Financial instruments: formula sheet

Key formulas

Financial liability test (IAS 32)

Contractual obligation to deliver cash or another financial asset = financial liability

If the issuer can avoid payment entirely, the instrument is equity. Look at substance, not the legal name.

Fixed-for-fixed (own shares)

Fixed cash for a fixed number of own shares = equity; variable number of own shares = liability

A variable number of shares means the holder gets a fixed value, so the issuer carries a liability.

Compound instrument split

Equity component = Proceeds − Fair value of liability component

Value the liability first, by discounting cash flows at the market rate for similar debt with no conversion option. Equity is the residual.

Amortised cost category

Business model: hold to collect AND SPPI test passed

Interest income uses the effective interest rate. Impairment applies under the expected credit loss model.

FVOCI category (debt)

Business model: hold to collect and sell AND SPPI test passed

Fair value changes go to OCI. Interest, impairment and exchange differences go to profit or loss. Cumulative OCI gain or loss is recycled on derecognition.

FVTPL category

Not amortised cost and not FVOCI = FVTPL

Includes derivatives, equity held for trading and debt failing SPPI. The default category.

Equity investment election

Irrevocable election at initial recognition: FVOCI for equity not held for trading

No recycling of gains or losses to profit or loss. Dividends are still recognised in profit or loss.

Liability component

Liability = Σ (coupon or redemption cash flow × discount factor at market rate for similar non-convertible debt)

Use the rate for debt without the conversion option. It is higher than the coupon rate on a convertible.

Equity component

Equity = Total proceeds − Liability component

A residual. It is not remeasured after initial recognition and is not discounted again.

Finance cost

Finance cost = Opening liability × market (effective) rate

Do not use the coupon rate. The finance cost is higher than the cash interest in the early years.

Closing liability

Closing liability = Opening liability + Finance cost − Cash interest paid

Amortised cost. If the bond is redeemed at par, the liability rises towards the redemption amount.

Transaction costs

Costs allocated to liability and equity in proportion to the split of proceeds

The costs of the liability part reduce its carrying amount. Recalculate the effective rate on the net amount.

Conversion

Dr Liability (carrying amount) Cr Share capital and share premium; equity component transferred within equity if required

No gain or loss in profit or loss on conversion at the original terms.

Fixed-for-fixed test

Fixed number of shares for a fixed amount of cash = equity feature; otherwise = derivative liability

If the test fails, the option is not equity and the instrument is not split in this way.

Initial measurement (not FVTPL)

Asset = fair value + transaction costs; Liability = fair value − transaction costs

For FVTPL items, transaction costs go to profit or loss immediately. Fair value is normally the transaction price.

Finance cost / income for the year

Opening amortised cost × EIR

Use the EIR, not the coupon rate. Time-apportion if the period is not a full year.

Amortised cost roll-forward

Closing = Opening + (Opening × EIR) − cash paid (liability) or cash received (asset)

Cash means coupon or instalment actually paid or received in the period. A final repayment is also cash.

Effective interest rate

EIR is the rate r where Σ [cash flow ÷ (1 + r)^t] = initial carrying amount

The cash flows include the capitalised transaction costs and any premium or discount. In most exam questions the EIR is given.

Change in estimated cash flows

New carrying amount = PV of revised cash flows at the original EIR; difference to profit or loss

This applies to items at amortised cost when the estimates change. For floating-rate items, re-estimating cash flows normally changes the EIR instead.

Trade receivables

Initial amount = transaction price (IFRS 15) if no significant financing component

Otherwise use fair value.

ECL (single scenario)

ECL = PD × LGD × EAD, discounted at the EIR

PD is probability of default, LGD is loss given default, EAD is exposure at default. In exams you are usually given the loss or the rate directly.

Probability-weighted ECL

ECL = Σ (probability of scenario × present value of cash shortfall in that scenario)

Use when the question gives several scenarios. Probabilities must add to 100%.

Stage 1 allowance

12-month ECL

Applies when there has been no significant increase in credit risk since initial recognition.

