Financial Instruments under ASPE Marcus Guenther, CA, MBA FocusROI Inc. 416 594 0005 ext. 2 [email protected]

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Disclaimer This presentation contains material with complex matters and may not apply to particular facts and circumstances. Therefore the presentation materials should not be relied upon as a substitute for professional judgment and specialized professional advice in connection with any particular matter.

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Session Agenda Modules: 1. Overview of Financial Instruments 2. Recognition and measurement

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Module 1 Overview of Financial Instruments

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M1 - Overview of Financial Instruments

Financial Assets & Liabilities  S. 3856 combines several existing Part V handbook sections and EICs  Reduced financial instrument disclosure requirements when compared to Part V s. 3855-3865. (i.e. full Part V for FI)  Increased disclosure requirements when compared to CICA Handbook – Accounting XFI 5

M1 - Overview of Financial Instruments

Scope of S.3856 1. Recognition, measurement of financial assets, liabilities and specified contracts to buy or sell non-financial items; 2. Classification of financial instruments:  From the perspective of the issuer, between liabilities and equity;  Related interest, dividends, losses and gains;

3. Offsetting; 4. Hedge accounting; and 5. Presentation and disclosure.

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M1 - Overview of Financial Instruments

Financial Instrument (FI)- Examples Common examples of financial instruments include: a) cash, demand or term deposits; b) commercial paper, bankers' acceptances, treasury notes and bills; c) accounts, notes and loans receivable and payable; d) bonds and similar debt instruments, both issued and held as investments; e) common and preferred shares and similar equity instruments, both issued and held as investments; and f) options, warrants, futures contracts, forward contracts, and swaps.

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M1 - Overview of Financial Instruments

FI – Scope of S. 3856 Note: Section includes equity investments and debt instruments investments, except for:  interests in subsidiaries, entities subject to significant influence, and joint ventures  investments held by an investment company that are accounted for at fair value in accordance with ACCOUNTING GUIDELINE AcG-18 i.e. Strategic or long-term investments – dealt with in other standards 8

M1 - Overview of Financial Instruments

Definitions  Amortized cost Is the amount at which a financial asset or financial liability is measured at initial recognition minus principal repayments, plus or minus the cumulative amortization of any difference between that initial amount and the maturity amount, and minus any reduction (directly or through the use of an allowance account) for impairment. 9

M1 - Overview of Financial Instruments

Definitions (cont’d)  Fair value Is the amount of the consideration that would be agreed upon in an arm's length transaction between knowledgeable, willing parties who are under no compulsion to act.

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M1 - Overview of Financial Instruments

Definitions (cont’d)  Financing fees Are amounts that compensate the lender for the risk of providing funds to the borrower. Financing fees, sometimes referred to as fees in lieu of interest, loan fees or financing costs, include: i.

Fees charged to originate, arrange or syndicate a loan or debt financing; ii. Commitment, standby and guarantee fees; and iii. Refinancing, restructuring and renegotiation fees. iv. Financing fees may be refundable or nonrefundable. Financing fees do not include transaction costs. 11

M1 - Overview of Financial Instruments

Definitions (cont’d)  Transaction costs Transaction costs are incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset or financial liability. i.

An incremental cost is one that would not have been incurred if the entity had not acquired, issued or disposed of the financial instrument. ii. Transaction costs include expenditures such as legal fees, reimbursement of the lender's administrative costs and appraisal costs associated with a loan. iii. Transaction costs do not include financing fees, 12 debt premiums or discounts.

M1 - Overview of Financial Instruments

Exercise: A multi-unit residential building owner has recently refinanced it’s long-term debt of $2M for another 5 year term and incurred the following fees:  CMCH fees  Bank financing fee  Break fee for previous mortgage which was terminated early to take advantage of favourable terms of new loan.

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M1 - Overview of Financial Instruments

Exercise (cont’d): Question: The client has capitalized all of the above fees as an asset on the b/s and is amortizing the “Financing fees” over the term of the new loan. Is this correct?

