lesson 2 course 0910 - universidad de sevillapersonal.us.es/cabad/lesson 2 course 0910.pdfvaluation...

1

1

Financial Accounting 09/10 2ºDE – LESSON 2 © Mª Cristina Abad Navarro, 2009

LESSON 2

Financial Instruments

2


Outline

1. Concept.

2. Classification of financial assets and its

accounting treatment.

3. Classification of financial liabilities and its

accounting treatment.

2

3


Financial instruments

P.G.C. Recognition and valuation standard no. 9:– Concept– Recognition– Valuation

4


Financial instruments -Concept

A financial instrument is a contract that gives rise to:– a financial asset of one entity and– a financial liability or equity instrument of

another entity.It may be:– A financial asset.– A financial liability.– An equity instrument.

3

5


Financial instruments -Recognition

An entity shall recognize a financial asset or a financial liability on its balance sheet when, and only when, the entity becomes a party to the contractual provisions of the instrument.

6


Financial assets

A financial asset is any asset that is:Cash,An equity instrument of another entity,A contractual right:– To receive cash or another financial asset from

another entity, or– To exchange financial assets or financial

liabilities with another entity under conditions that are potentially favorable to the entity;

4

7


Cash

Trade receivables

Non-trade receivables

Debt instruments

Equity instruments

Financial assetsof the company

Trade payables

Non-trade payables & debts

Debt instruments issued

Equity andFinancial liabilitiesof other company

Capital stock

9


Format of the Balance Sheet in P.G.C.

Normal model:

C) Current liabilitiesB) Current assets

A) EquityB) Non-current liabilities

A) Non-current assets

LIABILITIESASSETS

5

10


Financial assets

Financial assets shown in the balance sheet include:Cash and cash equivalentsLoans and receivables:– Trade (as accounts receivables)

– Non-trade (as loans to third parties or credits from the sale of tangible fixed assets)

Financial investments in negotiable securities:– Equity instruments (shares)

– Debt instruments (bonds & debentures)Derivative instruments

11


Financial liabilities

A financial liability is any liability that is:a contractual obligation: – (i) to deliver cash or another financial

asset to another entity; or – (ii) to exchange financial assets or

financial liabilities with another entity under conditions that are potentially unfavorable to the entity.

6

12


Cash

Trade receivables


Debt instruments

Equity instruments

Financial assetsof othercompany

Trade payables



Financial liabilities ofcompany

14


Equity instruments

An equity instrument is any financialinstrument that is:Included in Equity.For example: the ordinary shares issued by the company.

7

15


Cash

Trade receivables


Debt instruments

Equity instruments

Financial assets ofother company

Equity of thecompany

Capital stock

16


Financial assets

For presentation purposes:They are classified in a particular way

in the balance sheet

For valuation purposes:They are classified in a different way

in portfolios

8

17


Financial assets -Valuation

For the purpose of valuation, financial assets are classified into the following categories (NV 9ª.2):(1) loans and receivables;(2) held-to-maturity investments;(3) held for trading investments;(4) other financial assets at fair value through profit or loss;(5) Investments in equity of subsidiaries, joint-ventures and associated companies;(6) available-for-sale financial assets.

18


Financial assets - Valuation

Investments in equity of other companies with the intention of gaining control

(5) Investments in equity of subsidiaries, joint-ventures & associated companies

Negotiable securities that can be sold, but there is no intention at the moment

(6) available-for-sale financial assets

Negotiable securities acquired to be sold in the short term

(3) held for trading investments

Negotiable securities, representative of debts, that are expected to be held until the reimbursement date

(2) held-to-maturity investments

Trade and non-trade loan and receivables

(1) loans & receivables

9

19



It is enough to know their COST





It is important to know:- their FAIR VALUE, since they are going to be sold or can be sold





It is important to know:- their COST- the AMOUNT that is expected to BE COLLECTED



20








Initial valuation:

Fair value (price of transaction) + transaction costs

Subsequent valuation (*):

Amortized cost

(*) Trade receivables due in less than a year are valued at nominal value

10

21


The amortized cost of a financial asset is:

The amount at which the financial asset is measured at initial recognition,

(-) principal repayments,

(+) the cumulative amortization using the effective interest method of any difference between that initial amount and the maturity amount.


