Financial liabilities at FVTPL

Financial liabilities classified as “financial liabilities at fair value through profit or loss (FVTPL)” are initially recognized at their fair values. Any transaction costs associated with the financial liabilities are directly charged to the statement of profit or loss.

What are transaction costs? Transaction costs are incremental costs incurred to acquire or issue a financial instrument. The word incremental means that such costs would not have been incurred if the financial instrument were not acquired or issued. Some examples of transaction costs are given below:

  • instrument issuance or registration fee
  • commission of brokers and dealers
  • taxes and levies on sale/purchase of financial instruments etc.

Let’s see how FVTPL financial liabilities are measured subsequently.

Subsequent measurement

Financial liabilities at fair value through profit or loss (FVTPL) are subsequently measured at fair value. Gains and losses on fair valuation are recorded in the statement of profit or loss.

However, there is an exception to this rule. Changes in fair values that are due to an entity’s own credit risk changes are taken to the statement of comprehensive income.

Why is it so? Why are the changes in fair value related to credit risk changes are presented in the statement of comprehensive income? If an entity’s credit risk status deteriorates, the interest rate will increase in the market. When the future cash flows will be discounted at this increased interest rate to determine the fair value, it will result in reduced liability and a fair valuation gain. As the statement of profit or loss is a measure of an entity’s financial performance, it will be misleading to present gains in the statement of profit or loss which are due to an entity’s poor financial condition.

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

Example – Financial liability at FVTPL

On 1 January 20×1, ABC Company issued a 5% bond of $100,000 face value. Interest is payable annually in arrears. The bond is repayable at par after 5 years. The company’s intention is to trade this liability and has classified it as financial liability at FVTPL. Transaction costs of $2,000 were incurred to issue the bond. On 31 December 20×1, fair value of the bond was $87,000. The company has determined that $3,000 drop in fair value is purely due to deterioration of the company’s credit risk status. How should this financial liability be accounted for if the financial liability is transferred to another entity on 1 January 20×2 in exchange of $87,000?

Answer

Following journal entries will be made to record the above-mentioned transactions.