Financial assets at FVTPL

As explained in our chapter “classification of financial assets”, it is a residual measurement category, which means that financial assets (debt instruments) which do not meet the classification requirements of financial assets at amortized cost and FVOCI are classified as fair value through profit or loss (FVTPL). All financial assets held for trading are classified under this category.

In addition, default classification of investment in equity instruments is fair value through profit or loss (FVTPL). However, an entity can irrevocably opt to classify any investment in equity instrument not held for trading purposes as financial asset at FVOCI.

Now, let’s study the accounting of financial assets classified as “financial assets at fair value through profit or loss (FVTPL)”.

Initial recognition

An entity will recognize a financial asset when it becomes party to a contract of the financial instrument. Initially, a financial asset at FVTPL is recognized at its fair value. Unlike financial assets at amortized cost and FVOCI, transaction costs incurred to acquire the financial asset are NOT added in the cost of the financial asset. Transaction costs are charged to the statement of profit or loss directly. Formula for initial recognition of a financial asset at FVTPL is as follows:

Initial recognition of FVTPL financial asset = Fair value

Subsequent measurement

Financial asset at fair value through profit or loss (FVTPL) is subsequently measured at fair value. Gains and losses on fair valuation are recorded in the statement of profit or loss. Any dividend income from the investment in equity instruments is also recorded in the statement of profit or loss.

For debt instruments, interest income is recorded using effective interest rate. However, as at the end of each reporting period, fair value will be changed, therefore, the amortization table of financial asset and effective interest rate is revised.

Let’s take a look at the following examples to clarify our concepts related to the accounting of financial assets at FVTPL.

Example – FVTPL investment in equity instrument

On 1 January 20X1, XYZ Company invested $300,000 in shares of a multinational company. Commission of $6,000 was paid to the broker. As the company has bought these shares for trading, it has classified this investment as fair value through profit or loss (FVTPL). The company received dividend of $5,000 and $7,000 in years 20×1 and 20×2. Information regarding fair values of the investment is as follows:

  • Fair value on 31 December 20×1: $302,000
  • Fair value on 31 December 20×2: $315,000

How will this financial asset be accounted for by XYZ Company in the financial statement for the years ended 31 December 20×1 and 20×2?

Answer

On 1 January 20×1, financial asset will be recognized at its fair value. Transaction costs of $6,000 are directly charged as expense in the statement of profit or loss.

Financial asset = $300,000

Following are the journal entries related to financial year 20×1:

Bank A/C – Dr. $5,000

Dividend income (recorded in profit or loss) – Cr. $5,000

Financial asset – Dr. $2,000

Revaluation gain (P&L) – Cr. $2,000

(Revaluation gain is calculated by comparing the fair value of investment at year end with its carrying amount i.e. $302,000 – $300,000)

Following are the journal entries related to financial year 20×2:

Bank A/C – Dr. $7,000

Dividend income (recorded in profit or loss) – Cr. $7,000

Financial asset – Dr. $13,000

Revaluation gain (P&L) – Cr. $13,000

(Revaluation gain is calculated by comparing the fair value of investment at year end with its carrying amount i.e. $315,000 – $302,000)

Example – FVTPL investment in debt instrument

On 1 January 20X1, XYZ Company invested $200,000 in debentures carrying interest rate of 6% per annum. Interest is receivable annually in arrears. Commission of $4,000 was paid to a dealer who arranged this investment. As per contractual terms, the debentures will be redeemed at a premium of $10,000 over their nominal value. Term of the debentures is four years and will be redeemed on 31 December 20×4.

Fair values of the financial asset are given below:

  • Fair value on 31 December 20×1: $212,000
  • Fair value on 31 December 20×2: $215,000

On 31 December 20×2, the company sold the debentures for $215,000.

How will this financial asset be accounted for by XYZ Company, if the company’s business model is neither “hold to collect” nor “hold to collect and sell”?

Answer

As the company’s business model is neither “hold to collect” nor “hold to collect and sell”, therefore, it cannot be classified as financial asset at amortized cost or FVOCI. The investment in debentures will be classified as financial asset at fair value through profit or loss (FVTPL).

On 1 January 20×1, financial asset will be recognized at its fair value. Transaction costs of $4,000 are directly charged as expense in the statement of profit or loss.

Financial asset = $200,000

Subsequent measurement of the financial asset is shown below.