22


The effective interest method is a method of calculating the amortized cost of a financial asset and of allocating the interest income over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash receipts through the expected life of the financial instrument to the book value of the financial asset. The calculation includes all fees paid between parties to the contract that are an integral part of the effective interest rate, transaction costs, and all other premiums or discounts.


11

23



Loans and receivablesExample: Credit from the sale of tangible

fixed assets• 2/1/2008 a vehicle is sold.• Acquisition price: 24,000• Accumulated depreciation: 16,000• Selling price: 10,000 (in cash)• Date of receipt: in 2 years time• Amount to be collected in 2 years time: 12,000

24




fixed assets2/1/08 31/12/08 31/12/09

Selling price: 10,000

Cash Collection: 12,000

Interest revenue: 2,000 Implicit

12

25



Loans and receivablesExample: Credit from the sale of tangible fixed

assets

Initial valuation:Fair value (price of transaction) + transaction costs = 10,000 €

2,0001,600

(771) Profits from disposal of tangible fixed assets(477) V.A.T. collected

(281) Tangible fixed assets accumulated depreciation(57) Cash

16,000

1,600

24,000(218) Vehicles

to(253) Long-term credit from the sale of tangible fixed assets

10,000

26




fixed assets2/1/08 31/12/08 31/12/09

Long termcredit: 10,000

Long-term credit: 12,000

Interest revenue: 2,000

1,000 1,000

13

27


31/12/2008:

Subsequent valuation: amortized cost using the effective interest methodEffective interest rate:

2)1(000,12000,10i+

=

Effective interest rate: i = 9.545%



fixed assets

28




fixed assets2/1/08 31/12/08 31/12/09

Long termcredit: 10,000

Long-termcredit: 12,000

Long-term credit: 10,954.4

10,000 * 0.09545 = 954.4

10,945.5 * 0.09545 = 1,045.6

Total interest = 954.4 + 1,045.6 = 2,000

Amortizedcost

14

29




assets

Subsequent valuation:Amortized cost

(12,000)

0

(-) principal repayments

01,045.610,954.4

10,954.4954.410,000

Amortized cost(+) interestValue at initial recognition

12,000

+

30




assets

954.4(762) Revenues of creditsto(253) Long-term credit from the sale of tangible fixed assets

954.4

31/12/2008:

Subsequent valuation: Amortized cost

15

31




assets

12,000(253) Long-term credit from the sale of tangible fixed assets

to(57) Cash12,000

1,045.6(762) Revenues of creditsto(253) Long-term credit from the sale of tangible fixed assets

1,045.6

31/12/2009:

32


Financial assets-Valuation

Held-to-maturity investments

Example: Bonds and debentures

Debt instrument in the form of a document that implies the promise to pay back money owed. They can be transferred.

• Bonds

• Debentures

Fixed interest securities

16

33


Bonds and debentures- Example:

• A large amount of debt finance: $50 million

• May be divided into 50,000 bonds or debentures having a face value of $1,000.

• These would be sold to the public and could be owned by as many as 50,000 individuals (although some individuals might buy more than one debenture).


34



• The bond or debenture would require the payment of $1,000 to the investor at some time in the future (called the “principal amount” or “face value” of the bond), perhaps in ten years time.

• and require the payment of interest at a specified rate at regular intervals.


17

35



For example, a bond or debenture might provide the holder with:

• A right to receive interest at say 5% semiannually, or in other words, a right to receive $50 every six months until maturity.

• At maturity the holder would have the right to receive $1,000.


36



Another possibility a bond or debenture might provide the holder with:

• A right to receive a higher amount(reimbursement value) at maturity.

• At maturity the holder would have the right to receive, of example, $1,500.


18

37




http://www.tesoro.es/en/deuda/valores/vls_letras.asp

http://www.tesoro.es/en/deuda/valores/vls_bonos.asp

38


• Bond• Issuing value: 1,000• Maturity: in 3 years time• Reimbursement value: 1,500• Interest: 0%


Held-to-maturity investmentsExample: Bonds and debentures

19

39




1/1/Y1 31/12/Y1 31/12/Y3

Issuing value: 1,000

Reimbursementvalue: 1,500

Implicit interest: 500

31/12/Y2

40




Initial valuation:Fair value (price of transaction) + transaction costs = 1,000 €

1,000(57) Cashto(251) Long-term debt instruments

1,000

20

41


31/12/Y1:

