Question

The disclosure note of Big Products Ltd. showed the following (in millions):

 

Required:

1. Define financial instrument and financial asset.

2. With respect to cash, explain why the asset is classified as FVTPL. Under what circumstances would the fair value of cash change from the originally recognized value?

3. What is the definition of a cash equivalent?

4. With respect to accounts receivable, explain the difference between the accounting treatment of financial instruments classified as FVTPL and those classified as amortized cost. Why are some elements likely placed in one category versus the other?

Answer 1

Requirement 1

 

A financial instrument is any contract that gives rise to both a financial asset of one party and a financial liability or equity instrument for the other party. A financial asset is either cash or a contractual right to receive cash from another entity.

 

Requirement 2

 

Cash is always a FVTPL asset, so its classification is not controversial. The fair value of cash would change if its value were determinable with reference to an exchange rate. That is, its fair value would change if it were foreign currency whose Canadian dollar equivalency changed.

 

Requirement 3

 

Cash equivalents are limited to investments that are highly liquid and have little risk of price fluctuation - limited to an initial term of 90 days or less. 

 

Requirement 4

 

All financial instruments are initially recorded at fair value, which is the transaction value and establishes cost. FVTPL financial instruments are revalued at fair value at reporting dates, and changes in fair value are recorded as gains or losses in earnings. Assets carried at amortized cost are not revalued, except for amortization of appropriate amounts (discounts and premiums) and for allowances adjusted for expected credit losses. 

 

Accounts receivable are typically classified as amortized cost financial instruments. To be in this category, two conditions must be satisfied:

1. The objective must be to hold the item to collect (pay) contractual cash flows, and

2. Contractual cash flows must be solely for principal and interest. 

 

The element would be FVTPL if it was designated by management to be FVTPL. This might happen if the receivable was to be sold to a third party, or if it had to be classified to avoid an accounting mismatch, likely as part of a hedging strategy. The other option not asked for in this question is FVOCI (debt) if the business model test was not met.

 

Requirement 5

 

Notes receivable could be classified at FVOCI (debt) or amortized cost depending on their business. If the business model is to hold and eventually sell then FVOCI (debt) would be used.