ACCA Applied Skills · Financial Reporting

Financial instruments: formula sheet

Full chapter guide

Key formulas

Financial instrument: Contract → financial asset of one entity AND financial liability or equity instrument of another; Physical assets, prepayments and most tax balances are not financial instruments because they do not arise from a contract to receive or pay cash or other financial assets.
Financial liability test: Contractual obligation to deliver cash or another financial asset (or exchange on potentially unfavourable terms) = liability; If the issuer cannot avoid payment, it is a liability, whatever the legal name.
Equity test: No contractual obligation to pay + residual interest in net assets = equity; Payment depends entirely on the issuer's discretion.
Preference share rule: Mandatory redemption or holder's right to redeem = liability; dividends = finance cost. Irredeemable with discretionary dividend = equity; dividends = distribution; Mandatory dividends on irredeemable shares also point to a liability.
Fixed-for-fixed rule: Settled by exchanging a fixed amount of cash for a fixed number of own shares = equity; A variable number of shares, or a variable amount of cash, usually points to a liability.
Initial measurement: not at FVPL (asset): Initial carrying amount = Fair value + transaction costs; Applies to amortised cost and FVOCI assets, including equity investments elected at FVOCI.
Initial measurement: FVPL asset: Initial carrying amount = Fair value; transaction costs → expensed in profit or loss; Do not capitalise the costs. Debit finance or other expense.
Initial measurement: financial liability not at FVPL: Initial carrying amount = Fair value of proceeds − transaction costs; The effective interest rate is then calculated on this net amount.
Initial measurement: financial liability at FVPL: Initial carrying amount = Fair value of proceeds; transaction costs → expensed; Rare in FR questions, but the rule mirrors FVPL assets.
Derecognition of a financial asset: Gain or loss = Carrying amount − consideration received (any amounts held in OCI are treated as the standard requires); Derecognise when rights expire or when substantially all risks and rewards are transferred.
Initial carrying amount: Net proceeds = Fair value of proceeds − Issue costs; Issue costs reduce the liability at the start. They are not expensed immediately.
Finance cost: Finance cost = Opening liability × Effective interest rate; Use the opening balance for the year, not the nominal value.
Cash interest paid: Interest paid = Nominal value × Coupon rate; This is the amount paid in cash, not the P&L charge.
Closing liability: Closing liability = Opening liability + Finance cost − Cash paid; Redemption payments are also deducted in the year they are made.
Effective rate check: Net proceeds = Σ (Cash flow ÷ (1 + EIR)ⁿ); The exam usually gives the EIR. You rarely need to solve for it.
Convertible split: Liability = PV of cash flows at the straight-debt rate; Equity = Proceeds − Liability; Equity is the balancing figure.
Amortised cost debt: classification: SPPI passed + hold to collect → amortised cost; Interest income uses the effective rate on the opening carrying amount. Impairment (expected credit losses) also applies.
Amortised cost closing balance: Closing = Opening + (Opening × effective rate) − cash received; Cash received is the coupon (nominal value × coupon rate). Effective rate is the rate that discounts all cash flows to the initial amount.
Debt FVOCI: classification: SPPI passed + hold to collect and sell → FVOCI; Interest at effective rate and impairment go to profit or loss. Other fair value changes go to OCI and are recycled on disposal.
FVPL: Fails SPPI, or other business model → FVPL; Fair value gains and losses go to profit or loss. Transaction costs are expensed at purchase.
Equity investment: Default = FVPL; irrevocable election (not held for trading) = FVOCI; With the election, transaction costs are added to cost, gains and losses stay in OCI with no recycling, dividends go to profit or loss.
Initial measurement: Fair value + transaction costs (amortised cost and FVOCI); fair value only (FVPL); Transaction costs for FVPL assets are charged to profit or loss.
Liability component: Liability = PV of interest + PV of redemption amount, discounted at the market rate for non-convertible debt; Use the rate for similar debt without the conversion option. It is usually given in the question.
Equity component: Equity = Proceeds of issue − Liability component; It is a balancing figure. Never discount it.
Finance cost: Finance cost = Opening liability × effective (market) rate; Do not use the coupon rate. The cost is higher than the cash interest paid.
Closing liability: Closing liability = Opening liability + Finance cost − Cash interest paid; This is the amortised cost roll-forward.
Cash interest: Interest paid = Nominal value × coupon rate; This is the amount of cash that leaves the business.
Conversion: Dr Liability (carrying amount at conversion); Cr Share capital and share premium; The equity component remains in equity.
Stage 1 allowance: 12-month ECL = probability-weighted, discounted cash shortfalls from default events possible within 12 months after the reporting date; Shortfalls are discounted at the effective interest rate. Only defaults possible in the next 12 months count. Exams usually give the figure directly.
Stage 2 and 3 allowance: Lifetime ECL = PV of expected cash shortfalls over the remaining life; Shortfall = contractual cash flows − cash flows expected to be received, discounted at the original effective interest rate.
Provision matrix: Allowance = Σ (receivables in age band × expected loss rate for that band); Used under the simplified approach for trade receivables.
Profit or loss charge: Charge = closing allowance − opening allowance; A positive result is an expense. A negative result is a credit to profit or loss. Add any receivables written off as irrecoverable if they are charged separately.
Stage 3 interest: Interest revenue = (gross carrying amount − loss allowance) × effective interest rate; Stages 1 and 2 use gross carrying amount × effective interest rate.
Net carrying amount: Net carrying amount = gross carrying amount − loss allowance; This is what appears in the statement of financial position for amortised cost assets.