Subsequent valuation: amortized cost using the effective interest methodEffective interest rate:

3)1(500,1000,1

i+=

Effective interest rate: i = 14.47%



42




1,000 * 0.1447= 144.71

Total interest = 144.71 + 165.66 + 189.63 = 500

1/1/Y1 31/12/Y1 31/12/Y3Issuing value:

1,000Reimbursement

value: 1,500

Amortized cost: 1,144.71

31/12/Y2

1,144.71 * 0.1447=165.66

1,310.37 * 0.1447=189.63

Amortized cost: 1,310.37

21

43




Subsequent valuation:Amortized cost

0(1,500)189.631,310.37

0

0

(-) principal repayments

1,310.37165.66 1,144.71

1,144.71144.711,000

Amortized cost(+) interestValue at initial recognition

1,500

+

44




144.71(761) Revenues of debtinstruments

to(251) Long-term debt instruments

144.71

31/12/Y1:

Subsequent valuation: Amortized cost



165.66

31/12/Y2:

22

45




1,500(251) Long-term debt instruments

to(57) Cash1,500



189.63

31/12/Y3:

46
















23

47








Initial valuation:

Held for trading Fair value (price of transaction)

Available for sale Fair value (price of transaction) + transaction costs

Subsequent valuation:

Fair value

48








Fair value“The amount at which an asset could be bought or sold (or a liability could be incurred or settled) in a current transactionbetween knowledgeable, unrelated willing parties, other than a liquidation”.

market value

If no market exists: valuation techniques

If not reliable value: historical cost

24

49



Subsequent valuation:– Held for trading:At fair value through profit or loss changes in value are shown in the Income Statement as a profit or loss

50



Subsequent valuation:– Held for trading:

(540) Short-term holdings in equity instruments

(6630) Losses from held for trading portfolio(7630) Profits from held for trading portfolio

25

51



Example of valuation of Held for trading:

1/11/X7: acquisition of 1,000 shares of Telefónica at an unit price of 17 €.The purpose is to speculate with them during 3 months.31/12/X7: market price is 20 €.31/1/X8: shares are sold at a price of 24 €.

52


Financial assets


1/11/X7: acquisition of 1,000 shares of Telefónica at an unit price of 17 €.

17,000(570) Cashto(540) Short-termholdings in equityinstruments

17,000

26

53



31/12/X7: market price is 20 €.

Valuation at fair value:

3,000(7630) Profits fromheld for tradingportfolio

to(540) Short-termholdings in equityinstruments

3,000

RevenueIncome statement


54



31/1/X8: shares are sold at a price of 24 €.

24,000(540) Short-term holdings in equity instruments

to(570) Cash24,000


4,000(7630) Profits fromheld for tradingportfolio

to(540) Short-termholdings in equityinstruments

4,000

Revenue Income statement

27

55


Financial assets

Subsequent valuation:– Available for sale:At fair value through equity changes in fair value are recognized directly in equity.

56


Financial assets

Subsequent valuation:– Available for sale:

(250) Long-term holdings in equity instruments(133) Adjustments for changes in value of financial instruments available

for sale

(800) Losses from available for sale financial assets(900) Profits from available for sale financial assets(802) Transfer of profits from available for sale financial instruments(902) Transfer of losses from available for sale financial instruments

(6632) Losses from valuation at fair value of available for sale financial instruments

(7632) Profits from valuation at fair value of available for sale financial instruments

28

57


Financial assets

Example of valuation of Available for sale:

1/11/X7: acquisition of 1,000 shares of Telefónica at an unit price of 17 €.The purpose is to keep them indefinitely.31/12/X7: market price is 20 €.31/12/X8: market price is 24 €.1/1/X9: shares are sold at a price of 26 €.

58


Financial assets


1/11/X7: acquisition of 1,000 shares of Telefónica at an unit price of 17 €.

17,000(570) Cashto(250) Long-termholdings in equityinstruments

17,000

29

59


Financial assets




3,000(900) Profits fromavailable for sale financial assets

to(250) Long-termholdings in equityinstruments

3,000

Revenue recognized in EquityStatement of changes in Equity

60


Financial assets


31/12/X7:

Treatment of group 8 & 9 accounts:

3,000(133) Adjustments forchanges in value offinancial instrumentsavailable for sale

to(900) Profits fromavailable for sale financial assets

3,000

Equity Balance sheet

30

61


Financial assets






4,000

Revenue recognized in EquityStatement of changes in Equity

62


Financial assets


31/12/X8:

Treatment of group 8 & 9 accounts:



4,000

Equity Balance sheet

31

63


Financial assets


1/1/X9: shares are sold at a price of 26 €.

