ACCA AAA INT Syllabus D. Audit of Historical Financial Information - Financial liabilities - Categories - Notes 15 / 41
Finacial Liabilities has only 2 categories, FVTPL and Amortised Cost
The 2 categories of Financial Liability...
Fair Value Through Profit and Loss (FVTPL)
This includes financial liabilities incurred for trading purposes and also derivatives.
Amortised Cost
If financial liabilities are not measured at FVTPL, they are measured at amortised cost.
The good news is that whatever the category the financial liability falls into - we always recognise it at Fair Value INITIALLY.
It is how we treat them afterwards where the category matters (and remember here we are just dealing with the initial measurement).
Accounting Treatment of Financial Liabilities (Overview)
Initially | At Year-End | Any gain/loss | |
FVTPL | Fair Value | Fair Value | Income Statement |
Amortised Cost | Fair Value | Amortised Cost |
So - the question is - how do you measure the FV of a loan??
Well again the answer is simple - and you’ve done it already with compound instruments. All you do is those 2 steps:
STEP 1: | Take all your actual future cash payments |
STEP 2: | Discount them down at the market rate |
If the market rate is the same as the rate you actually pay (effective rate) then this is no problem and you don’t really have to follow those 2 steps as you will just come back to the capital amount…let me explain
10% 1,000 Payable Loan 3 years
Capital 1,000 x 0.751 = 751
Interest 100 x 2.486 = 249
Total 1,000
So the conclusion is - WHERE THE EFFECTIVE RATE YOU PAY (10%) IS THE SAME AS THE MARKET RATE (10%) THEN THE FV IS THE PRINCIPAL - so no need to do the 2 steps.
Always presume the market rate is the same as the effective rate you’re paying unless told otherwise by El Examinero.
Possible Naughty Bits
Premium on redemption
This is just another way of paying interest. Except you pay it at the end (on redemption)
e.g. 4% 1,000 payable loan - with a 10% premium on redemption.
This means that the EFFECTIVE interest rate (the rate we actually pay) is more than 4% - because we haven’t yet taken into account the extra 100 (10% x 1,000) payable at the end. So the examiner will tell you what the effective rate actually is - let’s say 8%.
The crucial point here is that you presume the effective rate (e.g. 8%) is the same as the market rate (8%) so the initial FV is still 1,000.
Discount on Issue
Exactly the same as above - it is just another way of paying interest - except this time you pay it at the start
e.g. 4% 1,000 payable loan with a 5% discount on issue.
So again the interest rate is not 4%, because it ignores the extra interest you pay at the beginning of 50 (5% x 1,000). So the effective rate (the rate you actually pay) is let’s say 7% (will be given in the exam).
The crucial point here is that the discount is paid immediately. So, although you presume that the effective rate (7%) is the same as the market rate (7% say), the INITIAL FV of the loan was 1,000 but is immediately reduced by the 50 discount - so is actually 950
NB You still pay interest of 4% x 1,000 not 4% x 950