Quick revision

A financial instrument creates a financial asset for one party and a liability or equity instrument for another.
Classify first: classification drives measurement and where gains and losses go.
Initial recognition is at fair value. For financial assets not at FVPL, add transaction costs. For financial liabilities not at FVPL, deduct transaction costs from the proceeds.
Transaction costs on FVPL items go straight to profit or loss.
Amortised cost: finance cost = opening balance × effective rate; closing = opening + finance cost − cash paid.
The effective rate is not the coupon rate when there is a discount, premium or issue cost.
A debt asset is at amortised cost if held to collect contractual cash flows that are solely payments of principal and interest.
FVOCI for debt requires both the business model (collecting and selling) and the SPPI test (solely payments of principal and interest). Equity shares not held for trading may be elected FVOCI. Gains and losses on FVOCI equity are never recycled to profit or loss, but dividends are recognised in profit or loss.
FVPL is the default for anything else, including shares held for trading.
Convertible debt: liability = present value of cash flows at the market rate for similar non-convertible debt; equity = proceeds minus liability.
The equity component of a compound instrument is not remeasured.
ECL: stage 1 uses 12-month losses. Stage 2 applies when credit risk has increased significantly since initial recognition, and stage 3 when the asset is credit-impaired; both use lifetime losses. Interest revenue is on the gross carrying amount in stages 1 and 2, and on the net carrying amount (gross less loss allowance) in stage 3.

Common mistakes

Classifying all preference shares as equity because they are called shares. Fix: Always check redemption terms and dividend obligations. Mandatory redemption makes it a liability.
Treating dividends on redeemable preference shares as a distribution in equity. Fix: If the share is a liability, its dividend is a finance cost in profit or loss.
Capitalising transaction costs on FVPL investments Fix: For FVPL, carrying amount is fair value only. Expense the costs straight away.
Adding costs to a financial liability instead of deducting them Fix: Net the costs against proceeds. A loan of ₹10,00,000 with ₹20,000 costs starts at ₹9,80,000.
Charging the coupon interest as the finance cost. Fix: The P&L charge is always opening liability × EIR. The coupon is only the cash paid.
Expensing issue costs in the year of issue. Fix: Deduct them from the proceeds. The EIR then spreads them over the life of the loan.
Using the coupon rate to calculate finance income on amortised cost assets. Fix: Income is opening carrying amount × effective rate. The coupon is only the cash received, which reduces the balance.
Adding transaction costs to an FVPL asset. Fix: Expense transaction costs in profit or loss for FVPL. Add them to cost only for amortised cost, debt FVOCI and equity FVOCI.
Showing the whole proceeds as a liability Fix: Always check whether it is convertible. If the holder can take shares, split it into liability and equity.
Discounting at the coupon rate Fix: Discount at the market rate for similar non-convertible debt. Discounting at the coupon rate would give back the nominal value and no equity.

Exam tips

In objective test questions, scan for the words 'redeemable', 'mandatory', 'at the option of the holder' and 'discretionary'. They usually decide the answer.
In written answers, name IAS 32 and use the phrase 'contractual obligation to deliver cash'. Then apply it to the facts given.
Always finish with the double effect: classification in the statement of financial position and the matching finance cost or distribution.
Read who the question asks about. The same loan is a liability for the borrower and an asset for the lender.
Do not waste time on measurement here. If the question only asks for classification, state the category and the reason, then move on.
In objective tests, the classification decides the answer. Read for words such as 'held for trading' or 'amortised cost' before you calculate.
Write the journal in your Section C answer. Markers give credit for showing costs going to profit or loss on FVPL items.
Watch for issue costs on loans. They are deducted and then feed into the effective interest rate calculation.