Financial Instruments
Definition of financial instruments：A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.
According to IFRS, there are two different requirements of financial instruments:
IAS 39----The old requirements
- Financial assets (investments) held for trading at fair value with changes in profit and loss on the income statement
- Held-to-maturity investments at amortized cost to the income statement
- Available-for-sale investments at fair value with changes in other comprehensive income (OCI)
- Receivables and loans at amortized cost to the income statement
After 2008 financial crisis, IFRS Issued IFRS 9 to replace IAS 39. This replacement took effect in 2015.
IFRS 9----The New requirement：：
- Equity investments: Equity investments are investments in stocks of other companies:
· Equity investments are measured at fair value.
· Changes in fair value appear in other comprehensive income and are not recycled to profit and loss.
- Other financial assets: Measurement options for other financial assets such as loans and investments in bonds and other debt follow:
· Amortized cost: Amortized cost may be used only if the asset gives rise on specified dates to cash flows that are solely payments of principal and interest on the outstanding principal and the entity’s business model calls for holding the asset to collect the cash flows. If a loan or debt is meant to be sold, it does not fit the business model.
· Fair value: All other financial assets must be accounted for at fair value.
- Financial liabilities: Most financial liabilities are measured at fair value:
· If change in fair value is market-based, such as a change in market interest rate, the change in fair value is reported in profit and loss on the income statement.
· If the change in fair value is due to credit risk, as when the entity that owes the debt has its debt rating lowered or is in risk of default, the change in fair value is reported in other comprehensive income.
I will primarily talk about the GAAP side of financial instruments. Under GAAP, financial instruments include cash, foreign currency, contracts, derivatives and etc. The financial instruments codification provides very basic ,detailed and vital information for measurement. On specified election dates, entities may choose to measure eligible financial instruments at fair value, in which case, unrealized gains or losses are reported in earnings. On the other hand, financial instruments no eligible for fair value option include investments in subsidiaries, pension benefits or liabilities and financial instruments classified as equity, but under IFRS, the fair value option can only be elected for financial assets if doing so eliminates or significantly reduces a measurement that would arise from measuring assets or liabilities or recognizing the gains and losses on them on different bases. The same principle applies to the election of fair value option for financial liabilities. Another aspect is concerned with the market risk of all financial instruments. By definition, market risk is the possibility of loss from changes in market value. US GAAP tells all entities are encouraged , but not required to disclose quantitative information about the market risk, on the IRFS side, it requires disclosure of the nature and extent of risks arising from financial instruments, including disclosure of credit risk for each class of financial instruments, disclosure of liquidity risk, and disclosure of market risk. IFRS imposes market risk information requirement on disclosure standard.
Pensions
IFRS and US GAAP differ when calculating the discount rate used to to determine the required amount in current pension funds. This can have a big impact on how much money employers and employees contribute toward the pension fund. Since the IFRS and GAAP standards differ when calculating the discount rate, this means that the amount contributed to the pension fund can also vary quite a bit depending on which standard is used.
Under IFRS, the pension fund discount rate is should be determined by referencing the market yields on high quality corporate bonds. Additionally, in the IFRS system, When there isn’t a market of high-quality corporate bonds, companies are required to look to the yield on government bonds for selecting the discount rate.