 Financial liabilities classified as held for trading – at fair value with changes in fair
values recognized in profit or loss
 Financial liabilities designated at FVPL – at fair value with changes in fair values
recognized as follows:
 When attributable to changes in the credit risk – other comprehensive income
 The remaining amount of change in the fair value – profit or loss.

Enrichment Activity:
1. As supplemental information, choose and watch at least one among the various discussions/lectures
on PFRS/IFRS 9 in YouTube.
2. Answer problem 1 and 2 on page 560 - 561

Lesson 12.2 PFRS 7 Financial Instruments: Disclosures

PFRS 7 prescribes the disclosure requirements for financial instruments that are classified as follows:

- Significance of financial instruments to the entity’s

o Statement of financial position – carrying amounts of
 Financial assets measured at FVPL showing separately
 Those that are designated
 Those that are mandatorily measured at FVPL
 Financial assets measured at amortized cost
 Financial assets measured at FVOCI showing separately
 Those that are mandatorily classified as such
 Those that are elected to be classified as such
 Financial liabilities at amortized cost
 Financial liabilities at FVPL showing separately
 Those that are designated
 Those that meet the definition of held for trading
Disclosures required:
Financial assets and financial liabilities measured at FVPL -
  The financial asset’s exposure to credit risk and the change in fair value
attributable to changes in credit risk
 Change in the fair value that is attributable to changes in credit risk
 Any cumulative gain or loss that were transferred within the equity or were realized
Financial assets measured at FVOCI

 Investments in equity securities should be disclosed and the reason for the
election
 Dividends recognized during the period
 Any transfers of cumulative gain or loss within the equity
 If any were disposed of,
o the reason for the disposal,
o the fair value on the derecognition date
o the cumulative gain or loss on disposal
Rreclassification of financial assets

 date of reclassification
 explanation of the change in business model
 amount reclassified between categories
 if reclassifies from FVOCI or FVPL to amortized cost or from FVPL to
FVOCI or amortized cost -
o fair value gain or loss that would have been recognized in profit or loss
or OCI if it had not been reclassified.
Offsetting financial assets and financial liabilities –

 the gross amounts of those assets and liabilities

 amount that were set off
 the net amounts presented in the statement of financial position
 description of the related legal right of set-off
Collateral –

 carrying amount of the financial assets pledged as collateral for liabilities

 terms and conditions of the pledge
 if the entity holds the collateral that is permitted to sell or repledge –
o the fair value of such collateral
o if has been sold or repledged –
 whether the entity has an obligation to return it
 the terms and conditions associated with the entity’s use of
collateral
Other disclosures:

 Allowance account for credit losses

 Defaults and breaches relating to loans payable –
o carrying amount of those loans payable, the principal, interest, sinking
fund or redemption terms
o whether the default was remedied or if the terms were renegotiated
before the financial statements were authorized for issue
o Statement of comprehensive income
 Items of income, expense, gains or losses
 Net gains or losses on
 o Financial assets and financial liabilities measured at FVPL showing
separately those relating to designated and mandatorily measured at
FVPL
o Financial assets measured at amortized cost
o Financial liabilities measured at amortized cost
o Financial assets measured at FVOCI showing separately those relating
to eleced and mandatorily measured at FVOCI
 Total interest revenue and total interest expense using effective interest
method
 Fee income and expense
- The nature and extent of risks arising from financial instruments to which the entity is exposed, and
how the entity manages those risks.
o Credit risk – will cause a financial loss of one party by failing to discharge an obligation
o Liquidity risk – difficulty in meeting obligations associated with financial liabilities
o Market risk – when the fair value of financial instrument will fluctuate because of the
changes in market prices, which consists of the following types of risk –
 Currency risk – due to the changes in foreign exchange rates
 Interest rate risk – due to the changes in market interest rates
 Other price risk – due to changes in market prices other than arising from interest rate
risk or currency risk.
The entity shall provide both qualitative and quantitative disclosures for each type of risks.
Enrichment Activity:
1. As supplemental information, choose and watch at least one among the various discussions/lectures
on PFRS/IFRS 7 in YouTube.
2. Answer problem 1 and 2 on page 527 – 528.