Stage 2 and 3 allowance

Lifetime ECL

Applies after a significant increase in credit risk (stage 2) or when credit-impaired (stage 3).

Interest income, stages 1 and 2

Gross carrying amount × EIR

The allowance does not reduce the interest base.

Interest income, stage 3

(Gross carrying amount − loss allowance) × EIR

Net carrying amount is used from the period after the asset becomes credit-impaired.

Provision matrix (simplified approach)

Allowance = Σ (receivables in age band × loss rate for that band)

Loss rates come from historical experience, adjusted for current conditions and forecasts.

Charge to profit or loss

Closing allowance − opening allowance

An increase is an impairment loss. A decrease is an impairment gain. Write-offs reduce both gross amount and allowance.

Rebuttable presumptions

More than 30 days past due = significant increase in credit risk; more than 90 days past due = default

These are presumptions, not fixed rules. An entity can rebut them with reasonable and supportable information.

Definition of a derivative

Value changes with an underlying + no or small initial net investment + settled at a future date

All three characteristics must be met. State each one and apply it to the scenario.

Initial measurement

Derivative recognised at fair value on the date you become party to the contract

Initial fair value is normally the transaction price. A forward is normally nil at inception. An option is normally the premium paid or received. Transaction costs on derivatives at FVTPL are expensed to profit or loss.

Subsequent measurement

Fair value through profit or loss, unless designated in a hedge

Gain or loss in profit or loss. The hedge accounting rules apply only if the hedge criteria are met.

Forward contract fair value (simple form)

Fair value = (forward rate now for the same remaining maturity − contract rate) × amount, discounted to present value if material

Use a forward rate quoted for the same maturity as the contract, and discount at an appropriate rate when the effect is material. 'To buy' means the entity has contracted to buy the underlying at the fixed contract rate: a positive result is an asset. For a contract to sell, reverse the sign.

Embedded derivative separation test

Separate if: host not an IFRS 9 financial asset AND not closely related AND meets derivative definition AND hybrid not at FVTPL

If the host is a financial asset in IFRS 9, never separate. Classify the whole asset.

Purpose of IFRS 7

Disclose: (1) significance of instruments + (2) nature and extent of risks

Use this as the two-part frame for any answer.

Risk types

Market risk = currency risk + interest rate risk + other price risk

Credit and liquidity risk are separate from market risk.

Liquidity maturity analysis

Maturity analysis of financial liabilities uses remaining contractual undiscounted cash flows

Amounts will not agree to carrying amounts because they are undiscounted and include interest.

Sensitivity analysis

Show effect on profit or loss and equity of reasonably possible changes in each relevant market risk variable

State the methods and assumptions used. If the entity uses a value-at-risk style analysis for management, it may give that instead.

Credit risk disclosures

Maximum exposure + collateral and credit enhancements + credit quality + ECL information

The ECL disclosures cover the inputs, assumptions and changes in the loss allowance.

Fair value disclosure link

Fair value of each class disclosed and compared with carrying amount, with IFRS 13 hierarchy levels for items measured at fair value

Hierarchy disclosure sits in IFRS 13 and IFRS 7 works with it.

