1ADVANCE ACCOUNTING Table of Contents Introduction......................................................................................................................................2 Discussion........................................................................................................................................2 Classification as liability or Equity..............................................................................................5 Conclusion.......................................................................................................................................7 Reference.......................................................................................................................................11
2ADVANCE ACCOUNTING Introduction Accounting for financial instruments is complex under IFRS. A broad review has been providedconsideringIAS32,‘FinancialInstrument:Presentation’,IFRS7,‘Financial Instrument Disclosure’, and IAS 39. ‘Financial Instrument: Recognition and Measurement’. The following chapters have been addressed among which includes classification of debt and equity and scope of the requirement (Uyar, Kılıç and Gökçen, 2016). Financial Instrument can also be interpret as any contract which gives an addition in the asset ofone entity and a financial liability or an instrument of equity to the other entity. Discussion General Accepted Accounting Principal (GAAP) explains the financial instrument as money in form of cash or any other evidence of ownership interest in the company or an entity (Wild, Creighton and Simmonds, 2015). The instrument can be in a form of contract which imposes a contractual obligation on one entity, either to give cash or any other financial instrument to a other entity or to exchange any financial instrument on unfavourable terms with the other entity. IAS 32 lays down principles for distinguishing between the financial instruments like equity and liabilities. The classification of the financial instrument is governed by the contractual terms rather than its legal form. IAS 32 outlines the requirement of accounting for presenting financial instrument, particularly while classifying such instrument as a financial asset, financial liabilities or equity instrument (Iasplus.com. 2020).An important feature which distinguishes a liability from equity is that while issuing an instrument, if the issuer is required to issue cash or any other financial asset to the bearer or holder than the instrument represents liability.
3ADVANCE ACCOUNTING Classification of net asset is done when a residual interest is represented in the net asset of the issuer (Pwc.com. 2020). The financial instrument comprises of a financial asset, equity instrument and financial liability (Mullinova, 2016). This instrument can be categorized into two groups: Cash Instrument: These are those instrument which is directly influenced by the market and the market also determines the value. This instrument can be in the form of securities, that is liquid i.e. readily transferable, and loans and deposits in which the borrowers and lenders agree on the transfer. DerivativeInstrument:Thesearethoseinstrumentwhichderivestheirvalueand characteristics based on the vehicles underlying components such as interest rates, assets or index. The instruments are over-the-counter (OTC) derivatives or can be exchange- traded derivatives. The derivative on equity is accounted under IAS 39. While considering any item in the balance sheet, it is important to understand the following terms (Fabozzi, 2018): Financial Asset: These are non-existing asset the value of which is derived from a contractual term like bonds, stocks and bank deposits. These assets are highly liquid as compared to other tangible asset. Assets which are in the form of cash or cash equivalent (Tan and Low, 2017)and includes a contract that will or may be settled from the equity instrument of the entity and which is a non-derivative, and for which the entity will receive a variable number of the other entity’s equity instrument is a financial asset. Financial assets are different from non-financial assets as it includes tangible and intangible assets.
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4ADVANCE ACCOUNTING Financial Liability: Financial liabilities are those future sacrifices that an entity is required to make in terms of economic benefits which arises due to some past transaction or any other activity in the past. This sacrifices that are required to be made in the future can be in the form of money or services owed to the other entity or party (Skoglund and Chen, 2015). It can also be defined as any liability that is a contractual obligation to give cash or any other financial instrument to the other party, or to change the financial asset to write off the liability under conditions that may be potentially unfavourable for the entity. Financial liability includes interest and debt payables which arises as a result of using other’s money in the past and accounts payable such as rent, purchases and lease payable to the other parties for the use of their products and spaces in the past. Equity Instrument: It refers to any documents which serve as legal evidence to individual or entity for proving their right in the firm. The instrument is primarily used to fund the business, and the individual who holds an equity instrument in the entity is called a shareholder. It can also be explained as a contract that shows the interest of an individual in the assets of the entity remaining after subtracting all the liabilities. There are various categories of equity instrument which are (Das, 2015): Common Stock:It is a common instrument issued by a public company to raise funds from the public. Under this stock the shareholders have the right to vote and is entitled to co-ownership of the company. The holder is also entitled to receive dividend and is entitled to receive entire share value acquired by them at the time of winding up of the company. Convertible Debentures: The unique feature of this bond is that it entitles the holder to convert such bonds into the common stock. Holder of the convertible debentures is
