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In a similar way that we have a package of financial standards pertaining to consolidations (so far we have addressed IAS 27 and IAS 28) we also have a package of standards pertaining to financial instruments. Certainly, up until the emergence of revenue, IFRS 15 and leases, IFRS 16, it could be argued that financial instruments, along with accounting for hedge transactions, were the most complicated and hard to understand standards. Again you should note that in all these articles we are targeting the key points in order to gain an awareness of the accounting issues. But, by the same token, the standards themselves must in all instances be read thoroughly and its application and implementation within each entity must be documented in great detail. It is actually a simple premise, being aware of the standards begs the question, do they apply to my organization. No standard can answer that question.

Financial Instruments and Standards

So what is so critical about financial instruments? The standard itself identifies the scope of what the IASB considers to be a financial instrument that also embraces hedging transactions to be discussed.

As you read below the extract (courtesy of www.Next-Finance.net ) from what happened to Barings, one of the most prestigious banks in the United Kingdom, now bankrupt following losses caused by Nick Leeson, one of its traders, you will realize how critical compliance with these financial standards are pertaining to financial instruments. We have repeated many, many, times the necessity that all financial statements must adhere to the framework, faithful representation and transparency, comparability and substance over form. Additionally, internal controls, SOX 404, over financial reporting (ICFR) along with COSO (2013-17) requires mandatory compliance.

Relative to what happened, and the size and structure of Barings, a major bank, it was so hard to believe that so many lapses could have occurred.

January 16th, 1995

Barely aged 25, Nick Leeson had a professional situation that he had never dreamed of, even though he had entered into a professional life about ten years too early. However, he soon lost money in his operations and hid the losses in an error account, 88888. He claimed that the account had been opened in order to correct an error made by an inexperienced member of the team.

At the same time, Leeson hid documents from statutory auditors of the bank, making the internal control of Barings seem completely inefficient. At the end of 1994, his total losses amounted to more than 208 million pounds, almost half of the capital of Barings.

On January 16th, 1995, with the aim of “recovering” his losses, Leeson placed a short straddle on Singapore Stock Exchange and on Nikkei Stock Exchange, betting that Nikkei would drop below 19 000 points. But the next day, the unexpected earthquake of Kobé shattered his strategy. Nikkei lost 7 % in the week while the Japanese economy seemed on the verge of recovery after 30 weeks of recession.

Nick Leeson took a 7 billion dollar value futures position in Japanese equities and interest rates, linked to the variation of Nikkei. He was “long” on Nikkei. In the three days following the earthquake of Kobé, Leeson bought more than 20 000 futures, each worth 180 000 dollars.

He tried to recoup his losses by taking even more risky positions, betting that the Nikkei Stock Exchange would make a rapid recovery; he believed he could move the market but he lost his bet, worsening his losses. They attained an abysmal low, (1,4 billion dollars), more than double the bankʼs capital who is now bankrupt because its own capital would be insufficient to absorb the losses generated by Leeson.

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.

 IAS 32 par.11

IFRS Workbook:

The standards require companies to disclose their exposure to financial instruments and to account for their impacts in most cases as they happen, rather than allowing problems to be hidden (Nick Leeson hid the losses in an error account, 88888).

When an issuer determines whether a financial instrument is a financial liability or an equity instrument, the instrument is an equity instrument only if both conditions (1) and (2) are met.

(1)     The instrument includes no contractual obligation:

  • to deliver cash, or another financial asset, to another undertaking; or
  • to exchange financial assets, or financial liabilities, with another undertaking under conditions that are potentially unfavourable (will make a loss) to the issuer.

(2)     If the instrument will, or may, be settled in the issuer’s own equity instruments, it is:

  • a non-derivative that includes no contractual obligation for the issuer to deliver a variable number of its own equity instruments;


  • a derivative that will be settled by the issuer exchanging a fixed amount of cash, or another financial asset, for a fixed number of its own equity instruments. (‘FIXED for FIXED’) For this purpose, the issuer’s own equity instruments do not include instruments that are themselves contracts for the future receipt, or delivery, of the issuer’s own equity instruments.

In addition, when an issuer has an obligation to purchase its own shares for cash, or another financial asset, there is a liability for the amount that the issuer is obliged to pay.

Photo: Breakingpic


4 (This Standard (IAS 32) shall be applied by all entities to all types of financial instruments except:

  • those interests in subsidiaries, associates or joint ventures that are accounted for in accordance with IFRS 10 Consolidated Financial Statements, IAS 27 Separate Financial 1 Statements or IAS 28 Investments in Associates and Joint Ventures. However, in some cases, IFRS 10, IAS 27 or IAS 28 require or permit an entity to account for an interest in a subsidiary, associate or joint venture using IFRS 9; in those cases, entities shall apply the requirements of this Standard. Entities shall also apply this Standard to all derivatives linked to interests in subsidiaries, associates or joint ventures.“

Lucubrate Magazine, Issue 50, December 21st, 2018

The photo on top: asia one

  • Accounting Series – Article No: 30
  • Accounting Theory – Advanced Part 20 (IAS 30)
  • by Peter Welch

Categories: Accounting, Magazine

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Peter Welch
Peter Welch

GlobalCfo.LLC is an expert at developing entrepreneurs and building 3-5 year business plans and cash flow projections as a prerequisite for accessing financing sources. GlobalCfo.LLC targets accounting standards compliance and theory, sound infrastructure /process mapping and COSO 2013-17/solid internal controls, ERM, and last but not least documentation /Policy and Procedures and other manuals. Additionally, interim CFO services (or Rent-a-CFO by the hour/day) are offered locally or remotely as well as training at all levels and all functions, not just accounting; e.g., management and leadership skills. Pre/Post-M&A is also offered.

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