FRS 102 Financial Instruments

Whether an instrument is classified as 'basic' or 'other' drives the accounting outcome. Many common instruments will fall within Section 11, but that should not be assumed without reviewing the contractual terms. The classification depends on the substance of the arrangement, not simply the label applied to it. 

This becomes particularly important for loans and receivables with unusual features. An interest-free loan may still be basic in some circumstances, but where payment terms extend beyond normal business terms or the arrangement is financed at a non-market rate, the transaction may constitute a financing transaction. In those cases, initial measurement is not simply the amount advanced or invoiced. Instead, the instrument is measured at the present value of future payments discounted at a market rate for a similar instrument. 

That is often where the practical accounting becomes more challenging. Interest-free or below-market loans between group entities, entities under common control, or between a company and its directors, may contain both a loan element and a capital contribution or distribution element. Similarly, sales made on extended credit terms may include both a revenue component and a financing component. The accounting, therefore, requires more than mechanical recognition of the cash amount. It requires an assessment of the commercial substance of the arrangement. 

Impairment of financial assets remains a key area of judgement. Financial assets measured at cost or amortised cost must be assessed for objective evidence of impairment at each reporting date. This is an incurred loss model, impairment losses must arise from past events and observable evidence, not from general expectations about future losses. For entities with material receivables, contract assets or intercompany balances, that distinction remains important. 

There are also targeted amendments relating to dividend income. Dividend income from non-derivative equity instruments is recognised in profit or loss only when the right to receive payment is established, the economic benefits are probable, and the amount can be measured reliably. This is a useful clarification for entities with investment holdings or group structures involving dividend flows. 

Derecognition is another area that is easy to underestimate. A financial asset is derecognised when contractual rights to cash flows expire or when the asset is transferred and the risks and rewards of ownership have been substantially transferred. Financial liabilities are derecognised only when extinguished. In practice, this matters when liabilities are refinanced or modified, and when receivables are factored or otherwise transferred. Entities need to assess whether a transaction is genuinely a derecognition event or whether the original instrument remains on balance sheet.