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M1 - Overview of Financial Instruments

Financial Instruments - Overview  Initial recognition of financial instruments at fair value  Subsequent measurement at either fair value or amortized cost  Financial instruments presented based on substance of transaction, not legal form  Guidance on derecognition considerations for assets and liabilities

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M1 - Overview of Financial Instruments

Financial Instruments Impairment - Overview  Single impairment model in ASPE  Impairment is discounted cash flow or selling price  Impairment reversals are recorded

Offsetting  Offsetting when legal right and intention 16

M1 - Overview of Financial Instruments

Derivatives  Derivatives in S.3856 are contracts  Usually have nominal value and minimal transaction fees.

 Freestanding derivatives are recognized and measured at fair value  Excludes non-financial derivatives

 Disclose notional and carrying amounts of all fair value measured derivatives  Other derivatives in hedging arrangements and linked derivatives require disclosures17

M1 - Overview of Financial Instruments

Definition Derivative: A derivative is a contract with all three characteristics: i.

It’s value changes in response to a change in a specified interest rate, financial instrument price, commodity price, etc. ii. Requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors. iii. It is settled at a future date.

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Module 2 Recognition and Measurement

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M2 - Recognition and Measurement

Initial recognition  All financial assets and liabilities issued or assumed in an arm's length transaction must be initially measured at fair value.  Where in the case of a financial asset or financial liability that will not be measured subsequently at fair value, adjusted by financing fees and transaction costs that are directly attributable to its origination, acquisition, issuance or assumption. Related party transactions are measured under HB section 3840

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M2 - Recognition and Measurement

Subsequent recognition  After initial recognition, at each reporting date, an entity will measure financial instruments at: i. investments in equity instruments at cost less any reduction for impairment; ii. all other financial assets at amortized cost; and iii. financial liabilities at amortized cost 21

M3 - Recognition and Measurement

Subsequent recognition (cont’d)  The following financial instruments may not be measured at cost subsequently: i. investments in equity instruments that are quoted in an active market; and ii. derivative contracts other than derivatives that are designated in a qualifying hedging; and iii. derivatives that are linked to, and must be settled by delivery of, equity instruments of another entity whose fair value cannot be readily determined. Changes in fair value shall be recognized in net income in the period incurred.

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M2 - Recognition and Measurement

Subsequent recognition (cont’d)  Entity may elect to measure any financial asset or financial liability at fair value by designating that fair value measurement shall apply: i. when the asset or liability is first recognized in accordance with this Section; or ii. for an investment in an equity instrument that was previously measured at fair value in accordance with paragraph, when the instrument ceases to be quoted in an active market. Any designation is irrevocable

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M2 - Recognition and Measurement

Portfolio Investments  Initially measured at fair value  Actively traded equities subsequently at fair value  Closing price  Can elect to measure any financial asset at fair value  Transaction costs and fees are expensed.

 All other investments (i.e. not quoted in active market) are subsequently measured at amortized cost  Transaction costs and finance fees netted against initial recognition at FV for assets or liabilities subsequently measured at amortized cost.  Premiums/discounts, transaction costs and fees are amortized over the life expected life of instrument. 24

M3 - Recognition and Measurement

Portfolio Investments - Disclosure  S. 3856 requires disclosure of CV each category of financial asset be disclosed :  financial assets measured at amortized cost;  investments in equity instruments measured at fair value; and  investments in equity instruments measured at cost less impairment.

 net gains and losses recognized on financial assets  total interest income  impairment loss or reversal to be presented on the face of the income statement or in the notes. 25

M2 - Recognition and Measurement

Portfolio Investments - Impairment  Assessment for impairment indicators done at each reporting period.  Where impairment, CV should be reduced to the highest of:  the present value of the expected cash flows discounted using a current market rate of interest appropriate to the asset;  the amount that could be realized by selling the asset; and  the amount the entity expects to realize on any collateral held, net of all costs necessary to exercise those rights.