5ADVANCE ACCOUNTING entitled to a defined rate of interest irrespective of the profit of the company. These bonds are popular for their profitable returns. Preferred Stock: It is also a common stock which involves the holder’s participation in the ownership of the company. The variation lies in the prior payments made at the time of distribution of dividends or distribution at the time of winding up of the company. Depository Receipt: Investors holding the depository receipt has the benefits similar to that of shareholder in every aspect. Classification as liability or Equity. As per IAS 32, the fundamental principal is to classify financial instrument either as an equity instrument or financial liability according to the substance of the contract and from its definition but not in its legal form. The decision regarding whether the item is financial liability or equity should be made initially at the time of recognition and it should not be changed with the change in the circumstances (Maglio, Agliata and Tuccillo, 2017). Classification of the instrument as debt or equity is vital because it directly affects in the valuation of gearing ratio, which is a critical measure that the financial user or stakeholders uses to measure the financial risk of the entity. The distinction that will arise from improper classification will also impact the profit of the company as the financial cost related with the financialliabilitieswillbechargedintheprofitandstatementwhichwillresultinan understatement of profit and therefore lower will be the tax payable to the government. Similarly, the dividends payable to the equity will be assigned from the profits, rather being treated as an expense (Worthington, 2016). Treating the equity as liability will not only decrease the profit but will also reduce the earning per share (EPS) of the company, thereby impacting the
6ADVANCE ACCOUNTING funding ability of the company since investors decide based on EPS of the company. A single instrumentissued may containthe qualitiesof both equityand liability,for example, a convertible bond, it is the bond which comprises the feature of converting it into shares rather than being repaid in cash than the accounting of such instrument will be done at the time when such debentures are converted into common stock, thereby reducing the liability and increasing the equity in the financial statement should be done. Equity Instrument cannot be re-measured. Changes in the fair value of the shares are is not measured by the entity while preparing financial statement, as the gain or loss will be experienced by the owner itself. The dividend is also paid from the retained earnings so it does not affect the carrying value of the equity instrument. On the other hand, if the shares issued are redeemable than the shares will be classified as a financial liability (debt) as the issuer will be required to pay back the money in future. Moreover, if there is a contractual right or obligation to deliver equity instrument to other entity for the benefits received in some fixed monetary amount, then such obligation is a financial liability. A new standard AASB 9 is applicable for the entities reporting from the period beginning January2018.Thisnewstandardprovidesclassificationandmeasurementofassetsand liabilities in the financial statement. This standard provided a new set of hedge accounting rules and laid down new principal for the impairment of financial assets. Conclusion The above report focusses on the importance of the accounting classification of the financial instrument and its consideration as a debt or equity. The classification plays a vital role in the financial report as it changes the decision of the user if any measurement is not appropriate. An inappropriate measure can lead to understatement or overstatement of profit and other dividend related decisions which are material to the user of the financial statement. The
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7ADVANCE ACCOUNTING adverseimpacthasbeenhighlightedwhichwillaffecttheentityfinancialpositionif classification is done inappropriately. The recent amendment of the new standard AASB 9 has also been highlighted which provides a principal for the impairment of the asset.
8ADVANCE ACCOUNTING TASK TWO DateSpot rateForward rate Receivable on forward contract Amount payable on forward contract Fair value of forward contract Gain/(loss) on forward contract 1/6/2019$1.00$0.90$100,0009000010000010000 30/6/2019$0.91$0.89$100,00089000910002000 1/8/2019$0.87$0.86$100,00086000870001000 1/10/2019$0.85$0.85$100,00085000850000 Journal entries DateAccountDebitCredit 1/6/2019Inventory100000 Cash100000 (being financial instrument purchased)
9ADVANCE ACCOUNTING 1/6/2019Financial Instrument100000 Inventory100000 (Beinginventoryconsideredasfinancial instrument) 1/6/2019Financial instrument 10,000 Other comprehensive income10000 (Being gain on foreign exchange) 30/6/2019Inventory2000 Other comprehensive income2000 (being gain on foreign exchange) 1/8/2019Financial1000 Other comprehensive income1000 (being gain on foreign exchange) 1/10/2019Cash
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10ADVANCE ACCOUNTING 87,000 Other comprehensive income 13,000 Financial Instrument100000 (being financial instrument sold)
11ADVANCE ACCOUNTING Reference Das, S.C., 2015. The Financial System in India: Markets, Instruments, Institutions, Services and Regulations. PHI Learning Pvt. Ltd. Fabozzi, F.J. ed., 2018. The handbook of financial instruments. John Wiley & Sons. Iasplus.com.(2020).IAS32—FinancialInstruments:Presentation. https://www.iasplus.com/en/standards/ias/ias32. Maglio, R., Agliata, F. and Tuccillo, D., 2017. Trend of IASB Project on the Distinction between Equity and Liabilities: The Case for Cooperatives and Continental European Firms. Mullinova, S., 2016. Use of the principles of IFRS (IAS) 39" Financial instruments: recognition and assessment" for bank financial accounting. Modern European Researches, (1), pp.60-64. Pwc.com.(2020).Availableat: https://www.pwc.com/gx/en/ifrs-reporting/pdf/financial_instruments_guide_maze.pdf Skoglund, J. and Chen, W., 2015. Financial risk management: Applications in market, credit, asset and liability management and firmwide risk. John Wiley & Sons. Tan, B.S. and Low, K.Y., 2017. Bitcoin–its economics for financial reporting. Australian Accounting Review, 27(2), pp.220-227. Uyar,A.,Kılıç,M.andGökçen,B.A.,2016.CompliancewithIAS/IFRSandfirm characteristics: evidence from the emerging capital market of Turkey. Economic research- Ekonomska istraživanja, 29(1), pp.148-161. Wild, K., Creighton, B. and Simmonds, A., 2015. Gaap 2000: UK Financial Reporting. Springer.
12ADVANCE ACCOUNTING Worthington, S., 2016. Exposing Third-Party Liability in Equity: Lessons from the Limitation Rules. Equity, Trusts and Commerce (Oxford, Hart Publishing 2017) Chapter, 14.