Recognition Principle
A financial asset must be recognized in the statement of financial position when, and only when:
- The entity becomes party to the contractual provisions
- All material terms of the contract are effectively established.
Classification & Measurement.
- Short term financial Assets: - Amortised Cost
- Derivative Assets: - Fair Value through Profit & Loss (FVTPL)
- Investment in Equity share: -
- Fair Value through Profit & Loss (FVTPL) – Maximum case
- Fair value through Other Comprehensive Income (FVTOCI) :- Only if Investments are not held for trading and entity opt irrevocable choice.
- Others: -
Classification is based on below test: -
Business Model Test & Contractual Cash Flow Test
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- Objective of Holding FA is to obtain contractual cash flows(only) from FA on specified date (Hold to collect) – Amortised Cost (AC)
- Objective of Holding FA is to obtain contractual cash flows from FA AND selling it (Hold to collect & sell) – Fair value through Other Comprehensive Income (FVTOCI)
- Other – Fair Value through Profit & Loss (FVTPL
If FA is capable of generating contractual cash flow solely due to principal and interest on specified date than CCFT Test is pass.
Initial recognition of Financial Assets
| Financial Asset Type | Contractual Cash flow Test | Business Model Test | Classification | Measurement |
|---|---|---|---|---|
| Cash & Cash Equivalents | Not required | N/A | Amortized Cost | Face value |
| Equity Investments | Not required | N/A | FVTPL | Fair value |
| EI (Exception) | Not required | N/A | FVOCI | Fair value |
| Derivatives | Not required | N/A | FVTPL | fair Value |
| Others | Passed | Hold-to-Collect | Amortized Cost | FV + costs → Amortized cost |
| Passed | Hold-to-Collect-and-Sell | FVOCI | FV + costs → FV (OCI) | |
| Not passed | other | FVTPL | Fair Value |
Example: -
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Company buys a 5-year, $1 million corporate bond (coupon: 5% fixed)
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Transaction costs: $10,000 (legal/advisor fees)
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Business model: Hold-to-collect (amortized cost)
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Contractual Cash Flow test: Passes (fixed coupon = principal + interest)
Journal Entries
Date Account Debit ($) Credit ($)
Trade Date Debt Investments (AC) 1,010,000
Cash 1,010,000
Year 1 Interest Income (5% × 1M) 50,000
Debt Investments* 3,200 (Amortization of costs)
* 10,000 transaction costs amortized over 5 years using EIR
Key Rules for Transaction Costs
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Capitalized for AC/FVOCI: Added to carrying amount
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Example: 1Mbond+10K fees = $1.01M initial recognition
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Expensed for FVTPL: Immediately hit P&L
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Example: $10K fees recorded as "Transaction Expense"
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Amortization: For AC, costs are amortized using EIR
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