 Impairment can be reversed if value recovers.

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M2 - Recognition and Measurement

Recognition and measurement Long-term Liabilities  A financial liability assumed in an arm’s length transaction be initially recognized at fair value and subsequently measured at amortized cost.  Transaction costs, would be an adjustment to the fair value when recognized.  Transaction costs do not include fees, debt premiums or discounts which are also adjustments upon initial recognition

 Non-arms length transactions are to be initially recognized and measured in accordance with Related Party Transactions s. 3840 27

M2 - Recognition and Measurement

Recognition and measurement Long-term Liabilities  Fair value of a financial liability with a non-market rate of interest is not equal to the cash consideration.  Measured as the present value of all future cash payments discounted using the prevailing market rates of interest for a similar instrument with a similar credit rating.  Any difference is recognized immediately in net income unless it qualifies for recognition as some other type of asset or liability.

 Fair value of a financial liability with a demand feature is not less than the amount payable on demand, discounted from the first date that the amount could be required to be paid. 28

M3 - Recognition and Measurement

Interest free loans  Initial measurement – examples:  Zero interest loan from government  Zero interest loan to employee

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M3 - Recognition and Measurement

Interest free loans: Examples  Zero interest loan from government:  The loan is discounted using market rates of interest  The difference is treated as government assistance and accounted for in accordance with that guidance

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M2 - Recognition and Measurement

Exercise 1: Example of zero interest loan from government – stipulated use to purchase equipment. Amount of loan: $100,000 Repayable at end of 3 years- non-interest bearing Market rate of interest is 4% Exercise: What are the journal entries initially required to record to loan and at the end of the first reporting period?

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M2 - Recognition and Measurement

Exercise 1: Initial recognition: DR Equipment CR Loan

$88,900* $88,900

*(100,000 x .899 – PV factor for three years, 4%)

Recording interest expense: DR Interest expense $3,600 CR Loan

$3,600

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M2 - Recognition and Measurement

Exercise 2: What would be the impact on the loan accounting in Exercise 1 if the interest free loan had been given to an employee?

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M3 - Recognition and Measurement

Exercise 2  Zero interest loan given to employee:  The loan is discounted using market rates of interest.  Assuming 4% was a market rate, the entry to record the loan would be the same.  The difference is treated as employee compensation instead of interest expense. 34

M3 - Recognition and Measurement

Long-term debt – cont’d  A debt with no stated repayment terms is deemed to be payable on demand.  If repayment is subordinated to the interest of another party, the earliest date at which payment could be demanded is the day following the maturity of the instrument to which it is subordinated.

 Amortized cost considers a premium or discount on the face amount of a financial instrument as a prepaid adjustment of interest and the amount should be amortized over the expected life of the instrument through net income as interest income or expense. 35

M3 - Recognition and Measurement

Financing fees  Borrowing fee in lieu of interest should be recognized as prepaid interest and amortized over the expected life of the financial instrument or the period to which the fee relates, if shorter.  Note: Effective interest method is not required but is an alternative amortization approach

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M3 - Recognition and Measurement

Fair value election – Long-term debt  Can elect to subsequently measure a financial liability at fair value  Election made at initial recognition.  Election is irrevocable.

 Fees and transaction costs would not be netted against the fair value.

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M2 - Recognition and Measurement

Derecognition Long-term Liabilities s.3856  Appendix to S. 3856 provides substantial detail concerning derecognition.  Guidance similar to EIC-88 (XFI)  Similar to EIC – 88 in XFI

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M2 - Recognition and Measurement

Derecognition Long-term Liabilities s.3856  Guidance concerning derecognition of liabilities substantially carries forward from CICA Handbook – Accounting  Long-term debt should only be derecognized) when the obligation is discharged, cancelled or expires.  If debt instrument is replaced with another having substantially different terms, the original financial liability is extinguishment and a new financial liability is recognized.  Similar same accounting is applied when the terms of the original debt are substantially modified.

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Questions

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