Quick revision

• IAS 32 classifies an instrument as liability or equity by substance: an obligation to deliver cash or another financial asset points to a liability.
• A fixed-for-fixed conversion into a fixed number of own shares gives an equity component in a compound instrument.
• Split accounting: the liability is the present value of the cash flows at the market rate for similar debt without the conversion option; equity is the residual.
• Debt assets with cash flows that are solely payments of principal and interest (SPPI) are at amortised cost if the business model is hold to collect. They are at fair value through other comprehensive income if the business model is hold to collect and sell. Otherwise they are at fair value through profit or loss. An entity may also choose fair value through profit or loss at initial recognition if that removes an accounting mismatch.
• Equity investments are at fair value through profit or loss unless you irrevocably elect fair value through other comprehensive income. For that election, gains and losses are never recycled to profit or loss on disposal, although dividends are still recognised in profit or loss.
• Effective interest rate: finance cost = opening carrying amount × effective rate; closing balance = opening + finance cost − cash paid.
• Transaction costs are added to (or deducted from) the initial carrying amount unless the item is at fair value through profit or loss, where they are expensed.
• The expected credit loss model uses 12-month losses at stage 1 and lifetime losses at stages 2 and 3. Interest is calculated on the gross carrying amount at stages 1 and 2, and on the net carrying amount (amortised cost after the loss allowance) at stage 3.
• Trade receivables without a significant financing component use the simplified approach with lifetime losses from day one.
• Derecognise a financial asset when the contractual rights to the cash flows expire or when substantially all risks and rewards are transferred. If substantially all risks and rewards are retained, keep the asset on the statement of financial position and recognise a liability for the proceeds. If they are neither transferred nor retained, assess control, which can lead to continuing involvement.
• Hedge accounting is optional. It needs formal designation and documentation at inception, and three criteria must be met: (1) an economic relationship between the hedged item and the hedging instrument, (2) credit risk does not dominate the value changes, and (3) the hedge ratio reflects the quantities actually hedged.
• Cash flow hedge: the effective portion goes to other comprehensive income and the ineffective portion goes to profit or loss. The amount in OCI is the lower of the cumulative gain or loss on the hedging instrument and the cumulative change in the fair value (present value) of the expected hedged cash flows. Any excess goes to profit or loss.

Common mistakes

• Classifying a redeemable preference share as equity because it is called a share. Fix: Check for a mandatory redemption or fixed dividend obligation. If the issuer cannot avoid payment, it is a liability and the dividends are finance costs.
• Applying only the business model test and forgetting SPPI. Fix: Always state both tests. A convertible bond held as an investment fails SPPI and goes to FVTPL even if the entity holds it to collect.
• Discounting at the coupon rate Fix: Discount at the market rate for similar debt without conversion. If you used the coupon, the liability would equal the proceeds and the equity would be nil.
• Charging finance cost equal to the cash interest Fix: Finance cost = opening liability × market rate. Cash interest is only the payment that reduces the liability.
• Charging the coupon rate to profit or loss instead of the EIR. Fix: Finance cost = opening balance × EIR. The coupon only appears in the cash column.
• Adding transaction costs to a financial liability instead of deducting them. Fix: For a liability, the costs reduce the net proceeds. The opening liability is proceeds less costs.
• Waiting for an actual default before booking any provision. Fix: Under IFRS 9 every asset in scope carries at least 12-month ECL from initial recognition, unless it is a simplified-approach asset, which carries lifetime ECL from day one.
• Charging the whole closing allowance to profit or loss each year. Fix: Charge only the movement: closing allowance less opening allowance. Remember write-offs reduce the allowance before the year-end top-up.
• Separating an embedded derivative from a hybrid financial asset. Fix: Under IFRS 9, if the host is a financial asset in scope, classify the whole contract using the business model and contractual cash flow test.
• Recording a forward contract at its price at inception. Fix: A forward normally has nil fair value at inception, so no entry is needed. Only changes in fair value are recorded afterwards.

Exam tips

• Write the test, then the fact, then the conclusion. Examiners reward application to the scenario, not recited rules.
• Say clearly whether you are dealing with the issuer or the holder. Mixing IAS 32 and IFRS 9 loses marks.
• For equity versus liability questions, discuss the substance and mention the effect on gearing and finance costs. This earns commercial awareness marks.
• Where an instrument has unusual terms, such as a conversion option, say what feature affects SPPI or splitting, and state any assumption you make.
• In ethics-linked requirements, note that structuring terms to show debt as equity may be earnings or gearing management, and link it to professional scepticism.
• Start with the split, even if the question is mostly narrative. Show the discounting clearly. Marks go for the market rate, the cash flows and the residual equity.
• Always show the amortised cost table for at least the first year. Examiners give marks for finance cost at the market rate and for the closing balance.
• Read the scenario for traps: a variable number of shares, early redemption terms, issue costs, or a rate quoted for the convertible rather than for similar debt. Each changes the answer.