Accounting for Financial instruments

3101AFE: WORKSHOP 8 – Semester 1 2016Topic 12: Accounting for Financial instrumentsSTUDENTS PLEASE NOTE: For Questions 1, 2, 3, 4, and 5 students are NOT expected to write100 words.QUESTION 1: Question 1 from Deegan Topic 12: Define financial instrument.QUESTION 2: Question 2 from Deegan Topic 12: What is a primary financial instrument?Provide some examples.QUESTION 3: Question 3 from Deegan Topic 12: What is a derivative financial instrument?Provide some examples.QUESTION 4: Question 8 from Deegan Topic 12: What is a compound financial instrument?Provide some examples.QUESTION 5: Question 6 from Deegan Topic 12: Would physical assets (such as inventories,property, plant and equipment) be considered to be financial assets? Why?QUESTION 6: Question 4 from Deegan Topic 12: What factors influence the value of aderivative financial instrument, and how should changes in the value of derivatives betreated from an accounting perspective?QUESTION 7: Question 9 from Deegan Topic 12: Is there a consequence for reported profitor loss if a particular financial instrument, for example, a preference share, is designated asdebt rather than equity? Explain the consequence.QUESTION 8: Question 13 from Deegan Topic 12: Why would companies perform a set-off ofassets and liabilities?QUESTION 9: Question 15 from Deegan Topic 12: Amber Ltd has the following statement offinancial position:Statement of financial position before set-offLoans Payable3,000, 000Loans receivable 3,600,000Shareholder’s equity 3,000, 000Non-current assets2,400,0006,000,0006,000,000Assume that Amber Ltd has an amount owing to Robyn Ltd of $900,000 and an amountreceivable from Robyn Ltd of $1,200,000. Assuming a right of set-off exists, why wouldAmber Ltd. want to perform a set-off? What would be the impact on the debt to assets ratio?QUESTION 10: Question 17 from Deegan Topic 12: Subsequent to initial measurement,financial assets are to be classified as being measured at either fair value or amortised cost.What is the basis for determining whether fair value or amortised cost shall be used?QUESTION 11: Question 21 from Deegan Topic 12: Futures contracts are considered to behighly leveraged instruments, with the result that considerable gains or losses can beincurred. What does this mean?QUESTION 12: Question 33 from Deegan Topic 12: Holder Ltd purchases an option contractfrom Issuer Ltd that gives Holder Ltd the right to acquire 100 000 options in Torquay Ltd for aprice (exercise price) of $10.00 per share. When the contract was exchanged the price ofTorquay Ltd shares were $9.00 each. The option entitles Holder Ltd to exercise the optionsand buy the shares any time within the next six months. If the options are not exercisedwithin the six month period, then the options will expire.Required: Determine whether a financial liability or financial asset exists from theperspective of Holder Ltd and Issuer Ltd. Further, if the price of shares in Torquay Ltd falls to$5.00, with the result that it is improbable that Holder Ltd will ever exercise the options, willthis change the classification of the options as either financial assets or financial liabilities?QUESTION 13: Question 40 from Deegan Topic 12: Read Fiona Buffini’s article ‘Accounts setfor a shake-up’ in Financial Accounting in the News 14.2. A number of issues areraised in the article about the introduction of IAS 39 (upon which AASB 139 is based),including:(a)many hedging contracts will need to be valued at fair value with anyresulting gains and losses having to go to the statement of comprehensiveincome;(b)from 2005 many derivatives were required to appear on the statement offinancial position for the first time;(c)from 2005 many financial instruments were required to be reclassified fromequity to debt; and(d)from 2005 there will be major cuts to corporate profits as a result of theintroduction of the accounting standard.Required: Explain why the above issues are likely to be of concern to many organisations.14. 2 FINANCIAL ACCOUNTING IN THE NEWSACCOUNTANTS SET FOR A SHAPE-UP, Fiona Buffini, AFR, 19 December 2003, p.4Australian companies have moved a step closer to a radical overhaul of the way they account for financialinstruments such as the hedges that are used to manage movements in interest rates, currencies and commodities.The London-based International Accounting Standards Board yesterday issued final rules for derivatives that willpotentially affect profits, gearing ratios and loan covenants of Australian companies. The move is a step closer touniform accounting standards and comes as United States politicians prepare proposals, due next week, which willalso shift American accounting closer to international norms. The IASB’s revised financial instruments standard, IAS39, will force companies to classify popular hybrid securities as debt rather than equity. It will also bring derivativesand securitised assets back onto companies’ balance sheets increasing assets and liabilities. The new AustralianSecurities and Investments Commission chairman, Jeffrey Lucy, has been a prime mover behind Australia’s move toglobal standards in a bid to improve the transparency of financial statements after corporate collapses here andoverseas. Under the new rules, many hedging contracts will need to be revalued and the gain or loss taken to thebottom line. Stockbroker JBWere has predicted that will cut profits of some major companies by more than 10 percent. ‘The release of [the standards] brings the capital markets closer to having one global language of financialreporting,’ said PricewaterhouseCoopers lead financial reporting partner Jan McCahey. ‘The IASB has tried toimprove the clarity of the rules. Is the Australian business community going to be happy? Probably not, but that’sbecause it imposes for the first time very significant restrictions around hedging that companies haven’t had to dealwith before.’ For the banks, normal portfolio hedging practices will be redundant under the new rules, while some $80billion of securitised home loans may be shifted on balance sheet. KPMG director Patricia Stebbens said therevisions to IAS 39 meant many Australian companies would potentially have to bringsecuritisations back on balance sheet with no transitional relief. This could have significant cost implications asentities might breach their debt covenant requirements. She said under a proposed Australian standard, companiesdoing securitisation via a special-purpose vehicle would have to quantify and disclose the effect of the changes asearly as June 2004 accounts.