26,000(250) Long-termholdings in equityinstruments

to(570) Cash26,000



2,000

64


Financial assets


1/1/X9: shares are sold at a price of 26 €.Transfer of the profits:

Revenue Income statement

9,000(7632) Profits fromvaluation at fair value of available forsale financialinstruments

to(802) Transfer ofprofits fromavailable for sale financial instruments

9,000

Statement of changes in Equity

32

65


Financial assets


31/12/X9: Treatment of group 8 & 9 accounts:

9,000(802) Transfer ofprofits from availablefor sale financialinstruments

to(133) Adjustments forchanges in value offinancial instrumentsavailable for sale

9,000



2,000

The accounts are closed

66
















33

67






Initial valuation:

Cost = Fair value (price of transaction) + transaction costs

Subsequent valuation:

Cost

(- value corrections for impairment)

68


Financial assets

Example of valuation of Investments in equity of subsidiaries, joint-ventures & associated companies:

1/11/X7: acquisition of 2,000,000 shares (20% of capital stock) of Telefónica at an unit price of 17 €.The purpose is to gain control over the management of the company.


34

69


Financial assets


1/11/X7: acquisition of 2,000,000 shares (20% of capital stock) of Telefónica at an unit price of 17 €.

34,000,000(570) Cashto(2404) Long-termholdings in associatedcompanies

34,000,000

70


Financial assets



Fair value (40,000,000) > Cost (34,000,000)

↓No impairment Book Value does not change

35

71



A financial liability is any liability that is:a contractual obligation: – (i) to deliver cash or another financial

asset to another entity; or – (ii) to exchange financial assets or

financial liabilities with another entity under conditions that are potentially unfavorable to the entity.

72


Cash

Trade receivables


Debt instruments

Equity instruments

Financial assetsof othercompany

Trade payables



Financial liabilities ofcompany

36

74



For presentation purposes:They are classified in a particular way

in the balance sheet

For valuation purposes:They are classified in a different way

in portfolios

75


Financial liabilities -Valuation

For the purpose of valuation, financial liabilities are classified into the following categories (NV 9ª.3):(1) debt and payables;(2) held for trading liabilities;(3) other financial liabilities at fair value through profit or loss;

37

76



It is important to know:- their FAIR VALUE, since they are going to be reacquired

Negotiable securities issued to be reacquired in the short term

(2) held for trading liabilities

It is important to know:- their COST- the AMOUNT that is expected to BE PAID

Trade and non-trade debts and payables

(1) Debts & payables

77



It is important to know:- their COST- the AMOUNT that is expected to BE PAID

Trade and non-trade debts and payables

(1) Debts & payables

Initial valuation:

Fair value (price of transaction) - transaction costs

Subsequent valuation (*):

Amortized cost

(*) Trade payables due in less than a year are valued at nominal value

38

78


Financial liabilities –Debts and payables

Debts and payables

Trade accounts payables: obligations arising from the acquisition of goods and services entering the operating cycleNon-trade payables: obligations that are not settled as part of the operating cycle (and are not derivative financial instruments) including:– debentures and other negotiable securities and – payables from the purchase of non-current assets.

79



The amortised cost of a financial liability is:the amount at which the financial liability is

measured at initial recognition (-) principal repayments, (+) the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount.

39

80



The effective interest method is a method of calculating the amortised cost of a financial liability and of allocating the interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments through the expected life of the financial instrument to the book value of the financial liability. The calculation includes all fees paid between parties to the contract that are an integral part of the effective interest rate, transaction costs, and all other premiums or discounts.

81


Financial liabilities –Debts and payablesExample: Long term debt.

2/1/2008: The company receives a loan from the Chase Manhattan Bank.Principal amount = 1,000,000 €.Date of settlement = total amount at the end of 2012.Opening fees = 100,000 €.

