FAQs – Classification of Financial Instruments

Measurement categories for financial assets

Measurement categories for financial assets What are the principal measurement categories for financial assets?  Principal measurement categories for financial assets are amortised cost, fair value through other comprehensive income – FVOCI and fair value through profit or loss – FVTPL.  As per the previous version, viz, IAS 39, the financial assets were classified as one of the following, viz, (a) fair value through profit or loss –FVTPL; (b) available for sale; (c) held to maturity; and (d) loans and receivables. Out of all these, the last category, viz, loans and receivables are now not a measurement category. Held to maturity is now known …
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Difference between amortised cost & held-to-maturity

Difference between amortised cost & held-to-maturity What is the difference between amortised cost classification as per Ind AS 109 and held-to-maturity classification as per IAS 39? A financial asset shall be measured at amortised cost if both of the following conditions are met: the financial asset is held within a business model whose objective is to hold financial assets in order to collect contractual cash flows; andthe contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. Amortised cost classification as per Ind AS 109 has similarities …
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Financial asset categorised as FVOCI

Financial asset categorised as FVOCI When will a financial asset be categorised as fair value through other comprehensive income? A financial asset shall be measured at fair value through other comprehensive income if both of the following conditions are met: the financial asset is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets; andthe contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. Here, the term principal refers to the fair value of the financial asset …
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Is there a choice to designate as FVTPL?

Is there a choice to designate as FVTPL? An entity has choice to designate a financial asset as measured at fair value through profit or loss. Explain. The option to designate a financial asset at fair value through profit or loss (FVTPL) is not without restrictions. There are certain conditions to be satisfied and above all, the option should be exercised at the inception of the financial asset. An entity may, at initial recognition irrevocably, designate a financial asset as measured at fair value through profit or loss if doing so eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to …
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Classification of derivative instruments

Classification of derivative instruments How are derivative instruments classified? Derivative instruments are a subset of financial instruments. In the definition of financial asset, we have the following phrase, viz, “to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity” and in the definition of financial liability “to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity”. This means that depending upon the net present value (fair value) of the derivative instrument it will either be shown as a financial asset or as a financial …
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FVOCI (equity instruments) and FVOCI (debt instruments)

FVOCI (equity instruments) and FVOCI (debt instruments) What is the difference FVOCI (equity instruments) and FVOCI (debt instruments) Debt instruments are classified as FVOCI if and only if both the following conditions are satisfied, viz, (a) financial asset is held within the business model whose objective is achieved by both collecting directly cash flows and selling of financial assets, and (b) the contractual terms of the financial assets represents solely payments of principal and interest. However, in the case of equity shares, the entity has irrevocable election choice that can be exercised on an instrument by instrument basis to classify such instruments …
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SPPI test & business model objective test

SPPI test & business model objective test Which criteria should be applied first – SPPI test or business model test? SPPI test refers to the evaluation of contractual cash flows that analyses if such cash flows represent solely payments of principal and interest on the principal amount outstanding. Business model is in fact not a test. An entity should examine its business model to arrive at whether the financial assets are held with the sole purpose of generating contractual cash flows or buying and selling of such financial assets or both. There is no specific order in which the two above-mentioned criteria are to …
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What does Interest represent?

What does Interest represent? Interest represents only the consideration for the passage of time. Do you agree? While interest is predominantly the consideration for time value of money, it also includes consideration for the credit risk associated with the principal amount outstanding during a particular period of time. It also includes consideration for other basic lending risks and costs as well as a profit margin. Contractual cash flows representing solely payment of principal and the interest (SPPI) on the principal amount outstanding are consistent with a basic lending arrangement. The two significant elements of interest are: Consideration for the time of value of …
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Difference between time value of money and modified time value of money

Time value & modified time value What is the difference between time value of money and modified time value of money? Time value of money is the element of interest that provides consideration for only the passage of time. That is, the time value of money element does not provide consideration for other risks or costs associated with holding the financial asset. In order to assess whether the element provides consideration for only the passage of time, an entity applies judgement and considers relevant factors such as the currency in which the financial asset is denominated and the period for which the …
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Change in contractual cash flows

Change in contractual cash flows When change in the terms is altering the contractual cash flows, should the SPPI test be carried out afresh? A proper assessment should be made afresh whenever there could be contractual term potentially changing the timing or amount of the contractual cash flows. A typical example is where a financial asset can be prepaid before the date of maturity or whether its term can be extended. For the purpose of this assessment, the contractual cash flows that could arise after the change in the contractual cash flows should be compared with the contractual cash flows before such …
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Long-term financial liability classified as FVTPL

Long-term financial liability classified as FVTPL Can a long-term financial liability be classified as subsequent measured at fair value through profit or loss? Yes. An entity may, on initial recognition, designate a financial liability as measured at fair value through profit or loss. If an entity exercises this option, then it cannot be revoked at any point of time. Also, the fair value option to designate a financial liability on initial recognition will be permitted only when doing so results in presenting more relevant information. This can be on account of two situations: Where it eliminates or significantly reduces a measurement or recognition …
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