Disclosing Financial Instruments

Both IFRS^® Accounting Standards and IFRS for SMEs^® Accounting Standard have requirements that apply only to financial instruments.

It can sometimes be difficult to determine whether to include assets and liabilities in the financial instruments’ notes such as the ‘financial assets and financial liabilities by category’ notes (applicable for both the IFRS Accounting Standards and IFRS for SMEs Accounting Standard) and the financial risk disclosures, particularly the ‘maturity analysis’ note in the liquidity risk disclosures for IFRS Accounting Standards.

IFRS 9 Financial Instruments (IFRS 9) and Section 11 Basic Financial Instruments (SME 11) requires that an entity, at a minimum, distinguish instruments measured at amortised cost from those that are measured at fair value. Now, more than ever, it is important to understand what is included in financial assets at amortised cost. Why? IFRS 9 requires an entity to determine the expected credit loss (ECL) for each financial asset at amortised cost and debt instruments at fair value through other comprehensive income. If an asset is not a financial asset, then, unless specifically required, e.g. for contract assets and a few others, the ECL assessment is not required. SME 11 similarly requires financial assets at amortised costs to be assessed for incurred impairment losses.

The IFRS 7 Financial Instruments (IFRS 7) disclosure requirements are only required for financial instruments. When presenting the financial instruments within the financial risk section it is important to include only those instruments which meet the definition of a financial instrument in terms of IAS 32 Financial Instruments: Presentation (IAS 32) or others specifically required. Non-financial instruments should not be included as part of the IFRS 7 disclosure requirements, unless IFRS 7 specifically includes it.

So, what is a financial instrument? A financial instrument is any contract that gives rise to a financial asset in one entity and a financial liability or equity instrument of another entity (see paragraph 11 of IAS 32). While it shouldn’t make much difference to the everyday reader of financial statements as to what is or isn’t a financial instrument, this is a focus area of the regulators and easy to clean up, so it’s worth getting right.

A key feature to differentiate if an item is a financial instrument or non-financial instrument is to determine whether there is a contractual right or obligation to either receive or pay cash or other financial asset. A contract is an agreement between two or more parties that creates enforceable rights and obligations. According to paragraph 9 of IFRS 15 Revenue from Contracts with Customers (IFRS 15) a contract is approved by the parties involved and allows entities to identify each party’s rights and to identify the payment terms. Where services have been received, but the invoice not yet received, there is no contract as, amongst other things, the payment terms cannot be identified without it. Statutory payments are also not considered contractual.

There are so many requirements that need to be considered in preparing financial statements, this guidance can help take the guess work out of what is considered a financial instrument or not, and certainly save you some time in that the non-financial assets do not need to be considered for ECL.

N1: Financial instrument disclosures / notes referred to in the above include:

·        Financial assets and financial liabilities by category;

·        The maturity analysis in the liquidity risk note (not required an IFRS for SME Accounting Standard requirement); and

·        Expected credit losses (incurred impairment losses) etc.

N2: Items excluded from the scope of financial instrument disclosures should either be excluded from the note entirely or indicated as ‘non-financial’ assets and liabilities.

N3: Accrued income and expenses are financial instruments if they are accrued in terms of a contract (for example, rentals or interest on a loan agreement), if it is an accrual for services received, and no invoice has been received yet, it is not a financial instrument.

N4: Deposits paid and received are financial instruments if, in terms of the contract, they will be settled in cash, usually at the end of the contract. If, for example, the deposit will be settled in payment for goods or services or utilised in lieu of the last month’s rent in a lease situation, they are not financial instruments but rather take the form of prepayments or income received in advance.

N5: Lease liabilities and lease receivables are scoped into the IFRS 9 derecognition and impairment requirements and are included within the IFRS 7 disclosure requirements.

N6: Refund liabilities and right to return assets are specifically excluded from the scope of IFRS 9.

N7: Contract Assets should be tested for impairment in terms of IFRS 9. IFRS 7 disclosures would be limited to those applicable to credit risk.

N8: When investments in subsidiaries, associates and/or joint ventures are carried at cost, they are scoped out of IFRS 7. However, when an entity exercises an accounting policy choice to account for these investments in accordance with IFRS 9, these are included within the IFRS 7 disclosures.

N9: Investment entities accounting for their investments in subsidiaries, joint ventures and/or associates in consolidated financial statements would be scoped into the IFRS 7 disclosures for investments at fair value.

N10: Including embedded derivatives accounted for separately as required by IFRS 9.

N11: When other receivables are raised to include items for which no contract or invoice exists it is not a financial instrument.