40

82



2/1/2008:

INITIAL VALUATION:

FAIR VALUE = AMOUNT RECEIVED – OPENING FEES = = 1,000,000 – 100,000 == 900,000 €

83


Financial liabilities –Debts and payablesExample: Long term debt.31/12/2008:

SUBSEQUENT VALUATION: AMORTISED COST USING THE EFFECTIVE INTEREST METHOD

EFFECTIVE INTEREST RATE:

54321

54321

)1(000,000,1

)1(0

)1(0

)1(0

)1(0000,9000

)1(000,000,1

)1(0

)1(0

)1(0

)1(0)000,100000,000,1(

ttttt

ttttt

+−

++

++

++

++

+=

++

++

++

++

+=−

EFFECTIVE INTEREST RATE: t = 2.13%

41

84


Financial liabilities –Debts and payablesExample: Long term debt.(*) payment of principal amount

01,000,0002012 (*)

100,000TOTAL

1,000,000 20,852 979,148 2012

979,148 20,417 958,732 2011

958,732 19,991 938,740 2010

938,740 19,574 919,166 2009

919,166 19,166 900,000 2008

Final amortised

cost(1)+(2)

payment(3)

Interest expense(2)=(1)xt

Initial amortisedcost (1)

Year

85


Financial liabilities –Debts and payablesExample: Long term debt.01/01/2008

900,000(170) Long-term debt withcredit institutions

toCash900,000

31/12/2008


to(6623) Interestexpense

19,166

42

86





19,574

31/12/2010



19,991

87





20,417

31/12/2011

979,148(520) Short-term debtwith credit institutions

to(170) Long-term debtwith credit institutions

979,148

43

88





20,852

31/12/2012

1,000,000Cashto(520) Short-term debtwith credit institutions

1,000,000

89



2/1/2008: The company receives a loan from the Chase Manhattan Bank.Principal amount = 1,000,000 €.Date of settlement = total amount at the end of 2012.Opening fees = 100,000 €.Annual interest rate = 10%.

44

90


Financial liabilities –Debts and payablesExample: Long term debt.If we only consider the contractual interest rate:

01,000,000100,000 1,000,0002012

1,000,000100,000 1,000,0002011

1,000,000100,000 1,000,0002010

1,000,000100,000 1,000,0002009

1,000,000100,000 1,000,0002008

Final Outstandingamount

Principal payment

Interestpayment

InitialOutstandingamount

Years

91



2/1/2008:

INITIAL VALUATION:

FAIR VALUE = AMOUNT RECEIVED – OPENING FEES = = 1,000,000 – 100,000 == 900,000 €

45

92



31/12/2008: SUBSEQUENT VALUATION: AMORTISED COST USING THE EFFECTIVE INTEREST METHOD

EFFECTIVE INTEREST RATE:

54321

54321

)1(000,100,1

)1(000,100

)1(000,100

)1(000,100

)1(000,100000,9000

)1()000,000,1000,100(

)1(000,100

)1(000,100

)1(000,100

)1(000,100)000,100000,000,1(

ttttt

ttttt

+−

++

−+

+−

++

−+

+−

+=

++

++

++

++

++

=−

EFFECTIVE INTEREST RATE: t = 12.83%

93


Financial liabilities –Debts and payablesExample: Long term debt.(*) payment of principal amount

01,000,0002012 (*)

100,000 TOTAL

1,000,000 25,095 100,000 125,095 974,905 2012

974,905 22,241 100,000 122,241 952,665 2011

952,665 19,712 100,000 119,712 932,953 2010

932,953 17,470 100,000 117,470 915,483 2009

915,483 15,483 100,000 115,483 900,000 2008

Final amortised

cost(1)+(4)

Difference(4)=(2)-(3)

Interest payment

(3)

Interest expense(2)=(1)xt

Initial amortisedcost (1)

Year

46

94




toCash900,000

31/12/2008

15,483

100,000

(170) Long-term debt withcredit institutionsCash


115,483

95



17,470

100,000



117,470

31/12/2010

19,712

100,000



119,712

47

96



22,241

100,000



122,241

31/12/2011


to(170) Long-term debtwith credit institutions

974,905

97



25,095

100,000

(520) Short-term debtwith credit institutionsCash


125,095

31/12/2012

1,000,000Cashto(520) Short-term debtwith credit institutions

1,000,000

lesson 2 course 0910 - universidad de sevillapersonal.us.es/cabad/lesson 2 course 0910.pdfvaluation...

Documents